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FINRA Sanctions Wells Fargo, Citigroup, Morgan Stanley & UBS

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Sales tactics for leveraged and inverse exchange-traded funds draw fines and client restitution requirements from FINRA.

The Financial Industry Regulatory Authority (FINRA) announced that it has sanctioned Citigroup Global Markets, Inc; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC a total of more than $9.1 million for selling leveraged and inverse exchange-traded funds (ETFs) without reasonable supervision and for not having a reasonable basis for recommending the securities. The firms were fined more than $7.3 million and are required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases.

FINRA sanctioned the following firms:

  • Wells Fargo – $2.1 million fine and $641,489 in restitution
  • Citigroup – $2 million fine and $146,431 in restitution
  • Morgan Stanley – $1.75 million fine and $604,584 in restitution
  • UBS – $1.5 million fine and $431,488 in restitution

Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, “The added complexity of leveraged and inverse exchange-traded products makes it essential that brokerage firms have an adequate understanding of the products and sufficiently train their sales force before the products are offered to retail customers. Firms must conduct reasonable due diligence and ensure that their representatives have an understanding of these products.”

ETFs are typically registered unit investment trusts (UITs) or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark or index. Leveraged ETFs seek to deliver multiples of the performance of the index or benchmark they track. Inverse ETFs seek to deliver the opposite of the performance of the index or benchmark they track, profiting from short positions in derivatives in a falling market.

FINRA found that from January 2008 through June 2009, the firms did not have adequate supervisory systems in place to monitor the sale of leveraged and inverse ETFs, and failed to conduct adequate due diligence regarding the risks and features of the ETFs. As a result, the firms did not have a reasonable basis to recommend the ETFs to their retail customers. The firms’ registered representatives also made unsuitable recommendations of leveraged and inverse ETFs to some customers with conservative investment objectives and/or risk profiles. Each of the four firms sold billions of dollars of these ETFs to customers, some of whom held them for extended periods when the markets were volatile.

Leveraged and inverse ETFs have certain risks not found in traditional ETFs, such as the risks associated with a daily reset, leverage and compounding. Accordingly, investors were subjected to the risk that the performance of their investments in leveraged and inverse ETFs could differ significantly from the performance of the underlying index or benchmark when held for longer periods of time, particularly in the volatile markets that existed during January 2008 through June 2009. Despite the risks associated with holding leveraged and inverse ETFs for longer periods in volatile markets, certain customers of these firms held leveraged and inverse ETFs for extended time periods during January 2008 through June 2009.

In settling these matters, the firms neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

Florida Securities Litigation and FINRA Arbitration

Contact Fort Lauderdale securities litigation attorney Howard N. Kahn, Esq. if you or someone you know has a securities dispute. In addition to being an experienced securities litigation attorney, Mr. Kahn also serves as a FINRA arbitrator for individual investors, brokers, and brokerage firms. You can reach him at 954-321-0176 or online.

FINRA Fines Citigroup Unit for Excessive Markups

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The Financial Industry Regulatory Authority (FINRA) announced this week that it fined Citi International Financial Services LLC, a subsidiary of Citigroup, Inc., $600,000 and ordered more than $648,000 in restitution and interest to more than 3,600 customers for charging excessive markups and markdowns on corporate and agency bond transactions, and for related supervisory violations.

According to a FINRA release:

Thomas Gira, Executive Vice President, FINRA Market Regulation, said, “FINRA is committed to ensuring that customers who purchase and sell securities, including corporate and agency bonds, receive fair prices. The markups and markdowns charged by Citi International were outside of appropriate standards for fair pricing in debt transactions, and FINRA will continue to identify and address transactions that violate fair pricing standards, regardless of whether a markup or markdown is above or below 5 percent.”

FINRA found that from July 2007 through September 2010, Citi International charged excessive corporate and agency bond markups and markdowns. The markups and markdowns ranged from 2.73 percent to over 10 percent, and were excessive given market conditions, the cost of executing the transactions and the value of the services rendered to the customers, among other factors. In addition, from April 2009 through June 2009, Citi International failed to use reasonable diligence to buy or sell corporate bonds so that the resulting price to its customers was as favorable as possible under prevailing market conditions.

During the relevant period, Citi International’s supervisory system regarding fixed income transactions contained significant deficiencies regarding, among other things, the review of markups and markdowns below 5 percent and utilization of a pricing grid for markups and markdowns that was based on the par value of the bonds, instead of the actual value of the bonds. Citi International was also ordered to revise its written supervisory procedures regarding supervisory review of markups and markdowns, and best execution in fixed income transactions with its customers.

In concluding this settlement, Citi International neither admitted nor denied the charges.

Contact Fort Lauderdale securities litigation attorney Howard N. Kahn, Esq. if you or someone you know invested in corporate or agency bond transactions sold by the Citi International Financial Services unit of Citigroup, Inc. In addition to being an experienced securities litigation attorney, Mr. Kahn also serves as a FINRA arbitrator for individual investors, brokers, and brokerage firms. You can reach him at 954-321-0176 or online.