NASD Fines Citigroup Global Markets, Inc. $250,000 In Largest Hedge Fund Sales Sanction To Date
Washington, D.C.— In its largest enforcement action to date involving hedge fund sales by broker-dealers, NASD has censured and fined Citigroup Global Markets, Inc., $250,000 for disseminating inappropriate sales literature. More than 100 pieces of sales literature distributed between July 1, 2002 and June 30, 2003, cited a targeted rate of return without providing a sound basis for evaluating the target, improperly used hypothetical returns in charts or graphs, and/or failed to include adequate risk disclosure. "As hedge funds and 'funds of hedge funds' are marketed more and more aggressively to individual investors, ensuring that those investors receive full and accurate information is critical," said NASD Vice Chairman Mary L. Schapiro. "This enforcement action underscores our commitment to making certain that firms provide the investing public with a sound basis for evaluating hedge fund investments, and adequately disclose all of the risks." Ninety-five of the pieces of sales literature contained targeted rates of return for particular funds but did not provide a sound basis for investors to evaluate the reasonableness of the stated target. Among the objectionable statements:
- "The Portfolio seeks to earn an annualized return of 15% or more, net of all fees, over a three- to five-year investment horizon, while maintaining volatility below that of world equities."
- "…targets a 12-14% annual net return…"
- "The portfolio seeks to earn an annualized return of LIBOR + 500 basis points."
Twenty-eight of the sales pieces for recently started funds of hedge funds improperly presented hypothetical performance for these funds. This hypothetical performance showed results for the funds before they had begun operating, and therefore did not reflect the actual performance of the funds of hedge funds. Instead, these hypothetical results were calculated by selecting a portfolio of individual advisors with whom the fund of hedge funds intended to or had recently begun to invest, and then combining the historic performance results of these selected advisors, using a hypothetical allocation of assets.
Because it reflected the selection of potential advisors and asset allocations made after the performance of those advisors was already known, the hypothetical performance invariably showed positive rates of return. Further, there was no guarantee that the particular fund of hedge funds being promoted would continue to invest with any or all of the selected advisors - or that allocation of assets to those advisors would be the same as that used in the hypothetical performance.
In addition, in some instances, the sales literature presented hypothetical performance results in a chart or graph in combination with the actual historical performance of the fund of hedge funds. Such presentations created the misimpression that the particular fund of hedge funds had a longer investment track record than it actually possessed.
Forty-four pieces of sales literature failed to include adequate risk disclosure. Each of these pieces contained some risk disclosure, but not full and complete risk disclosure. Among the disclosures that were not included: that the funds are speculative and involve a high degree of risk; that an investor could lose all or a substantial amount of his or her investment; that there is no secondary market nor is one expected to develop for investments in the funds; that there may be restrictions on transferring fund investments; that the funds may be leveraged; that the funds' performance may be volatile; that the funds have high fees and expenses that would reduce returns, and other specific risks as to the particular funds' investments and strategies.
In settling this matter, Citigroup neither admitted nor denied the allegations, but consented to the entry of findings.
As a result of a review of brokers and firms selling hedge funds and registered products (closed-end funds) that invest in hedge funds, NASD has become concerned that some may not be fulfilling their sales practice obligations, especially when selling and marketing these instruments to retail customers. NASD issued an Investor Alert in August 2002 (Investor Alert - Funds Of Hedge Funds - Higher Costs And Risks For Higher Potential Returns) and a Notice to Members in February 2003 advising firms of their suitability obligation to investors whenever recommending or selling hedge funds (http://www.nasdr.com/pdf-text/0307ntm.pdf). In addition, NASD has brought several enforcement actions against firms relating to their marketing and sales of hedge funds.
Investors can obtain more information about, and the disciplinary record of, any NASD-registered broker or brokerage firm by using NASD's BrokerCheck. NASD makes BrokerCheck available at no charge to the public. In 2003, members of the public used this service to conduct more than 2.8 million searches for existing brokers or firms and requested almost 180,000 reports in cases where disclosable information existed on a broker or firm. Investors can link directly to BrokerCheck at www.nasdbrokercheck.com. Investors can also access this service by calling 1-800-289-9999.
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