Last week, Citigroup agreed to pay the State of Massachusetts $30 mln to settle allegations that one of its analysts improperly released information about Apple’s supply chain to select hedge fund clients before making this information publicly available to all clients.
Last Thursday, William Galvin, the top securities regulator in Massachusetts, announced that Citigroup had agreed to pay a $30 million settlement because one of its technology analysts, Kevin Chang, leaked selective parts of an unpublished research report about Hon Hai Precision, one of Apple’s main suppliers of iPhones, iPods, and iPads, to SAC, T. Rowe Price, Citadel and GLG Partners before distributing this research to the general public.
Mr. Chang’s action, Mr. Galvin said, breached state and federal securities laws that require banks to prevent the disclosure of confidential information. It also violated a 2012 agreement Galvin had struck with Citigroup to not offer sneak peeks of its unpublished reports.
The $30 million fine by Massachusetts is one of the biggest that state securities regulators have ever collected and dwarfs the $2 million that Massachusetts obtained from Citigroup for improperly disclosing research on Facebook’s initial public offering only a year ago.
Galvin also explained the reason for the size of the settlement, “Just a year ago, with Facebook, we fined them [Citigroup] $2 million, when they were playing the same game.” Galvin added that when certain investors have inside information about a company, it puts other investors at a disadvantage, similar to ”going to the supermarket and having a weighted scale.”
In addition to the fine, Citigroup agreed as part of the settlement to increase compliance and review its electronic surveillance of communications between its analysts and those outside the company.
Background of the Case
The settlement reflects developments which took place in December 2012. On December 13th, Kevin Chang, a Citigroup technology analyst who covered Hon Hai Precision based in Taiwan, received a number of urgent e-mails from four institutional customers wanting to know if he agreed with the views in a research report published by Macquarie, predicting much lower shipments of the iPhone 5 than Wall Street had been expecting.
One of many such e-mails came from an employee at Stamford, Connecticut based hedge fund SAC Capital Advisors, which said “Hey Kevin, Are you picking up any order cuts to iPhone?’’ According to the settlement, SAC allegedly owned Apple stock.
After a number of similar requests, Chang sent out an unpublished report on Hon Hai with the results of his proprietary research, to clients at SAC, T. Rowe Price, Citadel and GLG Partners predicting a sharply lower number of iPhone sales. Chang slashed his first quarter 2013 iPhone sales estimates from 45 million units to 33 million units.
The rest of Citigroup’s clients didn’t received Chang’s note on Hon Hai with his lower iPhone shipment estimates until the next day, December 14th. Apple shares dropped 5.2% that day. Finally, two days later Citigroup’s analyst who covered Apple, lowered his rating on the company, releasing the information to the broader audience of Apple investors, according to the Massachusetts settlement.
“Due to Kevin Chang’s release of his research views prior to publication, he had to publish his research report early, but not before his revised Apple iPhone production estimates were communicated to the four clients,” Galvin said in a statement.
It is interesting to note that the four asset managers who received Chang’s research before the rest of the marketplace have currently not been charged with any wrongdoing. However, Galvin did not rule out pursuing legal claims against them for allegedly seeking and accepting the confidential research from Chang.
According to the complaint, Kevin Chang, was terminated last month.
Implications for the Research Industry
So, what does the Citigroup settlement mean for the professionals involved in the research industry?
Massachusetts Secretary of State William Galvin summed up his views about investment research, “It seems that the concept that investors are to be presented with a level playing field when it comes to the product of research analysts is a lesson that must be learned over and over again. But it’s important that it should be taught as often as necessary.”
In a recent speech New York Attorney General Eric Schneiderman showed his agreement with Galvin’s approach when he said that his department will go after firms and individuals who release analyst research early to certain clients. “Analyst sentiment is market-moving information,” he said at a conference.
The team at Integrity Research believes that the Citigroup case means that analysts and salespeople at research firms need to be extremely careful not to communicate their research findings to clients selectively as regulators are concluding that this could be seen as tipping material nonpublic information.
It also highlights the importance for all research firms to develop and implement rigorous compliance policies and practices to address the various risks inherent in each firm’s specific research processes.
Lastly, we also feel that the current Citi case highlights the fact that sell-side firms are not immune from creating serious compliance risks for their buy-side clients. Of course, we will have to see whether Secretary of State Galvin decides to push this issue with the four asset managers mentioned in their complaint.
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