Exclusive: Citi can promote executive tied to Grubman scandal

(Reuters) - Citigroup Inc C.N won approval to appoint as chief of equity sales an executive disciplined by regulators for failure to properly oversee Jack Grubman, a research analyst who issued fraudulent reports on companies to win business for the bank.

A Citibank sign on a bank branch in midtown Manhattan, New York, November 17, 2010. REUTERS/Mike Segar

The U.S. Securities and Exchange Commission approved a request by Citigroup to allow the executive, Kevin McCaffrey, to work as chief of equity sales in the Americas for Citigroup, the nation’s third-largest bank.

In return, Citi agreed to strictly monitor McCaffrey’s behavior, subject to conditions set by the Financial Industry Regulatory Authority, which was responsible for filing Citi’s request with the SEC.

In 2005, McCaffrey, was fined $120,000 and prohibited from working as a securities industry supervisor for 15 months.

He was penalized for failing in 2000 and 2001 to properly supervise Grubman, who regulators said issued “fraudulent and misleading” research reports to help Citi gain investment banking business. Grubman in 2003 paid civil penalties totaling $15 million and was barred from working in the securities industry for life.

Citi’s efforts to reinstate McCaffrey as a supervisor and promote him to a major executive post were surprising to many industry professionals because of the significant compliance responsibilities the company must take on to oversee him. “It’s virtually unheard of,” said one industry source. Wall Street professionals with a disciplinary background on par with McCaffrey’s “don’t rise again,” the source said.

The discovery of Grubman’s actions at Citigroup and similar ones at other brokerages led to a separation of research and investment banking functions at major Wall Street companies. More than a dozen companies participated in the settlement with regulators, which wound down in 2009.

McCaffrey, then head of North American equity research at Salomon Smith Barney Inc, was one of two supervisors who did not adequately respond to red flags that Grubman had “unrealistically bullish ratings” on companies he covered, according to a 2005 SEC document.

While the SEC barred McCaffrey from his supervisory role, it allowed him to reapply for his license after 15 months. McCaffrey also agreed to a 15-month suspension in a settlement with FINRA, Wall Street’s self-funded regulator.

Citi “must like the guy,” said Thomas Lewis, a lawyer for Stark & Stark in Lawrenceville, New Jersey, who represents brokers. Most industry professionals would not be allowed to continue working at their companies given a similar problem, he said. Citi also risks potential regulatory problems of its own if it does not fulfill the monitoring obligations, he said.

The conditions agreed to by Citigroup include weekly management meetings between McCaffrey and two high-level supervisors. McCaffrey will be assigned a dedicated senior compliance officer who will provide and document quarterly training, and Citigroup’s compliance department must conduct weekly reviews of all of McCaffrey’s electronic communications, including email and instant messages.

“In a small firm this would be impossible,” said George Brunelle, a New York-based securities lawyer. “You’d literally have to hire people to follow him around all day, and that’s pretty much what they’re requiring,” Brunelle said.

While brokerage industry professionals with prior disciplinary histories may become employed again subject to extra supervision, the outcome is especially unusual for someone whose job requires supervising others, experts said.

Citigroup spokesman Scott Helfman confirmed that McCaffrey will head the equities sales unit. “Kevin has satisfied all the regulatory requirements for reinstatement. We have complete confidence and trust in his abilities and believe he is the right person for the job,” Helfman said. He declined to comment further on why Citi would undertake such significant responsibilities to support McCaffrey’s new role.

FINRA’s requirements for supervising McCaffrey will remain in effect permanently, according to Daniel Sibears, FINRA executive vice president of member regulation programs. Citi must file a request with FINRA to lift any of its responsibilities, he said.

McCaffrey remained a licensed broker during the time he was unable to supervise employees. He has worked at Citigroup since in various roles since the 2005 decision, including as a managing director focused on business development in Asia and an investment adviser to a fund, according to the SEC order, published Monday.

Most recently, McCaffrey has been in a non-supervisory role related to equity sales.

McCaffrey did not return calls requesting comment.

Additional reporting by Jed Horowitz; Editing by Jennifer Merritt and Steve Orlofsky