Inside Citi, a Hedge-Fund Push Blows Up

When Citigroup Inc. was launching a pair of hedge funds last year, it didn't have to look far for investors. Brokers at the firm's Smith Barney unit drummed up hundreds of millions of dollars from retail clients, including some who were told the fixed-income funds were a safe place to stash money.

Since then, the hedge funds, devastated by the credit crunch, have plunged by 75% or more in value. After weeks of internal debate involving Sallie Krawcheck, the global wealth-management head, Citigroup is offering to cover some of the losses. An investor who put $500,000 into one of the hedge funds filed a federal lawsuit against Citigroup earlier this month.

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The losses by the two hedge funds at issue, called Falcon and ASTA/MAT, are the latest examples of the credit crunch hammering retail, or individual, investors who believed they were holding low-risk securities.

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Citigroup brokers and fund managers assured prospective investors that the new hedge funds were low-risk, with Falcon likely to post losses of no more than 5% a year in the worst-case scenario, according to people familiar with the situation.

"That's why they bought it," says a Smith Barney broker whose clients, many of them wealthy retirees, invested in the Falcon fund. "These kinds of clients weren't looking for a home run."

Robert Zeff, a retired lawyer in Boca Raton, Fla., invested $500,000 in Falcon at the advice of his Smith Barney broker. "He was a very conservative investor whose main issue was capital preservation," says Joe Osborne, who is representing Mr. Zeff in a lawsuit accusing Citigroup of fraud in its marketing of Falcon. Some individuals invested millions of dollars, according to lawyers and brokers.

As of March 31, the new Falcon fund was worth just 25% of its initial value, according to internal documents...