NYSE HEARING BOARD DECISION 07-143 September 7, 2007
Citigroup Global Markets Inc. Violated NYSE Rule 401(a) by failing to ensure delivery of prospectuses in connection with sales of registered securities in violation of Section 5(b)(2) of Securities Act of 1933 and to deliver trade confirmations to certain customers; violated NYSE Rule 1100(b) by failing to deliver product descriptions to customers that purchased Exchange Traded Funds; violated Rule 10b-10 under Securities Exchange Act of 1934 by failing to provide firm customers with confirmations for certain securities transactions; violated NYSE Rule 342 by failing to provide for, establish, and maintain appropriate procedures of supervision and control, including system of follow-up and review, with respect to its operational and technological activities relating to delivery of product descriptions and prospectuses and trade confirmations — Consent to censure, $2,250,000 fine, and undertaking.
Appearances:
For the Division of Enforcement For Respondent
Susan Merrill, Esq. Mark A. Adams, Esq.
Anthony Cavallaro, Esq.
Richard Chin, Esq.
Brian Vincent
Ronald Schwan
A Hearing Officer on behalf of the New York Stock Exchange LLC (“NYSE” or the “Exchange”) considered a Stipulation of Facts and Consent to Penalty entered into between NYSE Regulation, Inc.’s Division of Enforcement (“Enforcement”) and Citigroup Global Markets Inc. (“Respondent” or “Citigroup” or the “Firm”), an NYSE member organization. Without admitting or denying guilt, Respondent consented to a finding by a Hearing Officer that it:
I. Violated NYSE Rule 401(a) by failing to adhere to the principles of good business practice by failing to:
a. ensure the delivery of prospectuses in connection with certain sales of registered securities in violation of Section 5(b)(2) of the Securities Act of 1933; and
b. deliver trade confirmations to certain customers.
II. Violated NYSE Rule 1100(b) by failing to deliver product descriptions to customers that purchased Exchange Traded Funds.
III. Violated Rule 10b-10 of the Securities Exchange Act of 1934 by failing to provide Firm customers with confirmations for certain securities transactions.
IV. Violated NYSE Rule 342 by failing to provide for, establish and maintain appropriate procedures of supervision and control including a system of follow-up and review with respect to its operational and technological activities relating to the delivery of:
a. product descriptions and prospectuses; and
b. trade confirmations.
For the sole purpose of settling this disciplinary proceeding, without adjudication of any issues of law or fact, and without admitting or denying any allegations or findings referred to in the Stipulation of Facts and Consent to Penalty, Respondent stipulates to certain facts, the substance of which follows:
Background and Jurisdiction
1. Citigroup is a wholly owned subsidiary of Citigroup Financial Products, Inc. and indirectly a wholly owned subsidiary of Citigroup, Inc. Citigroup has both retail and institutional customers and provides investment banking, asset management, brokerage, securities trading, advisory and other financial services to customers, and engages in proprietary trading for its own accounts. Citigroup is a member of all principal exchanges, is registered as a block positioner, and is a Primary Dealer. As of 2006, the Firm had in excess of 600 branch offices and employed over 13,000 registered representatives. For the second quarter of 2006, the Firm had a net capital of approximately $2.7 billion.
2. By letter dated October 18, 2004 (the “October Letter”), which Citigroup received, Enforcement requested that Citigroup conduct a review of its policies and procedures in the area of prospectus delivery concerning the offering of new issues and the sale of mutual funds and provide Enforcement with the results of its assessments. Enforcement requested that the Firm use the time period of July 1, 2003 through
Hearing Officer Note: The facts, allegations, and conclusions contained in paragraphs 1 to 36 are taken from the executed Stipulation of Facts and Consent to Penalty between Enforcement and Respondent. No changes have been made to the stipulated paragraphs by the Hearing Officer.
1. October 31, 2004 for its review (the “Relevant Period”). Thereafter, Enforcement requested that the Firm expand its review regarding the delivery of prospectuses and product descriptions (collectively, “offering documents”). Subsequently, the Firm provided additional information.
2. On December 1, 2005, a new set of prospectus delivery rules became effective. Among other things, under the new rules, a final prospectus will be deemed to precede or accompany a security for sale for purposes of Section 5(b)(2) of the Securities Act as long as the final prospectus meeting the requirements of Section 10(a) of the Securities Act is filed or the issuer will make a good faith and reasonable effort to file it with the United States Securities and Exchange Commission as part of the registration statement within the time frame set forth in Securities Act Rule 424. See Securities Offering Reform, Exchange Act Release No. 34-52056, 2005 SEC Lexis 1789 (July 19, 2005).
3. In addition, during the course of investigating the Firm’s prospectus delivery procedures,
Citigroup self-reported to Enforcement that it failed to deliver trade confirmations to certain customers.
Summary of Violation Conduct
4. During the Relevant Period, the Firm failed to have appropriate policies and procedures relating to the delivery of offering documents to customers that purchased certain securities. The failure to have these policies and procedures caused Citigroup to experience numerous systemic deficiencies relating to the delivery of offering documents to customers that purchased certain securities. In particular, during the Relevant Period, the Firm failed to deliver product descriptions (or any other disclosure document, such as a prospectus) to certain customers who purchased Exchange Traded Funds (“ETFs”) in violation of NYSE rules. In addition, during the Relevant Period, the Firm failed to deliver prospectuses to certain customers who purchased equity and debt securities and mutual funds in violation of NYSE rules and federal securities laws. Further, Citigroup failed to send numerous trade confirmations to certain customers that purchased securities in violation of federal securities laws and NYSE rules.
Applicable Federal Securities Laws and NYSE Rules
5. Section 5(b)(2) of the Securities Act of 1933 (the “Securities Act”) prohibits the delivery of certain securities unless such delivery was accompanied by or preceded by a prospectus that met the requirements of the Securities Act.1
6. Section 4(3) of the Securities Act requires, in pertinent part, dealers to deliver a prospectus in connection with transactions in a security as to which a registration statement has been filed that take place prior to the expiration of a 40 or 90 day period after the effective date of such registration statement or prior to the expiration of such period after the first date upon which the security was bona fide offered to the public by the issuer or by or through an underwriter after such effective date, whichever is later (“aftermarket trades”).
7. Securities Act Rule 174 provides further rules regarding the delivery of prospectuses in connection with aftermarket purchases in securities that are issued on a national securities exchange. In particular, the rule states that, for transactions in securities listed on “a registered national securities exchange;no prospectus need be delivered after the expiration of twenty five calendar days after the offering date” for such securities. The offering date is defined as the later of the effective date of the registration statement or the first date on which the security was bona fide offered to the public.
8. NYSE Rule 1100(b) governs the delivery of written descriptions (commonly referred to as product descriptions) in connection with customer purchases of Investment Company Units, which include ETFs as defined in Section 703.16(A) of the NYSE Listed Company Manual. NYSE Rule 1100(b) provides that, with respect to ETFs “as to which the sponsor or other appropriate party has obtained an exemption from Section 24(d) of the Investment Company Act [of 1940]” and which are listed on the NYSE or have unlisted trading privileges, “members and member organizations shall provide to all purchasers of such [securities] a written description of the terms and characteristics of such securities, in a form prepared or approved by the Exchange, not later than the time a confirmation of the first transaction in such security is delivered to such purchaser.
9. Most sponsors of ETFs have obtained exemptions under Section 24(d) of the Investment Company Act of 1940. For certain transactions involving ETFs for which an exemption has not been obtained, member organizations are required to deliver prospectuses to customers who purchase such securities as required by Section 5(b)(2) of the Securities Act.
10. NYSE Rule 401(a) states: “[e]very member, allied member and member organization shall at all times adhere to the principles of good business practice in the conduct of his or its business affairs.”
11. The failure to send prospectuses and trade confirmations to customers constitutes a violation of NYSE Rule 401(a).
The Firm’s Prospectus Delivery Procedures
12. During the Relevant Period, Citigroup relied on its own prospectus fulfillment facility to deliver offering documents for its securities transactions.
Failure to Deliver Required Product Descriptions
13. During the Relevant Period and continuing until 2005, the Firm had a systemic deficiency relating to the delivery of product descriptions (or any other disclosure document, such as a prospectus) to customers that purchased certain ETFs. This systemic deficiency prevented the Firm from delivering product descriptions (or any other disclosure document, such as a prospectus) to customers who purchased ETFs. The failure to deliver product descriptions (or any other disclosure document, such as a prospectus) for ETF transactions constituted violations of NYSE Rule 1100(b).
14. The Firm is unable to determine the origination date of this systemic deficiency. In or about August 2005, the Firm established appropriate policies and procedures to ensure the delivery of product descriptions (or any other disclosure document, such as a prospectus) to customers that purchased ETFs.
Failure to Deliver Required Prospectuses
15. During the Relevant Period, Citigroup failed to maintain and establish appropriate policies and procedures regarding the delivery of prospectuses for certain aftermarket trades associated with (i) equity initial public offerings and (ii) debt securities issued by the Firm’s affiliates (“affiliate debt securities”).
16. The Firm’s failure to maintain and establish appropriate policies and procedures regarding the delivery of prospectuses for aftermarket trades caused systemic deficiencies relating to: (i) equity initial public offerings in which Citigroup was not a member of underwriting syndicates (“Non-Syndicate Equity IPO Aftermarket Transactions”); (ii) equity initial public offerings in which Citigroup was a member of underwriting syndicates (“Syndicate Equity IPO Aftermarket Transactions”); and (iii) affiliate debt securities aftermarket trades. These systemic deficiencies prevented the Firm from sending prospectuses to certain customers that purchased affiliate debt securities and engaged in Syndicate and Non-Syndicate Equity IPO Aftermarket Transactions. The failure to send prospectuses for these transactions constituted violations of NYSE Rule 401(a).
17. The Firm is unable to determine the origination dates for the deficiencies relating to Non-Syndicate and Syndicate Equity IPO Aftermarket Transactions and affiliate debt securities aftermarket transactions. In or about March 2005, the Firm made enhancements to its policies and procedures regarding the delivery of prospectuses in connection with Syndicate and Non-Syndicate Equity IPO Aftermarket Transactions and affiliate debt securities aftermarket transactions. The Firm’s enhancements to its policies and procedures regarding prospectus delivery for these types of transactions were completed in late 2006.
Failure to Deliver Prospectuses in Connection with Mutual Fund Transactions
18. Citigroup also experienced a systemic deficiency relating to the delivery of prospectuses to certain customers that purchased mutual funds. This systemic deficiency prevented the Firm from sending prospectuses for certain mutual funds transactions. The failure to deliver prospectuses for mutual fund transactions constituted violations of NYSE Rule 401(a).
19. From November 2002 to November 2004, Citigroup failed to deliver prospectuses in connection with customer purchases of mutual funds sold through specific sales channels. In November 2004, the Firm remediated this deficiency and enhanced its policies and procedures relating to the delivery of prospectuses for such mutual fund transactions.
20. During the Relevant Period, the Firm also failed to deliver prospectuses to certain customers that purchased proprietary mutual funds. In or about March 2005, the Firm remediated this deficiency and enhanced its policies and procedures relating to the delivery of prospectuses for proprietary mutual fund transactions.
21. Further, during the Relevant Period, Citigroup failed to ensure that annual updated prospectuses were delivered to customers who purchased mutual funds from five mutual fund families. In or about March to June 2005, Citigroup secured agreements under which these fund families agreed to deliver the necessary updates to customers.
22. The Firm is unable to determine the origination dates for the deficiencies relating to the delivery of prospectuses for proprietary mutual fund transactions and the mailing of annual updated prospectuses for certain fund families.
Failure to Deliver Trade Confirmations
23. Rule 10b-10 of the Securities Exchange Act of 1934 (the “Exchange Act”) provides, in pertinent part, any broker or dealer who effects a transaction in the account of a customer in any security to provide written notification of the date and time of the transaction, the identity, price, and number of shares of the security. The preliminary note to the rule indicates that this information must be provided to customers “at or before completion of such transaction.”
24. According to the Firm’s policies and procedures, customers that maintain managed discretionary investment accounts have the option of receiving trade confirmations or appointing an interested party to receive the trade confirmations.
25. To the extent that a customer wanted an interested party to receive the trade confirmations, the Firm required its customers to complete certain documentation and designate a Depository Trust Company participant or an interested party as the entity/person to receive such confirmations.
26. In late 2006, during the course of testing a recent system upgrade, the Firm discovered instances where trade confirmations were erroneously suppressed for non-managed and managed fee-based accounts because the necessary designations had not been made or the requested customer documentation had not been filed. With respect to non-managed accounts, the Firm determined that the accounts had previously been managed fee-based accounts and that an error occurred because the suppression code was not removed when the account switched to a non-managed account.
27. The Firm’s failure to deliver trade confirmations began in early 2001. During the Relevant Period, the Firm had a systemic deficiency relating to the delivery of trade confirmations to certain customers in certain managed and non-managed accounts. The Firm failed to send trade confirmations in excess of a million transactions, involving numerous customer accounts. The failure to deliver trade confirmations for these transactions constituted violations of Exchange Act Rule 10b-10 and NYSE Rule 401(a).
28. The customers who did not receive the trade confirmation were customers of Citigroup and one of its affiliates. Citigroup clears all transactions for Citigroup and its affiliate.
29. In March 2007, the Firm implemented new systems coding to ensure that when an account ceases to be managed, confirm suppression is immediately removed. In or about June 2007, the Firm implemented a remedial procedure to remove suppression coding from accounts for which confirmations were improperly suppressed. Citigroup is currently in the process of developing reinforced procedures to ensure that a managed account’s eligibility for suppression is verified prior to the account being coded as such.
Failure to Supervise (NYSE Rule 342)
30. NYSE Rule 342(a) provides, in pertinent part that: “(e)ach office, department or business activity of a member or member organization — shall be under the supervision and control of the member or member organization establishing it and of the personnel delegated such authority and responsibility.”
31. NYSE Rule 342(b) provides, in pertinent part that: “(e)ach member organization shall provide for appropriate supervisory control and shall designate a — principal executive officer to assume overall authority and responsibility for — each office, department or business activity, and provide for appropriate procedures of supervision and control — [and]” establish a separate system of follow-up and review to determine that the delegated authority and responsibility is being properly exercised.”
32. As set forth in paragraphs 4 to 23 and 31 to 32, Citigroup failed to provide for, establish and maintain appropriate procedures of supervision and control including a system of follow-up and review, with respect to its operational and technological activities relating to the delivery of product descriptions and prospectuses. In addition, during the Relevant Period, the Firm failed to maintain written procedures designed to ensure that prospectuses and product descriptions were being disseminated to customers that purchased certain securities as described above.
33. Also, as set forth in paragraphs 24 to 32, Citigroup failed to provide for, establish and maintain appropriate procedures of supervision and control including a system of follow-up and review, relating to the delivery of trade confirmations to certain customers.
Other Factors
34. The Firm cooperated fully in responding to Enforcement’s requests for information regarding the Firm’s policies, procedures, and practices for providing prospectuses, product descriptions, and trade confirmations to customers that purchased certain securities.
35. To comply with its current practices and applicable federal securities laws and NYSE rules, the Firm has enhanced its policies and procedures, including the development of new written supervisory and operational policies and procedures regarding the delivery of prospectuses and product descriptions.
36. The Firm self-reported its trade confirmation failures to Enforcement and has begun to enhance its policies and procedures regarding the delivery of trade confirmations.
Decision
The Hearing Officer, in accepting the Stipulation of Facts and Consent to Penalty, found Respondent guilty as set forth above.
Penalty
In view of the above findings, the Hearing Officer imposed the penalty consented to by Respondent of a censure, a fine in the amount of $2,250,000, and an undertaking to provide Enforcement with a written certification that Respondent’s current policies and procedures, including written supervisory and operational policies and procedures, regarding the delivery of prospectuses, product descriptions, and trade confirmations are reasonably designed to ensure compliance with the applicable federal securities laws and NYSE rules. Respondent will provide Enforcement with this written certification within 90 days from the date on which this Decision becomes final.
For the Hearing Board
Peggy Kuo – Chief Hearing Officer
Guiliano Law Group
If you have been the victim of securities fraud and you have a complaint, you should consult with an attorney. The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.
