Cease-and-Desist: In re Citigroup Global Markets, Inc.; In re Morgan Stanley Smith Barney LLC.

In In the Matter of Citigroup Global Markets, Inc., SEC Admin. Proc. File no. 3-17808 (Jan. 24, 2017), and In the Matter of Morgan Stanley Smith Barney LLC, SEC, Admin. Proc. File No. 3-17809 (Jan. 24, 2017), the Securities and Exchange Commission (“Commission”) found, in actions where the respondents neither admitted nor denied the findings, that Citigroup Global Markets Inc., (“CGMI”), and Morgan Stanley Smith Barney LLC (“MSSB”) violated Section 17(a)(2) of the Securities Act of 1933 (“Securities Act”).  CGMI and MSSB consented to the order of a cease-and-desist order based on the alleged violations and agreed to pay civil penalties to resolve the proceedings. 

According to the Order, CGMI is a wholly owned indirect subsidiary of Citigroup, Inc. that functions as a broker-dealer and investment advisor.  At the time of events, CGMI held 49% ownership interest in MSSB, a limited liability company that was also a broker dealer and investment advisor.  CGMI developed several quantitative foreign exchange trading models called the CitiFX Alpha family of strategies and incorporated them into the CitiFX Alpha Program, a financial program that operated as an investment contract to certain brokerage customers and advisory clients of MSSB (the “Relevant Investors”).  

Upon enrolling in the CitiFX Alpha Program, Relevant Investors opened foreign exchange trading accounts at CGMI and posted cash or securities to those accounts as collateral.  Financial advisors at MSSB, in tandem with CGMI, selected the notional amounts that the Relevant Investors traded.  Some Relevant Investors posted collateral as little as ten percent of their notional amount.  Additionally, Relevant Investors’ financial advisors were responsible for the size of the mark-ups charged on all CitiFX Alpha trades. 

The Commission claimed the two major assumptions regarding the CitiFX Alpha’s past performances were not adequately disclosed to the Relevant Investors during PowerPoint and oral presentations by CGMI personnel and MSSB financial advisors.  The presentations used past performance and risk metrics that assumed fully collateralized accounts, or accounts that had an equal amount of collateral to the notional amount.  The presentations also assumed no mark-ups would be charged on trades.  

The Commission also stated that the Relevant Investors included “individuals who had no experience in foreign exchange trading and who did not understand what a notional amount is; that the cash they posted to their foreign exchange accounts merely served as collateral; or that there was a difference between the notional amounts they traded and the amount of collateral they posted to their accounts.” 

Section 17(a)(2) of the Securities Act, 15 U.S.C. § 77q(a)(2), prohibits any person in the offer or sale of a security from obtaining money or property by means of any untrue statement of a material fact or any omission of material fact necessary to make statements, in light of the circumstances under which they were made, not misleading.  

The Commission determined that CGMI and MSSB had violated section 17(a)(2) of the Securities Act for failing to disclose the metrics used in presentations were not reflective of the degree of leverage the Relevant Investors would need, and for failing to disclose the adequate amount of mark-ups to be employed.  Both omissions materially altered disclosed performance and risk metrics, meaning that CGMI and MSSB omitted material information necessary to make non-misleading statements about the CitiFX Alpha program. 

CGMI and MSSB agreed the sanctions imposed by the Commission and the cease-and-desist order for their violations.  Each party was ordered to pay discouragement of $624,458.27, prejudgment interest of $89,277.34, and a civil money penalty in the amount of $2,250,000.00 to the Commission within 21 days. 

The primary materials for this case may be found on the DU Corporate Governance website.