Citi trial puts banks on notice to make sure they’re not next

Win or lose, Citibank’s battle to recover half a billion dollars from an 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.

In a six-day trial that wrapped up last week, Citigroup main banking unit laid out its case that 10 asset managers for Revlon lenders knew, or should have known, that the outsize August wire transfers were a whopping mistake. Instead of making a periodic interest payment as administrative agent on the loan, Citibank paid the full outstanding $900 million from its own pocket.

While some recipients returned the funds from one of the biggest banking errors in recent memory, Citibank had to sue for the remaining $500 million or so. A decision in the case, which has been closely monitored on Wall Street, is expected soon.

A loss for Citibank would increase the risks to administrative agents for syndicated loans, in which a group lends money to a borrower. But even if Citibank wins, banks may still tighten their controls to avoid a debacle like the Aug. 11 transfers, or even shun the agent’s role altogether — one that isn’t especially lucrative but helps them forge deeper relationships with borrowers and lenders.

‘Transformational case’

“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 Braden Perry, a partner at Kennyhertz Perry and an expert on legal and regulatory matters. He said the case “will also test whether poor internal controls and these types of egregious errors will be rectified by a court of law.”

Citigroup, based in New York, and lawyers for Quinn Emanuel Urquhart & Sullivan LLP, which is representing the defendants, declined to comment on the case.

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 in concluding the trial on Wednesday, U.S.

District Judge Jesse 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 by 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.

‘Trust and transparency’

In the wake of Citibank’s blunder, banks are likely reviewing their own systems for moving money and making sure they have enough approvers for payments of various sizes, said Renee Kuhl, executive director of the loan agency group at SRS Acquiom. For riskier borrowers, they may even require receipt of the funds before sending them out to lenders.

The case is a vivid reminder that “you need to make sure you have the operational piece in order and that you know what it’s doing,” Kuhl said. In terms of reputation, she said, “if Citi was a smaller third-party agent, it could mean devastation.”

A victory for the lenders would “undermine the smooth functioning of syndicated lending,” according to the Loan Syndications and Trading Association, whose more than 500 members include Citibank as well as most of the creditors involved in the case. The group has said that allowing the Revlon creditors to keep the mistaken fund transfers would destabilize a “market dependent on trust and transparency.”

Administrative agents collect and distribute interest payments and provide other housekeeping services on a loan, such as sending notices of payment to debt holders. Perry, the legal and regulatory expert, said the dispute could prompt banks acting as agents to shoulder the sort of “heightened” duties reflected in “the risk management and operational challenges that Citi appears to be prodded on by regulators.”

‘Tons of funds’

Elliott Stein, a senior litigation analyst for Bloomberg Intelligence, said it’s “actually a pretty close case, because of precedent favoring finality in transactions, which helps the defendant lenders.” Still, he said, “there’s enough wiggle room for the judge to distinguish this case on its facts and deliver a verdict for Citi.”

That outcome might not settle the issue for banks watching the case like a wipeout on the highway. However singular, it may have been harrowing enough to put some off of administrative agency altogether. While she sees no signs of big banks swearing off the role yet, Kuhl said some might use the case as a reason to do less of the work.

“It’s possible some of the larger institutional banks that don’t want to take on that risk or have the appetite for it may just start declining deals,” she said.

At SRS Acquiom itself, the legal battle spurred a review of the firm’s internal controls on money movement, signoff on payments, wire transfer protocols and the like, ensuring that “one person can’t just send out tons of funds and making sure there’s multiple levels of approvals,” Kuhl said.

Even that wasn’t enough to ward off trouble at Citibank, which already had a process known as “six eyes,” under which three people are involved in the review and execution of wire transfers that originate in the asset-based transitional finance group.

Final payment

The case featured an effective prepayment, or early full payment, of a debt — the unintended result of Citibank’s ill-fated wire transfer.
“Banks might think, well, maybe we should revisit the conditions under which we make final payment on a bond to make sure that this hasn’t been the artifact of a clinical keying error,” said Eric Talley, a professor of corporate law at Columbia Law School.

Philip Brendel, a senior credit analyst for distressed debt at Bloomberg Intelligence, thinks the Revlon lenders will probably prevail.

“The fact that it was an exact prepayment amount, to the penny, and you had all the witnesses saying they thought it was a prepayment” weighs against Citibank, he said, adding that the lenders were “surprised” by the wire transfer but didn’t necessarily suspect it was a mistake.

The case is Citibank NA v. Brigade Capital Management, 20-cv-6539, U.S. District Court, Southern District of New York (Manhattan).

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