December 19,2009

Following Abu Dhabi's Suit Against Citi, Will CIC Also Sue?

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The arbitration application by Abu Dhabi Investment Authority over a disastrous investment in Citigroup has many wondering whether China Investment Corporation (CIC) will initiate a similar action.



In November 2007, Abu Dhabi Investment Authority invested $7.5 billion in convertible Citi bonds, to be converted into common shares at $31.83 to $37.24 per share between March, 2010, and September, 2011. The bond interest rate prior to conversion is 11%. Citigroup's stock price is now hovering around $3.50 per share, down to about 10% of the agreed conversion price.

 

In December, 2007, CIC similarly invested $5 billion in Morgan Stanley mandatory convertible bonds, the conversion to be finished in July, 2010, with an interval period of two years and seven months and a price ranging between $48.07 and 57.68 per share. Morgan Stanley's current share price is about $30, only 60% of the agreed transfer price. The bonds' interest rate is 9%.

Abu Dhabi's investment is the scarier story. The highest share prices in recent years for Citigroup and Morgan Stanley both occurred in June 2007 or so, after which Citigroup fell from $55 to a bottom $1 on March 5 this year, rebounding to $3.5 now. Morgan Stanley also plummeted from about $73 in June, 2007, to $10.25 in November, 2008, climbing since to its present $30.

The core of Abu Dhabi's arbitration application is a claim of Citi's "fraudulent misrepresentation." Abu Dhabi is asking for the annulment of the investment agreement, or damages of more than $4 billion. Citi says the accusation is baseless and intends to conduct a defense.


Abu Dhabi's ultimate goal is not to recover its investment but to revise its provisions, such as renegotiation of its final price. Rochdale Securities analyst Dick Bove says that Citi may hope to reduce the price down to around $10 per share to resolve the problem satisfactorily.

But any success Abu Dhabi has in reduce their investment loss may create a dangerous precedent in international financial markets. Will CIC follow up and file for arbitration?

Perhaps, but perhaps
not. CIC's current public statements lay its misfortune in investments in Morgan Stanley and Blackstone to inexperience, not to mention such unexpected factors as the global financial squeeze, and not generally to "fraudulent misrepresentation." In May 2007, CIC invested $3 billion in Blackstone shares, which promptly fell by around 50%.

In April last year, the US law firm Coughlin Stoia Geller Rudman & Robbins LLP launched a joint lawsuit in behalf of investors in Blackstone's common shares in the New York Southern District Court, accusing Blackstone Group and some of its high management and directors of violating the Securities and Exchange Ordinance, specifically two acts of concealment in its IPO documents in violation of US federal securities laws. The allegation claims that before Blackstone's IPO, it had already known that the focus of bond insurers had shifted from conservative municipal bonds to collateralized debt obligations (CDO) backed by subprime mortgages, and that their investment in bond insurers had suffered great losses. In addition, Blackstone is said to have been well aware that its investment in Freescale Semiconductor was also in trouble, and market value of some enterprises invested in by Blackstone was declining, leading to impairment of its equity investment. In the registration statement for the listing of bonds, however, Blackstone did not accurately show these problems.

The lawsuit against
Blackstone was not joined by CIC, and the court did not support the investors. In its decision released in September, the judge stated that "the information provided by the plaintiff is insufficient, and there is bias." The judge also listed another important reason: "the plaintiff could have requested their money back, but they failed to do so, so the loss was caused by themselves."

Such was not the same case for CIC, as its investment is locked in for four years. If CIC had followed up the lawsuit against Blackstone, the result might have been different.


CIC seems however, to have accepted its loss. In its official statement it says it will wait and see after the lock-up period (up to May 2011), judging that it is perhaps better not to barge into a deadlock during strategic cooperation.


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