COMPLIANCE WATCH: No Pity For Advisers Charging Excess Fees

Aug 2010 // The Wall Street Journal

There’s an important if unpalatable message for financial advisers in a new arbitration ruling: A mistake is a mistake, even when an adviser’s company signs off on it.

A Financial Industry Regulatory Authority panel showed little sympathy for two advisers who sought $232 million in damages from Citigroup Global Markets Inc., the retail brokerage unit of Citigroup (C). The two were blamed for excessive trading fees the brokerage charged to a multibillion-dollar trust account they oversaw from 2005 to 2007.

Alan J. Kirman and Peter R. Dunn, who worked in a Boca Raton, Fla.-based branch office, didn’t dispute that the fees exceeded company guidelines for the account, which was taking in billions of dollars from the watershed Tobacco Trust Settlement of 1998. According to documents in a related court case, they said the lapse wasn’t their fault: Citigroup never showed them the fee schedule, they said, and all their trades and supporting documents were reviewed by the company’s legal department, compliance officers and other corporate management.

They sought both compensatory and punitive damages, but their argument was rejected by the panel. It also rings hollow with some lawyers.

“It doesn’t give rise to damages for the brokers,” says Jonathan Uretsky, a New York-based securities lawyer. “What would that mean? That it was wrong and you didn’t notice it, so I get to continue the wrongness?”

Not that Citigroup’s compliance department comes off looking good, after allegedly letting the fee discrepancy slip through for as long as two years. “It sounds very strange that it took so long for compliance to find this problem for such a large account,” says Tom Ajamie, a securities lawyer in Houston, Texas.

A Citigroup spokeswoman declined to comment on the advisers’ accusations, although the company said it was pleased with the arbitration ruling. The Finra panel didn’t explain its reasons, a typical practice in arbitration cases.

The Tobacco Trust Settlement of 1998 was an historic agreement between the nation’s largest tobacco companies at the time and attorneys general of 46 states. It required, among other things, payment of more than $200 billion to the states during a 25-year period beginning in 2000.

The tobacco companies deposited about $6.4 billion into the account during 2006 and 2007 alone, when Citigroup allegedly told Kirman and Dunn that fees they charged to the account exceeded terms described in Citigroup’s Form ADV, a disclosure form investment advisers file with the Securities and Exchange Commission. The two brokers alleged they never signed or received a copy of that document.

Brokers typically don’t rely on Form ADV to learn about fees, says Uretsky. The information, however, appears in other documents, such as a prospectus, which Citigroup would have likely prepared, he says. The trust account was subject to the Investment Company Act of 1940, which requires advisers to act as fiduciaries, or in the client’s best interest. “There would be better places where advisers could–and would look,” Uretsky says.

Another problem arose from the advisers’ roles as principal brokers, who typically trade on behalf of a firm from its own inventory. Citigroup’s Form ADV required that agency brokers, who trade on behalf of clients, conduct trades for certain trust accounts, such as the tobacco settlement account. The account was also subject to the Investment Company Act of 1940, which would require its advisers act as fiduciaries, say lawyers.

A conflict exists when an investment adviser acts as a principal broker, says George Brunelle, a New York-based securities lawyer. Principal brokers also typically seek the best prices for a firm, which may not be the best for clients, say lawyers.

Citigroup later transferred the account to a desk where it could be handled by agency brokers, according to court documents. The brokerage then allegedly “forced” the brokers to find new employment, they say. The two brokers joined Oppenheimer & Co. in March, 2008, according to regulatory documents. Dunn left Oppenheimer in April, 2009.

Alan Kirman and his lawyer didn’t return calls requesting comment. Efforts to reach Peter Dunn weren’t successful.