The US SEC announced settled cease-and-desist proceedings against dually registered broker-dealer and investment adviser Citigroup Global Markets Inc. (CGMI) for willfully violating recordkeeping requirements concerning expenses that the firm incurred in connection with its underwriting business.

Recordkeeping requirements of the federal securities laws require broker-dealers to make and keep current certain books and records reflecting all assets and liabilities.  

Unverified underwriting

The SEC’s order finds that, from at least 2009 through May 2019, CGMI used an unsubstantiated and unverified method to calculate and record indirect expenses associated with its work as an underwriter.

An underwriter is typically engaged by a company to manage and sell the company’s securities, in exchange for a fee. A lead underwriter may form an underwriting syndicate by enlisting other underwriters to participate in a securities offering.

Often, that lead underwriter will act as billing and delivery bank (BDB), responsible for, among other things, aggregating expenses incurred by the underwriting syndicate and computing the underwriting fees to be paid to the syndicate members, net of expenses, including indirect expenses.

From at least 2009 through May 2019, while serving as BDB, CGMI had no policies and procedures or review process for its method of estimating its indirect expenses associated with the underwriting of securities offerings.

“Underwriters serve a critical role as gatekeepers in securities offerings. They perform essential functions, including investor protection and also helping companies access capital to grow and innovate.”

Sanjay Wadhwa, Deputy Director, SEC Division of Enforcement

Instead, without knowing the basis during this period for its method, CGMI calculated its indirect expenses using a fixed percentage of each deal’s underwriting fee, which it divided into expense categories by fixed percentages and recorded in its general ledger.

As a result, CGMI violated the recordkeeping requirements of Rule 17a-3 under the Exchange Act, which requires broker-dealers to make and keep current certain books and records.

“Underwriters serve a critical role as gatekeepers in securities offerings. They perform essential functions, including investor protection and also helping companies access capital to grow and innovate,” said Sanjay Wadhwa, Deputy Director of the SEC’s Division of Enforcement.

“Recordkeeping failures such as these, perpetuated over at least a decade, can undermine the viability of those functions. The SEC will continue to vigorously enforce the books and records provisions of the federal securities laws, which are crucial to well-functioning markets.”

Calculation of indirect expenses

In May 2019, CGMI voluntarily revised its method of calculating indirect expenses associated with its underwriting business.

The SEC issued a $2.9m penalty in the case and said it considered CGMI’s prompt remedial actions and cooperation offered during the agency’s investigation of the matter.

Regulators have been emphasizing the importance of recordkeeping rules, penalizing financial services firms and their employees for their widespread and longstanding failures to maintain and preserve electronic communications.

US regulators have pointed out that proper recordkeeping is required in order to enable them to determine what happened in cases of allegations of wrongdoing.

Employees at a number of prominent financial services firms have been charged over the last year with routinely using personal devices to communicate about business matters and ‘the substantial majority of these off-channel communications’ were neither maintained nor preserved by the firms.

The firms admitted the facts set forth in their respective SEC orders and acknowledged that their conduct violated Section 17(a) of the federal securities laws, and they have agreed to pay combined penalties of well over a billion dollars at this point.

Gurbir S Grewal, Director of the SECs Division of Enforcement, has underscored “the importance of recordkeeping requirements,” which he also called “sacrosanct.” He and other US regulators have pointed out that proper recordkeeping is required in order to enable them to determine what happened in cases of allegations of wrongdoing and misconduct and ensure transparency and honest dealing in the securities marketplace.