Citigroup’s violations include: making unsuitable recommendations of the funds to 45 customers; failing to maintain required suitability records on its sales to over 8,200 investors in the funds, and failing to adequately disclose in Website advertising the risks of investing in managed futures.
In addition to the fine, NASD also ordered the firm to offer restitution to the 45 customers to whom the firm made unsuitable recommendations. Those customers invested a total of $203,000 in the futures funds, in individual investments ranging from $2,000 to $20,000.
“Managed futures are complicated and risky investment products that are unsuitable for many investors,” said NASD Vice Chairman Mary L. Schapiro. “Commodity trading is speculative. It is volatile. It involves a high degree of leverage. It is typically not well understood by average retail investors. So it is crucial that firms meet their suitability and disclosure obligations when selling these products.”
From January 2002 to November 2003, Citigroup marketed and sold the two proprietary managed futures products to over 8,200 investors, raising approximately $199 million. The funds have relatively high fees, with total sales and management fees ranging from 8.10% to 10.75%.
While NASD does not have jurisdiction over commodities, these funds were structured as limited partnerships and investors purchased units in a direct participation program (DPP), which is a securities product sold by brokers under NASD’s jurisdiction. These units are relatively illiquid and there is no trading market for them, although investors can redeem their units once a month or at the discretion of the fund.
The prospectuses for the futures funds established minimum net worth and income requirements designed to ensure that only suitable customers purchased the funds. The prospectuses required each investor to have a net worth of at least $150,000, or a minimum net worth of $45,000 combined with an annual income of at least $45,000. In addition, some states require that sales of the futures funds be limited to investors who meet more restrictive net worth and annual income requirements.
NASD found that Citigroup sold the funds to 45 customers who did not meet the minimum net worth and income requirements. For example, one customer had just lost her job and her futures fund investment of $4,000 represented a rollover from her Individual Retirement Account. The customer’s income was zero and her net worth was $25,000. NASD found that the firm’s unsuitable recommendations and sales occurred across 29 branch offices.
Because of the inherent risks of investing in DPPs, NASD rules require firms to maintain documents for each DPP customer disclosing the basis for determining that the investment was suitable. NASD found that the firm failed to maintain those records, and failed to establish and maintain a supervisory system and written procedures designed to ensure that suitability requirements were met.
Although Citigroup maintained a database of its customers that showed holdings in Citigroup brokerage accounts, investment objectives, net worth, income, and age, it could not be determined whether each broker reviewed that information and made suitability assessments based on that information. NASD found that Citigroup did not require its brokers to update the database and that the database was not consistently updated at the time of the sale of the futures funds.
Finally, NASD found that Citigroup posted an advertisement on its website that described managed futures products generally but that failed to adequately disclose and describe the substantial risks of investing in these products, including that an investor could lose all of his/her investment; that an investor’s ability to redeem units is limited and that no market exists for the units, and that managed futures funds’ high fees and expenses may completely offset any profits or gains.
In settling with NASD, Citigroup neither admitted nor denied the allegations, but consented to the entry of NASD’s findings.
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.
NASD is the leading private-sector provider of financial regulatory services, dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. NASD touches virtually every aspect of the securities business - from registering and educating all industry participants, to examining securities firms, enforcing both NASD rules and the federal securities laws, and administering the largest dispute resolution forum for investors and member firms. For more information, please visit our Web Site at www.nasd.com.
