Citigroup Faces SEC Investigation Over Fraud in Mexico

Source: Thinkstock

Source: Thinkstock

Last week, financial services firm Citigroup Inc. (NYSE:C) reported that it was forced to downwardly revise its 2013 earnings by $235 million (or $360 million before taxes) after discovering fraud at one of its subsidiaries in Mexico. This week, a source familiar with the situation told Reuters that the U.S. Securities and Exchange Commission is investigating the firm for possible accounting fraud or any violations of the Foreign Corrupt Practices Act.

The adjustment, charged to Citi’s fourth-quarter Transaction Services operating expense, amounts to a 1.4 percent reduction in full-year earnings to $13.7 billion. The fraud was discovered at at a company called Oceanografia S.A. de C.V. (OSA), a Mexican oil services company that is a primary supplier to Petroleos Mexicanos, or Pemex, the Mexican state-owned oil company. OSA earns as much as 97 percent of its revenue from Pemex.

Through Banco Nacional de Mexico, or Banamex, Citigroup extended about $585 million in short-term credit to OSA in order to finance accounts receivable from Pemex. This means that Citigroup lent OSA money and OSA used its accounts receivable from Pemex as collateral. Banamex, acting as a sort of intermediary, also had about $33 million in loans directly outstanding to OSA or tied up in standby letters of credit issued on behalf of OSA.

The credit appeared to be in good standing until February 11, when the Mexican government barred OSA from acquiring new business with Pemex for 21 months. The ban was enforced by Mexico’s anti-corruption agency, which accused OSA of violating agreements with the state oil company.

The ban prompted Citigroup and Pemex to launch a review of their relationship with OSA. The review found that of the $585 in supposed accounts receivable owned by OSA, just $185 million was valid. That is, Pemex had just $185 million worth of work on its books.

Citigroup CEO Michael Corbat said: “Although our inquiry into this fraud is continuing, we have been responding forcefully over the past week by assessing the overall exposure to Citi, coordinating with law enforcement, pursuing recovery of the misappropriated funds, and seeking accountability for anyone involved. Specifically, we have been taking the following actions: first, we immediately began a ‘rapid review’ — throughout Banamex and the rest of Citi — of programs similar to the one at issue here. At this point, we believe this is an isolated incident.”

As a result of the investigation, Mexico’s finance ministry has taken over control of OSA from CEO and majority shareholder Amado Yanez, son of the company’s founder, Amado Yanez Correa. According to the younger Yanez, OSA was still “working as normal” as recently as February 14, Reuters reports, but investors don’t seem to be buying it. OSA bonds due in 2015 fell to 17 cents on the dollar following Citigroup’s announcement on Friday.