The Importance of Effective Trade Surveillance

 

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On August 19, 2015, The Securities and Exchange Commission “SEC” announced that Citigroup Global Markets (“Citigroup”) has agreed to settle charges that it failed to enforce policies and procedures to prevent and detect securities transactions that could involve the misuse of material, nonpublic information. Additionally, the SEC stated the firm also failed to adopt and implement policies and procedures to prevent and detect principal transactions by an affiliate.[1]

The SEC’s order finds that Citigroup violated Section 15(g) of the Securities Exchange Act of 1934, which requires brokers and dealers to establish, maintain, and enforce policies and procedures to prevent the misuse of material, nonpublic information. Citigroup also violated Section 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-(7), which require registered investment advisers to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its rules.

The SEC’s announcement stated Citigroup has agreed to pay a $15 million penalty and has agreed to adopt and implement upgraded policies and procedures. Additionally, Citigroup agreed to retain a consultant to review and recommend improvements to its trade surveillance and advisory account order handling and routing.  Without admitting or denying the findings, Citigroup consented to the SEC’s order that censures the firm and requires it to cease and desist from committing or causing these violations.

The SEC investigation found that Citigroup did not review thousands of trades executed by several of its trading desks during a 10-year period.  Personnel used electronically generated reports to review trades on a daily basis, but technological errors caused the reports to omit several sources of information about thousands of relevant trades.

According to the SEC’s order instituting a settled administrative proceeding:

  • The compliance and surveillance failures occurred from 2002 to 2012.
  • Citigroup also inadvertently routed more than 467,000 transactions on behalf of advisory clients to an affiliated market maker, which then executed the transactions on a principal basis by buying or selling to the clients from its own account.
  • Citigroup’s policies and procedures to avoid such occurrences were not reasonably designed or implemented and failed to divert certain advisory orders away from this affiliate.
  • Citigroup’s trade surveillance failed to detect these principal transactions for more than two years because the firm relied upon a report that was not reasonably designed to capture the principal transactions executed through this affiliate.
  • Citigroup voluntarily paid $2.5 million (its total profits from the principal transactions) to the affected advisory client accounts.

Andrew J. Ceresney, Director of the SEC’s Division of Enforcement stated. “Today’s high-speed markets require that broker-dealers and investment advisers manage the convergence of technology and compliance, Firms must ensure that they have devoted sufficient attention and resources to trade surveillance and other compliance systems.” This announcement by the SEC should serve as a reminder to firms of their obligation to develop, enforce, and test policies and procedures to prevent the misuse of material, nonpublic information. As this announcement demonstrates, failure to do so can result in significant and severe regulatory penalties. Additionally, firms must ensure they have adopted and implemented adequate policies and procedures to prevent and detect principal transactions by an affiliate. This issue can especially arise with hybrid Investment Advisers that use an affiliated Broker-Dealer as custodian as fixed income investments are typically executed by the Broker-Dealer as principal transactions and could create the same violation enforced in the Citigroup case. Investment Advisers need to be especially careful if they use an affiliated Broker-Dealer as custodian for advisory business.

CCLS can help. We can assist firms with developing comprehensive policies and procedures designed to monitor and prevent the misuse of non-public information, as well as providing guidance on testing methodologies and metrics. For more information on this and other related subjects, please contact us at info@corecls.com or (619) 278-0020.

[1] SEC Press Release 2015-171 August 19, 2015