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How Citi gave away $900 mn by mistake

Whether Citibank manages to win or lose its eventual appeal, the accidental payment is sure to prompt a review of internal controls in the industry and could have a lasting impact on the more than $1 trillion syndicated loan market. (Photo: Bloomberg)Premium
Whether Citibank manages to win or lose its eventual appeal, the accidental payment is sure to prompt a review of internal controls in the industry and could have a lasting impact on the more than $1 trillion syndicated loan market. (Photo: Bloomberg)

  • Would you claim ‘finders keepers’ on a mistaken transfer by Citibank? These asset managers did and won in court.
  • The decision is the latest blow to Citigroup, which is updating its underlying controls and technology after regulators slapped it with a $400 million fine for deficiencies last year.

NEW YORK : In a court battle that is likely to send ripples across the global banking system, Citigroup Inc. unexpectedly lost a legal battle to recover half a billion dollars that it sent to Revlon Inc.’s lenders “by mistake".

A 30-year-old legal precedent that essentially says “finders keepers" in certain financial transactions will now make it hard for Citigroup to get the transaction overturned.

The bank has said it will appeal the court ruling—issued this week by a federal judge in New York—that rejected its attempt to recover $504 million it accidentally sent to asset managers for Revlon lenders last summer.

Citigroup had made the transfer to fulfil its role as Revlon’s “loan agent". However, instead of the interest amount that was due, the whole loan amount got transferred as a result of a back-office blunder. The recipients of this largesse include Brigade Capital Management, HPS Investment Partners and Symphony Asset Management.

The judge, Jesse Furman of the southern district of New York, said the recipients shouldn’t have been expected to know that the transfer, which totalled more than $900 million before some lenders returned their share, was an error.

“To believe that Citibank, one of the most sophisticated financial institutions in the world, had made a mistake that had never happened before, to the tune of nearly $1 billion would have been borderline irrational," wrote Furman, who presides in Manhattan.

The outcome is fascinating as an instance of strict judicial rule-following. As Furman framed his opinion, the legal rule was clear: under New York law, a creditor can keep a mistaken payment as long as he has “no knowledge" that it was sent in error.

The decision is the latest blow to Citigroup, which is in the midst of a years-long effort to update its underlying controls and technology after regulators slapped it with a $400-million fine for deficiencies in both areas last year. The New York-based company is also undergoing a leadership change, with incoming chief executive officer Jane Fraser set to take the reins on 1 March.

For the lucky recipients of the multi-million-dollar transfer, the decision is a boon. The asset managers have been locked in a battle with billionaire investor Ronald Perelman’s struggling cosmetics company Revlon over its May 2020 restructuring. They argued that the 11 August 2020 payment—one of the biggest banking errors in recent memory—settled Revlon’s debt to them under a 2016 term loan and didn’t look like a mistake when it arrived. So, it was theirs to keep. They can keep the money, pending an appeal, but can’t spend it, the judge said.

It won’t be easy to appeal the court decision, said Columbia Law School professor Eric Talley, an expert in corporate law and finance. “Citi has a reasonable chance on appeal, but this outcome will create some stiff headwinds," Talley said.

Citigroup’s shares pared gains on the verdict and finished Tuesday up less than 1%. The stock has gained 4% this year.

Not the fairest result

In his 101-page ruling, Furman said the outcome of the case was surprisingly straightforward, even if it may not seem like the fairest result.

“The transfers matched to the penny the amount of principal and interest outstanding on the loan," Furman wrote. “The accompanying notices referred to interest being ‘due’, and the only way in which that would have been accurate was if Revlon was making a principal prepayment."

The key precedent is a curious 1991 New York state court case called Banque Worms v. BankAmerica International. In that case, New York’s highest court ruled that under a principle called discharge for value, when a third party mistakenly sends money from a debtor to a creditor, the creditor can keep the payment if it didn’t realize it was sent in error and didn’t make any misrepresentations.

Instead of making an interest payment as administrative agent on the Revlon loan, Citibank paid the full outstanding $900 million, and out of its own pocket. Some of the recipients returned the money, but about $504 million got stuck.

Applying the testimony in the Citibank case to the law spelt out in the Banque Worms decision, Furman said the central issue at hand was whether, at about 6pm on 11 August 2020—at the moment of the mistaken transfer—the lenders were all “on constructive notice of Citibank’s mistake". Ticking through the evidence, he found they weren’t.

That’s a challenge for Citibank, Columbia professor Talley said. It can argue that Furman simply interpreted the facts incorrectly when he found that the lenders had no reason to believe the payment was in error, he said. But “because appellate courts are a step removed from the trial, they tend to be much more deferential to trial court judges’ interpretation of the facts", Talley said.

The bank may have more luck arguing that Furman got the law wrong when he found that the lenders could have reasonably expected that Citibank was paying off the loan since they received the exact amount they were owed—despite the fact that the full debt wasn’t due yet.

“To take the most likely example, Citi might argue that the discharge-for-value defence doesn’t apply unless the debt is due and payable, which it wasn’t here," Talley said. “And thus, the trial court judge just got it wrong on the ingredients of the claim. This type of claim is probably their best chance on appeal, because it involves very little deference by the appellate court."

Inconceivable error

Citigroup on Tuesday said Furman got it wrong.

“We strongly disagree with this decision and intend to appeal," Danielle Romero-Apsilos, a spokeswoman for the bank, said in a statement after the ruling. “We believe we are entitled to the funds and will continue to pursue a complete recovery of them." The bank had no additional comment.

Furman said representatives of each lender “credibly and persuasively testified that they reasonably believed the payments were intentional prepayments" of the 2016 loan. The judge rejected Citibank’s claim that the size of the transfer alone should have alerted the lenders to the blunder.

Given that banks have security procedures to ensure that such mistakes don’t occur, “it would have been virtually inconceivable to a reasonable investor in (the lenders’) position that Citibank had wired nearly $900 million by mistake", Furman said.

“Citigroup has an uphill battle succeeding on an appeal," said Braden Perry, a partner at Kennyhertz Perry and an expert on legal and regulatory matters. The judge found that the bank’s “six eyes" system, in which three people must approve a transaction, “broke down after a contractor checked the wrong box on a digital payment form", he noted.

Under the six-eyes protocol, an employee designated as a “maker" manually puts payment information into the bank’s Flexcube loan processing program. In most cases, Citigroup relies on the outside technology firm Wipro Ltd for this step. The second step also typically involves a Wipro employee, who serves as a “checker" on the maker’s work.

The last step features a team of Citigroup employees who serve as the “approver" and the final check on the payment. For the $900-million mistaken Revlon transfer, Vinny Fratta was the approver.

Fratta, a senior manager in Citigroup’s global loan operations group, joined the bank in 2006.

After a series of promotions, he was named to manage the asset-based transitional finance group in 2012, overseeing a team of six Delaware-based Citi employees and nine Wipro employees in India who work exclusively with the bank.

In a declaration filed in court, Fratta said the bank can process hundreds of wire transactions a day using the Flexcube system. It has a default mode that will send a wire payment unless the maker in the six-eyes system overrides that option. While that box was checked for some portion of the Revlon payments, it wasn’t checked for all of them.

At first, Fratta figured the error was due to a technical failure.

But “as the day wore on", he said during court proceedings, “I accepted that the mistake had not been caused by any sort of glitch but rather by human error, and that I was one of the humans responsible for the error."

Fratta, the “approver" of the transfer, said in a declaration that he was “shocked" to discover the error. “My first reaction was reflected in a 9.51am chat to Mr Raj," he said, referring to a contractor in India who’d been the “checker" on the payments.

“‘Oh my,’" Fratta said he told Raj, asking, “Did we have proof that the wires went to the specific lender identified in his email? Did it go to all lenders? How much was the overpayment?"

Fratta said his intention had been to transfer to Revlon lenders interest payments of about $8 million.

A transformational case

The judge brushed aside some of Citigroup’s other arguments, including its claims that allowing the transfer to proceed was simply unfair and that the New York state rule is bad law. Those arguments are “squarely foreclosed" by the decision in Banque Worms, Furman said.

“The problem for Citibank is that the court does not write on a blank slate," he wrote.

That doesn’t mean the law is unchanging. While the federal appeals court in Manhattan, which would hear the bank’s appeal, doesn’t have the power to change state law, New York’s top court can revisit its own decision. It might do just that if it finds, as Talley does, that Tuesday’s ruling “was probably not a good development for the most sensible evolution of the law".

Certainly, the bank seemed to score its share of points at the trial in December 2020, where Citibank argued that the transfers were a clear error and that the firms had no right to them.

Under questioning by a lawyer for the bank, a senior loan operations associate at Symphony testified that its standard practice is to look into fund transfers made without notice and to return the money if it was sent in error. He said he had seen money sent by mistake to his firm or to counterparties before.

“We would review the wire, confirm it was a mistake" and, if “money was not owed, we would send it back", he testified. Asked whether mistaken interest payments were common, he said they were.

Whether Citibank manages to win or lose its eventual appeal, the accidental payment is sure to prompt a review of internal controls in the industry and could have a lasting impact on the more than $1 trillion syndicated loan market.

“It could be a leading and transformational case on the responsibilities of agents and the potential liability of those agents for errors in the loan process," said Kennyhertz Perry partner Braden Perry. He said this case “will test whether poor internal controls and these types of egregious errors will be rectified by a court of law".

Citibank’s controls on the payment—part of a creaky system that was on its way out when the error occurred—were perhaps especially weak. But during the trial, Furman reached outside his courtroom to issue a broader warning.

“The industry should figure out a way of dealing with these things even if this was a black swan event," he said during the proceedings which were held via videoconference. “Whatever my ruling is in this case, I hope the world, the market, takes notice of what’s happened here and the uncertainties that have resulted."

Although it’s too early to tell exactly what changes might be in store, the case is a cause celebre and a signal to bankers to make sure their own house is in order.

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