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DOCKET NO. CO-10-7777-S
I. PRELIMINARY STATEMENT
II. CONSENT TO WAIVER OF PROCEDURAL RIGHTS
WHEREAS, CGMI, through its execution of this Consent Order, voluntarily waives the following rights:
To be afforded notice and an opportunity for a hearing within the meaning of Sections 36b-15(f) and 36b-27(a) of the Act and Section 36b-27(d)(2) of the Act, as amended, and Section 4-177(a) of the General Statutes of Connecticut;
To present evidence and argument and to otherwise avail itself of Sections 36b-15(f) and 36b-27(a) of the Act and Section 36b-27(d)(2) of the Act, as amended, and Section 4-177c(a) of the General Statutes of Connecticut;
|3.||To present its position in a hearing in which it is represented by counsel;|
|4.||To have a written record of the hearing made and a written decision issued by a hearing officer; and|
|5.||To seek judicial review of, or otherwise challenge or contest the matters described herein, including the validity of this Consent Order;|
NOW THEREFORE, the Commissioner hereby enters this Consent Order.
|CGMI admits the jurisdiction of the Commissioner, neither admits nor denies the Findings of Fact and Conclusions of Law contained in this Consent Order, and consents to the entry of this Consent Order by the Commissioner.|
IV. FINDINGS OF FACT
|1.||CGMI (which includes Smith Barney, a division of CGMI) has engaged in the sale of ARS in the state of Connecticut.|
Auction Rate Securities
ARS as a general term refers to long-term debt or equity instruments tied to short-term interest rates that are reset periodically through an auction process.
|3.||An ARS auction is regarded as a “fail” or “failed auction” if there is not a buyer available for every ARS being offered for sale at the auction. In the event of a failed auction, the investors that wished to sell their ARS were unable to do so and would continue to hold the ARS and wait until the next successful auction to liquidate their positions.|
|4.||Beginning in February 2008, the ARS market experienced widespread failed auctions (“2008 Auction Failures”).|
|5.||Common categories of ARS instruments include: (1) auction preferred shares of closed-end funds (“Preferreds”); (2) municipal auction rate certificates (“Municipal ARS”); and (3) student loan-backed auction rate certificates (“Student Loan ARS”). The interest rates paid to ARS holders are intended to be set through a Dutch auction process.|
|6.||The interest rate set at an ARS auction is commonly referred to as the “clearing rate”.|
In order to determine the clearing rate, the buy bids are arranged from lowest to highest interest rate (subject to any applicable minimum interest rate). The clearing rate is the lowest interest rate at which all ARS available for sale at the auction can be sold at par value.
CGMI’s Activities in the ARS Market
|8.||Trading of ARS at CGMI is performed by the Short-Term Tax-Exempt Sales and Trading Desk (“Auction Desk”).|
|9.||CGMI’s Auction Desk includes traders and sales coordinators. The sales coordinators on the Auction Desk at times provided information to, and answered questions from, CGMI’s financial advisers regarding ARS.|
|10.||For approximately twenty (20) years, CGMI has been an underwriter of ARS. The compensation earned for underwriting activities of Preferreds is typically one percent (1%) of the outstanding amount of the ARS underwritten. Since the late 1990s, the compensation for underwriting other types of ARS has generally been a fraction of one percent (.25% to .35%) of the outstanding amount of ARS underwritten.|
|11.||CGMI’s ARS underwriting activities are primarily handled by investment bankers. The Auction Desk often consulted the investment bankers with respect to various ARS matters.|
|12.||The cost of the financing to issuers is directly related to the clearing rates set at the auctions for the issuer’s ARS. As an underwriter, CGMI had an interest in providing low-cost financing to the issuers of the ARS that it underwrote because its ability to provide low-cost financing affected the possibility of additional underwriting business.|
|13.||CGMI typically served as a manager of ARS auctions. CGMI’s roles for each auction were typically set forth in a broker-dealer agreement entered into between CGMI and the ARS issuer.|
|14.||CGMI often served as the sole manager of ARS auctions or as the co-manager of auctions with other large broker-dealers.|
|15.||CGMI’s compensation for serving as an ARS auction manager is typically twenty-five (25) basis points (annualized) of the ARS amount that CGMI sold to its clients.|
|16.||If CGMI was either a sole or co-manager for an ARS, it may also have been designated as the lead or senior manager for the entire offering or for specific tranches (portions or sections) of the ARS offering.|
|17.||Prior to February 2008, CGMI’s practice was to submit cover or support bids in all auctions for which it was the lead broker-dealer.|
CGMI placed support bids to: (1) prevent failed auctions; and (2) prevent an auction from clearing at a rate that CGMI believed did not reflect the market for the particular ARS being auctioned.
For auctions where CGMI was designated a lead manager, it regularly placed support bids for the entire amount of ARS for which CGMI was designated the lead. These support bids ensured that there were enough buyers for every ARS available for sale at the auctions and, as a result, the auctions would not fail.
Marketing and Listing of ARS
|20.||Prior to the 2008 Auction Failures, CGMI marketed the following statement to its clients “[t]o date, CGMI, as lead manager, has never been involved in a failed auction.”|
|21.||CGMI and CGMI personnel marketed and sold ARS to investors in Connecticut as money-market alternatives, cash equivalents, and/or liquid investments.|
From on or about August 30, 2006 until on or about April 10, 2008, CGMI stated on its website that “[f]rom an investor’s perspective, and subject to the conditions discussed in more detail below [including the risk of a failed auction and liquidity risk], ARS are generally viewed as an alternative to money market funds.”
|23.||ARS are characterized on customer account statements according to the type of security. Until March 2008, CGMI’s account statements listed Preferreds under a heading of “Money market and auction instruments”.|
|24.||Since approximately 2004, CGMI has prepared and provided a document titled “Portfolio Review” (also formally called “Private Client Monitor”) to its clients. The Portfolio Review provides a snapshot of client accounts and is a way for CGMI’s clients to review their asset allocations and historical performance.|
The asset classes under which ARS are listed on the Portfolio Review include: (1) “Cash” (if the ARS reset period is seven (7) days or less, i.e., floaters whose rate is subject to adjustment based upon auction results); and (2) “Cash Equivalents”.
CGMI did not provide its financial advisers with the training and information necessary to explain adequately ARS products or the mechanics of the auction process to CGMI’s clients.
ARS Market from August 2007 to February 2008
|27.||In or about August and September 2007, some ARS auctions managed by other broker-dealers experienced failures (“2007 Auction Failures”). These 2007 Auction Failures were primarily based on credit quality concerns related to the ARS at issue.|
|28.||As a result of the 2007 Auction Failures and other market conditions, the ARS market began to see decreases in demand for ARS. Based on the decreasing demand, CGMI accumulated an increasing amount of ARS in its inventory because a higher number of CGMI’s support bids were being filled.|
|29.||Another effect of the decreasing demand in the ARS market was a general increase in the clearing rates. Given the increase in clearing rates, some ARS issuers contacted CGMI’s investment bankers to express their complaints with the cost of their financing and threatened to take future underwriting business to other firms.|
|30.||Because of the significant increase in CGMI’s ARS inventory, CGMI personnel began to discuss the possibility that there might come a time when CGMI could no longer support the auctions. These discussions started in or about August 2007 and continued until the 2008 Auction Failures. During this time, CGMI understood that its withdrawal from the ARS market would result in some auction failures and the illiquidity of ARS held by its clients.|
|31.||Throughout the fall of 2007, CGMI advised some ARS issuers to refinance their ARS into other types of financing such as variable rate demand obligations.|
Despite its advice to ARS issuers, on or about November 8, 2007, CGMI increased the sales credit paid to financial advisors at Smith Barney in connection with the sale of Seven-day (7-day) Municipal ARS.
CGMI’s internal reasons for the increased sales credit included: (1) “move increasing inventory”; (2) make “the product more attractive relative to other options”; (3) “greater pressure on our balance sheet”; and (4) “greater pressure from issuers concerning execution versus competitors.”
On February 11, 2008, CGMI did not place any support bids in auctions for Student Loan ARS. As a result, on that date, all of the Student Loan ARS auctions where CGMI was designated the lead manager failed.
After February 11, 2008, CGMI no longer continued to place support bids on all ARS for which it was designated the lead manager. Subsequently, many auctions then failed, resulting in the illiquidity of billions of dollars invested in ARS.
Auction Desk Tapes
|36.||CGMI recorded the Auction Desk’s phone calls. These calls sometimes included conversations with issuers, other CGMI personnel, and institutional investor clients.|
|37.||After a tape was fully recorded, it would be catalogued and maintained for a period of ninety (90) days. Following this ninety-day (90-day) period, the tape would be placed in a pool of tapes available for re-recording. CGMI represents that recycled tapes were randomly selected from the available pool for re-recording.|
|38.||On or about April 17, 2008, the multi-state task force requested documentary evidence related to ARS, including tape recordings, for the period from January 1, 2007 through April 17, 2008, from CGMI.|
|39.||On or about July 2, 2008, CGMI informed the multi-state task force that certain tapes of the Auction Desk for the period from mid-October 2007 through February 13, 2008, had been overwritten pursuant to CGMI’s represented tape recycling process. Upon discovery of the issue, CGMI promptly requested the suspension of the recycling of the Auction Desk tapes. CGMI represents that it subsequently determined that only one (1) of the nine (9) tapes for the period July 13, 2007 through July 2, 2008, had in fact been overwritten.|
As of July 2, 2008, CGMI had not overwritten the tapes for the period from July 13, 2007 through December 17, 2007, and for the period from February 14, 2008 through July 2, 2008.
CGMI failed to take adequate steps to secure one (1) tape of the Auction Desk.
V. CONCLUSIONS OF LAW
|1.||The Commissioner has jurisdiction over this matter pursuant to the Act.|
The Commissioner finds CGMI failed to supervise its employees and engaged in dishonest or unethical practices in the securities business, that this conduct violates Section 36b-4(b) of the Act and Section 36b-31-6f(b) of the Regulations, and that grounds therefore exist to revoke CGMI’s registration under Section 36b-15(a) of the Act.
The Commissioner finds that the entry of this Consent Order is necessary or appropriate in the public interest or for the protection of investors and consistent with the purposes fairly intended by the policy and provisions of the Act.
VII. CONDITIONS PRECEDENT
As conditions precedent to the entry of this Consent Order, CGMI represents, through the execution of this Consent Order, that CGMI has taken the following measures with respect to current and former customers that purchased “Eligible ARS” from CGMI.
Eligible ARS. For purposes of this Consent Order, “Eligible ARS” means ARS that were purchased at CGMI on or before February 12, 2008, and that have failed at auction at least once between August 7, 2008, and December 11, 2008.
Eligible Customer. As used in this Consent Order, “Eligible Customer” means:
Offer Period. No later than November 5, 2008, or, for those Eligible Customers not identified prior to November 5, 2008, despite CGMI’s best efforts, as soon as practicable thereafter, CGMI offered to purchase, at par plus accrued and unpaid dividends/interest, Eligible ARS from Eligible Customers. This offer period was required to remain open until at least February 5, 2009 (“Offer Period”). CGMI extended the Offer Period beyond this date and it remained open until June 12, 2009. To the extent that CGMI was made aware that an Eligible Customer did not receive notice of the offer, the Offer Period remained open for that Eligible Customer until at least Five (5) p.m. (Eastern Time) on June 1, 2009.
|4.||Initial Notice. No later than seven (7) business days from December 11, 2008, CGMI made its best efforts to identify and provide written notice to Eligible Customers, informing them of the relevant terms of the offer to repurchase, the specific security and quantity purchased (where practicable), and informing them that the offer may be the only opportunity for the investor to liquidate the ARS holdings, and that the offer to repurchase was being made pursuant to a settlement with various regulators. CGMI also provided written notice to any Eligible Customers identified subsequent to the initial notice.|
|5.||Second Notice. To the extent that any Eligible Customer had not responded to CGMI’s offer to purchase its Eligible ARS, CGMI made its best efforts to provide any such Eligible Customer a second written notice on or before forty-five (45) days before the end of the Offer Period including the terms detailed in paragraph VI (4) above, notifying such Eligible Customer of the impending expiration of the Offer Period, describing the state of the ARS market at that time, and explaining the consequences of failing to sell its ARS to CGMI prior to the expiration of the Offer Period.|
Notification to Customers Who Purchased ARS at Other Firms. With respect to CGMI customers who held ARS in their accounts at CGMI that were purchased at other firms, by no later than forty-five (45) days from December 11, 2008, CGMI used its best efforts to notify such customers that they should contact those firms directly to determine whether such firms were extending an offer to purchase the customers’ ARS.
|7.||Customer Assistance Line. No later than two (2) business days from December 11, 2008, CGMI established a dedicated toll-free telephone assistance line, with appropriate staffing, to provide information and to respond to questions concerning the terms of this Consent Order. CGMI was required to maintain this dedicated telephone assistance line through December 31, 2009.|
|8.||Purchase Acceptance Deadline. Eligible Customers may have accepted CGMI’s offer to purchase Eligible ARS by notifying CGMI within the Offer Period and consistent with the provisions of paragraphs VI (9) and VI (10) below.|
Purchases Relating to Eligible Customers Who Custody Their Eligible ARS at CGMI. For Eligible Customers who custodied their Eligible ARS at CGMI as of August 31, 2008:
Purchases Relating to Eligible Customers Who Custody Their Eligible ARS Away From CGMI. For Eligible Customers who custodied their Eligible ARS away from CGMI as of August 31, 2008:
|11.||Relief for Investors Who Sold Below Par. CGMI made its best efforts to identify any Eligible Customers who sold Eligible ARS below par between February 11, 2008, and December 11, 2008. By November 5, 2008, CGMI paid any such identified Eligible Customers the difference between par and the price at which the Eligible Customer sold the Eligible ARS, plus reasonable interest thereon. CGMI promptly paid any such Eligible Customers identified thereafter.|
|12.||Relief Efforts for Institutional and Other Customers. CGMI endeavored to work with issuers and other interested parties, including regulatory and governmental entities, to expeditiously and on a best-efforts basis provide liquidity solutions, by December 31, 2009, for institutional investors and other customers that purchased Eligible ARS from CGMI on or before February 12, 2008, and were not otherwise covered by paragraph VI (2) above.|
|13.||Refund of Refinancing Fees to Municipal Issuers. By January 1, 2009, CGMI refunded to municipal issuers underwriting fees the issuer paid CGMI for the refinancing or conversion of their ARS that occurred after February 11, 2008, where CGMI acted as underwriter for both the primary offering of ARS between August 1, 2007 and February 11, 2008, and the refunding or conversion of the ARS after February 11, 2008.|
Reports to NASAA. Within twenty (20) days following the end of each month, commencing with a report that covered the month ending November 30, 2008, and continued through and including a report that covered the month ended December 31, 2009, CGMI submitted a monthly written report detailing the efforts in which CGMI engaged and the results of those efforts with respect to CGMI’s institutional investors’ holdings in ARS. The report was submitted to a representative specified by the North American Securities Administrators Association (“NASAA”). Beginning in April 2009, CGMI met quarterly with a designated NASAA representative to discuss its progress with respect to its obligations pursuant to this Consent Order. Such quarterly meetings shall continue until such meetings have covered the period through and including December 31, 2009. The reporting or meeting deadline set forth may continue to be amended with permission from a designated NASAA representative.
Consequential Damages Claims. CGMI consented to participate, at the Eligible Customer’s election, in the special arbitration procedures as described below. Under these procedures, an arbitration process, under the auspices of the Financial Industry Regulatory Authority (“FINRA”), have been and continue to be made available for the exclusive purpose of arbitrating any Eligible Customer’s consequential damages claim. These arbitrations are governed by the procedures described below:
|16.||Other Proceedings/Relief. All customers, including but not limited to Eligible Customers who avail or have availed themselves of the relief provided pursuant to this settlement, may pursue any remedies against CGMI available under the law. However, those customers that elect or have elected to utilize the special arbitration procedures set forth above, rather than regular arbitration at FINRA, are limited to the remedies available in the special arbitration process and may not bring or pursue a claim relating to ARS in another forum.|
VII. CONSENT ORDER
On the basis of the Findings of Fact, Conclusions of Law, and CGMI’s consent to the entry of this Consent Order,
IT IS HEREBY ORDERED THAT:
This Consent Order concludes the Investigation by the Department and any other action that the Department could commence under the Act on behalf of Connecticut as it relates to CGMI’s marketing and sale of ARS to CGMI’s “Eligible Customers”.
This Consent Order is entered into solely for the purpose of resolving the above-referenced multi-state investigation, and is not intended to be used for any other purpose.
CGMI shall cease and desist from violating the Act and will comply with the Act.
Within ten (10) days after the entry of this Consent Order by the Commissioner, CGMI shall remit to the Commissioner, by electronic funds transfer, the sum of One Million Fourteen Thousand Four Hundred Eighty-six and 84/100 Dollars ($1,014,486.84).
In contemplation of this settlement, the Department has refrained from taking legal action, excluding this Consent Order, against CGMI with respect to CGMI’s marketing and sale to its institutional investors until a date after December 31, 2009.
Following an investigation regarding auction rate securities conducted in 2008 by a NASAA multi-state task force, the NASAA Task Force recommended to NASAA members certain settlement terms intended to resolve such investigation into the marketing and sale of auction rate securities by CGMI. After this Consent Order is entered, to the extent that CGMI enters into any settlement with any NASAA jurisdiction relating to the marketing and sale to Eligible Customers of Eligible ARS that were the subject of the multi-state investigiation, and CGMI agrees to a term that is more favorable to Eligible Customers of such jurisdiction regarding their Eligible ARS than the corresponding term herein, CGMI will apply the more favorable term to Eligible Customers (as defined in Section VI, paragraph 2) in Connecticut regarding their Eligible ARS (as defined in Section VI, paragraph 1) if requested to do so by the Commissioner.
|7.||If payment is not made by CGMI, or if CGMI defaults in any of its obligations set forth in this Consent Order, the Department may vacate this Consent Order, at its sole discretion, upon ten (10) days notice to CGMI and without the opportunity for administrative hearing.|
|8.||This Consent Order is not intended to form the basis for CGMI or any of its affiliates or current or former employees to be subject to any disqualifications contained in the federal securities law, the rules and regulations thereunder, the rules and regulations of self-regulatory organizations or various states’ securities laws including any disqualifications from relying upon the registration exemptions or safe harbor provisions. In addition, this Consent Order is not intended to form the basis for any such disqualifications.|
|9.||For any person or entity not a party to this Consent Order, this Consent Order does not limit or create any private rights or remedies against CGMI including, without limitation, the use of any e-mails or other documents of CGMI or of others for the marketing and sale of ARS to investors, limit or create liability of CGMI, or limit or create defenses of CGMI to any claims.|
|10.||Nothing herein shall preclude the State of Connecticut, its departments, agencies, boards, commissions, authorities, political subdivisions and corporations, other than the Department, and only to the extent set forth in paragraphs VII (1) and VII (5) above (collectively “State Entities”), and the officers, agents or employees of State Entities from asserting any claims, causes of action, or applications for compensatory, nominal and/or punitive damages, administrative, civil, criminal, or injunctive relief against CGMI in connection with the marketing and sale of ARS by CGMI.|
|11.||This Consent Order shall not disqualify CGMI or any of its affiliates or current or former employees from any business that they otherwise are qualified or licensed to perform under applicable state law and this Consent Order is not intended to form the basis for any such disqualification.|
|12.||This Consent Order is not intended by the Commissioner to subject CGMI, or any of its officers, directors, affiliates, current or former employees, or other persons that would otherwise be disqualified as a result of this Consent Order to any disqualifications under the laws of any state, the District of Columbia or Puerto Rico (collectively “State”), including, without limitation, any disqualifications from relying upon the State registration exemptions or State safe harbor provisions.|
|13.||This Consent Order and any dispute related thereto shall be construed and enforced in accordance with, and governed by, the laws of Connecticut without regard to any choice of law principles.|
|14.||CGMI enters into this Consent Order voluntarily and represents that no threats, offers, promises, or inducements of any kind have been made by the Department or any member, officer, employee, agent or representative of the Department to induce CGMI to enter into this Consent Order.|
|15.||This Consent Order shall be binding upon CGMI and its successors and assigns as well as to the successors and assigns of relevant affiliates with respect to all conduct subject to the provisions above and all future obligations, responsibilities, undertakings, commitments, limitations, restrictions, events and conditions.|
NOW THEREFORE, the Commissioner enters the following:
|1.||The Findings of Fact, Conclusions of Law and Consent Order set forth above, be and are hereby entered;|
|2.||Entry of this Consent Order by the Commissioner is without prejudice to the right of the Commissioner to take enforcement action against CGMI based upon a violation of this Consent Order or the matters underlying its entry, if the Commissioner determines that compliance with the terms herein is not being observed or if any representations made by CGMI and reflected herein are subsequently discovered to be untrue; and|
|3.||This Consent Order shall become final when issued.|
|Issued at Hartford, Connecticut,||_______/s/_________|
|this 8th day of July 2010.||Howard F. Pitkin|
CONSENT TO ENTRY OF ORDER
I, Elaine H. Mandelbaum, state on behalf of Citigroup Global Markets Inc., that I have read the foregoing Consent Order; that I know and fully understand its contents; that I am authorized to execute this Consent Order on behalf of Citigroup Global Markets Inc.; that Citigroup Global Markets Inc., agrees freely and without threat or coercion of any kind to comply with the terms and conditions stated herein; and that Citigroup Global Markets Inc., voluntarily consents to the issuance of this Consent Order, expressly waiving any right to a hearing on the matters described herein. Citigroup Global Markets Inc. further agrees that it shall not claim, assert, or apply for a tax deduction or tax credit with regard to any state, federal or local tax for any administrative monetary penalty that Citigroup Global Markets Inc. shall pay pursuant to the foregoing Consent Order.
|Name: Elaine H. Mandelbaum|
|Title: Managing Director|
|Citigroup Global Markets Inc.|
County of: New York
On this the 1st day of July, before me, Barbara Beltz, the undersigned officer, personally appeared Elaine H. Mandelbaum, who acknowledged herself to be the Managing Director of Citigroup Global Markets Inc., a corporation, and that she, as such Managing Director, being authorized to do so, executed the foregoing instrument for the purposes therein contained, by signing the name of the corporation by herself as Managing Director.
Notary Public/Commissioner of the Superior Court
Date Commission Expires: January 18, 2014