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SFC reprimands and fines Citigroup Global Markets Asia Limited $348.25 million for serious regulatory failures over client facilitation activities

Issue date: 2022-01-28 16:22:16

The Securities and Futures Commission (SFC) has reprimanded and fined Citigroup Global Markets Asia Limited (CGMAL) $348.25 million for allowing various trading desks under its Cash Equities business to disseminate mislabelled Indications of Interest (IOIs) and make misrepresentations to institutional clients when executing facilitation trades from 2008 to 2018 (Notes 1 to 3).

The SFC considers that such pervasive dishonest behaviour would not have continued but for serious lapses and deficiencies in its internal controls, compliance function and management oversight.

The SFC is also of the view that CGMAL’s failures and misconduct were attributable to the failures by certain former members of its senior management to discharge their supervisory duties.  The SFC will commence disciplinary proceedings against these individuals in due course (Note 4).

CGMAL has taken remediation steps and enhancement measures to rectify and strengthen its internal controls in respect of IOIs and client facilitation activities, including the appointment of an independent reviewer to review and validate its controls framework.

Mr Ashley Alder, the SFC’s Chief Executive Officer, said: “The severity of CGMAL’s failures exposed a culture that encouraged chasing revenue at the expense of basic standards of honesty.  As a result, in the face of unrelenting commercial pressure to solicit more business and increase CGMAL’s market share, deceptive practices were deployed at the expense of clients’ best interest and to the detriment of market integrity.”

“The sanction against CGMAL is warranted because it fell far short of the standards expected of licensed intermediaries.  It also underscores the SFC’s zero tolerance attitude in its determination to root out misconduct by licensed intermediaries,” Mr Alder added.

Mr Thomas Atkinson, the SFC’s Executive Director of Enforcement, said: “A key concern of the SFC is the failure of CGMAL’s senior management to ensure the maintenance of appropriate standards of conduct and adherence to relevant regulatory requirements, and to understand, manage and monitor its business and risks.  The prevalence of the misconduct for a prolonged period reflects a failure on the part of CGMAL’s senior management to properly discharge their management and supervisory responsibilities.”

Mislabelled IOIs

Since at least 2008, CGMAL’s Equities Sales Trading Desk had sent IOIs tagged as “Natural”, “In Touch With” and/or “P:1” to clients when there was no genuine client interest or specific client that CGMAL was in touch with (Note 5).

These mislabelled IOIs, which were generated with reference to certain percentage of the average daily volumes of selected blue-chip stocks in the market, were designed to provoke client enquiries with the purported belief that traders would be able to find natural opposite flows to cross with the client order given the active trading of the stocks and the size of CGMAL’s trading platform.  The Facilitation Desk of CGMAL would step in to provide liquidity when traders failed to source natural liquidity on an agency basis upon client enquiry.

CGMAL’s mislabelling of IOIs was not only contrary to the relevant industry guidelines that it claimed to have adopted but, more importantly, inconsistent with the fundamental principles of being honest with clients and treating them fairly.

Misrepresentation and non-disclosure to conceal the principal nature of facilitation trades

The SFC reviewed 174 sample facilitation trades executed by CGMAL’s various trading desks from January 2014 to December 2018 and found that in 127 of them, the heads and traders of the desks:

• gave factually incorrect information to the client or took positive steps to conceal the principal nature of the trade;
• made misleading statements that could be interpreted by the client as indicating that the trade would be executed on an agency basis, or sometimes remained silent notwithstanding some indication of the client’s belief that the trade was an agency trade; and/or
• remained silent or were not explicit with the client about the involvement of the Facilitation Desk and failed to obtain client’s consent before routing the client’s order to the Facilitation Desk for execution (Note 6).

Clients generally prefer transactions on an agency basis (ie, natural liquidity) over facilitation.  By misrepresenting a facilitation trade as an agency trade or refraining from informing the client about the involvement of the Facilitation Desk, CGMAL could avoid losing a trade to a competitor.

Internal control failures

The prevalence of the misconduct among the desks over a period of more than 10 years indicates serious and systemic lapses across CGMAL’s controls framework and its first and second lines of defence.  In particular, before November 2018, CGMAL failed to:

• put in place any policies or controls to monitor the issuance of “In Touch With” and “P:1” IOIs and ensure that such IOIs were backed by specific client interest;
• have adequate internal guidelines and enforce them in relation to pre-trade disclosure of and obtaining client consent for facilitation trades.  Instead, CGMAL deliberately excluded the requirement for obtaining client consent for facilitation trades when revising its compliance guidelines in 2018;
• implement effective compliance monitoring in respect of its facilitation activities to ensure that traders had made pre-trade disclosure of CGMAL’s principal capacity and obtained clients’ prior consent;
• provide training to traders on IOIs and pre-trade consent for facilitation activities;
• record and monitor communications and ensure sufficient segregation between agency and facilitation desks; and
• identify and rectify system errors that had led to the sending of erroneous post-trade messages to clients, which incorrectly indicated that CGMAL acted in an agency capacity when in fact it acted as principal (Note 7).

Since at least 2014, CGMAL had multiple opportunities to identify and rectify the above failures but failed to do so until the misconduct was discovered during an SFC on-site inspection in late 2018 (Note 8).

The SFC considers that CGMAL has failed to comply with various provisions in the Code of Conduct for Persons Licensed by or Registered with the SFC, and the Management, Supervision and Internal Control Guidelines for Persons Licensed by or Registered with the SFC (Note 9).

In deciding the disciplinary sanctions, the SFC took into account all relevant circumstances, including:

• the dissemination of mislabelled IOIs, misrepresentation of the source of liquidity when executing facilitation trades and the exclusion of the requirement for prior consent for facilitation trades from CGMAL’s internal guidelines were dishonest and intentional;
• the duration of the misconduct exceeded 10 years and only came to light as a result of the inspection in 2018;
• CGMAL’s senior management turned a blind eye to the misconduct by allowing the desks to adopt mislabelled IOIs and perpetrate misrepresentation with a view to achieving business growth;
• CGMAL’s compliance function failed to properly discharge its duties;
• CGMAL has since then taken disciplinary actions against and summarily dismissed employees who had engaged in the misconduct;
• CGMAL has taken remediation steps and enhancement measures to stop the misconduct and address the SFC’s regulatory concerns;
• CGMAL’s cooperation with the SFC in resolving the SFC’s concerns and accepting the SFC’s findings and disciplinary action; and
• a strong message needs to be sent to the industry to deter other market participants from permitting similar failures to occur.

End

Notes:

1. CGMAL is licensed under the Securities and Futures Ordinance to carry on Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities), Type 5 (advising on futures contracts), Type 6 (advising on corporate finance) and Type 7 (providing automated trading services) regulated activities.
2. An IOI is a widely used form of advertisement or representation made by licensed corporations to clients as a way to source potential clients with an interest in trading.
3. In an agency trade, the licensed corporation acts as agent to find a counterparty (ie, natural liquidity) to cross with the client’s order.  In a facilitation trade, the licensed corporation acts as principal and fulfils the client’s order by buying or selling the securities from/to the client using the firm’s capital.
4. The SFC is of the view that senior management of a licensed corporation includes, among others, directors of the corporation, responsible officers of the corporation, and Managers-In-Charge of Core Functions.  Please see the SFC’s circular to licensed corporations regarding measures for augmenting the accountability of senior management dated 16 December 2016.
5. Since early 2017, CGMAL represented to clients that the AFME/IA Framework for Indications of Interest (AFME Framework) issued by the Association for Financial Markets in Europe and the Investment Association was adopted in classifying its IOIs.  According to the AFME Framework, “P:1” or “In Touch With” IOIs can be issued where there is a reasonable expectation of interest from a specific client and resulting trades are expected to be of a riskless nature.
6. The SFC has not reviewed any facilitation trades prior to 2014 since CGMAL no longer retained audio records for such period.
7. The messages were sent via Financial Information eXchange, an electronic communications protocol for the international real-time exchange of securities transaction information.
8. In July 2014, CGMAL’s senior management attended a roundtable meeting with the SFC, during which attendees’ attention was drawn to common deficiencies found in client facilitation activities in the market, including missing explicit client consent and lack of independent checking of client consent.  CGMAL conducted a gap analysis following the meeting but failed to identify the misconduct or rectify the failures.  On 14 February 2018, the SFC published a circular to licensed corporations on client facilitation, providing further guidance on the standards of conduct and internal controls the SFC expects of firms providing client facilitation services.  CGMAL conducted a further gap analysis following the publication of this circular but still failed to identify the misconduct or rectify the failures.
9. Please refer to the Statement of Disciplinary Action for details of the relevant regulatory requirements.

News captured as of:2022-01-28 16:22:16

Source: SFC