NYSE Regulation has censured and fined the Smith Barney unit of Citigroup Global Markets $50 million for failing to supervise trading of mutual fund shares and variable annuity mutual fund sub-accounts, failing to prevent violative market timing by its brokers, and failing to maintain adequate books and records. Of the total amount, $35 million in disgorgement and half of the $10-million penalty will be placed in a distribution fund to compensate harmed investors, Smith Barney neither admitted nor denied the allegations.

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NYSE Regulation, Inc. announced today it has censured and fined the Smith Barney Division of Citigroup Global Markets Inc. (“CGMI”) of New York, New York, a member firm, for failing to supervise trading of mutual fund shares and variable annuity mutual fund sub-accounts, failing to prevent violative market timing by its brokers, and failing to maintain adequate books and records.

Of the $50 million total payment, $35 million in disgorgement and one-half of the $10 million penalty to be paid to NYSE Regulation will be placed in a distribution fund to compensate injured customers of the firm who invested in the affected mutual funds. Five million dollars will be paid to the State of New Jersey regarding a separate regulatory matter arising out of the same conduct.

“Member firms that inadequately supervise their businesses run the risk of disgorging profits and paying additional penalties," said Susan L. Merrill, chief of enforcement, NYSE Regulation. “The issuance of internal policies and memoranda is not enough: they must be effectively enforced. Actions must follow words.”

To read the decision, click on the following link: Citigroup Global Markets Inc., Decision 07-107 (NYSE Hearing Board July 13, 2007)

Between January 2000 and September 2003 (the “Relevant Period”), CGMI failed to adequately supervise its branch offices and certain financial consultants (“FCs”), who engaged in market timing, including the use of deceptive trading practices to conceal their own identities or the identities of their timing customers, as well as their excessive trading.

CGMI was on notice that its FCs were engaged in market timing activity that was potentially harmful to the mutual funds and the long-term shareholders, many of whom were also non-timing customers of the firm. While the firm had compliance policies in place, the enforcement of its policies and procedures was ineffective.

Market timing, while not illegal, can harm mutual fund shareholders because it can dilute the value of their shares, disrupt the management of the fund’s investment portfolio, and cause the fund to incur considerable extra costs associated with excessive trading.

Market timing may violate federal securities laws and NYSE Rules if deception is used to conceal the nature or identity of a transaction from a fund or to induce a fund to accept trades that it would not accept under its own market timing policies.

The firm’s FCs executed hundreds of thousands of market timing trades, a number of which were executed through the use of deceptive practices, thereby enabling the FCs and customers to evade detection by mutual funds.

During the Relevant Period, over 150 FCs using over 200 FC numbers in 60 branches engaged in approximately 250,000 market timing exchanges in over 1,500 accounts on behalf of more than 1,100 customers. According to calculations by NYSE Regulation, this activity generated approximately $32.5 million in gross revenues.

Deceptive practices employed by FCs included the improper use of: multiple branch code prefixes, multiple registered representative identification numbers, multiple customer accounts, multiple limited liability companies, multiple tax ID numbers for accounts, structured trades in amounts below certain thresholds; accounts opened under the auspices of other financial institutions; and market timing through mutual fund sub-accounts of variable annuities.

In non-proprietary mutual funds, certain FCs entered into “Sticky Asset Agreements” that allowed select timing customers exchange privileges that were not offered to other shareholders. Certain FCs also entered into explicit market timing “Administrative Fee Arrangements” with known market timing customers that provided for a monthly or quarterly fee based upon assets under management. The firm should have been aware that the use of these fee arrangements facilitated market timing and thus violated the firm’s compliance policies as well as mutual fund prospectus restrictions.

During this period, hundreds of communications were sent to CGMI from non-proprietary mutual funds and from insurance companies (selling variable annuities through mutual fund sub-accounts) that monitored the trading in their mutual funds and complained of violations of exchange limits or market timing.

CGMI undertook efforts to stop market timing and had largely ended timing in its proprietary funds as well as in its own fee based mutual fund trading programs by the end of 2001–early 2002, although market timing continued in non-proprietary funds.

Between 1997 and 2002, it had issued several successive compliance policies and other memoranda that, among other things, prohibited market timing in the firm’s fee-based mutual fund programs, contained an overview of mutual fund prospectus policies, and reiterated prohibitions on market timing in proprietary and non-proprietary mutual funds and redefined the trading parameters that the firm considered to be indicative of market timing. FCs were required to comply with both firm policies and mutual fund prospectus limitations, whichever was more restrictive.

Although the firm’s policies gradually evolved during this period, they were inadequate and were inadequately enforced. The firm failed to adequately supervise its FCs who continued to market time in non-proprietary mutual funds until September 2003 with the firm’s knowledge, even after the firm issued an April 2002 memorandum prohibiting all market timing.

In addition, the firm failed to adequately supervise trading in mutual fund sub-accounts of variable annuities and to maintain the required books and records which hindered both the firm’s ability to supervise that activity and the subsequent regulatory investigation of market timing in those products.

Although there was no finding of late trading, the firm also failed to maintain books and records of mutual fund trade cancellations and rejections related to market timing, and the times when mutual fund trades were communicated to the firm (as opposed to executed) which prevented NYSE Regulation from determining whether “late trading” occurred or orders were administratively entered after 4:00 p.m.

The NYSE hearing officer noted the firm’s cooperation in this investigation—a factor considered in determining an appropriate sanction—including periodic briefings about the firm’s internal investigation with the Division of Enforcement of NYSE Regulation.

CGMI shall also retain an Independent Distribution Consultant to plan and administer the distribution of the $40 million in disgorgement and penalty to the firm’s customers who invested long-term in the same mutual funds that were the subject of market timing.

This disciplinary action concerned violations of Section 17(a) of the Securities Exchange Act of 1934 and Rules 17a-3 and 17a-4 thereunder, and NYSE Rules 342, 401(a), 440 and 476(a).

In settling these charges brought by NYSE Regulation, Citigroup Global Markets Inc. neither admitted nor denied guilt. Investigations of individuals are continuing.

About NYSE Regulation

NYSE Regulation, Inc., is a not-for-profit corporation dedicated to strengthening market integrity and investor protection. It protects investors by regulating the activities of member organizations through the enforcement of marketplace rules and federal securities laws.

NYSE member organizations hold 98 million customer accounts or 84 percent of the total public customer accounts handled by broker-dealers. Total assets of NYSE member organizations are over $5 trillion. They operate from 20,000 branch offices around the world and employ 195,000 registered personnel. NYSE Regulation, Inc. also ensures that companies listed on the NYSE and on NYSE Arca meet their financial and corporate governance listing standards.

For more information, visit our Web site at www.nyseregulation.com .  

Edited by: Erin Kello


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