Citigroup Fined $600,000 for Implementing Tax Avoidance Strategies that Defrauded IRS of Billions in Taxes

Citigroup Inc. was fined $600,000 by the Financial Industry Regulatory Authority (FINRA) formerly known as the National Association of Securities Dealers, a private-sector regulator of U.S. broker dealers with supervisory authority over 4,800 U.S. brokerages, which determined that Citigroup Global Markets assisted their clients to avoid paying billions of dollars of U.S. taxes.

The recent fine against Citigroup is part of a larger U.S. Senate investigation regarding global tightening on tax evasion schemes as numerous governments attempt to close widening budget gaps fueled by economic weakness. At the center of the U.S. Senate investigation and tax recovery effort has been the U.S. Department of Justice’s case against UBS AG, a Swiss banking conglomerate. In October 2008, UBS AG agreed to pay $780 million to settle criminal claims that it helped U.S. citizens evade taxes.

In the case against Citigroup, FINRA determined that Citigroup employed two main trading strategies to help their clients avoid paying U.S. taxes. The first trading strategy Citigroup employed from 2000-2004 to help their clients avoid paying U.S. taxes, was designed primarily to enrich Citigroup. The strategy involved Italian stock trades and loaning the stocks to Citigroup’s Swiss affiliate to avoid paying U.S. withholding taxes.

The second strategy that Citigroup employed from 2002-2005 involved buying U.S. stocks from foreign broker-dealer, selling the U.S. stocks back to the foreign broker-dealers before dividends were paid. After a series of interim steps, including using a derivative contract commonly known as a total return swap, the foreign clients would receive an amount equal to the dividends as a “dividend equivalent” free of withholding taxes. The “dividend equivalent” is not subject to U.S. withholding taxes. In 2006, Citigroup paid approximately $24 million to the Internal Revenue Service for using this strategy.

FINRA’s Executive Vice President and Chief of Enforcement, Susan Merrill, stated that “Citigroup’s inadequate supervision resulted in improper trading… increasingly complex trading strategies must be governed by supervision that is equally sophisticated.” FINRA determined that Citibank lacked written procedures to govern total return derivative swap transactions. FINRA also determined that Citigroup employees deviated from the procedures that Citigroup did implement. Furthermore, Citigroup failed to report certain stock trades to the New York Stock Exchange, as required by securities regulators.

In an era of heightened corporate governance, in part due, to the adoption of Sarbanes-Oxley as result of corporate misconduct by former Wall Street darlings such as Enron, K-Mart, Adelphia Communications et cetera, it is shameful that corporate misconduct of this magnitude continues to proliferate in the markets. I find myself repeatedly asking why major corporations engage in such reprehensible conduct. Citigroup’s implementation of total return dividend swap-links, intentionally designed to deceive the IRS, is not only manipulative and fraudulent, it is also illegal. However, FINRA’s fine of a mere $600,000 seems grossly under representative of the magnitude of Citigroup’s conduct.

FINRA stated that the amount of the $600,000 fine was influenced by Citigroup’s willingness to report the violations to FINRA. Citigroup neither admitted nor denied wrongdoing in agreeing to settle the investigation.

Lydie Nadia Cabrera Pierre-Louis
St. Thomas University School of Law
lplouis@stu.edu