Tuesday, April 6, 2010
In its first enforcement action involving a broker-dealer stock borrow program, the Financial Industry Regulatory Authority (FINRA) announced today that it has fined Citigroup Global Markets, Inc. $650,000 for disclosure and supervisory violations relating to the operation of its Direct Borrow Program (DBP). FINRA's investigation found that between Jan. 1, 2005, and Nov. 30, 2008, Citigroup's DBP borrowed fully paid hard-to-borrow securities owned by the firm's customers, who were in large part retail customers. The borrowed securities went into a pool of securities used, among other things, to facilitate Citigroup's clients' short-selling strategies. The DBP arranged for more than 4,000 loans involving more than 770 different securities borrowed from more than 2,300 customers. The average annual value of outstanding loans from customers was approximately $301 million.
FINRA found that Citigroup failed to disclose adequately certain material information to customers participating in the DBP, including that the securities were hard-to-borrow; that the interest rates could be reduced by the firm; that the brokers received commissions for the duration of the loan; that while the securities were on loan, dividends were paid as "cash-in-lieu" of dividends and were therefore subject to higher tax rates; and, that shares on loan could be sold by the customers at any time.
In addition, FINRA found that the DBP operated without a system or procedures specifically designed to supervise the activities of the DBP staff and the firm's brokers and to adequately monitor the accounts of customers who participated in the DBP.
FINRA also found that Citigroup distributed three versions of marketing materials to the public regarding the DBP that were not fair and balanced and did not provide a sound basis for evaluating the facts in regard to the DBP.
In concluding this settlement, Citigroup neither admitted nor denied the charges, but consented to the entry of FINRA's findings.