The NASD has fined Citigroup Global Markets $400,000 and ordered it to pay an additional $715,000 in restitution to fund firms it cheated out of sales charges by falsely claiming that its clients were disabled.

Citigroup consented to the NASD’s findings, which included supervisory and recordkeeping violations, but neither admitted or denied guilt, as is customary in most settlements.

According to the regulator, more than 100 Citigroup brokers contrived to obtain waivers of mutual fund sales charges by falsely claiming their clients were disabled. Between June 2001 and June 2002, the Citigroup reps improperly entered disability waivers for hundreds of clients over the course of 2,419 mutual fund transactions, worth $47 million.

Using Citigroup's electronic order entry system, the brokers claimed that their customers were entitled to waivers of the Contingent Deferred Sales Charge (CDSC) applied to sales of B and C shares of mutual funds because those clients were disabled. They didn’t just limit their claims to people, either. At times, they claimed that hedge funds buying mutual fund shares were disabled, so as to dodge the sales charges.

The brokers’ actions should have raised eyebrows because disability-based CDSC waivers are a relatively occurrence among mutual fund sales. To obtain such a waiver, most firms require that the broker obtain and submit documentation stating that the client’s disability falls within the parameters defined by the IRS or the fund's prospectus. Furthermore most disability waivers are available only when a customer becomes disabled after the mutual fund purchase.

One Citigroup broker entered disability-based CDSC waivers for over 80% of his customers, according to the regulator.

The NASD also charged Citigroup with failing to maintain, update and enforce the policies, systems and procedures necessary to prevent such abuses. For starters, Citigroup’s electronic order entry system was unsupervised, allowing brokers to receive CDSC waivers for customers without anyone at the firm vetting the process. It also failed to implement exception reports, in which brokers would explain their application for the waivers. It also neglected to take other reasonable steps to ensure the reps abided by the mutual funds’ own prospectus terms governing the waivers.

The NASD came down hard on the firm because it had committed similar abuses before. In 1997, two Citigroup registered reps faced NASD disciplinary actions for obtaining CDSC waivers for clients under false pretenses. But afterwards, the firm failed to implement new procedures to prevent recurrence of similar misconduct, the regulator states.

It’s also possible that the brokers’ wrongdoing may have preceded June 2001. So Citigroup has agreed to notify the affected fund firms of possibly improper disability waivers before that date. Those firms will have the chance to make additional restitution claims.

“Firms are obligated to be alert for supervisory ‘red flags’ and address systemic weaknesses that could permit widespread abusive behavior," said NASD executive vice president and Head of Enforcement James S. Shorris. “In this case, because Citigroup effectively failed to address a known problem, its representatives were able to improperly exploit the mutual funds' fee waiver provisions that were specifically reserved for disabled individuals - extending them even to hedge funds.”

In related actions, the NASD has brought disciplinary actions against five Citigroup brokers for their part in the CDSC-waiver scam. In November of last year, Citigroup broker Patricia Kwan agreed to the regulator’s findings and accepted a bar from association with any member firm. Earlier this year, the NASD's Department of Enforcement filed additional complaints against two current and two former Citigroup brokers—Timothy Behany, Edward M. VanGrouw, Carl Martin Trevisan and David Joseph Cottam, which are currently being litigated.

In addition to the fine, disgorgement and disciplinary actions, the NASD has also ordered Citigroup to review all of the policies, systems, procedures and training related to CDSC waivers. Citigroup must also provide the NASD with quarterly certifications that it has reviewed all CDSC disability waivers, and to provide training regarding CDSC waivers to all retail managers and reps.

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