Hedge fund firm Citadel Investment Group will return millions to clients who asked to exit last year, but were locked in when its flagship funds lost more than half their value during the financial crisis.

The Chicago-based firm, which invests $12 billion, informed clients on Tuesday it plans to give back $250 million on October 1 and to make another distribution at the end of the year, according to an investor who asked not to be named.

Citadel last year was one of many hedge funds to block investor exits. Now its decision to return the money suggests the worst may be over for the $1.4 trillion hedge fund industry after it suffered its worst-ever losses and record outflows last year.

Normally, Citadel lets its wealthy investors remove a portion of their assets every quarter. But when the flagship funds tumbled 55 percent late in 2008, the firm halted the requests for fear that too much money would exit at once.

Improved liquidity conditions and Citadel's top flight returns -- its Wellington and Kensington portfolios have gained about 44 percent in the first seven months of the year -- allowed the firm to honor some of last year's requests.

Citadel and many other prominent fund firms, including Tudor Investment Corp, blocked exits last year, often arguing that hasty sales of illiquid and large positions would disrupt already tumbling markets even more.

(Reporting by Svea Herbst-Bayliss; editing by Andre Grenon)