The U.S. Securities and Exchange Commission announced that it has settled charges against two subsidiaries of Citigroup Inc. over allegations that it pushed its mutual fund subsidiary to drop its external transfer agent and use the bank’s internal firm without disclosing that the external firm would be doing most of the work at a large discount.

In an order issued today, the SEC found that the two subsidiaries, Citigroup Global Markets Inc. and Smith Barney Fund Management LLC, misrepresented and omitted material facts when recommending to the boards of the mutual funds that the funds change from the third party transfer agent they previously used to a transfer agent that was a Citigroup affiliate.

Under the settlement, the respondents are ordered to pay US$208 million in disgorgement and penalties and to comply with substantial remedial measures, including an undertaking to put out for competitive bidding certain contracts for transfer agency services for the mutual funds. The firms consented to the order, without admitting or denying the findings.

The penalty breaks down into a payment of $128 million in disgorgement and interest, and $80 million in penalties and remedial measures. The remedial measures include a requirement that, in the event a Citigroup affiliate intends to submit a proposal to serve as transfer agent for the mutual funds, the adviser to the funds must also seek competitive bids from transfer agents unaffiliated with Citigroup. The competitive bidding process will be overseen by an independent monitor, accountable only to the boards of the mutual funds, but paid for by the respondents.

According to the commission’s order, the investment adviser placed its interest in making a profit ahead of the interests of the mutual funds it had a duty to serve. It says that the firm didn’t properly disclose that most of the actual work was to be done under a subcontract arrangement with the funds’ existing third party transfer agent at steeply discounted rates. “Rather than passing the substantial fee discount on to the mutual funds, the respondents, through the affiliated transfer agent, took most of the benefit of the discount for themselves, reaping nearly $100 million in profit at the funds’ expense over a five year period,” it says.

“Fund advisers owe a duty of undivided loyalty to the funds they serve. They cannot place their own interests above the funds’ interests, and they cannot hide the ball. They must disclose to the funds all material information regarding their compensation and the benefits they receive and all information regarding any conflicts of interest they may have,” says the SEC’s director of enforcement Linda Chatman Thomsen.

The commission’s investigation regarding the individuals involved is ongoing.