state of new york ) county of monroe )securities.stanford.edu/filings-documents/1038/c... · the...

UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK

In re Citigroup Inc. Securities Litigation

Master File No. 07 Civ. 9901 (SHS)

STATE OF NEW YORK ) ) ss: COUNTY OF MONROE )

DECLARATION

of

GREGG A. JARRELL*

July 15, 2011

* William E. Simon Graduate School of Business Administration, University of Rochester, Rochester, NY 14627

Case 1:07-cv-09901-SHS Document 102 Filed 07/15/11 of 48

TABLE OF CONTENTS

I. INTRODUCTION AND SUMMARY OF OPINIONS .......................................................... 1�

II. QUALIFICATIONS AND COMPENSATION .................................................................... 2�

III. MATERIALS REVIEWED .................................................................................................. 3�

IV. COMPANY OVERVIEW...................................................................................................... 4�

V. MARKET EFFICIENCY FOR CITIGROUP COMMON STOCK ................................... 5�A.� The Cammer Factors for Market Efficiency ............................................................. 7�

i)� Weekly Trading Volume ................................................................................ 7�ii)� Analyst Coverage ............................................................................................ 8�iii)� Market Makers.............................................................................................. 10�iv)� Form S-3 Eligibility....................................................................................... 11�v)� Cause and Effect Relationship ..................................................................... 12�

B.� Other Indicia of Market Efficiency ......................................................................... 35�i)� Market Capitalization .................................................................................. 35�ii)� Bid-Ask Spread ............................................................................................. 36�iii)� Statistical Test for Weak-Form Market Efficiency ................................... 37�iv)� Institutional Investors ................................................................................... 39�v)� Short Interest ................................................................................................. 40�vi)� Put-Call Parity .............................................................................................. 42�

C.� Conclusion ................................................................................................................. 45�


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I, Gregg A. Jarrell, declare as follows:

I. INTRODUCTION AND SUMMARY OF OPINIONS

1. As described in greater detail in this Declaration, I am a tenured Professor of

Economics and Finance at the University of Rochester’s William E. Simon Graduate School of

Business Administration. I have been retained by Lead Plaintiffs’ counsel, Kirby McInerney

LLP (“Counsel”), to opine on issues relating to the market efficiency of the common stock of

Citigroup Inc. (“Citigroup” or the “Company”) during the period from February 1, 2007 through

April 30, 2008, inclusive (the “Class Period”).1 At this time, I have not been asked to offer any

opinions related to materiality, loss causation or damages in this Action, and I therefore have not

undertaken analyses of these issues. I expect to offer opinions on these issues at an appropriate

time as requested by Counsel.

2. In my opinion, during the Class Period, Citigroup common stock traded in what

economists refer to as an informationally efficient market. I provide detailed explanations and

bases for this opinion in the sections that follow.

3. I understand that discovery in this case is ongoing. Therefore, I reserve the right

to amend this Declaration to reflect new information available to me in light of the ongoing

discovery process, information provided by other experts in the litigation, documents provided

by Counsel, future rulings from the Court in this Action, and trial proceedings.

1 The Amended Consolidated Class Action Complaint dated February 20, 2009 (the

“Complaint” contains a Class Period of January 1, 2004 through January 15, 2009 (Complaint at p. 1). In an Opinion and Order dated November 9, 2010 (the “November 9, 2010 Opinion”), the Court denied the motion to dismiss claims related to alleged CDO-related misstatements and omissions over two periods, February 2007 through November 3, 2007 and November 4, 2007 through April 2008 (November 9, 2010 Opinion at p. 68). I have been asked to assume by Counsel that the Class Period begins on February 1, 2007 and ends on April 30, 2008.


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II. QUALIFICATIONS AND COMPENSATION

4. I am currently a tenured Professor of Economics and Finance at the University of

Rochester’s William E. Simon Graduate School of Business Administration, where I have been a

member of the faculty since 1988. I hold a Ph.D. in Business Economics from the University of

Chicago (1978), with major concentrations in Industrial Organization and Finance, as well as an

MBA (1976) from the University of Chicago. I received a B.S. in Business Administration from

the University of Delaware (1974). I attended high school at New York Military Academy

(1967-70).

5. From 1977 to 1981, I was an Assistant Professor of Economics at the Graduate

School of Management at the University of Rochester. From 1981 to 1983, I was a Post-

Doctoral Research Fellow at the University of Chicago’s Center for the Study of the Economy

and the State. Thereafter, from 1983 to 1984, I was a Senior Economist with Lexecon, Inc., a

Chicago-based economics consulting firm specializing in antitrust and securities litigation. I also

served as an expert in mergers and acquisitions on the 1983 United States Securities and

Exchange Commission (the “SEC”) Advisory Committee on Tender Offer Policy.

6. From 1984 through 1987, I was the Chief Economist for the SEC in Washington,

D.C. I also served as an Adjunct Professor at the Georgetown University Law School in

Washington, D.C. during 1985 and 1986, where I co-taught a course on securities regulation.

After leaving Washington D.C. in 1987, I was the AT&T Foundation Resident Management

Fellow at the University of Rochester’s Simon School. From 1987 to 1988, I was the Senior

Vice President and Director of Research at the Alcar Group, Inc., a Chicago-based management

consulting and software firm specializing in financial valuations of businesses and securities.

7. Since joining the Simon School faculty at the University of Rochester as a tenured

professor, I have served (from 1988 to 1990) as director of the school’s Managerial Economics


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Research Center. I also served as director of the Bradley Policy Research Center at the Simon

School from 1990 to 1994. While at the Simon School, I have taught a course titled Cases in

Finance to second-year MBA students that covers, among other subjects, the operation of

financial markets and the market for corporate control, the economics of mergers and

acquisitions, valuation analysis for businesses and securities, the response of stock prices to

public information, and financial regulation of securities markets. I also teach a price theory

course called Managerial Economics that includes applications of intra-company pricing of

transfers of products and services. I have received twelve Superior Teaching Awards. I have

authored or co-authored more than two dozen articles and studies in scholarly journals generally

on the topics of mergers and acquisitions, the regulation of financial markets, and the response of

stock prices to the release of information, among other things. My curriculum vitae, with a list

of publications and of recent cases in which I have testified as an expert at deposition or trial, is

attached as Exhibit 1.

8. My compensation, which is not contingent upon the outcome of this matter, is

based on the number of hours worked on this assignment, as well as reimbursement of out-of-

pocket expenses. My hourly rate is $600. To assist me in this assignment, I have worked with

Forensic Economics, Inc., whose employees acted under my supervision and direction for this

assignment. Forensic Economics, Inc., located in Rochester, New York, was founded in 1989.

The hourly rates of the employees of Forensic Economics, Inc. who worked on this assignment

range from $155 to $500.

III. MATERIALS REVIEWED

9. In the course of my assignment in this action, I (or employees of Forensic

Economics acting under my supervision) have reviewed numerous case documents, including:


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the Complaint; the November 9, 2010 Opinion; stock price data related to Citigroup common

stock, peer companies and various market and industry indexes; filings with the SEC made by

Citigroup; and news stories, press releases, analyst reports and conference call transcripts

relating to Citigroup. Attached as Exhibit 2 is a comprehensive list of materials reviewed in

connection with this Declaration. Specific documents and information relied upon in reaching

my opinions are cited in the text of this Declaration and exhibits.

IV. COMPANY OVERVIEW

10. Citigroup is a diversified global financial services holding company whose

businesses provide a broad range of financial services to consumer and corporate customers. At

the end of 2006, Citigroup had more than 200 million customer accounts and did business in

more than 100 countries. The Company also had approximately 144,000 full-time and 10,000

part-time employees in the United States and approximately 183,000 full-time employees outside

the United States.2 Citigroup common stock was listed on the New York Stock Exchange

(NYSE) under the ticker symbol “C.”3

11. The Company had total assets of $2.2 trillion and $1.9 trillion at December 31,

2007 and 2006, respectively.4 For the years ended December 31, 2007 and 2006, Citigroup had

total revenue (net of interest expense) of $81.7 billion and $89.6 billion, respectively, and net

2 Citigroup 10-K filed February 23, 2007, p. 2. 3 Citigroup 10-K filed February 23, 2007, p. 178. 4 Citigroup 10-K filed February 22, 2008, p. 3, and 10-K filed February 23, 2007, p. 3.


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income of $3.6 billion and $21.5 billion, respectively.5 Of the Company’s total 2006 net income,

56% was from the U.S. and 44% from outside the U.S.6

12. Citigroup was managed along the following five business segments (with

percentage of total 2006 net income in parentheses): Global Consumer Group (56%); Corporate

and Investment Banking (33%); Global Wealth Management (7%); Alternative Investments

(6%); and Corporate/Other (-2%).7

V. MARKET EFFICIENCY FOR CITIGROUP COMMON STOCK

13. A finding of market efficiency for a security means that the security price

contains all relevant information.8

14. The Efficient Market Hypothesis has historically been divided into three

categories, each dealing with a different type of information. Weak form tests of the Efficient

Market Hypothesis are tests of whether information contained in historic prices is fully reflected

in current prices. Semi-strong form tests of the Efficient Market Hypothesis are tests of whether

publicly available information is fully reflected in current prices. Finally, strong form tests of

the Efficient Market Hypothesis are tests of whether all information, public or non-public, is

5 Citigroup 10-K filed February 22, 2008, p. 3, and 10-K filed February 23, 2007, p. 3. 6 Citigroup 10-K filed February 23, 2007, p. 5. For 2007, Citigroup’s net income from

outside the U.S. was $7.0 billion, which exceeded its total net income of $3.6 billion. Citigroup 10-K filed February 22, 2008, p. 20.

7 Citigroup 10-K filed February 23, 2007, p. 16. The percentage of net income for the Corporate/Other segment includes 1% of income from discontinued operations.

8 Generally, the market is considered efficient if it meets the criteria in the definition of a “semi-strong efficient market,” defined as a “[m]arket in which security prices reflect all publicly available information.” See Richard A. Brealey and Stewart C. Myers, Principles of Corporate Finance, 5th Edition, McGraw Hill, 1995, p. G11. Stated another way, the market for the security is informationally efficient.


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fully reflected in security prices.9 The literature on the Efficient Market Hypothesis indicates

that as new information causes investors to revise their expectations about future cash flows and

growth opportunities, the market price of a security responds quickly in an unbiased manner to

reflect this new information.

15. Class action securities litigation generally requires a presumption of market

efficiency to certify a class, and the courts have generally adopted the semi-strong form of the

efficient market hypothesis. For example, in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), the

U.S. Supreme Court stated: “Recent empirical studies have tended to confirm Congress’ premise

that the market price of shares traded on well-developed markets reflects all publicly available

information, and, hence, any material misrepresentations.”10

16. Cammer v. Bloom (“Cammer”) explains:

As the Supreme Court succinctly explained in Basic: “...in an open and developed securities market, the price of a company’s stock is determined by the available material information regarding the company and its business.... Misleading statements will therefore defraud purchasers of stock even if the purchasers do not directly rely on the misstatements...”11

17. In securities litigation, the courts have used certain tests to determine if a security

trades in an efficient market, including the five factors set forth in Cammer. I examined the

accepted Cammer factors for market efficiency in regard to Citigroup common stock during the

Class Period. In addition to the five Cammer factors, I also considered additional indices of

9 See Edwin J. Elton, Martin J. Gruber, Stephen J. Brown and William N. Goetzmann,

Modern Portfolio Theory and Investment Analysis, Sixth Edition, John Wiley & Sons, Inc., 2003, p. 402.

10 See Basic, Inc. v. Levinson, 485 U.S. 224, 108 S.Ct. 978485 (1988) at 246. 11 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1276.


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market efficiency, some of which have been considered by other courts12 and/or discussed in the

academic literature.

A. The Cammer Factors for Market Efficiency

18. In Cammer, five factors were listed that indicate that a security is traded in an

efficient market: (i) average weekly share turnover of more than 1%; (ii) coverage of the

company by securities analysts; (iii) the presence of market-makers or arbitrageurs; (iv) the

eligibility of the company to file a Form S-3 with the SEC; and (v) evidence of the stock price

reacting to material information. I discuss each of these five factors below.

i) Weekly Trading Volume

19. The first significant indication of an efficient market in Cammer is that the

average trading volume per week exceeds one percent of shares outstanding. Cammer states

that: “...average weekly trading of two percent or more of the outstanding shares would justify a

strong presumption that the market for the security is an efficient one; one percent would justify

a substantial presumption.”13

20. The reported trading volume during the Class Period for Citigroup’s common

stock was 18.9 billion shares, which was approximately 3.75 times the 5.0 billion average shares

outstanding over the Class Period. The average weekly trading volume as a percentage of shares

outstanding was 5.8% over the Class Period, which meets the higher “strong presumption”

Cammer benchmark of 2% (see Exhibit 3).14 Exhibit 3 also contains average results for each

12 For example, Cheney v. CyberGuard Corp., 213 F.R.D. 484, *501-02 (S.D. Fla. 2003)

and In re. DVI Securities Litigation, 249 F.R.D. 196, *208 (E.D. PA. 2008). 13 See Cammer v. Bloom, 711 F. Supp. (D.N.J. 1989) at 1286. 14 I calculate weekly volume as the sum of the daily volume during the week beginning

on Monday and ending on Friday. The number of common shares outstanding was obtained from Citigroup’s SEC filings. Between SEC reporting dates, the ratio of weekly volume to


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quarter during the Class Period (Exhibit 4 contains daily stock price data for Citigroup common

stock). The trading volume for Citigroup’s common stock supports a finding that Citigroup’s

common stock traded in an informationally efficient market during the Class Period.

ii) Analyst Coverage

21. The second indication of an efficient market in Cammer is the number of

securities analysts following and reporting on the stock. These analyst reports served the

purpose of disseminating publicly available information along with analysis and

recommendations of the analysts to investors. Cammer states: “…it would be persuasive to

allege a significant number of securities analysts followed and reported on a company’s stock

during the class period.”15 Significant analyst coverage implies that information about the

company is disseminated to investors quickly. The greater the number of analysts, the more

likely information about the company is “relied upon by investors.”16

22. According to First Call data, analyst coverage of Citigroup ranged between 13

and 23 analysts during the Class Period, with an average of 19 (see Exhibit 3).17 More than 500

analyst reports were issued during the Class Period by such firms as Bank of America; Bear

Stearns; Bernstein Research; Buckingham Research; CIBC; Credit Suisse; Deutsche Bank;

Goldman Sachs; JPMorgan; Keefe, Bruyette & Woods; Lehman Brothers; Merrill Lynch;

Morgan Stanley; Punk, Ziegal; Sandler O’Neill; and UBS.18

common shares is calculated by dividing the weekly volume by the outstanding common shares last reported in Citigroup’s SEC filings. Partial trading weeks at the start and end of the Class Period are excluded from the analysis.

15 See Cammer v. Bloom, 711 F. Supp. (D.N.J. 1989) at 1286 (footnote omitted). 16 See In re Xcelera.com Securities Litigation, 430 F.3d 503, 514 (1st Cir. 2005). 17 I used the number of analysts in the consensus EPS estimate for the upcoming fiscal

year. Source: First Call (via FactSet). 18 Based on analyst reports I requested and provided by Counsel, as well as reports


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23. In addition, another measure of information available about a company is the

sheer amount of media coverage, company information and news stories available to the market.

In Cheney v. CyberGuard (“CyberGuard”), the court stated: “Plaintiffs have shown that

CyberGuard was featured in a significant number of news items indicating that information

regarding CyberGuard may have been widely distributed, which would support a finding of

efficiency.”19

24. During the Class Period, over 27,000 news stories and press releases about

Citigroup appeared in leading financial publications, including The Wall Street Journal, The New

York Times, Dow Jones News Service, Reuters News and Bloomberg News.20 Additional

information about Citigroup was distributed through Citigroup’s SEC filings. Appendix B is a

chronology spanning the period February 2007 through April 2008 that lists analyst reports,

news stories, press releases and SEC filings disseminated during the Class Period.21,22

currently available on Thomson Research and Thomson Reuters Knowledge electronic databases.

19 See Cheney v. CyberGuard Corp., 213 F.R.D. 484, 499 (S.D. Fla. 2003). 20 Stories obtained through searches on Bloomberg and Factiva. See footnote 21 for the

search criteria used (over 14,000 and 13,000 stories, respectively). I note that the search did not include all possible sources.

21 I compiled a list of all Citigroup SEC filings from the SEC EDGAR database. The list of analyst reports is based on reports I requested and were provided by Counsel or obtained from Thomson Research or the Reuters Knowledge databases. I obtained conference call transcripts from Bloomberg. For news stories, I searched Bloomberg and Factiva. For Bloomberg, I used the ticker symbol “C” and searched for all sources with “medium” relevance. For Factiva, I searched the company code for “Citigroup Inc.” and the following list of sources: Associated Press Newswires, Business Wire, Barron’s, BusinessWeek, Dow Jones Business News, Dow Jones Corporate Filings Alert, Dow Jones International News, Dow Jones News Service, Forbes, Fortune, Market Wire, PR Newswire, Regulatory News Service, Reuters News, The New York Times, The Wall Street Journal (print and online), USA Today and thestreet.com. Bloomberg acquired BusinessWeek in December 2009, and Factiva no longer carries BusinessWeek articles, nor has Bloomberg fully incorporated BusinessWeek. As such, I also performed a search via Google for BusinessWeek articles on Citigroup surrounding the top ten days discussed below.

22 I note that Appendix B does not contain all news stories, analyst reports or other public


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25. The broad dissemination of information about Citigroup through analyst reports,

the news media, company press releases and regular SEC filings supports the finding that

Citigroup common stock traded in an informationally efficient market during the Class Period.

iii) Market Makers

26. The third indication of an efficient market in Cammer is the presence of market

makers.23 Market makers exist in quote-driven markets like Nasdaq, which is organized by a

dealer association. The market makers provide liquidity to traders.24 For quote-driven markets

like Nasdaq, the larger the number of market makers, the greater is the confidence of high

liquidity.

27. Citigroup traded on the NYSE during the Class Period, which is primarily an

order-driven market with a floor-based trading system.25 On the NYSE, a specialist is assigned

to each security and is required to offer liquidity for that security.26 Thus, because this Cammer

factor relates to an over-the-counter stock that is traded in a quote-driven system, the number of

market makers is not relevant to a NYSE stock, for which a single specialist provides liquidity

for each listed stock. The presence of a NYSE specialist indicates an efficient market for

Citigroup common stock. In addition, it is common economic practice to treat securities traded

on the NYSE as being priced in an efficient market.

information regarding Citigroup, but is rather a large sample of information currently available.

23 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1286-87. 24 See Larry Harris, Trading & Exchanges: Market Microstructure for Practitioners,

Oxford University Press, 2003, pp. 93, 195. 25 See Larry Harris, Trading & Exchanges: Market Microstructure for Practitioners,

Oxford University Press, 2003, pp. 48, 96. 26 See Larry Harris, Trading & Exchanges: Market Microstructure for Practitioners,

Oxford University Press, 2003, p. 496; Shane A. Corwin, “Differences in Trading Behavior Across NYSE Specialist Firms,” The Journal of Finance 54(2), April 1999, 721-745, p. 723.


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iv) Form S-3 Eligibility

28. The fourth indication of an efficient market in Cammer is the eligibility of the

company to file a Form S-3 with the SEC. The Cammer court found that eligibility to file a

Form S-3 “...is an important factor weighing in favor of a finding that a market is efficient.”27

Cammer quotes from an SEC release that: “[Form S-3] is predicated on the Commission’s belief

that the market operates efficiently for these companies, i.e., that the disclosure in Exchange Act

reports and other communications by the registrant, such as press releases, has already been

disseminated and accounted for by the market place.”28 According to Cammer: “The ‘public

float’ aspect of Form S-3 requirements ensures that enough investors have in fact read the

previously filed document... It is this aspect of the Form S-3 requirements that calls into play the

efficient market hypothesis.”29

29. At the time of the Cammer decision, the filing of a Form S-3 registration

statement required firms to file reports under the Securities Exchange Act of 1934 for three years

prior to the Form S-3 filing and to have $150 million of stock held by non-affiliates (or $100

million of stock held by non-affiliates coupled with annual trading volume of 3 million shares

per year).30 The SEC has since modified the requirements for filing a Form S-3. Among the

current requirements for filing a Form S-3 registration statement are that a company be organized

and operating under the laws of the United States or its territories, has filed reports under the

Exchange Act for twelve calendar months, has suffered no default of its obligations and has an

27 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1285. 28 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1284, italics in original. 29 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1285, n33. 30 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1271.


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aggregate market value of common equity held by non-affiliates of $75 million or more.31 As

noted above, the “…‘public float’ aspect of the Form S-3 requirements ensures that enough

investors have in fact read the previously filed document.”32 The value of Citigroup common

stock held by non-affiliates during the Class Period ranged between $96.5 billion and $271.6

billion (see Exhibit 3), far exceeding the $75 million threshold requirement and ensuring that

enough investors have read its SEC reports. Citigroup was also organized and operated under

the laws of the United States during the Class Period, satisfying the organizational requirement.

In fact, Citigroup filed Form S-3s with the SEC during the Class Period on May 11, 2007 and

October 3, 2007.33

v) Cause and Effect Relationship

30. The fifth and most salient factor for an efficient market according to Cammer is

“[a] cause and effect relationship between unexpected corporate events or financial releases and

an immediate response in the stock price.”34 Cammer states that: “…one of the most convincing

ways to demonstrate [market] efficiency would be to illustrate, over time, a cause and effect

relationship between company disclosures and resulting movements in stock price.”35

31. Not every news item is expected to generate a statistically significant return. For

example, if the news story, analyst report or company disclosure only repeats information that

was already fully known, or merely confirms investors’ current expectations, no price reaction in

the security would be expected. A news story, analyst report or company disclosure will cause a

31 See SEC 1379, “Form S-3, Registration Statement under the Securities Act of 1933,

General Instructions,” updated April 2009, pp. 2-4. 32 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1285, n33. 33 Source: Morningstar Document Research. 34 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1287. 35 See Cammer v. Bloom, 711 F. Supp. 1264 (D.N.J. 1989) at 1291.


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statistically significant return only when the information is new and unexpected, and when the

information materially changes the value of the security to investors. Similarly, a disclosure that

omits such material information would not be expected to change the price of the security. Thus,

in applying the fifth Cammer factor, it is relevant to test directly whether the stock price changes

are in response to material, unexpected news by analyzing the new information that accompanies

significant stock returns.

32. Cammer does not provide any specific tests, indicia or factors on which it would

rely in reaching its determination concerning the existence of an adequate cause and effect

relationship. Economists in academia and private practice, however, have published scholarly

research studies that presented various tests and statistical methodologies that can provide

probative economic evidence concerning the existence of a cause and effect relationship

consistent with market efficiency.36 I employ such tests to analyze the efficiency of Citigroup

common stock.

33. For many of the tests I used to detect the presence of a cause and effect

relationship between relevant news events and resulting movements in the price of Citigroup

common stock, I rely on event study methodology, which is discussed in Appendix A.

36 Both the courts and academic literature use event studies as a test of semi-strong

market efficiency. Professor Eugene Fama wrote: “Event studies are the cleanest evidence we have on efficiency (the least unencumbered by the joint-hypothesis problem). With few exceptions, the evidence is supportive.” See Eugene F. Fama, “Efficient Capital Markets: II,” The Journal of Finance 46, 1575-1617, December 1991, p. 1602. Examples of event study analysis used by courts as part of the determination of whether a market is efficient include: In re Xcelera.com Securities Litigation, 430 F.3d at 512-14 (1st Cir. 2005) and Barrie v. Intervoice-Brite, Inc., No. 3:01-CV-1071-K, 2006 WL 2792199, at *8 (N.D. Tex. Sept. 26, 2006).


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a) Reaction to Material New Information

34. I first present a direct study of the cause and effect relationship between

Citigroup’s stock price returns and economic news by carefully studying the 10 days in the Class

Period when Citigroup’s common stock had the largest (absolute) t-statistics.37 This study,

although it uses event study empirical techniques, is not limited by the designation of a particular

event to study exclusively.38 Rather, this study pre-selects 10 days in which Citigroup’s common

stock has the largest (absolute value) t-statistics.39 Then, I study in detail the actual news

disclosed on those days, evaluate the economic significance of the valuation-relevant information

on these actual disclosures, and contrast these economic conclusions with the direction and exact

size of the excess stock price return that day. In a semi-strong form efficient market, there will

be a close agreement between the significance of valuation-relevant information contained in the

various disclosures and the direction and significance of that day’s excess stock return. In a less

efficient market with respect to public information a significant proportion of the big-return days

will have little or no valuation-relevant information that is disclosed that day.

37 Because of the adjustments to volatility used to calculate the t-statistics, I use the t-

statistics rather than the actual excess returns to define the ten days to be analyzed. 38 As an example of a particular event to study, I analyzed the stock-price reaction to

earnings surprises for Citigroup. I note that I do not rely on this analysis because there was other economic information in the earnings releases that would confound the findings and conclusions from this event study. Consequently, the results are not informative.

39 I note here that there is published scholarly research that also performs an event study and starts with “… major stock price and trading volume movements and then explore[s] directly for those economically significant information events driving such movements.” See Paul Ryan and Richard J. Taffler, “Are Economically Significant Stock Returns and Trading Volumes Driven by Firm-Specific News Releases? A Nonlinear Test of the Random-Walk Hypothesis,”Journal of Business Finance & Accounting, 31(1) & (2), January/March 2004, 49-82, p. 50. Another study focused on stock price movements as a “… sufficient statistic for information events.” See Jennifer Conrad, Bradford Cornell, Wayne R. Landsman, and Brian R. Rountree, “How Do Analyst Recommendations Respond to Major News?” Journal of Financial and Quantitative Analysis 41(1), March 2006, 25-49, p. 31.


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35. Specifically, I investigated the 10 largest (in absolute value) t-statistics for

Citigroup during the Class Period, of which 7 were statistically significant at the 99% confidence

level (i.e., t-statistics that exceeded 2.58) and 3 were statistically significant at the 95% level

(i.e., t-statistics that exceeded 1.96),40 and were accompanied by heavy trading volume.

36. The 10 largest t-statistic days are represented by 7 negative and 3 positive excess

returns. As shown in my event study in Exhibit 5, and discussed in the following sub-sections,

on most days I find an economically consistent correspondence between the direction and

general magnitude of the excess returns and the news disclosed on that day.41 I discuss each of

the ten days below.

1. February 26, 2007

37. After the market closed on Friday, February 23, 2007, Citigroup filed its Form

10-K with the SEC which stated:

The Securities and Exchange Commission is conducting a non-public investigation into the Company’s treatment of certain potential Argentina-related losses in the 2001 fourth quarter and the treatment of certain specific tax reserves and releases during the period 2000 to 2004 related to the Associates businesses acquired in the 2000 fourth quarter. In connection with these matters, the SEC has subpoenaed witness testimony and certain accounting and internal controls-related information for the years 1997 to 2004. The Company is cooperating with the SEC in its investigation. The Company cannot predict the outcome of the investigation.42

40 As discussed in greater detail in Appendix A, I consider excess returns with a t-statistic

greater than or equal to 1.96 in absolute value (95% confidence level) to be statistically significant.

41 This analysis is not meant to identify or discuss all news or information disclosed on the dates analyzed in this section.

42 Citigroup Form 10-K filed February 23, 2007, p. 173.


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38. On Sunday, February 25, 2007, Citigroup named a new Chief Financial Officer.43

On Monday, February 26, 2007, The Wall Street Journal reported that:

[the appointment] fills a gap in Chief Executive Charles Prince’s leadership team but doesn’t clear up who eventually will replace him as CEO. …The finance chief’s job was vacated last month, when Mr. Prince moved Sallie Krawcheck out of that post and into a job as head of the bank’s global wealth-management division following the abrupt ouster of its chief.”44

39. On Monday, February 26, 2007, Citigroup’s stock price declined 2.03%, closing

at $52.68 per share, $1.09 per share below its previous closing price of $53.77 per share.

Citigroup’s reported volume was 35.6 million shares, 2.3 times the average daily volume of 15.6

million shares from the start of the Class Period through February 23, 2007. Citigroup’s excess

return (net of market and industry effects) was -1.62%. The t-statistic is -2.44, significant at the

95% confidence level.

40. On Monday, February 26, 2007 after the market closed, the Associated Press

reported that: “Citigroup Inc. suffered the biggest loss Monday on the Dow Jones Industrial

Average after the company said the Securities and Exchange Commission is investigating tax

issues stemming from the New York bank’s acquisition of a financing company in 2000.”45

2. March 1, 2007

41. After the market closed on Wednesday, February 28, 2007, Bloomberg News

reported that: “Citigroup agreed to become [ACC Capital Holding]’s primary ‘warehouse’

lender and has an option to buy closely held ACC Capital’s wholesale mortgage origination and

43 “Citi Names Gary Crittenden as Chief Financial Officer,” Business Wire, February 25,

2007, 11:33 am. 44 “Citigroup Hire Leaves CEO Issue --- American Express Official Is Named Finance

Chief; Not Clear Prince Successor,” The Wall Street Journal, February 26, 2007. 45 “Citigroup sinks on DJIA; Merck rises on upgrade, Coca-Cola's beverage approved,”

Associated Press Newswires, February 26, 2007, 4:47 pm.


17

servicing businesses ….”46 On Thursday, March 1, 2007, Citigroup announced that it had

purchased Ecount, a processor of prepaid payroll cards, hoping to expand a market that Citigroup

had estimated to have grown to about $2 trillion.47 In addition, Citigroup announced that it was

making two “significant” changes to its credit card business, eliminating a practice called

“universal default” and also eliminating “any time for any reason” increases to fees and rates.48

42. On Thursday, March 1, 2007, Citigroup’s stock price increased 1.41%, closing at

$51.08 per share, $0.71 per share above its previous closing price of $50.37 per share.


million shares from the start of the Class Period through February 28, 2007. Citigroup’s excess

return (net of market and industry effects) was 1.70%. The t-statistic is 2.56, significant at the


3. May 16, 2007

43. On Tuesday, May 15, 2007, after the market closed, it was reported that

billionaire Edward Lampert’s ESL Investments had built a 15.2 million share stake in Citigroup,

according to an SEC filing made that day.49 Bloomberg reported that: “Citigroup Inc. added 95

cents, or 1.8 percent, to $53.74 in after-hours trading. ESL Investments Inc., the hedge fund

started by Edward Lampert, disclosed it has built an $800 million stake in the largest U.S. bank.

46 “Citigroup Offers New Financing to Mortgage Lender ACC Capital,” Bloomberg

News, February 28, 2007, 6:00 pm. 47 “Citigroup Acquires Ecount, Processor of Prepaid Payroll Cards,” Bloomberg News,

March 1, 2007, 11:35 am. 48 “Citi Announces Industry Leading Changes to its Credit Card Practices,” Business

Wire, March 1, 2007, 1:03 pm. 49 “Lampert’s ESL Reports Holding 15.2 Million Citigroup Shares,” Bloomberg News,

May 15, 2007, 5:13 pm.


18

ESL held 15.2 million Citigroup common shares as of March 31, according to a filing with the

U.S. Securities and Exchange Commission.”50

44. On Wednesday, May 16, 2007, Citigroup’s stock price increased 4.02%, closing

at $54.91 per share, $2.12 per share above its previous closing price of $52.79 per share.


million shares from the start of the Class Period through May 15, 2007. Citigroup’s excess



45. Market commentary on Wednesday, May 16, 2007 discussed the Lampert stake,

including stories in The New York Times and The Wall Street Journal.51 After the market closed,

the Associated Press reported: “Citigroup Inc. posted the largest gain Wednesday on the Dow

Jones industrial average, after billionaire Edward S. Lampert’s firm bought at least 15 million

shares of [the] financial services giant.”52

4. August 2, 2007

46. On Thursday, August 2, 2007, Citigroup’s stock price increased 1.99%, closing at

$47.24 per share, $0.39 per share above its previous closing price of $46.85 per share.


million shares from the start of the Class Period through August 1, 2007. Citigroup’s excess


50 “Applied Materials Drops; Citigroup Advances: U.S. After-Hours,” Bloomberg News, May 15, 2007, 6:16 pm.

51 “Lampert Fund Takes Stake in Citigroup,” The New York Times, May 16, 2007; “Moving The Market:Lampert Plants Hedge-Fund Flag In Citigroup Turf,” The Wall Street Journal, May 16, 2007.

52 “Dow Jones industrial average lifted by Citigroup, Procter & Gamble, Johnson & Johnson,” Associated Press Newswires, May 16, 2007, 4:37 pm.


19

95% confidence level. I have found no new information that can potentially explain Citigroup’s

positive excess return on this day.

5. November 5, 2007

47. On Sunday, November 4, 2007, Citigroup announced “significant declines since

September 30, 2007 in the fair value of the approximately $55 billion in U.S. sub-prime related

direct exposures” and that “…the reduction in revenues attributable to these declines ranges from

$8 billion to $11 billion ….”53 The press release also disclosed that:

The $55 billion in U.S. sub-prime direct exposure in S&B as of September 30, 2007 consisted of (a) approximately $11.7 billion of sub-prime related exposures in its lending and structuring business, and (b) approximately $43 billion of exposures in the most senior tranches (super senior tranches) of collateralized debt obligations which are collateralized by asset-backed securities (ABS CDOs).54

48. Citigroup also announced that Charles Prince, its Chairman of the Board and

CEO, had elected to retire.55

49. Following the company’s press release, but before markets opened on Monday,

November 5, 2007, Fitch Ratings downgraded Citigroup’s Long-term Issuer Default Rating

(IDR) to “AA” from “AA+” and its Rating Outlook was Negative.56

50. On Monday, November 5, 2007, Citigroup’s stock price declined 4.85%, closing

at $35.90 per share, $1.83 per share below its previous closing price of $37.73 per share.

Citigroup’s reported volume was 230.2 million shares, 7.2 times the average daily volume of

53 “Citi’s Sub-Prime Related Exposure in Securities and Banking,” Business Wire, November 4, 2007, 6:38 pm.

54 “Citi’s Sub-Prime Related Exposure in Securities and Banking,” Business Wire, November 4, 2007, 6:38 pm.

55 “Robert E. Rubin to Serve as Chairman of the Board of Citi,” Business Wire, November 4, 2007, 6:38 pm.

56 “Fitch Downgrades Citigroup to ‘AA’; Outlook Negative,” Fitch Investment Research, November 5, 2007, 4:59 am.


20

32.0 million shares from the start of the Class Period through November 2, 2007. Citigroup’s

excess return (net of market and industry effects) was -4.13%. The t-statistic is -2.85, significant

at the 99% confidence level.

51. News and analyst reports on Monday, November 5, 2007 expressed surprise over

the $55 billion in sub-prime mortgage exposure, which was “… more than four times the $13

billion it indicated on a conference call with analysts just three weeks ago….”57 Analysts cut

Citigroup’s price targets58 and analysts commented:

CEO Chuck Price is stepping down, prompted by an estimated $8-$11 billion in additional subprime/CDO-related losses. This is materially higher than our expectation, and reflects previously undisclosed subprime CDO exposures of $43 billion for a total of $55 billion - much higher than the prior disclosed $13 billion.59

Expect initial stock reaction to be negative as the $55 bill size of the S&B subprime exposure is far larger than the $25 bill we had estimated or the $13 bill many investors expected.60

While the change in mgmt is likely to receive a positive reaction, the size of the marks (and more significantly the size of Citi’s CDO exposure itself) was beyond market expectations.61

6. November 6, 2007

52. On Monday, November 5, 2007, after the market closed, Moody’s downgraded

the long term ratings of Citigroup and lowered the Bank Financial Strength Rating (BFSR) of

57 “Citigroup, Having Failed To Hedge, May Face More Writedowns,” Dow Jones News

Service, November 5, 2007, 6:11 pm. 58 “Citigroup Falls as Analysts Reduce Targets After Prince Quits,” Bloomberg News,

November 5, 2007, 12:41 pm. 59 “Downgrade to Accumulate,” The Buckingham Research Group Analyst Report,

November 5, 2007. 60 “CDO Losses Way Above Estimate with More Possible; Sell into Any CEO Chg

Rally,” Morgan Stanley Analyst Report, November 5, 2007. 61 “Mixed Bag as Citi Faces the Music,” Bank of America Analyst Report, November 5,

2007.


21

Citibank.62 The outlook on the long term debt ratings of Citigroup was changed to negative from

stable and Moody’s placed the BFSR under review for possible downgrade. Moody’s stated:

[its] actions follow the disclosure by Citigroup that it has a direct sub-prime mortgage exposure of $55 billion in its investment banking operations, including a $43 billion exposure to senior tranches of collateralized debt obligations (CDOs). Citigroup estimates that this exposure would result in a decline in revenue ranging from $8 billion to $11 billion. If taken, such a decline would result in a sizable quarterly loss for Citigroup.

The action also follows the announcement that Citigroup’s CEO, Charles Prince, has resigned, with Robert Rubin becoming interim Chairman and Sir Win Bischoff Acting CEO. This interim management solution illustrates the company's limited progress with succession planning. The board and management now face a major governance challenge at a very difficult time. The latest disclosures about sub-prime-related losses continue to suggest problems with management’s reporting to the board on risk controls, and underscore concerns about board oversight over Citigroup’s operational strategy.63

53. On Tuesday, November 6, 2007, Bank of America analyst, John McDonald, cut

his rating to “Neutral” from “Buy” and cut his price target to $39 from $45 per share. The

Associated Press reported, before the market opened that:

McDonald said he downgraded the Dow Jones industrial average component because the relatively low price of the shares no longer balances out the risk in owning the stock. “We no longer view valuation as a reason to recommend the stock, due to eroding confidence in earnings and book value,” he said in a note to clients. “Also, we have decreased confidence in positive catalysts, including leverage to rate cuts, cost savings, and management change.” ...McDonald said there are “lingering” risks that Citi will have to mark down more of its approximately $55 billion

62 “Moody’s downgrades Citigroup’s ratings (Snr to Aa2 from Aa1),” Moody’s Investor,

November 5, 2007, 4:00 pm. 63 “Moody’s downgrades Citigroup’s ratings (Snr to Aa2 from Aa1),” Moody’s Investor,

November 5, 2007, 4:00 pm.


22

exposure. He also pointed to concerns about credit deterioration in both international and domestic consumer businesses.64

54. On Tuesday, November 6, 2007, BusinessWeek reported that: “Some investors

believe Citi could be forced to take more writedowns, if the prices of collateralized debt

obligations continue to fall. ‘We estimate that Citi has written down about one quarter of its

CDO…exposure, which might not be enough,’ says analyst Mike Mayo of Deutsche Bank (DB).

‘Information risk is huge because we don’t know where the $55 billion of exposure has been

written down,’ he adds.” 65

55. On November 6, 2007, Bloomberg News reported before the market opened that

Citigroup had:

… named Richard Stuckey to manage most of its $43 billion of subprime mortgage assets, choosing the same executive who nine years ago helped unwind Long-Term Capital Management LP’s bad bets.

Stuckey, 51, will run the Sub-Prime Portfolio Group, created after the largest U.S. bank by assets said Nov. 4 that it will write down as much as $11 billion of subprime debt and Chief Executive Officer Charles Prince resigned. Stuckey will oversee most of the bank’s securities linked to homeowners with poor credit, according to a memo sent to employees and confirmed by Citigroup spokesman Dan Noonan.66

56. An article in Bloomberg News before the market opened on Tuesday, November

6, 2007 also commented that it “defie[d] belief” that all of Citigroup’s $8 to $11 billion decline

in value of its subprime-related assets occurred after September 30, 2007, stating:

64 “Banc of America lowers rating on Citigroup, citing concerns about risk of further

writedowns,” Associated Press Newswires, November 6, 2007, 8:34 am. 65 “Citi’s Leadership Challenge,” BusinessWeek, November 6, 2007, 12:01 am. 66 “Citigroup Names Stuckey to Run Subprime Group After Writedowns,” Bloomberg

News, November 6, 2007, 12:05 am.


23

It’s as if we’re supposed to believe that all this stuff at Citigroup happened after September ended, notwithstanding the $8.4 billion of bad subprime mortgage stuff at Merrill Lynch & Co. that happened before September ended. And we’re also supposed to believe Citigroup’s brass didn’t have a clue any sooner…. In other words: We did nothing wrong. There is no reason to question the $2.21 billion of net income Citigroup reported for the third quarter, down a mere 60 percent from a year earlier. (Citigroup also lowered its third-quarter earnings from the $2.38 billion it originally announced Oct. 15.) Fairly presented in all material respects, the saying goes.67

57. Also on Tuesday, November 6, 2007, Bloomberg News reported before the

market opened that Citigroup disclosed in an SEC filing the previous day that it had “…

provided $7.6 billion of emergency financing to the seven structured investment vehicles it runs

after the SIVs struggled to repay maturing debt.”68

58. On November 6, 2007, Citigroup’s stock price declined 2.28%, closing at $35.08

per share, $0.82 per share below its previous closing price of $35.90 per share. Citigroup’s

reported volume was 151.7 million shares, 4.6 times the average daily volume of 33.0 million

shares from the start of the Class Period through November 5, 2007. Citigroup’s excess return

(net of market and industry effects) was -4.63%. The t-statistic is -3.20, significant at the 99%

confidence level.

59. After the market closed on Tuesday, November 6, 2007, a Dow Jones Business

News article discussed Citigroup’s stock price decline:

Citigroup Inc. (C) saw its shares move down 2.3% amid reports that the same executive who steered its role in the rescue of collapsed hedge fund Long-Term Capital Management has been tapped to run a new dedicated subprime unit. Citi’s shares were

67 “Citigroup’s Subprime Explanation Defies Belief: Jonathan Weil,” Bloomberg News,

November 6, 2007, 12:12 am. 68 “Citigroup SIVs Have Drawn on $7.6 Billion of Liquidity Lines,” Bloomberg News,

November 6, 2007, 9:01 am.


24

also downgraded to neutral from buy by Bank of America Securities analysts, who cited “eroding confidence in earnings and book value.”69

7. November 27, 2007

60. On Monday, November 26, 2007, after the market closed, Citigroup announced

that the Abu Dhabi Investment Authority would invest $7.5 billion for a 4.9% stake in

Citigroup.70 Analyst comments about the news were mixed, but included lower EPS estimates

(reflecting the cost of the new equity and on-going concerns about credit losses) and some

questions about the sustainability of its dividend:

Citigroup’s issuance of $7.5B of new equity to Abu Dhabi provides an extra capital cushion but probably not enough for it to meet its capital targets while absorbing upcoming problems. To reflect the cost of the new equity and on-going concerns about credit losses (in additional to likely write downs in 4Q07 related to subprime structured products), we’re lowering our 2008 estimate by 10 cents to $3.70 and our price target from $29 to $27. Maintain Sell.71

Abu Dhabi Investment Advisors’ (ADIA) $7.5 billion investment in Citi shores up its capital base and reduces investment risk in C. However, the capital injection does not change our outlook for C’s earnings or the stock. We expect EPS is more likely to decline than to increase given its exposure to deteriorating US consumers and declining growth in its investment bank.72

…the move should be dilutive to EPS (because of the increase in dilutive shares and to a lesser extent, higher funding costs mitigated by potentially more assets on the balance sheet). Moreover, the move may raise questions as to the sustainability of

69 “MARKET SNAPSHOT: U.S. Stocks Close Ahead As Crude Scales New Highs,”

Dow Jones Business News, November 6, 2007, 4:20 pm. 70 “Citi to Sell $7.5 Billion of Equity Units to the Abu Dhabi,” Business Wire, November

26, 2007, 9:39 pm. 71 “Sacrificing Earnings for the Balance Sheet,” Deutsche Bank Analyst Report,

November 27, 2007. 72 “ADIA Stake Reduces (But Does Not Eliminate) Investment Risk in C, EPS Outlook

Still Tough,” Morgan Stanley Analyst Report, November 27, 2007.


25

the dividend if, on the one hand, it pays out about $11B in dividends per year, and on the other hand, is raising capital.73

…C’s willingness to raise significant capital despite substantial share price declines makes us hesitant to accept this solves C’s capital issues.74

Deal buys Citi time & helps shore up tough capital situation but doesn’t make the issues go away.75

61. Bloomberg News reported mid-day on Tuesday, November 27, 2007 that:

“Merrill Lynch & Co., Citigroup Inc. and other banks that underwrote collateralized debt

obligations linked to U.S. mortgages may end up reporting $77 billion of losses on their

holdings, half of which they have already recognized, according to JPMorgan Chase & Co.76

62. On Tuesday, November 27, 2007, Citigroup’s stock price declined 1.24%, closing

at $30.32 per share, $0.38 per share below its previous closing price of $30.70 per share.77 On

this same day, the market return was 1.50% and the industry return was 2.83%, so that

Citigroup’s negative 1.24% gross return translated to a negative 4.17% excess return.


38.4 million shares from the start of the Class Period through November 26, 2007. Citigroup’s

73 “Move toward stability at a cost,” Deutsche Bank Analyst Report, November 27, 2007. 74 “First Look at Capital Infusion,” Sandler O’Neill Partners Company Note, November

27, 2007. 75 “Glass Half Empty, or Half Full?” UBS Investment Research Report, November 27,

2007. 76 “CDO Losses May Double at Merrill, Other Banks, JPMorgan Says,” Bloomberg

News, November 27, 2007, 12:51 pm. 77 I note that some news stories on November 27, 2007 reported that Citigroup’s stock

price increased. For example, see “Citigroup and Financials Lead Market Rebound,” Briefing.com, November 27, 2007, 4:36 pm. One news story reported that it appeared the exchanges put out a revised closing price for Citigroup on November 26, 2007 of $29.80. See “Citigroup-C: Revised Close Price [MORE],” TheFlyontheWall.com, November 27, 2007, 10:38 am.


26


at the 99% confidence level.78

8. December 12, 2007

63. Before the market opened on Wednesday, December 12, 2007, Bloomberg News

reported on analyst comments that Citigroup may have to cut its dividend, warning of further

stock-price declines and urging investors to “short” Citigroup shares because earnings will

continue to weaken:

CIBC analyst Meredith Whitney and Betsy Graseck, her counterpart at Morgan Stanley, said they expect the biggest U.S. bank to lower its dividend from the current 54 cents a share. “We are pitching Citi as our top short idea for 2008,” wrote Graseck. “We don’t believe the stock has bottomed out.”79

64. On Wednesday, December 12, 2007, Citigroup’s stock price declined 5.30%,

closing at $31.47 per share, $1.76 per share below its previous closing price of $33.23 per share.


40.8 million shares from the start of the Class Period through December 11, 2007. Citigroup’s


at the 99% confidence level.

78 I note that using closing stock prices from the NYSE, Citigroup’s stock price increased

$0.52 from $29.80 on November 26, 2007 to $30.32 on November 27, 2007. But, I use the U.S. composite closing stock prices in my analysis (obtained from Bloomberg), which results in Citigroup’s stock price declining $0.38 from $30.70 on November 26, 2007 to $30.32 on November 27, 2007. If I were to use the NYSE closing prices on November 26, 2007 and November 27, 2007, Citigroup’s stock price return on November 27, 2007 was 1.74% and its excess return would be -0.99%, which would not be statistically significant at the 95% level.

79 “Citigroup May Cut Dividend, Shares May Fall, Morgan, CIBC Say,” Bloomberg News, December 12, 2007, 9:06 am.


27

65. After the market closed on Wednesday, December 12, 2007, Reuters News

reported that:

Vikram Pandit, Citigroup’s new chief executive, is likely to seek to cut the giant bank’s dividend to preserve capital, analysts and investors said on Wednesday. …Concern about the difficulties facing Pandit contributed to a 5.5 percent decline in the bank’s shares on Wednesday to $31.47.80

9. January 16, 2008

66. Before the market opened on Tuesday, January 15, 2008, Citigroup reported its

fourth quarter and fiscal year 2007 results, which included $18.1 billion in pre-tax write-downs

and credit costs on sub-prime related direct exposures in fixed income markets, and a $4.1 billion

increase in credit costs in U.S. consumer primarily related to higher current and estimated losses

on consumer loans.81 Citigroup further stated it took write-downs of $17.4 billion on sub-prime

related direct exposures and that these exposures as of September 30, 2007 and December 31,

2007 were comprised of: gross lending and structuring, $11.7 billion (September) and $8.0

billion (December); net ABS CDO super senior exposures, $42.9 billion (September) and $29.3

billion (December); and gross ABS CDO super senior exposures, $53.4 billion (September) and

$39.8 billion (December).82 Citigroup also announced a series of financial actions to strengthen

its capital base.83 Citigroup’s stock price declined on Tuesday, January 15, 2008.84 After

80 “ANALYSIS-Pandit likely to seek to cut Citi’s dividend,” Reuters News, December

12, 2007, 5:43 pm. 81 “Citi Reports Fourth Quarter Net Loss of $9.83 Billion, Loss Per Share of $1.99,”

Business Wire, January 15, 2008, 6:30 am. 82 “Citi Reports Fourth Quarter Net Loss of $9.83 Billion, Loss Per Share of $1.99,”

Business Wire, January 15, 2008, 6:30 am. 83 “Citi Announces Key Actions to Enhance Capital Base,” Business Wire, January 15,

2008, 6:31 am. 84 On Tuesday, January 15, 2008, Citigroup’s stock price declined 7.30%, closing at

$26.94 per share, $2.12 per share below its previous closing price of $29.06 per share.


28

Citigroup’s information released on Tuesday, January 15, 2008, Reuters News reported on

Wednesday, January 16, 2008 before the market opened that: “At least four brokerages [Sanford

C. Bernstein, Punk Ziegel, UBS and Deutsche Bank] cut their 2008 earnings forecast for

Citigroup ….”85 Reuters News further reported:

Deutsche Bank cut its price target on the stock to $25 from $27, while UBS lowered its target to $29 from $30. Citi’s loss raises issues as it relates to accelerating problems in cards, mortgage, and U.S. consumer, Deutsche Bank analyst Mike Mayo, who maintained a “sell” rating, said in a note to clients. UBS analyst Glenn Schorr maintained a “neutral” rating citing Citi’s sizable exposures across the credit spectrum and the fact that the operating environment continues to weaken on both the consumer and capital markets sides of the business. Analyst Howard Mason of Sanford C. Bernstein said he lowered his 2008 earnings estimate for Citigroup to reflect higher loss rates on U.S. consumer loans in 2008 and 2009 and lower core net interest margin due to the interest expense on issuing preferred capital.86

67. Other analyst comments on Wednesday, January 16, 2008 included further

concerns about credit losses at Citigroup:

We remain Underweight the credit since we don’t believe the market has really factored in the current economic cycle and the reserve build that might be required in this environment. The capital raise and dividend cut are positive, in our view, but not likely enough to offset the weakness in credit quality.87

Citigroup’s reported volume was 220.9 million shares, 5.0 times the average daily volume of 44.6 million shares from the start of the Class Period through January 14, 2008. Citigroup’s excess return (net of market and industry effects) was -3.01%. The t-statistic is -2.08, significant at the 95% confidence level.

85 “UPDATE 2-Brokerages cut Citigroup 2008 share view,” Reuters News, January 16, 2008, 6:58 am.

86 “UPDATE 2-Brokerages cut Citigroup 2008 share view,” Reuters News, January 16, 2008, 6:58 am.

87 “Basic credit quality weakness offsets capital injections; Remain Underweight,” JP Morgan Analyst Report, January 16, 2008.


29

The most disturbing trend in the fourth quarter results, in our opinion, was the rapid rise in consumer losses.88

68. On Wednesday, January 16, 2008, Citigroup’s stock price declined 2.60%,

closing at $26.24 per share, $0.70 per share below its previous closing price of $26.94 per share.


45.4 million shares from the start of the Class Period through January 15, 2008. Citigroup’s

excess return (net of market and industry effects) was -4.53% and its t-statistic was -3.13,

significant at the 99% confidence level.

69. After the market closed on Wednesday, January 16, 2008, the Associated Press

discussed Citigroup’s stock price decline as follows:

Citigroup Inc.'s stock continued to sink Wednesday a day after the bank reported a loss of nearly $10 billion for the fourth quarter…. Goldman Sachs analyst William F. Tanona said even after Citigroup cut its dividend by 40 percent and sold a $12.5 billion stake in itself to a litany of investors, “we still do not believe the company is completely out of the woods yet.” Citigroup still has $37 billion in exposure to subprime debt and $43 billion in exposure to structured investment vehicles and leveraged loans, he said. “With consumer credit quality deteriorating rapidly in the U.S., we believe the firm will face additional headwinds in upcoming quarters, which should further dampen upcoming results,” he said.89

10. March 17, 2008

70. On Monday, March 17, 2008, before the market opened, Dow Jones Business

News reported that “J. P. Morgan Chase & Co. said Sunday evening that it is buying battered

broker Bear Stearns Cos. for $236 million in a Federal Reserve-backed bailout unprecedented in

88 “Citigroup Shakes Global Money Tree For Spare Change To Shore Up Capital Base,”

Oppenheimer Analyst Report, January 16, 2008. 89 “Loss of nearly $10 billion continues to sink Citi’s stock as worries about future

persist,” Associated Press Newswires, January 16, 2008, 6:37 pm.


30

scope and execution…. The deal offers Bear investors $2 a share, a massive discount to the

firm’s closing price of $30 on Friday.”90

71. Also before the market opened on March 17, 2008, Bloomberg News reported

that “[b]anks and brokerages may fall by half because Bear Stearns Cos.’s sale to JPMorgan

Chase & Co. for $2 a share will create a ‘major negative revaluation’ of financial shares,

Oppenheimer & Co.’s Meredith Whitney said.”91

72. During the morning of March 17, 2008, Oppenheimer & Co. analyst Meredith

Whitney gave a Bloomberg TV interview.92 Bloomberg News reported that: “Large U.S. banks

including Citigroup Inc. and Wachovia Corp. may tumble as much as 50 percent because of

more loan losses and writedowns of securities, Oppenheimer & Co. analyst Meredith Whitney

said in a Bloomberg TV interview today.”93

73. Reuters News also reported during mid-day that, in morning trading on Monday,

March 17, 2008: “…Citigroup shares fell as much as 9.1 percent as investors worried that the

collapse of Bear Stearns Cos …could foreshadow more credit and liquidity problems at other

financial services companies.”94

90 “UPDATE: J.P. Morgan To Buy Bear Stearns For $2 A Share,” Dow Jones Business

News, March 17, 2008, 5:18 am. 91 “Brokerage Stocks May Drop 50% More, Oppenheimer's Whitney Says,” Bloomberg

News, March 17, 2008, 7:13 am. 92 “Meredith Whitney Says Citigroup, Wachovia Are Overvalued: Video,” Bloomberg

News, March 17, 2008, 11:07 am. 93 “WaMu, National City Plunge as Buyout Prospects Fade (Update5),” Bloomberg

News, March 17, 2008, 5:27 pm. A news headline earlier in the day stated “Meredith Whitney Says Citigroup, Wachovia Are Overvalued: Video,” Bloomberg News, March 17, 2008, 11:07 am.

94 “Wells Fargo passes Citigroup in market value,” Reuters News, March 17, 2008, 1:21 pm.


31

74. Also on March 17, 2008, BusinessWeek reported that an Edward Jones analyst

estimated that: “Citigroup is likely to take additional writedowns totaling $9.3 billion, with $5.9

billion related to CDOs, $2.2 billion to CMBS, and $1.2 billion to leveraged loans.”95

75. On March 17, 2008, Citigroup’s stock price declined 5.86%, closing at $18.62 per

share, $1.16 per share below its previous closing price of $19.78 per share. Citigroup’s reported

volume was 181.6 million shares, 3.3 times the average daily volume of 55.7 million shares from

the start of the Class Period through March 14, 2008. Citigroup’s excess return (net of market

and industry effects) was -4.43% and its t-statistic is -2.63, significant at the 99% confidence

level.

76. After the market close on March 17, 2008, Bloomberg News reported that: “Large

banks and brokerages plunged after JPMorgan Chase & Co. (JPM US) agreed to buy Bear

Stearns Cos. (BSC US) for less than a 10th of the bank’s value and UBS AG downgraded U.S.

financial shares on concern liquidity problems may worsen.”96

77. Because of the association between the large stock price excess returns and the

value implications of the economic news about Citigroup released at the same time, I conclude

that these results support a finding of market efficiency for Citigroup common stock over the

Class Period.

95 “A Red Flag for Bank Liquidity,” BusinessWeek, March 17, 2008, 12:01 am. 96 “Ashland, CSX, ExpressJet, Lehman, Rite Aid: U.S. Equity Movers,” Bloomberg

News, March 17, 2008, 4:42 pm. I also note that, before the market opened on March 17, 2008, Bloomberg News also reported that “Banks and brokerages plunged after JPMorgan Chase & Co. agreed to buy Bear Stearns Cos. (BSC US) for less than a 10th of the bank’s value and UBS AG downgraded U.S. financial shares on concern liquidity problems may worsen.” (“Citigroup, Goldman, McDonald’s, Radian: U.S. Equity Preview,” Bloomberg News, March 17, 2008, 7:48 am.)


32

b) Speed of Price Reaction to New Information

78. Perhaps the most basic hallmark of market efficiency is prompt incorporation of

the effects of new information in stock prices through trading activity in the market.97 To test

this, I first select all trading days in which the t-statistic of the excess return is at least 2.58,

indicating a 99% confidence level for daily statistical significance.98

79. It is well known that large stock price returns and news events are highly

correlated, so I assume for Citigroup that the big-return days are also big-news days.99 For my

purposes, it matters not exactly what is the news other than it has caused a positive or negative

excess return that is significant at the 99% confidence level. After identifying these high return

days, I check to see how long it takes for Citigroup’s trading market to fully adjust to these pre-

selected big-news days.

97 Professor Eugene Fama wrote: “The typical result in event studies on daily data is that,

on average, stock prices seem to adjust within a day to event announcements. The result is so common that this work now devotes little space to market efficiency. The fact that quick adjustment is consistent with efficiency is noted, and then the studies move on to other issues. In short, in the only empirical work where the joint hypothesis problem is relatively unimportant, the evidence typically says that, with respect to firm-specific events, the adjustment of stock prices to new information is efficient.” See Eugene F. Fama, “Efficient Capital Markets: II,” TheJournal of Finance 46, 1575-1617, December 1991, pp. 1601-1602.

98 I note here that there is published scholarly research that also performs an event study and starts with “…major stock price and trading volume movements and then explore[s] directly for those economically significant information events driving such movements.” See Paul Ryan and Richard J. Taffler, “Are Economically Significant Stock Returns and Trading Volumes Driven by Firm-Specific News Releases?” Journal of Business Finance & Accounting, 31(1) & (2), January/March 2004, 49-82, p. 50. Another study focused on stock price movements as a “… sufficient statistic for information events.” See Jennifer Conrad, Bradford Cornell, Wayne R. Landsman, and Brian R. Rountree, “How Do Analyst Recommendations Respond to Major News?” Journal of Financial and Quantitative Analysis 41(1), March 2006, 25-49, p. 25.

99 See footnote 98. See also Eugene F. Fama, “Efficient Capital Markets: II,” Journal of Finance 46(1), December 1991, 1575-1617; and Eugene F. Fama, Lawrence Fisher, Michael C. Jensen and Richard Roll, “The Adjustment of Stock Prices to New Information,” InternationalEconomic Review 10(1), February 1969, 1-21.


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80. Exhibit 6 indicates there were 7 trading days during the Class Period for Citigroup

common stock with excess returns that were statistically significant at the 99% confidence level

(“big-return days”), included in the 10 trading days discussed above. As described in the

previous section, there are disclosures of economically material information by my review that is

consistent with the sign and size of the stock’s excess return.

81. I also examined the excess stock return the day after the 7 big-return days with

news and find that 2 had excess returns that are significant at the 95% confidence level. On

these days, news stories or analyst reports continue to be released, generally reflecting

commentary by market participants that is consistent with the sign and size of the stock’s excess

return.100 By the next day, however, none had significant stock returns at the 95% level of

significance. This test shows that the new information causing large stock returns was generally

impounded into the stock price within one day for Citigroup common stock, which supports the

hypothesis that Citigroup’s trading market was semi-strong form efficient. See Exhibit 6.

100 The big-return days followed by another statistically significant return day are

November 5-6, 2007 and March 17-18, 2008. November 5 and 6, 2007 and March 17, 2008 are discussed in the prior section. On March 18, 2008, Citigroup’s stock price increased as it was reported that: (i) analysts at Morgan Stanley said U.S. financial stocks are getting closer to “bottoming out” and trimmed their sell positions in Citigroup Inc. and National City Corp. (“Morgan Stanley Says Financial Stocks Close to ‘Bottoming Out,’” Bloomberg News, March 18, 2008, 5:58 am); and (ii) securities firm shares rebounded after Lehman Brothers and Goldman Sachs reported first-quarter profit that beat analyst estimates and other financial shares gained after the Federal Reserve lowered the U.S. benchmark interest rate three-quarters percentage point to 2.25 percent to reinvigorate bank lending and keep the economy out of recession (“Allscripts, Getty Realty, MF, NYSE, Sunrise: U.S. Equity Movers,” Bloomberg News, March 18, 2008, 4:51 pm). On Tuesday, March 18, 2008, Citigroup’s stock price rose 11.22%, closing at $20.71 per share, $2.09 per share above its previous closing price of $18.62 per share. Citigroup’s reported volume was 152.4 million shares, 2.7 times the average daily volume of 56.1 million shares from the start of the Class Period through March 17, 2008. Citigroup’s excess return (net of market and industry effects) was 3.72% and its t-statistic was 2.21, significant at the 95% confidence level.


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c) Correlation of Absolute Stock Returns with Trading Volume

82. Next, I check for a cause-and-effect relationship between information and stock

returns consistent with market efficiency by regressing Citigroup’s daily absolute stock-price

returns against its daily trading volume over the Class Period.101 Since 1970, economists have

published studies of the empirical correlation between absolute stock returns and volume for

stocks and other securities traded in the U.S. and elsewhere.102 A strong, direct relationship is

the widespread finding, and this evidence is generally interpreted as exhibiting that both volume

and stock-price changes have common ties to the flow of new information about the security.

The stock-price adjustment reflects the overall average change in prices to material new

information, while the volume reflects changes in expectations of individual traders. Thus, new

material information that causes differing valuation views among investors for a given security

will generally also cause greater than normal trading volume.

83. By definition, material value-relevant news causes significant stock-price changes

(either up for positive news or down for negative news). But, it is also natural that the greater is

a particular day’s stock-price change, the greater will be the cross-sectional variation in the

101 An “absolute return” means that each negative return is transformed into a positive

return (i.e., only the magnitude but not the direction of the return is considered). 102 For a survey of the literature see, Jonathan M. Karpoff, “The Relation between Price

Changes and Trading Volume: A Survey,” Journal of Financial and Quantitative Analysis 22(1), March 1987, 109-126. Also, see R. L. Crouch, “A Nonlinear Test of the Random-Walk Hypothesis,” American Economic Review 60, March 1970, 199-202; Thomas W. Epps and Mary Lee Epps, “The Stochastic Dependence of Security Price Changes and Transaction Volumes: Implications for the Mixture-of-Distributions Hypothesis,” Econometrica 44(2), March 1976, 305-321; Lawrence Harris, “Cross-Security Tests of the Mixture of Distributions Hypothesis,” Journal of Financial and Quantitative Analysis 21(1), March 1986, 39-46; Lawrence Harris, “Transaction Data Tests of the Mixture of Distributions Hypothesis,” Journal of Financial and Quantitative Analysis 22(2), June 1987, 127-141; and Randolph Westerfield, “The Distribution of Common Stock Price Changes: An Application of Transactions Time and Subordinated Stochastic Models,” Journal of Financial and Quantitative Analysis 12(5), December 1977, 743-765.


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valuation of individual investors who are reacting to that day’s news. That is, big-news days will

also correspond with greater-than-normal differences among individual investors about their

expectations about the exact value implications of that day’s material news.

84. Thus, I check for this volume-absolute return relationship using both Citigroup’s

absolute stock returns and absolute excess stock returns, both regressed on (the natural log of)

Citigroup’s trading volume on a daily basis over the Class Period. These two regressions are

presented in Exhibit 7.

85. In both regressions, I find a strong, positive relationship between daily volume

and the absolute value of Citigroup’s stock price returns. The t-statistics of 12.01 (daily returns

and volume) and 13.77 (daily excess returns and volume) indicate that these two estimated

coefficients are positive at a statistical confidence level in excess of 99%. This evidence

supports a finding of market efficiency, in my opinion, because it reflects a very active trading

market for Citigroup’s stock in which new information that affects Citigroup’s stock value

causes the simultaneous generation of trading volume as the market of individual investors reacts

to this information.

B. Other Indicia of Market Efficiency

i) Market Capitalization

86. A large market capitalization and/or large public float are indicators of market

efficiency because there is a greater incentive for investors to collect and analyze information

about large corporations.103 Citigroup’s market capitalization ranged from approximately $96.9

billion to $273.0 billion during the Class Period (see Exhibit 3). Excluding the holdings of

affiliates, the range of the market capitalization of Citigroup’s public float was $96.5 billion to

103 See Cheney v. CyberGuard Corp., 213 F.R.D. 484 at 501.


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$271.6 billion (see Exhibit 3). Citigroup’s large market capitalization and public float support a

finding that Citigroup common stock traded in an informationally efficient market during the

Class Period.

ii) Bid-Ask Spread

87. Bid-ask spreads are one component of the cost of trading financial securities.

Courts have used excessive bid-ask spreads as an indication of a less efficient market because

large spreads can make transactions in the security prohibitively expensive. For example, in

Krogman v. Sterritt, the court found that a bid-ask spread “…of 5.6% was extremely high,

suggesting market inefficiency.”104 Whereas in CyberGuard, that court found that a bid-ask

spread of 2.44% “…weighs in favor of market efficiency ....”105

88. As a benchmark, I conducted an empirical study of bid-ask spreads over the entire

Class Period representing 2,784 securities listed on the NYSE. I found the average spread for

these NYSE firms was 0.26%.106 By comparison, the average bid-ask spread for Citigroup

common stock during the Class Period was 0.06% (see Exhibit 3), which is consistent with

104 See Cheney v. CyberGuard Corp., 213 F.R.D. 484 at 501, (citing Krogman v. Sterritt,

202 F.R.D. 467, 474 (N.D. Tex. 2001)). 105 See Cheney v. CyberGuard Corp., 213 F.R.D. 484 at 501. 106 I calculated the average bid-ask spread for all NYSE listed firms (exchange code equal

to 1) using closing bid and closing ask prices obtained from the University of Chicago’s Center for Research in Security Prices (“CRSP”) database. I excluded observations for the following reasons: non-active (trade status not equal to A); ask price less than or equal to the bid price; ask price that was more than $5 greater than the bid price; missing bid price, ask price, closing price or shares outstanding. The daily bid-ask spread for each security (based on CUSIP) was calculated over the Class Period as the ask price less the bid price, all divided by the average of the bid and ask prices. From this, I then calculated each security’s average daily bid-ask spread (excluding those securities with less than 100 observations). Finally, I calculated the average across securities of each security’s average daily bid-ask spread (excluding Citigroup). I also calculated the average bid-ask spread for securities with average market caps similar to that of Citigroup’s $205 billion during the Class Period. For companies with average market caps of between $50 billion - $500 billion (53 securities), the average bid-ask spread was 0.07 % over the Class Period.


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spreads typically found on the NYSE, and considerably below the threshold used in

CyberGuard.107 An average bid-ask spread of 0.06% would not be a significant deterrent to

arbitrage activity in Citigroup common stock and supports the conclusion that Citigroup common

stock traded in an informationally efficient market during the Class Period.

iii) Statistical Test for Weak-Form Market Efficiency

89. I also conducted statistical tests to determine whether the returns for Citigroup

common stock exhibited autocorrelation (which is also referred to as “serial correlation”).108

Autocorrelation in a stock’s returns means that tomorrow’s stock price movement can be

predicted with a degree of statistical confidence based solely on the price movement today.

Market efficiency requires that all public information, including today’s stock returns, be

impounded in tomorrow’s stock price so that there are no such arbitrage opportunities available

based on public information.109 Conversely, the presence of autocorrelation implies that an

investor might have an unexploited arbitrage opportunity greater than trading costs. For

example, negative autocorrelation means that if the stock price goes down today, it will likely go

up tomorrow. The ability to successfully predict the movement in a stock price tomorrow based

107 0.06% is the under the 2nd percentile (i.e., approximately 98% of NYSE stocks had a

higher average bid-ask spread. 108 Autocorrelation has been widely studied in the financial economics literature and

accepted by the courts. For example, see Burton G. Malkiel, “efficient market hypothesis,” in The New Palgrave: A Dictionary of Economics, vol. 2, E to J, ed. by John Eatwell, Murray Milgate and Peter Newman, Macmillan., 1998, pp. 120-123; see also Lehocky, 220 F.R.D. at 506; In re Polymedica Corp. Sec. Litig.,, 453 F. Supp. 2d at 276-77. “The term ‘random walk’ is usually used loosely in the finance literature to characterize a price series where all subsequent price changes represent random departures from previous prices. Thus, changes in price will be unrelated to past price changes.” (Malkiel, p. 120).

109 Weak form tests of the efficient market hypothesis are tests of whether information contained in historic prices is fully reflected in current prices, thus an analysis of autocorrelation is a test of weak form market efficiency. Weak form efficiency is a necessary condition for semi-strong form efficiency because semi-strong efficiency encompasses all public information, including past prices.


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on what it did today would allow any investor to earn abnormal returns based on this pattern,

absent transaction costs. If the arbitrage opportunity is statistically significant, but unprofitable

given positive trading costs, then the serial correlation would not be economically significant.

Economists have long used the first-order autocorrelation of a stock’s returns to check for

potential market inefficiency.110 Courts have acknowledged that “…if there is a serial

correlation in the stock prices, it lends to a finding of market inefficiency.”111

90. To test for autocorrelation, I first performed a regression analysis of Citigroup’s

daily common stock returns on the return from the previous day over the Class Period. I found

no significant autocorrelation for Citigroup’s raw returns, but significant autocorrelation (at the

95% confidence level) for the excess returns.112 See Exhibit 8, Panel A. Autocorrelation can be

induced due to new information affecting stock prices over consecutive days. In order to test

whether new information on consecutive days was potentially causing the statistical finding of

autocorrelation in the excess returns, I re-ran the regressions while excluding data related to the

observations where there were consecutive excess returns statistically significant at the 99%

confidence level, November 5-6, 2007.113 After removing these three observations, I found no

statistically significant autocorrelation in either the raw return or the excess return regression.114

110 For example, see Eugene F. Fama, “Efficient Capital Markets: II,” Journal of Finance

46(5), December 1991, 1575-1617. See also, John Y. Campbell, Andrew W. Lo and A. Craig MacKinlay, The Econometrics of Financial Markets, Princeton University Press, 1997, p. 44.

111 See Lehocky v. Tidel, 220 F.R.D. 491, 506-07 (S.D. Tex. 2001); see also In re Polymedica Corp. Sec. Litig., 453 F. Supp. 2d 260, 277 (D. Mass. 2006).

112 The coefficient for Citigroup’s stock return from the previous day over the Class Period is 0.079 with a t-statistic of 1.39, which is not significant at the 95% confidence level. The coefficient for Citigroup’s excess return from the previous day over the Class Period is 0.126 with a t-statistic of 2.22, which is statistically significant at the 95% confidence level. See Exhibit 8, Panel A.

113 I thus removed data for November 5, 6 and 7, 2007. 114 The coefficient for Citigroup’s stock return from the previous day over the Class


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See Exhibit 8, Panel B. These results are consistent with a random walk and market efficiency,

and support my opinion that Citigroup’s stock returns during the Class Period did not violate

market efficiency.115

iv) Institutional Investors

91. Another indication of market efficiency is the presence in the market of many

institutional investors, arbitrageurs, and other professional full-time investors. Such investors are

generally considered to be sophisticated investors who attempt to profit from trading mispriced

securities. If the price of a security is too low, arbitrageurs can profit simply by purchasing the

security and holding until it appreciates. If the price is too high, however, the arbitrageur can sell

its holdings, or perhaps even “short” the stock (i.e., sell a stock that the arbitrageur does not

own).

92. Generally, institutional investors have significant experience in evaluating

investments and assessing the effect of new information on future prospects of a traded

company’s stock. The following studies comment on the use of institutional holdings as a proxy

for market efficiency. Bernard, Botosan and Phillips state: “...the [market] inefficiencies appear

characteristic of primarily smaller stocks on those major exchanges, or by stocks with little

institutional following.... A small number of studies suggest that market inefficiencies are

Period is 0.065 with a t-statistic of 1.15, which is not significant at the 95% confidence level. The coefficient for Citigroup’s excess return from the previous day over the Class Period is 0.101 with a t-statistic of 1.77, which is not statistically significant at the 95% confidence level. See Exhibit 8, Panel B.

115 “The term ‘random walk’ is usually used loosely in the finance literature to characterize a price series where all subsequent price changes represent random departures from previous prices. Thus, changes in price will be unrelated to past price changes.” (Burton G. Malkiel, “efficient market hypothesis,” in The New Palgrave: A Dictionary of Economics, vol. 2, E to J, ed. by John Eatwell, Murray Milgate and Peter Newman, Macmillan., 1998, pp. 120-123, p. 120).


40

greater when institutional involvement is lower....”116 A study by Barber, Griffin and Lev also

concludes that, in isolation, institutional holdings are a proxy for market efficiency.117 Thomas

and Cotter argue that an important available proxy for market efficiency is the level of

institutional investors’ ownership in a company’s stock.118

93. During the Class Period, institutions held an average of 66% of Citigroup’s

common shares outstanding (see Exhibit 3).119 The ownership of Citigroup common stock by

these sophisticated institutional shareholders who could act as arbitrageurs directly facilitates and

is an indicia of an efficient market.

v) Short Interest

94. The amount of short interest for Citigroup common stock during the Class Period

was between 0.4% and 2.4% of Citigroup’s common shares outstanding with an average of 1.1%

(see Exhibit 3). The average short interest for NYSE firms during the Class Period was 3.33% of

shares outstanding.120 The presence of short sellers in Citigroup common stock is an indication

of arbitrage activity, which is a necessary component of a well-functioning efficient market.

Moreover, the level of short interest in relation to shares outstanding provides no indication of

116 See Victor L. Bernard, Christine Botosan, and Gregory D. Phillips, “Challenges to the

Efficient Market Hypothesis: Limits to the Applicability of Fraud-on-the-Market Theory,” Nebraska Law Review 73, 1994, 781-811, p. 792.

117 See Brad M. Barber, Paul A. Griffin, and Baruch Lev, “The Fraud-on-the-Market Theory and the Indicators of Common Stocks’ Efficiency,” Journal of Corporation Law 19, Winter 1994, 285-312, p. 302.

118 See Randall S. Thomas and James F. Cotter, “Measuring Securities Market Efficiency in the Regulatory Setting,” Law and Contemporary Problems 63(3), Summer 2000, 105-122, p. 106.

119 Source: Thomson Reuters On Demand. Institutional ownership ranged between 62% and 69% during the Class Period. See Exhibit 3.

120 Source: Bloomberg (Bloomberg Ticker: NYSIPRTS Index) and calculated as the average of the monthly data over the Class Period.


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any constraint on short selling activities during the Class Period, such as the inability to locate or

borrow the necessary shares to initiate a short position.121

95. To examine arbitrageurs’ ability to cover a short position (i.e., purchase shares

that were previously sold), I also examined the short interest ratio, which indicates how many

trading days its takes on average to cover short positions.122 The average short interest ratio for

Citigroup common stock was 1.1 days and ranged between 0.4 days and 2.0 days during the

Class Period (see Exhibit 3). This indicates that, on average, it would take short sellers

approximately two trading days to cover their entire short position in Citigroup common stock,

assuming that historical trading volume remained constant.

96. A short interest ratio of 1.1 days indicates that the market for Citigroup common

stock had sufficient support from its specialist and other market participants to absorb the

volume from short covering during the Class Period. Additionally, the narrow bid-ask spreads

discussed above facilitate arbitrage activity and provides no indication that covering short

positions would be prohibitively expensive. Furthermore, the trading imbalance that should

result from any constraint in covering short positions would manifest itself in a violation of put-

call parity, which I analyze next and find supports market efficiency.

121 Before an investor can sell shares in a company that the investor does not already

own, the investor (i.e., short seller) typically must first locate or borrow shares from its broker. Those borrowed shares then can be sold by the short seller. However, if the short interest in a particular security is exceptionally high, short sellers may experience difficulties in locating a sufficient amount of shares available to be borrowed. Such difficulties could limit the exploitation of arbitrage opportunities, thereby potentially impairing market efficiency.

122 The short interest ratio equals short interest divided by average daily trading volume. For this analysis, I use a rolling daily average volume for 20 trading days.


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vi) Put-Call Parity

97. In addition to trading the stock directly, arbitrageurs can also profit from any

perceived mispricing of the common stock by trading in call and put options on the common

stock.123 In an efficient market, the various call and put options of a stock will be priced relative

to one another (and the stock) so as to provide zero profits from arbitraging these securities

against one another. Economists refer to this no-arbitrage state as put-call parity.

98. Put-call parity is a theoretical relation between call option prices, put option

prices and stock prices that should hold because a portfolio of put and call options plus risk-free

bonds can be constructed to replicate the payoff from purchasing the underlying common stock.

For American-style options on dividend paying stocks, the put-call parity relation implies an

upper and lower bound on the value of the put and call option prices such that:

S � D � X � C � P � S � Xe�rt, where S denotes the current price of Citigroup common stock, D denotes the present value of

future dividends, X denotes the exercise price of the option, C is the call option price, P is the put

option price, r is the risk-free interest rate and t is the time to expiration of the options.124 I

conducted an empirical test to determine whether Citigroup common stock and exchange-traded

options on Citigroup common stock violated put-call parity on any day during the Class Period.

123 A call option gives the holder the right, but not the obligation, to purchase the

underlying security at a specific price (the “exercise price”) on, or possibly before, a specific date (the “expiration date”). A put option gives the holder the right, but not the obligation, to sell the underlying security at the exercise price on, or possibly before, the expiration date.

124 See, for example, John C. Hull, Options, Futures, and Other Derivatives, Sixth Edition, Prentice Hall, 2006, p. 219.


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99. I obtained daily bid and ask data for options on Citigroup common stock from

OptionMetrics, LLC’s Ivy DB database.125 The Ivy DB database includes daily open interest,

volume and bid and ask prices for each option.126 The database includes a non-standard

settlement identifier for options whose terms change due to stock splits or other events.127 For

the risk-free interest rate, I used the U.S. Treasury constant maturity rate closest to days to

expiration.128,129

100. For the present value of dividends, I used the last known dividend as a proxy for

future dividend expectations, and created a quarterly series of constant dividends beginning on

the next dividend ex-date and continuing through the expiration date of each respective option.

125 According to OptionMetrics, “Ivy DB is the first widely available, comprehensive

source of high-quality historical price and implied volatility data for the US equity and index options markets. Ivy DB is available to banks, institutions, hedge funds, universities, and other organizations. Encompassing twelve years of data, Ivy DB contains accurate historical prices of options and their associated underlying instruments, correctly calculated implied volatilities, and option sensitivities.” See http://www.optionmetrics.com/ivydbus.html.

126 Open interest is the number of outstanding option contracts at a given point in time. In general, equity option contracts represent 100 shares of the underlying equity and prices are quoted on a per underlying share basis.

127 Non-standard settlements may include non-standard contract sizes and underlying prices. There were no non-standard settlement options on Citigroup common stock during the Class Period. In the data, I identified two instances with apparently incorrect data. One were $42.50 Jan 2009 options on January 4, 2008, which showed two set of option pairs. I removed the options that, based on option symbol, apparently had an incorrect exercise price (the remaining data for the removed options showed a $5 exercise price). The second incorrect data was on November 5, 2007 for $42.50 June 2008 options. There was no other data for these options and the symbols matched to $42.50 June 2007 options.

128 Interest rate data was obtained from the Federal Reserve Board database available at https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H.15. The following cut-offs were used in assigning interest rates to time to maturity: 1-60 days, 1 month rate; 61-136 days, 3 month rate; 137-273 days, 6 month rate; 274-547 days, one year rate; 548-912 days, 2 year rate; and over 912 days, the 3 year rate. I converted the interest rates to continuous compounding, 2 x ln(1+r/2), where r is interest rate based on semiannual compounding.

129 Because expiration dates are on Saturdays in the dataset, I set the number of days to expiration as the expiration date less the trading date less one.


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Each dividend series was then discounted from its respective payable dates using the risk-free

interest rates described above.130

101. Both the upper and lower bounds were tested over pairs of options with valid bid

and ask prices on days on which bid and ask quotes for Citigroup common stock were

available.131 Because these bounds are derived from the economic assumption of no arbitrage,

the lower bound was tested using the ask price for the call option, the bid price for the put and

the bid price of the stock; the upper bound was tested using the bid price for the call option, the

ask price for the put option and the ask price of the stock. The results obtained showed that only

183 (0.67%) violations of put-call parity out of the 27,214 option pairs during the Class Period.

On average, these 183 violations had arbitrage profits that amounted to only 0.15 % of

Citigroup’s common stock price at the same time.132,133

130 Source for distribution ex-dates and payable dates: Bloomberg. 131 I excluded observations in which the bid price was greater than the ask price for the

call option, put option or common stock. 132 The percent violation was calculated in relation to the bid-ask midpoint of Citigroup’s

common stock, specifically as the absolute value of: {min[0, Sask - (Cbid - Pask + Xe-rt)] + max[0, Sbid - (Cask - Pbid + D + X)]} / Sbidask (rounded to the nearest 0.01%).

133 In In re Polymedica Corp. Sec. Litig.,, 453 F. Supp. 2d at 275, the court found that an average put-call parity disparity of 3.5% during the “Contested Period” was a sign of an impediment to short selling because the market did not return to put-call parity. Prior to the Contested Period, the average disparity was only 0.5%, which the Polymedica court found to be consistent with normal stocks.


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102. The results from my put-call parity analysis are summarized in the following

table:

Observations 27,214 Violations of Put-Call Parity 183 Violations as a % of Total Observations 0.67% Sample Statistics for the 183 Violations Average 0.15% Median 0.08% Maximum 1.03%

103. The results in the table above show that there are extremely few violations of the

put-call parity relation in this data and the few violations that are observed indicate little profit

before deducting the transaction costs that would be incurred to construct the arbitrage portfolio

and are an indicia of an efficient market.

C. Conclusion

104. Based on my analysis of the data relevant to the Cammer factors including an

event study of Citigroup common stock, as well as additional tests for market efficiency that are

summarized in Exhibit 9, I conclude that Citigroup common stock traded in an efficient market

with regard to publicly disclosed information during the Class Period.

105. I understand that discovery in this case is ongoing. Therefore, I reserve the right

to amend this Declaration to reflect new information available to me in light of the ongoing

discovery process, information provided by other experts in the litigation, documents provided

by Counsel, future rulings from the Court in this Action, and trial proceedings.


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