The Financial Industry Regulatory Authority (FINRA) fined Citigroup Global Markets, Inc. $650,000 for disclosure and supervisory violations relating to the operation of its stock borrow program.
What is a stock borrow program?
A stock borrow program is an agreement between the customer and his/her brokerage firm that allows the brokerage firm to borrow securities from the customer’s account for some form of compensation to the customer. The brokerage firm uses the borrowed securities for its other investment strategies to benefit itself and its other customers. There are a number of different programs and investment strategies that employ borrowed stock to be used in short selling strategies or option trading strategies.
According to FINRA’s investigation, between Jan. 1, 2005, and Nov. 30, 2008, Citigroup’s stock borrow program borrowed “fully paid hard-to-borrow securities” owned by the firm’s retail customers. The borrowed securities went into a pool of securities to facilitate short-selling strategies for Citigroup’s other customers.
FINRA found that Citigroup failed to disclose adequately certain material information to customers participating in the stock borrow program, such as:
• the securities were hard-to-borrow;
• the interest rates could be reduced by the firm;
• the brokers received commissions for the duration of the loan;
• while the securities were on loan, dividends were paid as “cash-in-lieu” of dividends and were subject to higher tax rates; and,
• shares on loan could be sold by the customers at any time.
FINRA also found that the stock borrow program operated without a system or procedures specifically designed to supervise the activities of the Citigroup’s employees and to adequately monitor the accounts of customers who participated in the program.
Is a Stock Borrow Program Suitable?
This is an example of a structured investment program offered to retail customers that allegedly was not presented fairly and fully. A financial advisor has a duty to disclose material information about the product being offered. Stock borrow programs are not suitable for all customers and must be recommended only when considering the customer’s financial status, the customer’s tax status, and the customer investment objectives. A financial advisor has a duty to recommend investments suitable for the customer based on these and other factors such as the client’s risk tolerance, investment experience, and liquidity needs.