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News November 22, 2004 Issue

Targeted Returns Objectionable in Hedge Fund Sales Literature, Says NASD

Last month, the NASD settled an enforcement proceeding against Citigroup Global Markets for making "unsubstantiated claims" in its hedge fund sales literature. At issue: statements indicating that the hedge fund targeted a specific return, such as the fund "targets a 12 - 14 % annual return" or "seeks to earn an annualized return of LIBOR + 500 basis points."

To settle the case, Citigroup paid $250,000, the largest sanction in a NASD hedge fund sales case so far. A NASD press release announcing the settlement noted that the sales literature that cited the targeted returns "did not provide a sound basis for investors to evaluate the reasonableness of the stated target."

The case now is raising eyebrows in the broader investment management legal community, where targeted returns frequently are included in mandates at the request of clients. The NASDís position that such statements are objectionable has left some lawyers wondering how the NASDís views (if not its jurisdiction) might translate into areas other than hedge fund sales literature. "Weíre kind of scratching our heads as to what the level of the NASDís understanding is about that number," said one investment management lawyer. He noted that it is common for institutional managers and their clients to discuss targeted returns, and that both sides understand what it is there for. A targeted return, he said, provides information on the amount of risk that will accompany the management of the portfolio. "Everyone knows that you canít predict the market," he added. However, another investment management lawyer predicted that regulators would likely to distinguish between institutional managerís use of targeted returns in mandates and the use of targeted returns in sales literature used in marketing hedge funds to individual investors.

In addition to the 100 pieces of hedge fund sales literature that allegedly contained targeted returns, the NASDís press release also claimed that Citigroupís hedge fund sales literature improperly presented hypothetical performance for fund of hedge funds. The NASD noted that the hypothetical performance "invariably showed positive rates of return."