Can You Still Trust the Citi?

Investors who are clients of Citigroup (NYSE: C) and its subsidiaries should be asking themselves whether it still makes sense to keep assets at this bank.

Even investors who were not affected by an alleged conflict of interest should be aware of the following events. Citigroup agreed to pay a $285 million fine, without admitting guilt, because it sold investors $1 billion of a proprietary collateralized debt obligation (CDO) that produced $700 million of losses for clients within two years. That's not the worst part. Citigroup made a profit of more than $100 million when it allegedly used company assets to bet against the performance of its own product.

US District Court Judge Jed S. Rakoff rejected the settlement, and took the US Securities and Exchange Commission to task "for allowing repeat offenders like Citi to avoid fraud charges and other statutory consequences that should accrue to serial violators of the law." Unless the SEC and Citi can come to another agreement, the case will go to jury trial next July 16. (See SEC Position a Travesty for Investors.)

Don't be misled by Citigroup's willingness to pay a fine without admitting guilt. It wants to minimize adverse publicity and major lawsuits from the investors who incurred the $700 million of losses. Citigroup's actions are designed to protect its own interests. Plus, paying the fine keeps the executives who made these decisions out of jail.

The fact that Citigroup agreed to pay the fine is enough of a reason for investors to question Citigroup's actions and priorities. Investors rely on Citigroup for competent, ethical advice that is not colored by potential conflicts of interest.

Investors should have increased concern if they are customers of Citigroup's broker/dealer operation. Regardless of title or what they have been told, Citigroup's advisors are really stockbrokers or sales representatives. Investors can make this determination based on how the "advisor" is compensated. Stockbrokers are paid commissions to sell financial products. Real advisors are paid fees.

Stockbrokers are also held to an ethical standard called "Suitability." That is, they are supposed to make suitable recommendations based on their knowledge of their clients' goals, tolerance for risk, and financial situation. Suitability is a deliberately vague standard that varies by client. Plus, investors are required to sign agreements that protect companies from claims that they were sold unsuitable investments.

Investors who have at least $100,000 of invested assets should require a professional who is a Registered Investment Advisor or an Investment Advisor Representative. These professionals are paid fees for their knowledge, advice, and services.

More importantly, they are held to the highest ethical standard in the financial services industry. They are required to always put their clients' financial interests ahead of their own. That means they have increased exposure and liability if they recommend investing in a proprietary product that has excessive or unknown risk characteristics.

How is Wall Street handling this stockbroker versus financial advisor dichotomy? It is fighting to prevent stockbrokers being held to a fiduciary standard. Its principal strategy is to spend more than $300 million on lobbyists who influence the decisions of politicians who control industry regulations. Wall Street maximizes profits when rules favor companies and not investors.

If representatives sell products for commissions, investors are at risk: The representatives' recommendations may benefit the company more than they benefit the investors.

Investors would sleep better at night if their Citigroup representatives were Investment Advisor Representatives, who acknowledged they are financial fiduciaries in writing and are compensated with fees, not commissions.