NASD Orders Citigroup to Pay Over $1.1 Million for Failing to Prevent Brokers' Submission of False Information to Mutual Funds
Washington, D.C. — NASD announced today that it has fined Citigroup Global Markets Inc. $400,000 for supervisory and recordkeeping violations in connection with a ploy by more than 100 of its brokers to improperly obtain waivers of mutual fund sales charges by falsely claiming that their customers were disabled. The firm was also ordered to pay $715,000 in restitution to the affected mutual fund entities.
NASD found that the ruse was carried out from June 2001 through June 2002. With respect to possible improper waivers pre-dating June 2001, the firm agreed to contact the distributors of affected mutual funds, notify them that there may have been improper disability waivers and give them an opportunity to make additional restitution claims. To date, NASD has taken disciplinary action against five Citigroup registered representatives relating to this misconduct. NASD investigations into other Citigroup brokers are continuing.
NASD also ordered Citigroup to review its policies, systems, procedures and training relating to Contingent Deferred Sales Charge (CDSC) waivers in mutual fund transactions. For one year, Citigroup must also provide a quarterly certification to NASD that it has reviewed all CDSC disability waivers granted, has verified that they were appropriately granted (or corrected those waivers that were not appropriately granted), and has retained required supporting documentation. The firm was also required to provide appropriate training regarding CDSC waivers to its retail managers and representatives.
"Firms are obligated to be alert for supervisory 'red flags' and address systemic weaknesses that could permit widespread abusive behavior," said NASD Executive Vice President and Head of Enforcement James S. Shorris. "In this case, because Citigroup effectively failed to address a known problem, its representatives were able to improperly exploit the mutual funds' fee waiver provisions that were specifically reserved for disabled individuals - extending them even to hedge funds. This widespread failure contributed to the ability of Citigroup representatives to process over 2,400 improper waivers based on false disability claims."
A CDSC is the sales charge that mutual fund companies impose on investors who sell/redeem their Class B shares within a certain period after purchase. CDSCs may be waived under certain circumstances as defined by the mutual fund prospectus - typically death, disability or a qualified distribution. In order to obtain a disability-based waiver for a customer, a broker is often required to obtain and/or submit certain documentation evidencing the customer's eligibility for a CDSC waiver as defined by the IRS or the particular fund's prospectus. The eligibility for a CDSC waiver is further narrowed by the timing of the disability; the waivers are generally available only when the customer becomes disabled after the mutual fund purchase. Further, in most cases, the disability-based waiver can be taken only within one year of the date the customer becomes disabled.
NASD found that, from June 1, 2001 through June 30, 2002, Citigroup representatives improperly entered disability waivers for hundreds of customers in connection with 2,419 mutual fund transactions totaling $47 million. Those registered representatives, in most cases, misrepresented on Citigroup's electronic order entry system that their customers were entitled to CDSC waivers because they were disabled. In several instances, Citigroup registered representatives even entered CDSC waivers for hedge funds, thereby claiming that those entities were "disabled" individuals as defined by the Internal Revenue Service or in the applicable prospectus.
NASD also found that Citigroup failed to maintain, update and enforce reasonable internal policies, systems and procedures in a number of respects, including:
- The firm's electronic order entry system provided an unsupervised method for its representatives to obtain CDSC waivers for customers. Citigroup failed to develop any exception reports, or otherwise provide for reasonable steps to ensure registered representatives' compliance with the applicable prospectus terms.
- While Citigroup issued a Compliance Memo in 1999 to its managers and directors advising that CDSC waivers could not be granted "except in circumstances specified in the fund prospectus," the firm failed to implement policies or procedures reasonably designed to ensure compliance with this directive.
- In those instances where a fund prospectus and/or dealer agreement specifically required the representative to obtain and/or submit certain documentation to support the CDSC waiver claim or, at minimum, to determine that the customer had become disabled, Citigroup had no system or procedures designed to ensure compliance with these documentation requirements and in fact failed to ensure that its registered representatives had obtained and/or submitted this information or otherwise complied with such requirements.
In addition, Citigroup failed to act on "red flags" and provide for effective follow-up and review, or otherwise monitor mutual fund transactions, to ensure that CDSC waivers were granted in accordance with the terms of the applicable mutual fund prospectus:
- Following disciplinary actions filed in 1997 against two of the firm's registered representatives for obtaining CDSC waivers for their customers under false pretenses, the firm failed to implement any new procedures reasonably designed to prevent recurrence of such misconduct, and otherwise failed to conduct a meaningful follow-up and review in subsequent years to determine whether it had successfully addressed the problems noted in the cases.
- In several instances, Citigroup registered representatives entered CDSC waivers for multi-million dollar mutual fund transactions by hedge funds, making the inexplicable claim that those entities were "disabled individuals" as defined by the IRS or in the applicable prospectus. Even when four of the transactions, totaling approximately $21 million, were blocked by the mutual fund companies, Citigroup failed to scrutinize those transactions.
- Over a 13-month period, CDSC waivers based on an improper and/or unsupported claim of customer disability were entered in 2,419 transactions totaling approximately $47 million, an extraordinarily high number for approximately 100 brokers. Yet Citigroup failed to scrutinize those transactions or make inquiry of the brokers entering those transactions. For example, one representative entered disability-based CDSC waivers for over 80% of his customer base. Most of those customers were not disabled, and, in many cases, they subsequently used the proceeds to make new investments.
NASD also found that the improper CDSC waivers entered by Citigroup's registered representatives caused the firm's books and records to contain false information regarding the disability status of customers and their entitlement to such waivers.
In concluding this settlement, Citigroup neither admitted nor denied the charges, but consented to the entry of NASD's findings.
To date, NASD has filed disciplinary actions against five Citigroup registered representatives for seeking CDSC waivers based on false claims that their customers were disabled. On Nov. 2, 2005, NASD barred former Citigroup broker Patricia Kwan from association with any member firm. Kwan consented to the bar without admitting or denying NASD's findings. On Feb.14, 2006, NASD's Department of Enforcement filed a complaint against two current and two former Citigroup brokers - Timothy Behany, Edward M. VanGrouw, Carl Martin Trevisan and David Joseph Cottam. The complaint is currently being litigated.
Under NASD rules, a firm or individual named in a complaint can file a response and request a hearing before and NASD disciplinary panel. Possible remedies include a fine, censure, suspension, or bar from the securities industry, and disgorgement of gains associated with the violations.
The issuance of a disciplinary complaint represents the initiation of a formal proceeding by NASD in which findings as to the allegations in the complaint have not been made and does not represent a decision as to any of the allegations contained in the complaint. Because this complaint is unadjudicated, interested persons may wish to contact the respondent before drawing any conclusions regarding the allegations in the complaint.
Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2005, members of the public used this service to conduct more than 4.3 million searches for existing brokers or firms and requested more than 194,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at www.nasdbrokercheck.com. Investors can also access this service by calling (800) 289-9999.
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