In August of 2020, Citibank, one of the largest banks in the world, made a catastrophic error. While executing a routine interest payment, Citi inadvertently wired an extra $894 million to a small group of hedge funds. After some delicate prodding, funds holding about $350 million of the cash returned it to the bank. The holders of the remaining half billion, however, decided they would rather keep the money, setting the stage for a protracted courtroom battle over the legal validity of ‘finders, keepers’. The story of how such a sophisticated financial institution sent nearly a billion dollars to the wrong person begins, appropriately enough, with the distressed debt of a now-bankrupt company.
Over the past several years, Revlon, a cosmetics company, found itself in a string of precarious liquidity positions. With debts coming due and not enough cash to service them, Revlon pursued a series of aggressive restructuring plans. The most notorious of these involved siphoning collateral away from an old loan to use as collateral for a new loan. This would provide Revlon with some much-needed cash, but would effectively destroy the security of the old loan. To effectuate such a drastic change, Revlon needed a majority of the investors in the old loan to vote to amend the loan terms.
Obviously, investors would need some persuasion to decimate their own collateral. Revlon offered to roll certain investors into the new loan in exchange for voting yes on the amendment. This effectively extended the maturity for these investors while maintaining their collateral, but left old loan investors outside of the ‘roll-up’ in a significantly deteriorated position. When Revlon realized that even their roll-up deal would not secure them a majority, they attained an additional line of credit (which they had no intention of drawing on) in order to dilute the ‘No’ votes. Through this bag of tricks, Revlon eventually attained a majority, and with it, a liquidity lifeline.
As is standard practice in debt roll-ups, investors holding the old loan were entitled to receive the accrued interest on their positions when converting into the new loans. As administrative agent on the loan, Citi was responsible for processing that payment, transferring the funds from Revlon to investors. In the first sign of trouble, Citi informed Revlon that, due to technical limitations, Citi could not process interest payments for just a portion of the holders of the old loan. Either everyone would get paid accrued interest, or no one would.
Revlon thus agreed to pay off the accrued interest of all investors, simply because Citi’s software was so clunky as to make it necessary. Even more terrifying was the fact that Citi had no way to pay off the accrued interest on the loan without simultaneously repaying the principal amount as well. To solve this, Citi employees set up the transaction so that the principal portion of the payment would be directed to an internal ‘wash’ account, ensuring the money would not leave the bank. While the transaction would be processed for the entire amount of the loan, investors should have only received their accrued interest.
Clearly, things did not go according to plan. Investors, mostly made up of hedge funds and other specialized investment vehicles, awoke on August 11th 2020 to find that Citi had accidentally sent them a full payment for both the principal and interest amounts of their loans to Revlon. Rather than being directed to an internal account, the principal payments had gone out the door. As detailed in later court filings, Citi employees who processed the transaction were supposed to check two additional boxes to ensure the wash account would work as desired. Apparently, the interface was so unintuitive that three separate employees reviewed the pending transaction without noticing a mistake worth nearly a billion dollars.
Standard industry practice is to return funds that were mistakenly transferred. This is bolstered by legal precedent which sensibly asserts that parties who receive money mistakenly must return it. One does not forfeit all their property rights simply because they made a mistake. In a world of fallible people, irreversible transactions would create monstrous and inefficient checking costs. With this background, some hedge funds chose to return the extra cash.
Others, though, felt entitled to the money, and decided to try their luck in court. Many of the investors who received the mistakenly transferred funds were the same investors that Revlon had sidelined during the roll-up deal. They were understandably outraged at the company for, in the investor’s view, fraudulently expropriating their collateral. Considering that Revlon was sliding into bankruptcy, and the loans were unlikely to be paid back in full, this became an even more urgent concern.
Citi sued to recover their funds, and, somewhat surprisingly, lost. While the general rule is that mistakenly transferred funds must be returned, New York law contains an exception pleasingly known as the “Banque Worms” doctrine, named after the plaintiff in the primary case. The exception holds that when a party receives money that it is legally owed, without immediately knowing the payment is in error, the party gets to keep the money, regardless of whether the transfer was intended or not. Since the hedge funds were in fact creditors to Revlon, with an outstanding principal balance, the court decided that they were owed the money they received.
Citi appealed the ruling, arguing that lenders were not owed their principal balance for another several years, since the maturity date on the loans had not been reached. Moreover, investors should have known immediately that the payment was in error. At the time, Revlon’s loans were trading at less than half of their face value. No company in the world would pay off the full principal amount of loans that they could retire cheaper by buying them on the market. The court eventually ruled in Citi’s favor, and the hedge funds were ordered to return the money back. After two years in court, sanity eventually prevailed.
Narrowly, the answer to how Citi accidentally wired almost a billion dollars to the wrong person is human error and a poor user interface. More broadly, the answer involves esoteric banking law and the brutally aggressive nature of corporate debt restructurings. The shocking part of the Citi debacle is not just that the bank sent money to the wrong person, but that Citi did not immediately get the money back. Mistaken transfers are common in finance, due to the volume of transactions occurring and the non-zero probability of error on each transaction. Typically these mistaken transfers do not take two years in court to reverse, however. Now that the money is back in Citi’s hands, they would be advised to put some of it to use upgrading their ancient software.
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