FINRA fined Citi Global Markets $1.85 million for best execution and supervisory violations, and ordered the firm to make restitution to clients of $638,000.
The SEC, meanwhile, charged a telecom firm and two former executives for revenue recognition and fraud, an investor relations firm executive for insider trading based on client news announcements and two information technology execs with mischaracterizing resale transactions.
FINRA Fines Citi Global Markets, Orders Restitution
Citi Global Markets was fined $1.85 million by FINRA and ordered to make restitution of $638,000 to clients after it failed to provide best execution in approximately 22,000 customer transactions involving nonconvertible preferred securities, and for related supervisory deficiencies that persisted for more than three years.
According to the agency, one of Citigroup’s trading desks employed a manual pricing methodology for nonconvertible preferred securities that failed to appropriately incorporate the National Best Bid and Offer (NBBO) for those securities. Because of that, Citigroup priced more than 14,800 customer transactions inferior to the NBBO.
Also, Citigroup priced more than 7,200 customer transactions inferior to the NBBO because the firm’s proprietary BondsDirect order execution system used a faulty pricing logic that only incorporated the primary listing exchange’s quotation for each nonconvertible preferred security. Since multiple exchanges trade securities, that meant that, because Citigroup failed to look beyond the primary listing exchange, it missed the possibility of a better price.
FINRA also found that the firm’s supervisory system and written supervisory procedures for best execution in nonconvertible preferred securities were deficient. Citigroup failed to review any customer transactions in nonconvertible preferred securities whether executed on BondsDirect or manually by the trading desk, to make sure they complied with the firm’s best execution obligations. This was despite the fact that the firm had received several inquiry letters from FINRA staff.
Not only that, while many of the transactions at issue were identified on FINRA’s best execution report cards, the firm only attempted to access its best execution report cards once during the relevant period.
Citigroup neither admitted nor denied the charges, but consented to the findings. SEC Charges Telecom Firm, Two Former Execs on Revenue Scheme, Fraud
Newport Beach, California-based AirTouch Communications Inc., its former president and CEO Hideyuki Kanakubo, and former CFO Jerome Kaiser were charged by the SEC with improperly recognizing as revenue more than a million dollars’ worth of inventory that was shipped to a Florida warehouse but not actually sold.
They are also charged with defrauding an investor from whom they secured a $2 million loan for the company based on phony information connected to the inventory shipments.
According to the agency, the company and execs put together a revenue recognition scheme that violated generally accepted accounting principles (GAAP), which establish that revenue cannot be recognized unless it is “realized or realizable” and “earned.”
Included in the net revenues of a little over $1.03 million reported by AirTouch in its quarterly report for Q3 2012 was approximately $1.24 million in inventory that had been shipped to a company in Florida that agreed to warehouse AirTouch’s products in anticipation of future sales.
AirTouch develops and sells telecommunications equipment, including a product called the U250 SmartLinx that was designed in early 2012 for sale to Mexico’s largest provider of landline telephone services. During that year, AirTouch discussed with the Florida company the possibility of it warehousing U250 SmartLinx units for potential future sale to the Mexican entity or other AirTouch customers.
The Florida company’s CEO told Kanakubo that, while it wouldn’t buy the SmartLinx units, it would warehouse them and provide logistics for eventual delivery when the products were sold. But once the products were shipped, Kanakubo and Kaiser reported them as sold, although they never were, and recorded the value of the items as revenue, then signed certification statements falsely claiming the company’s financial results were accurate.
If it hadn’t accounted for those shipments as revenue from the Florida company, AirTouch would have had zero revenue to report for the quarter.
The firm also managed to con an investor out of a $2 million short-term bridge loan by representing the shipment as a sale. Two days after the loan funds came in, Kanakubo authorized $15,000 payments to himself and to Kaiser.
The two also hid the truth about the shipment from the company’s board of directors, controller, and outside independent accountant.
Investor Relations Firm Exec Charged with Insider Trading
Michael Anthony Dupre Lucarelli, the director of market intelligence at a Manhattan-based investor relations firm, was charged by the SEC with insider trading ahead of impending news announcements by more than a dozen clients.
According to the agency, Lucarelli, who had no legitimate reason to do so, repeatedly checked out clients’ draft press releases stored on his firm’s computer network before public announcements were made. He then routinely bought stock or call options based on good news in the announcements, or sold short or bought put options when the news was bad. He made nearly $1 million in the process.
Lucarelli’s firm advised companies in advance of earnings announcements, or other significant events, such as a merger or clinical drug trial result. Before an announcement was to be made, Lucarelli began taking a position in a client’s securities. Usually this was in the days immediately preceding the announcement, although in a few cases he started buying weeks in advance. Immediately after the announcement, he would start to divest of his position and lock in the profits.
Knowing that what he did was illegal, he also hid what he was doing by telling brokerage firms on account opening forms that he was self-employed or retired, to avoid disclosing that he worked for an investor relations firm.
The SEC’s investigation is continuing.
Two Execs Charged on Mischaracterization of Resale Transactions
Two executives at a Dallas-based information technology company have been charged by the SEC with mischaracterizing an arrangement with an equipment manufacturer to purport that it was conducting so-called “resale transactions” to inflate the company’s reported revenue.
Then-CEO Lynn R. Blodgett and then-CFO Kevin R. Kyser caused the disclosure failures at Affiliated Computer Services (ACS), which has since been acquired by Xerox Corporation.
According to the agency, ACS provided business process outsourcing and information technology services. Shortly before the end of Q1 in fiscal year 2009, ACS found that its revenue would fall short of company guidance and consensus analyst expectations.
To avoid this, ACS arranged for an equipment manufacturer to redirect orders it had already received from one of its customers through ACS. This made it look as if ACS was involved in resale transactions, which was not true. ACS then reported $124.5 million in fiscal 2009 revenue from these transactions as though it had resold the equipment itself.
Blodgett, Kyser and ACS did not adequately describe the arrangement in its financial reporting, and the phony revenue in turn allowed ACS to publicly report inflated internal revenue growth (IRG). Blodgett and Kyser emphasized the inflated IRG as a key metric in earnings releases and other public statements to investors, and a portion of their annual bonuses was linked to IRG.
Blodgett and Kyser have agreed to pay nearly $675,000 to settle the SEC’s charges. Without admitting or denying the findings, they have agreed to collectively disgorge IRG-related bonuses plus prejudgment interest totaling $569,327, and they each must pay $52,000 penalties.
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