The SEC has continued to closely scrutinize disclosures related to trading in the markets. Its most recent cases involved Citigroup and Morgan Stanley. The actions are based on not disclosing that models used to market a product contained assumptions that were not disclosed to investors about the collateral in the model account or the fact that mark-ups were not considered in the model. In the Matter of Citigroup Global Markets, Inc., Adm. Proc. File No. 3-17808 (January 24, 2017); In the Matter of Morgan Stanley Smith Barney LLC, Adm. Proc. File No. 3-17809 (January 24, 2017).
Citigroup Global Markets is a wholly owned, indirect subsidiary of Citigroup, Inc. The firm is a registered broker-dealer and investment adviser. Morgan Stanley Smith Barney is also a registered broker-dealer and investment adviser. Citigroup Global holds a 49% ownership interest in Morgan Stanley Smith Barney. The Orders in each action are largely the same.
This action revolves around a product marketed and traded by both firms called CitiFX Alpha family of strategies. Citigroup Global developed a number of quantitative foreign exchange trading models referred to under the CitiFX Alpha family name. In this case the product constituted an investment contract. It included seven quantitative trading models that collectively generated trading signals for 16 pairs. The firm generated the signals each morning and then executed the trades. The group of investors who purchased the product – called the Relevant investors in the Orders — had nothing to do with generating the signals. Typically those investors were not informed about them prior to the trades being executed. Indeed, the product was marketed as a way for the Relevant investors to track the quantative trading models of Citigroup Global.
Personnel from each firm marketed the product using a power point presentation created by Citigroup Global. An oral presentation was given tied to the power point. The presentations reviewed past performance and risk metrics. Those metrics assumed a fully collateralized account, that is, one in which the collateral equaled the notional amount being traded. Those metrics also assumed that no mark-ups would be charged. The assumptions were not detailed in the presentations.
The Relevant investors included individuals who had no experience in foreign exchange trading. They did not have an understanding of a notional amount, that the cash in the account merely served as collateral or that there was a difference between the notional amount traded and the collateral posted.
Each Relevant investor in the program opened a foreign exchange trading account at one of the firms. Each posted collateral that was less than the notional amount of the foreign exchange portfolio traded. The financial adviser for each investor selected the size of the mark-ups charged. Stated differently, the actual accounts did not mimic the model portfolio in the power point. By failing to disclose the two assumptions in the model depicted in the power point – that the collateral equaled the notional amount being traded and there were no mark-ups, the Order alleges that Citigroup Global and Morgan Stanly Smith Barney omitted material information that was necessary to make the statements about the product not misleading within the meaning of Securities Act Section 17(a)(2).
To resolve the proceedings each Respondent consented to the entry of a cease and desist order based on the Section cited in the Order. In addition, each will pay disgorgement of $624,458.27, prejudgment interest and a civil penalty of $2,250,000.