WealthManagement Magazine

NASD Tightens Noose on Hedge Fund Sales Practices

A top NASD official said on Wednesday that the regulatory agency has launched an investigation into brokers selling hedge funds to individual investors without alerting them to the potential risks.

A top NASD official said on Wednesday that the regulatory agency has launched an investigation into brokers selling hedge funds to individual investors without alerting them to the potential risks.

“The marketing and sales of hedge funds to individual investors has been an ongoing focus of the NASD,” said Barry Goldsmith, executive vice president of enforcement at the NASD, in a prepared statement. “We are continuing to look at issues in this but cannot comment on any specifics.”

Goldsmith’s remarks came in response to a Bloomberg wire report that the broker watchdog sent letters of inquiry to at least 10 brokerage houses, including Citigroup, Merrill Lynch and UBS. The NASD reportedly asked the firms what type of cautionary disclosures were made to investors when selling hedge funds that carried minimums of $50,000 or less. The firms were also asked if they paid brokers sales incentives to pitch certain hedged vehicles, according to Bloomberg.

The NASD reportedly said in its letter that the investigation should not be interpreted as a sign that examiners have concluded that the targeted firms violated securities laws. NASD spokesman Tom Holloman declined to comment on the contents of the letter or disclose the names of the firms implicated.

Hedge funds have long been viewed as the domain of wealthy “accredited” investors and institutions with a bigger appetite for risk. But they’ve come downstream in recent years, as a slew of new products have flooded the marketplace.

One of the more popular investments is the fund of hedge funds, which is a pooled investment (oftentimes registered with the SEC) that invests in a variety of underlying unregistered hedge funds with a minimum investment as low as $25,000. Unlike an open-ended mutual fund, investors cannot redeem shares directly with the fund unless the fund offers to do so.

This isn’t the first time hedge fund sales practices have drawn the ire of regulators. In October 2004, the NASD slapped Citigroup’s brokerage unit with a $250,000 fine for distributing hedge fund sales literature that didn’t adequately explain risks or disclose performance properly.

In April of that year, Altegris Investments was penalized for similar practices, ponying up $175,000 for its misdeeds. In that case, the NASD censured and fined the company’s chief compliance officer $20,000 for failing to adequately supervise the firm’s advertising practices.

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