The US Financial Industry Regulatory Authority (Finra) has fined JP Morgan Securities US$2.8m for violating the Securities and Exchange Commission's (SEC) Customer Protection Rule and for related supervisory failures. The SEC rule creates requirements to protect customers' funds and securities.

The Customer Protection Rule requires a broker-dealer, which maintains custody of customer securities, to obtain and maintain physical possession or control over certain of those securities to ensure that customers could recover their assets in the event of the broker-dealer's insolvency. These securities must be segregated in a 'control location' and be free of liens or any other encumbrance that could prevent customers from taking possession of their securities. A firm cannot use segregated securities for its own purposes, according to the rule.

According to Finra, from March 2008 to June 2016, JP Morgan Clearing Corp. 'did not have reasonable processes in place to ensure that its possession or control systems were operating properly'. Shares that should have been segregated were available for the firm's use, due to systemic coding and design flaws, recurring and unresolved deficits and unreasonable supervision. By failing to move and maintain securities in good control locations, the firm created deficits in foreign and domestic securities valued at hundreds of millions of dollars. According to the regulator, in one case, JP Morgan failed to move Italian securities to a good control location for nearly two years, and on one sample day, created a deficit in 81 Italian securities worth approximately US$146m.

In determining the appropriate monetary sanction, the regulator considered JP Morgan's cooperation in undertaking a plan to address the violations and that it over-reserved cash deposits in an effort to protect customers from its failed segregation of securities.

In addition, Finra also fined Citigroup Global Markets Inc. (CGMI) US$5.5m and required the firm to pay at least US$6m in compensation to retail customers for displaying inaccurate research ratings for numerous equity securities during a nearly five-year period, and for other related supervisory violations.

The watchdog found that from February 2011 through December 2015, CGMI displayed to its brokers, retail customers and supervisors inaccurate research ratings for more than 1,800 equity securities -more than 38% of those covered by the firm. Because of errors in the electronic feed of ratings data that the firm provided to its clearing firm, the firm either displayed the wrong rating for some covered securities (e.g., 'buy' instead of 'sell'), displayed ratings for other securities that CGMI did not cover or failed to display ratings for securities that CGMI, in fact, rated.

The firm's actual research reports, which were available to brokers, and the research ratings appearing in those reports, were not affected by these errors.

According to the regulator, the inaccuracies in the research ratings feed had widespread, adverse consequences. As a result of the errors, CGMI brokers solicited thousands of transactions inconsistent with the firm's actual ratings and negligently made inaccurate statements to customers about those ratings.

They also solicited transactions that violated certain firm-managed portfolio guidelines, which were premised on CGMI research ratings. For example, the portfolios were prohibited from containing equity securities the firm had rated 'sell'. Because CGMI brokers relied on inaccurately displayed ratings, many customers' portfolios improperly included 'sell'-rated securities. CGMI supervisors, relying on those same inaccurate ratings, failed to detect and prevent a substantial number of transactions that were actually inconsistent with CGMI research or portfolio guidelines. The firm also made materially inaccurate statements and omissions regarding more than 19,000 research ratings on customer account statements, sent more than 1,000 customer email alerts with inaccurate ratings, and displayed inaccurate ratings on online portals available to customers.

According to Finra, Citi failed to timely correct the inaccurately displayed ratings, despite numerous red flags alerting the firm to ratings inaccuracies for several securities. The firm also failed to conduct testing reasonably designed to verify the accuracy of research ratings data that it used and distributed.

JP Morgan was a top provider of structured products in the US market in 2017 with over 2,900 structured products sold worth US$8.7bn whereas Citi marketed 348 products worth US$946m of which 342 products where issued by CGMI, five by Citigroup Funding, and one by Citigroup Inc.

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