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Citi Trader, Who Made $100 Million Last Year, Insists on Keeping His Deal in Place

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On the surface, the particulars of this case seem simple. A Citigroup commodities trader who says he has a contract that could yield him a $100 million payment this year is crossing swords with the new Treasury pay czar, Kenneth Feinberg.

The Wall Street Journal story portrays the pay deal for the trader, Andrew Hall, as a problem for Citi, The bank, maybe. The bank’s top brass, quite the reverse. This is like throwing Bre’er Rabbit in the briar patch. The rich contract established a high pay ceiling. If you know anything about the cognitive bias, anchoring, this is very powerful (if you don’t know the literature, be sure to read on the studies used to test for it. It’s very insidious). Win or lose, that number is now a legitimate. Second, independent of anchoring, Citi is not likely to fight Hall unless pushed by Treasury. A big payout for him provides an umbrella for everyone else.

Before the “sanctity of contracts” crowd tunes up, why don’t you folks wrap your minds around a few other legal obligations of a public company, such as the duty of care that its officers have? Deals like Hall’s are close to a firm within a firm, always a bad idea. Arrangements like that led directly or through knock-on effects to the end of Drexel, the mess at AIG, and the Treasury bond scandal at Salomon. For instance:

Mr. Hall is contractually obligated to receive pay based on Phibro’s profits, and some observers on Wall Street believe Citigroup has a better chance at repaying the U.S. money with its Phibro unit humming.

Critics, however, argue that pay agreements like these need to be redrawn in light of Citigroup’s taxpayer-funded bailout. Soon the U.S. government will be a 34% owner of Citigroup…

Mr. Hall has long operated with remarkable independence. In late 2007 he shot down Citigroup executives who wanted to merge Phibro with the bank’s asset-management arm, which could have clipped his ability to make big investment bets….

Mr. Hall’s pay contract has multiple parts. He has long had a profit-sharing contract with Citigroup and its predecessor banks entitling him to a large percentage of Phibro’s gains. The percentage he and his small team of traders get under the contract terms currently stands below 30%.

Mr. Hall’s pay and independence from Citigroup’s home office reflects a track record of making sizable, successful investment bets. A few years ago, for instance, Mr. Hall, 58 years old, anticipated an important shift in the way the world valued oil, and correctly bet that long-term and short-term energy prices would abandon their historical relationship with each other. In making that investment, Citigroup gave Mr. Hall more leeway to take on risk than it usually gives entire teams, according to traders….

Citigroup doesn’t report Phibro’s detailed financial results, but a footnote in the company’s annual report says that $667 million in 2008 revenue from “principal transactions” related to commodities “primarily includes” Phibro’s results.

Latitude like that is inappropriate in a large organization. Men like Hall hold their employers hostage with the threat that they will go start a hedge fund. But that entails additional duties, like dealing with peaky investors and needing to worry about end-of-month results. While some star traders go on to be very successful hedge fund operators, others fade surprisingly quickly. Those irritating organizational constraints might actually be to their benefit.

Consider John Whitehead, former co-CEO of Goldman, who was incensed that the pay levels in 2006:

“I’m appalled at the salaries,” the retired co-chairman of the securities industry’s most profitable firm said in an interview this week. At Goldman, which paid Chairman and Chief Executive Officer Lloyd Blankfein $54 million last year, compensation levels are “shocking,” Whitehead said. “They’re the leaders in this outrageous increase….

Whitehead, who left the firm in 1984 and now chairs its charitable foundation, said Goldman should be courageous enough to curb bonuses, even if the effort to return a sense of restraint to Wall Street costs it some valued employees. No securities firm can match the pay available in a good year at the top hedge funds.

“I would take the chance of losing a lot of them and let them see what happens when the hedge fund bubble, as I see it, ends,” Whitehead, 85, said….

If the Citi executives really wanted to, they could go over Hall’s conduct with a fine toothed comb and find violations of bank policy (most big honchos break expense rules). And the formalities here do not matter much. Hall is a big producer, perceived to have the upper hand.

No where is the asymmetry of this arrangement mentioned: that Hall and his team get the upside (30%, more than a hedge fund success fee, more than even LTCM in its glory days, which got a 25% upside fee), but the taxpayer gets stuck with the losses. Hall and his bunch have the richest option deal going. Nor does it bother to point out that Hall would find it hard to get access to as much capital as Citi provides him on such rich terms from the outside. Citi not only provides him with more equity than he is likely to be able to raise (certainly for a 30% upside fee) and his cost of funding is sure to be considerably lower than if he were to operate on his own.

Citi is already too big to fail. The Phibro team is a stand-alone unit that takes a lot of risk that is not appropriate for a government-supported entity. The government safety net should extend only to crucial financial infrastructure. This is a great opportunity for Citi to shed a risky, non-core activity, which is exactly what it should be doing.

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23 comments

  1. craazyman

    the taxpayer should charge this fool a stiff annual fee for bailout insurance.

    that would cut his profits down to size, and he still could be a big self-important rich dude.

    what a loser this jerk is

    are there any adults left on Wall Street to run the industry with some gravitas?

  2. Bruce Krasting

    Yves, Would you be happy if the tax on bonuses in excess of $5mm were taxed at say 60%???

    Or is your concern that the risk of this activity is too much for a wounded Citi to take on?

    If it is the latter I would say don't worry. What if they did lose another 100mm on a bad bet? It would not change the outcome. These are rounding numbers when it comes to whether C will survive or fail.

    But if we strip C of anything that has risk and profit potential we might as well just close them now.

  3. Independent Accountant

    YS:
    I have posted on this issue before. Let this genius leave. It is inconceivable he is making the money for Citigroup he claims to make. What's his cost of capital charge? If Citigroup did not benefit from Zimbabwe Ben's suppressing interest rates, it would have folded a long time ago.

  4. JD

    Very good point about anchoring, and about the Directors responsibilies here.

    But what is happening in this labor market (for bankers & traders)? The industry has contracted – where is the competitive pressure to get these jobs from those just outside the superstar salary circle? Instead we have salaries bid up after the crisis?

  5. RTD

    Isn't the US government the single largest shareholder in Citi now? That muscle needs to be flexed. If any phoney-baloney libertarians want to cry about the sanctity of property and contracts and other nonsense, we can remind them that the US government effectively OWNS Citi and is just exercising its property right over them. Not to mention the fact that Citi would not even exist today if not for the graciousness of the government, and thus there would be no bonus to even pay this guy in the absence of government intervention.

    Nevertheless, this problem will never go away in the absence of structural reform.

    We need Glass-Steagall II. Separate:
    1. Banks – take deposits and make loans
    2. Investment Banks – underwrite new offerings, provide merger/acquisition/divestiture support
    3. Broker/Dealer/Asset Managers – execute trades and manage funds for clients only
    4. Proprietary Trading Firms – trade for themselves

    Banks would be prohibited under law from lending to 2,3,4. The Fed would provide lender of last resort protection to 1 and perhaps some very limited protection to 2. 3 would be highly regulated from a client protection standpoint but have no government safety net. 4 would be on their own to do as they please (in the absence of bank loans and client funds, they'd simply be gambling owners' equity).

    –RueTheDay

  6. Kid Dynamite

    YS – it sounds like you are concerned that Phibro employees will be incented to take risks to earn big payouts.. there's an easy fix to this that doesn't involved tearing up the pay deals – limit the leverage/risk they can take. voila.

  7. vlade

    Go over the chum with a toothcomb (as you suggested) – contract is two way, not one one way. If he's clean as a lily, pay him and terminate the contract (possibly, if he's really as good as he claims, offer to set him up a hedge fund with Citi as a seed investor).

    Sack the directors and anyone who ever had anything to do (executively) wish his contracts for lack of due care. All legal and clear, but requires a bit of courage.

  8. Agent Vanilla

    Expenses? All expense reimbursements are are approved by a reporting line manager, and the receipts sent off to a 3rd location for actual payment. Very hard to prove the expense was handled incorrectly without smearing a bunch of other people in the process. You want to kill a big target in a financial firm? You find him violating a regulatory and internal compliance control rule, such as taking a business call on an unrecorded line, failure to sign a dealing ticket, etc. Those acts have a single point of responsibility…

  9. Siggy

    A bonus of $100 million is a bit more than unseemly. I doubt that the trader in question is worth that kind of compensation. And if he really is that good, well, why is not out on his own trading with his own money. Whoever in the executive suite that approved his contract needs to be terminated. Now if he leaves and Phibro is no longer profitable and that causes Citi to crash, then as substantial shareholders we should call for the liquidation of the enterprise.
    In fact, as shareholders we should exit the investment and help Citi to the bankruptcy court.

  10. Anonymous

    If Phibro is such a risk to Citi it should be spun off or closed down. Simple but hard to do if the unit makes money year after year in good and bad times…

    It amazes me that the top performers are perceived as risk and must be leveled with the mediocre. You need'm to beat over the competitors.

    Stop the witch hunt.

    [no position in C; not working in financials since 2006]

  11. profnickd

    government safety net

    We used to call this "welfare" — I don't see why the term still doesn't apply just because we're talking about banking irresponsibility and incompetence and not other forms of irresponsibility and incompetence.

  12. Oregon Guy

    I don't know about Yves, but my beef with this is paying a single worker $100M for an unproductive activity.

    Making money from money doesn't increase the tangible net worth of the United States or the World and outlandish rewards for speculation and rent-seeking results in outsourcing tangible wealth creation to the Chinese while we blow debt-driven asset bubbles at home. The result since 1980 is stagnant real wages for the middle-class, rapid growth debt, and economic instability.

    The case of this gentleman is not important. The remedy is changing the tax code to reduce the gain for financial speculation in equities, real-estate, and commodities below that of investment in productive assets. The problem is the capture of both political parties by the lobbyists of the FIRE economy that makes applying the remedy impossible.

  13. Yves Smith

    Agent,

    With all due respect, your comment is naive. I've seen this done to line managers running businesses. Happens ALL the time.

    Hall is clearly a C-level equivalent. He runs a business unit. Do you think anyone "reviews" his expenses? He would have signing authority to some level, at least $5000, maybe higher. So part of the issue would be not just his personal expenses, but ones he approved for his subordinates.

    And there is also the question of misrepresenting the expenses on reports, for instance, report says X (four guys taken to lunch. all claimed to be counterparties) when in fact it was Y (one a counterparty, the rest having nothing to do with the business, just personal buddies). That's a simple example, but you get the point.

    For instance, one expense violation that was caught was that an IT unit had a corporate apartment on long term lease. They had some consultants who were outside the NYC metro area, but when projects were in crunch phase, they needed them to be on site, and this happened enough the time that it was cheaper to keep the apartment than pay for hotels.

    The apartment also wound up being used for assignations during the day, quite often.

    Anon of 12:13,

    You are missing the point. The taxpayer is funding Citi. Citi and managers get the upside, the taxpayer gets stuffed with the downside. Hall is not being funded on stand-alone terms, he gets massive subsidies by being part of Citi. Citi would be toast and he would be putting together his own hedge fund were in not for the benevolence of Paulson, Bernanke, and Geither.

    Hall clearly takes large risks AND refused to accept moves (the reorg mentioned in the piece) that are for the greater good of Citi.

    Short term profit and risk are two different issues. Citi has no business being in highly risky businesses when funded by the public, PARTICULARLY with the management team being compensated in excess of hedge fund standards.

    LTCM and the quants that blew up last year looked like sure fire winners until they got in trouble. Those sort of operations go down fast and hard.

  14. Anonymous

    . hard to do if the unit makes money year after year in good and bad times…

    Only Bernard Madoff can make money year over year in good and bad times.

    Hall lost some $100m for his employer during the first Gulf War when the oil price plunged. Hall is now a government-subsidized gambler. When Hall “locks in on an idea, he’ll take it to the extreme”.

  15. Anonymous

    If he and his unit are such hotshots then Citi should be able to offload the risk and the negative bailout-associated PR by selling the unit now at top-dollar, so they can benefit from him without having him around anymore. And then he'd be free to do his wonderful thing somewhere else.

    Win Win all around…

  16. Anonymous

    This happened before at Phillip Brothers (Phibro) when it was still a unit of Englehardt Minerals.

    Trader Marc Rich felt he should have earned at least a million dollars. His boss, Ludwig Jesselson, thought that no one was worth a million dollars a year. Marc Rich left and started his own firm. cf. Metal Men by Craig Copetas.

    This is sometimes cited as the catalyst for traders' high salaries today.

  17. Anonymous

    Nick knows what he knows

    Everyone in their soul knows this is wrong from so many perspectives that volumes can be written on it.

    Hall did not produce a good or a service. He did not create, explore,,produce or refine a single drop of energy. He entered into a gamble and won. A gamble where the losers are the consumers. Had he lost the gamble, the taxpayers would ultimately pay the tab.

    Is it any wonder why the man who can't heat his home, lost his job, and has no reason to believe things will improve tomorrow can be driven to yield to his most primival instincts to destroy the beast that threatens his very survival and that of his posterity.

  18. Anonymous

    Now wait a minute folks; a $100 million bonus *is* beyond the pale, but Citi signed on to this because they wanted the benefits of the outsized gains this guy had a track record of producing. Citi (at least the 'old' Citi) is responsible for this contract.

    The compromise is simple. Any bonus for trading profits earned prior to the original bail-out date he keeps, any earned after that date he forfeits, as Citi would not have existed after that date; at least not in its current form.

    That way, the trader keeps the bonus that would have been earned prior to the public rescue.

    I don't think we know if that number is $0, $100 million or anything in between. Also, clearly we know the guy is going to leave at that point as his contract certainly terminates with such a material change; taking the best employees with him.

    Before you all flame me, we all need to understand that that is the price that we as shareholders are going to pay; and as has been pointed out here, that may be a good thing; as a public ward, this unit needs to close, as it is not appropriate for Citi's current state and future realignment. Less risky financial institutions is the goal for the future, I think we all agree.

  19. Bob

    A few simple comments, I like the article, and would also very much like to see Citigroup and all other large public companies, not just in the financial vertical, but all public companies wipe out the ridiculous blotted compensation packages, parachute agreements, etc. Public companies should be regulated by law to not have the legal right to exceed certain limits, other than payment based on actual performance, and even then it needs to be spelled out in federal regulations how the terms must protect the public company from payments that do not correctly reflect revenue gains for the public company.

    Lastly, I would really like all these financial reporters and analyst to stop interchanging the names Citi/citi with Citigroup. Citi is a completely different company, not associated in any way that I know of with Citigroup, other than the fact that they are both in the financial market space. It’s like referring to GM as Ford, or Pepsi as Coke. Worst of all it really made this rookie, non-pro investor feel pretty stupid, that I purchased shares of Citi (CIT) originally thinking it was part of, or the same thing as Citigroup, (C) because of the improper and incorrect looseness of writers and others using or saying Citi when they were actually referring to Citigroup. No wonder I was confused; or do I still have it wrong? If not, please, everyone, especially those of you who should know better, stop using Citi as shorthand for Citigroup. Too bad Citi can’t take legal action, or better yet, since Citi is in worse shape that Citigroup, Perhaps Citigroup should take legal action against those who refer to them as Citi. We rookies don’t need any help with the confusion factor!

    My two Pesos . . .

    . . . Not to be confused with Pesetas.
    Citi NOT EQUAL TO Citigroup
    And . . .
    Peso NOT EQUAL TO Peseta
    Did you know that the first time the dollar sign was ever used as the symbol for any currency was for the Peso? The United States adopted the use of the $ much later. So perhaps we should cal it the Peso Sign, not the Dollar Sign.

    :^)

  20. Bob

    Didn’t read the comment posted before mine, when I wrote my comment.

    The only reason these so called super producers get the deals they have in the past, is because the companies, and investors like the guy who posted just before me, have bought into the false fear that losing these guys is bad, or that they really have anything better to go to if they don’t get what they want. An early post pointed out that most of them typically leverage the threat that they will go start their own hedge fund. The problem is that they would not be able to get anywhere near the amount of capital/cash to do the hedging, and certainly it would cost them much more to borrow it or get it from other investors, therefore the money left over, if they could even rake together the money on their own, would be much, much, much less than the artificially high compensation plans they have with the PUBLIC companies they currently work for. It is not in the best interest of any investor to believe or accept that it is worth paying these inflated compensation amounts to these people. Let them go, let them succeed somewhere else if they really, really can, but history shows that most of them fail big time. They need the company’s capital to make the investments they are good at, more than the companies and investors need them. Let them go, please let them go, or they can stay but at a much lower, more reasonable compensation level.

    Two more Pesos from Bob, the rookie.

  21. BobAgain

    Didn’t read the comment posted before mine, when I wrote my comment.

    The only reason these so called super producers get the deals they have in the past, is because the companies, and investors like the guy who posted just before me, have bought into the false fear that losing these guys is bad, or that they really have anything better to go to if they don’t get what they want. An early post pointed out that most of them typically leverage the threat that they will go start their own hedge fund. The problem is that they would not be able to get anywhere near the amount of capital/cash to do the hedging, and certainly it would cost them much more to borrow it or get it from other investors, therefore the money left over, if they could even rake together the money on their own, would be much, much, much less than the artificially high compensation plans they have with the PUBLIC companies they currently work for. It is not in the best interest of any investor to believe or accept that it is worth paying these inflated compensation amounts to these people. Let them go, let them succeed somewhere else if they really, really can, but history shows that most of them fail big time. They need the company’s capital to make the investments they are good at, more than the companies and investors need them. Let them go, please let them go, or they can stay but at a much lower, more reasonable compensation level.

    Two more Pesos from Bob, the rookie.

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