Citigroup Global Markets Inc. Fined $1.4 Million by FINRA for Margin Violations and Inaccurate Reporting Over Nine-Year Period: A Deeper Look into Possible Beneficiaries of the Lax Margin Enforcement
Citigroup Global Markets Inc. (CGMI), a member of the Financial Industry Regulatory Authority (FINRA) since 1936, recently settled regulatory violations through a Letter of Acceptance, Waiver, and Consent (AWC). These violations, spanning nearly a decade from 2012 to 2021, resulted in a $1.4 million fine and a formal censure from FINRA.
The settlement addresses CGMI's failure to collect required initial and maintenance margin on over-the-counter (OTC) equity option contracts with affiliated entities, as well as related infractions involving net capital computation, inaccurate financial reporting, and recordkeeping violations.
Key Findings
1. Failure to Collect Required Margin
From October 2012 to March 2021, CGMI did not collect required initial and maintenance margin on OTC equity option contracts with two affiliated entities. The firm discontinued its manual margin calculation process in 2012 and did not implement an automated solution until May 2022. This lapse resulted in significant margin deficiencies:
- Sample data for March-May 2020 revealed deficiencies ranging from $16 million to $2.2 billion for one affiliate.
- For the other affiliate, deficiencies ranged from $1 million to $81.1 million on sampled dates.
2. Improper Extension of Credit
FINRA found that CGMI improperly extended credit to affiliated entities by executing OTC option trades in cash accounts, which violated Exchange Act § 7(c), Regulation T, and FINRA Rules 4210 and 2010. Cash accounts are restricted from such transactions without specific exemptions, which were not applicable in this case.
3. Inaccurate Net Capital Reporting
CGMI overstated its net capital by failing to deduct margin deficiencies from calculations, violating the Securities Exchange Act § 15(c)(3) and related rules. During the sample period in 2020, the overstatement reached as high as $2.2 billion.
4. Inaccurate Books, Records, and Regulatory Filings
The firm's failure to account for margin deficiencies resulted in inaccurate general ledger entries and net capital computations. Consequently, CGMI submitted flawed Financial and Operational Combined Uniform Single (FOCUS) reports to regulators, violating Exchange Act § 17(a)(1) and related FINRA rules.
Who Wasn’t Margin-Called and Why?
Given the substantial deficiencies revealed in CGMI’s reporting, speculation has emerged about potential beneficiaries and reasons certain entities avoided margin calls. Based on past track records, two possibilities stand out:
1. Affiliated Hedge Funds with Strategic Interests
It's plausible that affiliated hedge funds, which maintain close financial ties to CGMI, benefited from lenient oversight. Historically, large hedge funds have been known to influence the system, leveraging relationships to sidestep immediate repercussions, as seen in past financial crises.
2. Market Makers or High-Frequency Trading Firms
Firms functioning as market makers or engaging in high-frequency trading (HFT) could have avoided margin calls due to their critical role in maintaining market liquidity. Regulators often grant such entities leeway to prevent disruption in the broader market. This raises questions about whether CGMI’s lax margin practices were an intentional oversight to support such players.
Sanctions and Remediation
- Fine and Censure: CGMI consented to a $1.4 million fine and a formal censure.
- Corrective Measures: Upon discovering the violations in early 2021, CGMI initiated remediation efforts, including an internal investigation and the implementation of an automated margin calculation system by May 2022.
Implications for the Industry
The case underscores the critical importance of adhering to margin requirements and maintaining accurate financial records. FINRA Rule 4210, which governs margin practices, serves to protect market integrity and mitigate systemic risks. CGMI’s lapses not only conferred financial advantages to its affiliates but also highlighted vulnerabilities in oversight and operational processes.
Broker-dealers are reminded to:
- Implement robust compliance systems for margin calculation.
- Regularly audit financial and operational controls.
- Ensure accuracy in regulatory filings to avoid penalties and reputational damage.
Conclusion
The CGMI case illustrates how lapses in compliance can have far-reaching consequences. While the firm has taken steps to address deficiencies, the $1.4 million fine serves as a stark reminder of the costs of regulatory non-compliance in the financial industry. FINRA’s action reinforces its commitment to upholding standards of integrity and accountability among its members.