NASD Hedge Fund Probe Expands

NASD is examining whether some of the biggest brokerage firms inappropriately sold hedge fund products to individual investors, according to Bloomberg.

Officials at NASD's Washington headquarters refused to comment on letters sent as part of the investigation. However, Bloomberg reported that three people with direct knowledge of the probe said that the regulator has sent letters to Merrill Lynch, Citigroup and UBS, broadening the scope of an investigation that started in June.

NASD is seeking information about customers who bought "retail hedge fund products" for $50,000 or less, according to the unnamed individuals, in an effort to determine whether the brokerage powerhouses adequately informed their clients about the risks associated with hedge funds.

NASD required brokers to recommend investments based on the best interest of the clients, not the salesman. "You worry about small investors getting involved through the back door in investments that aren't suitable for them because they're too risky or the fees are too high," said former U.S. Securities and Exchange Commission Chief Counsel David Becker.

Since 1995, hedge fund assets have grown to $1.1 trillion, an increase of 600% in five years. During the same time span, the average fund increased by approximately 11%.  Part of the growth may be attributed to a change in rules five years ago that allowed smaller investors to participate in hedge funds, which were previously limited only to accredited investors with $1 million or more.  In 2004, the SEC called the hedge fund boom "a development of significant concern," leading to the new rule requiring hedge funds to register with the Federal regulator by Feb. 1.

Spokespeople from Merrill, UBS and Citigroup each declined comment, according to Bloomberg. The three are among the largest of the approximately 5,200 brokerages NASD regulates. The investigation into hedge fund sales began in June, when the NASD asked 10 firms about their hedge fund marketing techniques.

All three offer "funds of funds," or products comprised of multiple hedge funds, rather than multiple stocks. SEC filings show that the minimum investment in such products can be less than $50,000.

NASD officials noted that the probe is just that and "shouldn't be construed" as a sign that any of the firms named have violated any securities laws.

The staff of Money Management Executive ("MME") has prepared these capsule summaries based on reports published by the news sources to which they are attributed. Those news sources are not associated with MME, and have not prepared, sponsored, endorsed, or approved these summaries.