Citigroup/Smith Barney Pays $978,000 For Failure to Supervise
Employees Involved With Unsuitable Short Selling Strategy
NEWARK, NJ - Citigroup Global Markets Inc. has been ordered to pay $978,000 under
the terms of a consent order announced today by Attorney General Anne Milgram,
Consumer Affairs Acting Director Stephen B. Nolan and Bureau of Securities Chief
Franklin L. Widmann. Citigroup will pay $500,000 in civil monetary penalties
and an additional $478,000 in restitution.
The settlement with the Bureau of Securities resolves allegations that Smith
Barney -- a division of Citigroup -- failed to supervise two agents operating
out of the Short Hills, New Jersey branch office, and failed to maintain accurate
books and records with respect to these agents? activities.
"Investors lost millions of dollars because of the way Smith Barney operated its business by failing to supervise its sales agents,?? Milgram said. "The penalty and additional restitution ordered in this case is a clear demonstration that the State intends to hold broker-dealers responsible for monitoring their agents? activities, especially where the investing public is at risk.??
In late May 2003, the two agents recommended a highly speculative short sale trading strategy for Trinity Industries Inc. ("TRN") shares to some of Smith Barney?s clients, which included New Jersey residents. Short selling involves selling shares of a particular stock that an investor borrows from the market, but does not own. The investor bets that the price of a stock will decrease over time so that they may make future purchases of the shares at a lower price to replace the borrowed stock and profit from the difference. However, because the price of a stock can rise dramatically, the investor is exposed to virtually an unlimited risk of loss.
By early July 2003, the two agents had shorted approximately 263,000 shares of TRN in the accounts of 42 clients, many of whom were unsuitable for this type of investment strategy when considering their age, investment objectives and financial profiles.
At the time the short sale trading strategy commenced, 26 customers were over the age of 60 and 21 customers were dependent on investments or retirement assets as a primary source of income. The concentration levels of the margined TRN short positions in certain accounts were nearly 70 percent of the accounts? total value by the end of July 2003.
Among the victims was a 67 year-old woman with an estimated annual income of $37,500 derived primarily from investments, who, despite maintaining a moderate risk tolerance, lost approximately $52,500.
Despite the presence of these and other red flags that should have suggested a need for additional review, the Short Hills Branch Manager and his Sales and Operations Managers approved the TRN short sale transactions.
The price of TRN shares continued to rise over the coming months which resulted in mounting losses and, in certain client accounts, the issuance of margin calls, which require clients to deposit additional cash or securities as collateral against potential losses.
At the time of these transactions, Smith Barney did not require agents to file a plan of solicitation for short sale strategies, enabling the two agents to implement the TRN short sale strategy without prior oversight by the firm.
"High risk, speculative and unsuitable trading can have a devastating impact when things turn bad,"said Acting Director Nolan. "Broker-dealers need to make certain the securities trading strategies recommended by their agents are properly reviewed and deemed suitable for clients."
Over a four-day period in August 2003, the two agents, without prior client consent, altered account profiles of the clients who maintained a conservative or moderate investment profile to reflect an aggressive risk tolerance, and in certain situations allow for speculation. These changes permitted the positions to remain open and accumulate additional losses. Client losses attributable to the TRN short sale strategy eventually totaled more than $3 million.
"Here a highly speculative trading strategy recommended by Smith Barney agents, combined with a lack of vigilance by the firm to detect and prevent unsuitable trades in many clients accounts, resulted in investors? losses of millions of dollars,"said Bureau Chief Widmann. "The first line of protection against this type of conduct should be a broker-dealer's supervisory system."
The Bureau of Securities found that by failing to detect and prevent the unsuitable trading activity offered by its agents, and the agents? alteration of account profiles with inaccurate information, Smith Barney failed to supervise its agents and failed to maintain accurate books and records. These failures constitute violations of the New Jersey Uniform Securities Law, and are grounds to assess a civil monetary penalty and impose other appropriate remedial measures.
"Client account profiles were altered, without detection by the firm, to include inaccurate information and conform to the speculative nature of this unsuitable trading activity,"said Bureau Chief Widmann. "Broker-dealers are duty-bound to maintain accurate books and records, and to make certain that systems are in place to ensure the integrity of those records."
As mitigating factors, subsequent to the start of the Bureau of Securities investigation, Smith Barney cooperated with the investigation and implemented procedural changes at both the firm and branch levels to increase oversight of agent activities. Smith Barney also paid certain clients approximately $1.6 million in restitution.
The consent order was entered into by Citigroup without admitting or denying the Bureau?s findings.
The investigation was conducted for New Jersey by Chief of Enforcement Richard Barry, Supervising Investigators Michael McElgunn and Leon C. Martin, and Investigating Attorney Peter C. Cole of the Bureau of Securities. Deputy Attorney General Christopher W. Gerold assisted the Bureau on this matter.