[Flashback] Citibank subsidiary accused of $73 million derivatives fraud by Korea’s Simmtech


Posted by Padma LAU Heng Ee, Year 4 undergrad at the School of Business, Singapore Management University

Citibank subsidiary accused of $73 million derivatives fraud

A Korean subsidiary of Citibank allegedly induced a Korean company into a series of derivative contracts holding “enormous risk” that cost the company $73 million, a lawsuit filed in New York state court says.

21 AUG 2013Peter Hamner

Simmtech Co., a worldwide seller of circuit boards for semiconductors, filed suit in the New York County Supreme Court, saying Citibank Korea Inc. fraudulently sold it derivative contracts allegedly designed to hurt Simmtech and benefit Citibank.The complaint says the derivatives, including knock-in and knock-out options, dual currency deposits, and currency coupon swaps, were supposed to help the company hedge against the risk of changes in the exchange rate between the U.S. dollar and Korean won.

An option contract gives the owner of the contract the right to buy or sell a fixed number of securities at a set date for a set price, while a knock-in option is a contract that becomes an option contract when a set market price is met.  A knock-out option sets a ceiling for an option contract holder’s profit margin.

Simmtech says it entered into a combination of these contracts between 2006 and 2008 at the direction of Citibank Korea.  When the contracts expired between 2008 and 2010, the company lost $73 million, the suit says.

The Citibank subsidiary, working with Citibank NA, engaged in a plan to take advantage of Simmtech’s “lack of financial expertise and lack of familiarity with the English language and American law,” the complaint says.

(Click here to read the complaint on Westlaw.)

Simmtech says Citibank also made bets against the derivatives so that if the client lost, Citibank gained.  This presented a conflict of interest, and breached the defendants’ fiduciary duty to Simmtech and other clients, the lawsuit says.

Citibank marketed the derivatives to Simmtech and other clients as a “safe bet” premised on materials provided to clients indicating a small risk on the part of the investor.

In reality, the suit says, the derivatives “were highly complex, exotic, risky foreign exchange vehicles that exposed Simmtech to virtually unlimited liability.”

The complex derivatives were designed to benefit Simmtech in their first year but “disguised” the fact that the company faced large risks in the second and third years of the contracts, the suit says.

Moreover, the complaint says, when a supplier like Simmtech wants to hedge against exchange rate changes, it should be advised to enter into derivative contracts with a less risky three-month horizon as opposed to a three-year horizon, the suit claims.

The complaint says the three-year length of the contracts exposed Simmtech to larger changes and unpredictability in the dollar-won exchange rate and, as a result, larger losses.

“Rather than being hedges, i.e., instruments that avoided risk, they were instruments that caused Simmtech to assume risk — enormous risk,” the plaintiff says.

In addition, while the products were marketed to clients as “zero-cost,” they actually contained hidden fees, the suit says.

The complaint alleges fraud, conspiracy to commit fraud, aiding and abetting fraud, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, conspiracy to breach fiduciary duty, and violations of Korean securities and commercial law.

Simmtech Co. Ltd. v. Citibank NA et al., No. 652560/2013, complaint filed (N.Y. Sup. Ct., N.Y. County July 22, 2013).


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