Citigroup has been forced to bail out one of its best-known hedge funds with a $100 million (£51 million) capital injection, in another setback for the world’s biggest financial services operator.

The banking giant has also shut the door on redemptions from CSO, a $500 million hedge fund based in Berkeley Square, London, after investors tried to withdraw almost a third of the funds. CSO specialised in the corporate credit markets.

The capital injection, which will also involve Citigroup offering new and existing investors a fee waiver to take part in a further fundraising, came after the conclusion of a dispute lasting nearly six months between the Wall Street bank and a seven-strong group of investment banks.

The row centred on the terms of a proposed CSO investment in a €7.2 billion (£5.4 billion) leveraged buyout deal for ProSiebenSat.1, the German satellite broadcaster. Citigroup has parted company with John Pickett, one of its star credit traders, in the wake of the affair.

The bank invested an undisclosed amount of its own capital in the fund and last night sources refused to rule out legal action from either party.

Citigroup is still reeling from $18 billion of writedowns as a result of its exposure to sub-prime mortgage markets.

The bank’s losses in the credit markets forced the resignation of Charles Prince, the bank’s chairman and chief executive.

Vikram Pandit, Citigroup’s replacement chief executive, briefly supervised the bank’s alternative investments group, although his arrival came after the problem investment in the leveraged loan. According to sources, CSO’s difficulties began last June, when Mr Pickett placed a €1.25 billion order to buy ProSiebenSat.1 securities. Initial demand for the deal among the investment community had been huge and the seven banks coordinating the sale had to scale back CSO’s allocation, believed to be between €500 million and €750 million.

However, the ProSieibenSat.1 bond sale reached the market just as the effects of the credit crunch were beginning to hit. Sources said that Mr Pickett tried to cancel his order, which is also understood to have breached Citigroup’s internal trading limits. Mr Pickett argued that the selling banks had changed the terms of the loans and he should have the right to walk away. The banks disagreed and a dispute broke out that was not resolved until late December, when Citigroup agreed to take an allocation of €512 million. By then the bonds were trading well below their face value, sources said.

A Citigroup spokesman said that the funds were fully supervised and that the suspension was temporary and in the interests of stabilising CSO.

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