Citi, Morgan Stanley Face Suit

Citigroup Inc.’s ( C - Analyst Report ) underwriting role has drawn criticism, as an investor recently filed a lawsuit against the company in the New York state court in Manhattan, according to a Bloomberg report.

Citi, along with a number of other companies such as Morgan Stanley (MS) and HSBC Securities (USA) Inc. of HSBC Holdings Plc. (HBC) were among the underwriters of a $300 million debt offering by Overseas Shipholding Group Inc. (OSGIQ).

The investor has charged Overseas directors and officers as well as these underwriters for signing deceptive financial documents for the company’s offering in March 2010.

Notably, Overseas filed for bankruptcy on November 14, after announcing that the company’s financial statements from 2009 through the first two quarters of 2012 were inaccurate. With shipping rates declining, the company has incurred losses for several quarters in the past.

With the declaration of inaccuracies in the statement and announcement of withdrawal, the market was shocked and the company’s credit rating faced downgrades. The plaintiff argued that ignorant of such erroneous statements in the offering documents, investors purchased these notes and when their prices fell, significant losses were incurred.

According to the suit, the underwriters bear liability for damages to the extent of the amount of the securities each company dealt with during the offering. As per the report that cited the complaint, Citi, Morgan Stanley and HSBC, handled $225 million of the notes collectively.

We believe that mounting legal claims pose a risk for Citi and this could result in a revision of estimates for Citi, which currently retains a Zacks #3 Rank, translating into a short-term Hold rating. Increasing legal claims lead to heightened legal costs. To lessen the overhang, the company often opts for settlements that drain the company’s funds, which could have otherwise been steered toward growth purposes.