FINRA Imposes $15 Million Fine on Broker-Dealer for Supervisory Failures Relating to Equity Research
Commentary by Steven Lofchie
FINRA imposed a $15 million fine on a broker-dealer for supervisory failures relating to the firm's equity research activities.
The broker-dealer, Citigroup Global Markets, Inc. ("Citi"), was charged with failures involving:
1. Selective Dissemination of Non-Public Research. According to FINRA, Citi's equity research analysts had frequent contact with institutional customers, including hosting "idea dinners" with institutional customers at which research analysts discussed their latest ideas, and participated in stock-picking contests. In certain cases, the research analysts provided non-public research information in advance of published research, or stock picks that were inconsistent with the research analyst's previously published research. FINRA claimed that as research analysts were compensated based partly on the ratings they received from customers at these events, this created a heightened risk that the research analysts might discuss non-public research information with these institutional customers before the publication of the relevant research report. Despite this risk, FINRA claimed that Citi's written compliance and supervisory procedures did not specifically address the scope of permissible communications at such dinners, nor did Citi take adequate steps to supervise communications by research analysts at these events.
In a separate incident, FINRA claimed that a non-U.S. research analyst employed in one of Citi's non-U.S. offices distributed non-public research information concerning a company to certain clients. In turn, a FINRA-registered equity sales representative working at that non-U.S. office sent that information to certain other clients. FINRA charged Citi with failing to prevent the selective dissemination of non-public research information by individuals in the non-U.S. office.
2. Preparation of Materials for Use in Investment Banking Road Show. According to FINRA, a research analyst assisted in preparing a company for an investment banking road show by commenting on the proposed road show presentation. According to FINRA, by doing so, Citi breached the prohibition on equity research analysts "indirectly" participating in an investment banking road show, even though the analyst did not attend. Although Citi's written compliance procedures included a general prohibition on equity research analysts participating in investment banking road shows, FINRA claimed that Citi's written procedures were deficient because they did not specifically address the circumstances in which research analysts were prohibited from "indirectly" participating in road shows.
3. Inadequate Internal Disciplinary Procedures. FINRA acknowledged that Citi issued approximately 100 internal warning notices concerning violations of Citi's selective distribution and client communication policies to its research analysts over a nine-year period. Nevertheless, FINRA claimed, Citi did not discipline its research analysts effectively for such failures, thus failing to deter future violations. Specifically, FINRA noted a lack of increased penalties for more severe or repeat violations, as well as undue delays in Citi's disciplinary process.
See: FINRA Press Release.
Commentary
This is a significant enforcement action in terms of both the severity of the fine imposed on Citi by FINRA and the lessons to be learned by other firms, as discussed below. Firms should consider these issues in light of the proposed new debt and equity research rules that FINRA filed with the SEC last week, which place an overarching obligation on firms to adopt and implement written policies and procedures to "identify and effectively manage conflicts of interest" arising from firms' research activities.
a. Written Compliance and Supervisory Procedures. Firms should consider whether their written compliance and supervisory procedures adequately address the specific risks arising from the activities in which analysts participate. As indicated by FINRA, general statements (e.g., the dissemination of non-public research ahead of research reports or participation in road shows) may not be adequate. Firms should consider whether specific activities (e.g., idea dinners, stock pick contests or indirect assistance in road shows) warrant additional guidelines. In addition, firms should consider whether compliance personnel receive adequate notification of new types of activities that may need to be addressed in their written procedures.
b. Supervision of Research Analyst Activities. Firms should consider the adequacy of their procedures for monitoring the activities of their research analysts, particularly where those activities pose a heightened risk that analysts could be tempted to engage in impermissible communications. Firms should consider which measure might address such risks appropriately, including pre-screening certain research analysts communications or requiring direct oversight of such communications.
c. Internal Disciplinary Procedures. Firms should consider whether their internal disciplinary procedures adequately address breaches of regulatory requirements. Specifically, firms should consider whether the disciplinary procedures are timely (without undue delay), and impose appropriate sanctions to deter future breaches (e.g., increasingly severe sanctions for more severe or repeated breaches).
d. Applicability to Non-U.S. Affiliates. Firms should consider the extent to which they need to monitor or coordinate the oversight of research activities with their non-U.S. affiliates in order to ensure compliance with applicable SEC and FINRA Rules. This will be particularly relevant where non-U.S. offices participate in the research activities of the U.S. broker-dealer or where non-U.S. affiliates employ FINRA-registered personnel that are subject to the FINRA Rules.