Citigroup Global Markets, Inc. has the dubious distinction of being the subject of the first enforcement action by the Financial Industry Regulatory Authority (FINRA) involving a broker-dealer stock borrow program.
Citigroup was fined $650,000 for what FINRA alleged were issues with both disclosure and supervisory violations in its Direct Borrow Program or DBP. According to the investigation, which covered nearly a three-year period from early 2003 through late 2005, the Citigroup DBP borrowed securities that were then placed in a pool of securities. This was used to support the firm's client's short-selling strategies. The loans averaged $301 million a year and were borrowed from over 2,000 customers.
FINRA alleged that Citigroup did not supervise its DBP staff or establish procedures to do so. Moreover, brokers did not adequately monitor the accounts of customer involved in the DBP.
The allegations, which were neither admitted nor denied by the firm, center around what FINRA claimed to be failures to disclose or to adequately disclose material information to customers in the DBP. FINRA found that Citigroup did not inform customers of many critical facts that could impact this activity including such things as the fact that the firm could reduce interest rates, that the loans could be sold by customers, that brokers received commissions throughout the loan period, and that higher tax rates could apply to these dividends.
Other issues FINRA found in this case involved the branches and what they knew and did not know. For example, many branch managers and supervisors were not aware that Citigroup had a DBP or that brokers they were supervising had customers involved in it. Further, customer accounts that had securities in the DBP could not be monitored with tools generally used internally. These accounts could not be monitored to accurately reflect customer's positions or to monitor the ongoing appropriateness of the activity for specific customers.
As has been determined in other cases, the marketing materials regarding the DPB were found to be misleading regarding risk and other issues.
At the time of settlement all loaned shares had been returned to Citigroup customers who were involved in the DBP.
Contact the New York City law firm of Gusrae Kaplan Nusbaum PLLC for broker and dealer advisory services, as well as regulatory and enforcement representation.
