Citi unit settles compliance systems case

Dec 13, 2016
<p>Finra says firm&rsquo;s tools weren&rsquo;t reasonably designed to ensure accurate securities pricing</p>

Citigroup Global Markets has agreed to pay an $850,000 fine to settle allegations its compliance systems and procedures were lacking in ways linked to ascertaining the value of its securities holdings and its net capital.

The Financial Industry Regulatory Authority (Finra) has accepted a letter of acceptance, waiver and consent from the firm, which does not admit or deny wrongdoing. A message left with Citigroup’s press office requesting comment was not returned.

According to Finra, from 2009 through at least June 2012 Citigroup failed to establish and maintain supervisory systems, procedures and written supervisory procedures (WSPs) reasonably designed to ensure it calculated accurately the value of the securities it held. Finra alleges that Citigroup’s supervision was inadequate in that the firm:

  • Did not have adequate procedures to ensure it verified its pricing in a consistent manner
  • Used different methods to value the same securities for different purposes, and had no system or procedure to compare these valuations and identify or investigate discrepancies.

Specifically, Finra says that during the period at issue a Citigroup trader would estimate the value of a security that did not have an easily identifiable market price and, to verify the accuracy, the firm’s product control group (PCG) would compare the trader’s marks to prices it derived from market data collected from sources including the firm’s market-making desks and vendor prices.

But the firm’s WSPs failed to spell out how the PCG should use this information to conduct its reviews, according to Finra. For example, it says, the WSPs did not specify: which sources the PCG should rely on as principal sources, and which should be considered secondary; what types of alternative pricing methods the PCG should use for certain product types; and what thresholds the PCG should use to determine whether a trader’s mark was so different from the PCG’s determination that it was likely inaccurate.

The firm lacked systems and procedures to ensure the pricing differences were identified and reasonable under the circumstances, Finra says. Although it had a report that identified instances when a single security was assigned multiple prices within its inventory, that report was generated only on a monthly basis, did not capture customer securities and was distributed only to the PCG, Finra alleges.

Finra also says that, between December 2010 and July 2011, Citigroup’s system for applying required deductions to the value of certain of its mortgage-backed securities (MBS) positions when computing the firm’s net capital was inadequate.

According to the self-regulatory organization (SRO), the system was not reasonably designed because it did not update required deductions after they had been adjusted manually and the firm lacked an adequate process to monitor, review or otherwise supervise manual adjustments. As a result, Finra says, Citigroup overstated its net capital during this period by amounts as high as $26 million.

The firm used its FOCUS haircut system to apply haircuts automatically to its MBS positions in order to calculate its net capital, according to the SRO. But during the period at issue, Citigroup lacked adequate supervisory systems and WSPs for monitoring and reviewing manual overrides in that system, Finra says. As a result of these alleged issues, the firm violated Rule 15c3-1(c)(2)(vii) under Section 15c of the Securities Exchange Act (see Compliance pointer, below) and Finra rules 3010 (a) and (b) and 2010, the SRO adds.

In addition, since or around 1998 through June 2012, the firm failed to have adequate systems and procedures in place to ensure its stock record accurately reflected bond loan transactions and related repurchase agreements, Finra alleges.

Exchange Act Rule 15c3-I requires a broker-dealer to maintain a minimum amount of net capital and to compute its net capital in accordance with specified formulas. To compute its net capital, a broker-dealer must determine the value of the securities it owns and then deduct a specified percentage of the value of each of those securities.

Under Exchange Act Rule 15c3-1(c)(2)(vii), if a broker-dealer owns securities for which there is no ready market or that cannot be publicly offered or sold without registration, it must deduct ‒ or ‘haircut’ ‒ 100 percent of their value from its calculations. On July 13, 2001, the SEC issued a no-action letter spelling out the circumstances when a broker-dealer must deduct 100 percent of the value of its MBS, and when it could apply a haircut of less than 100 percent to investment grade MBS.

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