Sentinel trustee sues Citadel, Goldman Sachs for roles in alleged fraud

By Caroline Salls

Pittsburgh, Dec. 5 - Sentinel Management Group, Inc.'s Chapter 11 trustee filed a lawsuit Thursday against Citadel Equity Fund, Ltd., Citadel LP and Citadel Investment Group, LLC in an attempt to avoid fraudulent transfers made to the Citadel defendants on the eve of Sentinel's bankruptcy.

According to the complaint filed with the U.S. Bankruptcy Court for the Northern District of Illinois, beginning in 2003, Sentinel insiders perpetrated an alleged fraud against the company and its customers.

Instead of segregating customer funds and using them to purchase safe and liquid investments for the segregated customer pools, as required by law, Chapter 11 trustee Frederick J. Grede said in the complaint that these insiders embarked on a massive leveraging and commingling scheme, for their own benefit, which treated all assets controlled by Sentinel as part of a single undifferentiated pool.

As part of the scheme, Grede said the insiders acquired or controlled more than $3 billion in securities on leverage, using hundreds of millions of dollars in securities that were supposed to be segregated for customers in order to do so.

The leverage and misuse of these securities was allegedly concealed from both Sentinel's customers and its regulators, and Grede said much of what was purchased with this leverage was risky, illiquid and unsuitable securities, which exposed Sentinel and all of its customers to tremendous risk in the event of a market downturn.

When the scheme began to unravel, Grede said the insiders decided they had to protect one group of Sentinel customers, namely its Seg 1 commodity broker clients, in order to avoid scrutiny of Sentinel's business operations and the discovery of their scheme and to cover up the true cause of the massive losses suffered as a result of the scheme.

Grede is alleging that the insiders shifted hundreds of millions of dollars in cash and securities from other accounts to Seg 1 segregated accounts during the three weeks leading up to Sentinel's bankruptcy, paid off Seg 1 customers in cash, and sold the company's most liquid portions of its securities portfolio to Citadel in a non-competitive bulk sale one day before Sentinel's bankruptcy filing in an attempt to generate enough cash to pay off the remaining Seg 1 customers.

Grede alleged in the complaint that the transfers to Citadel were intended to defraud, hinder and delay Sentinel's customers and creditors by creating the false appearance that Seg 1 assets had been segregated for Seg 1 creditors and the reason for losses in the customer portfolios was turmoil in the markets, as well as by reducing the assets available to repay other creditors.

According to the complaint, Citadel was allegedly able to exploit the insiders' desperate attempt to cover-up their underlying fraud by acquiring the securities for far less than their reasonably equivalent value in a non-competitive bulk sale and by further extracting a $47.1 million market uncertainty concession, "to the direct detriment of Sentinel's creditors who had gone unpaid while Citadel realized a windfall."

Grede also named Goldman Sachs & Co. as a defendant in the Citadel lawsuit because it allegedly was the immediate transferee of the securities from Citadel, and it allegedly agreed to split the profits from subsequent securities sales with Citadel.

Sentinel, a Northbrook, Ill., investment adviser, filed for bankruptcy on Aug. 17, 2007. Its Chapter 11 case number is 07-14987.

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