Thursday, May 27, 2010

FINRA Press Release: FINRA Sanctions Citigroup

Citigroup Pays $1.5 Million for Supervisory Failures Related to Elaborate Scheme to Misappropriate Millions in Trust Funds Belonging to Cemeteries Located in Michigan and Tennessee

The Financial Industry Regulatory Authority (FINRA) issued a press release this week announcing that 
it has imposed a monetary sanction of $1.5 million against Citigroup Global Markets Inc. for supervisory violations relating to its handling of trust funds belonging to cemeteries in Michigan and Tennessee. The sanction represents a $750,000 fine and disgorgement of $750,000 in commissions, which is being returned to the cemetery trusts as partial restitution.
The settlement is detailed in the FINRA AWC No. 20070094327-02.

FINRA found that Citigroup broker Singer and two of his customers, Smart and Bush, misappropriated trust accounts. Successively, Smart and Bush owned a group of Michigan cemeteries. Smart used the trust accounts of Michigan cemeteries to purchase the very same Michigan cemeteries and other cemeteries and funeral homes in Tennessee in August 2004. Singer opened up multiple accounts for Smart and Bush and for entities which they owned and he improperly transferred the cemetery trust funds to these accounts. Furthermore, FINRA found that Citigroup failed to implement special supervision when the company knew about the group’s suspicious activities.

Misappropriation is the illegal use of funds by a person or group of persons entrusted to manage such funds.

Monday, May 24, 2010

FINRA Press Release: Auction Rate Securities

FINRA Fines Nuveen $3 Million for Use of Misleading Marketing Materials Concerning Auction Rate Securities

The Financial Industry Regulatory Authority (FINRA) issued a press release this week announcing that
it has fined Nuveen Investments, LLC, of Chicago, $3 million for creating misleading marketing materials used in sales of auction rate preferred securities (ARPS). The Nuveen Funds' ARPS were a form of auction rate securities, which are long-term securities with interest rates or dividend yields that are reset periodically through an auction process. In contrast to other types of auction rate securities, the Nuveen ARPS were preferred shares issued by closed end mutual funds to raise money for the funds to use to invest.
The settlement is detailed in the FINRA AWC No. 2008013056701.

Auction rate securities (ARS) were first issued in the mid-1980s by corporations. The market for ARS grew rapidly over the next two decades and widely issued by a diverse range of institutions such as closed-end mutual funds, municipalities and student loan trusts. ARS were long-term floating rate securities whose coupon payments were determined at auctions that were typically held every 7 to 35 days, making ARS long-term securities with short-term floating rates. Broker dealers marketed ARS as liquid, short-term cash equivalents. However, ARS auctions failed en masse in February 2008 and proved to be illiquid and unsellable in the short-term.

SLCG has written papers on the ARS that describes the ARS, what they are, how their auctions worked, and why they failed. SLCG was also recently hired by the State of North Carolina to advise on the liquidity solutions to ARS investors who have yet been able to redeem these illiquid securities.

Investors can use our dedicated website for other in-depth analyses of security products.

Thursday, May 20, 2010

In the News: Equity Indexed Annuities

Forbes published an article on equity-indexed annuities (EIAs). It describes the history of and market for EIAs, compares EIAs with other fixed and variable annuities, and briefly weighs the advantages and disadvantages of EIAs.

An annuity makes periodic payments to the holder of the annuity. There are fixed annuities that make fixed payments and variable annuities that make variable payments. EIAs are similar to both fixed and variable annuities in that they pay an interest rate linked to an equity index and guarantee a minimum interest rate. EIAs are especially marketed to retirees by the insurance industry. EIAs are complex contracts whose true risks and costs are often obscured and the lack of SEC oversight and regulation have resulted in ‘unscrupulous’ sales practices of equity-indexed annuities issuers.

For more in-depth analysis, SLCG has written a paper on equity-indexed annuities. Investors can visit our dedicated website for related papers and notes.

Tuesday, May 18, 2010

Reverse Convertibles tied to TiVo Stock

J. P. Morgan's 64% Note Tied to TiVo Stock Shows Risks of Reverse Convertibles

Bloomberg issued a news release reporting on the reverse convertible, a structured product, on TiVo.

A reverse convertible note is a type of structured product that is linked to an equity security or an index. It is a short-term note that pays a relatively high coupon rate compared to traditional notes. The returns of the note at maturity depends on whether the equity, called ‘reference asset’, falls below a pre-specified trigger price during the term of the note. If it does, then the note returns the market value of the number of shares of the reference asset which could have been purchased on the note’s pricing date with the note’s face value. If it does not, then the note returns its face value.

SLCG has written a paper ‘What TiVo and JP Morgan teach us about Reverse Convertibles’ that values and analyzes a large sample of reverse convertible notes. We find that these notes are largely and consistently overpriced, yet reverse convertibles continues to be sold which, combined with the complexity of and the lack of a secondary market for these notes, implies that investors do not fully understand the returns and risks of these notes.