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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.
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