In the first action of its kind, the Washington-based National Association of Securities Dealers (NASD) has censured and fined Altegris Investments for "failing to disclose the risks associated with hedge funds when marketing them to investors".
Altegris Investments Inc. of La Jolla, California was fined US$175,000 for failing to disclose the risks associated with hedge funds when marketing them to investors.
The NASD said some of the firm's sales literature also contained "exaggerated and unwarranted statements" about these products.
NASD also censured and fined Altegris' Chief Compliance Officer, Robert Amedeo, US$20,000 for failing to adequately supervise the firm's advertising practices in this area.
Jon Sundt, Altegris's President, stated: "Altegris has always strived to conduct its business in the most compliant way possible. The NASD acknowledged that we delivered offering documents to investors that may have described some or all of the risks associated with hedge fund investing. However they are requiring that each piece of sales literature independently comply with their risk disclosure standards. I would encourage hedge fund industry professionals to read this NASD action carefully, as it may prompt them to reconsider their current marketing and advertising policies."
Mr Sundt said: "We understand that recently hedge funds have come under increasing scrutiny as regulators attempt to educate investors and develop additional regulatory guidelines. Altegris views this heightened regulatory interest as a positive development for both investors and those firms interested in maintaining the highest industry standards. We welcome any additional clarity and guidance that the regulators can provide to this rapidly growing and changing industry."
NASD found that between October 2002 and February 2003, Altegris distributed 26 different pieces of hedge fund sales literature to its customers.
Each of these marketing pieces failed to include important disclosures regarding specific risks of investing in hedge funds and made unbalanced presentations about the particular hedge funds that failed to provide investors with a sound basis for evaluating whether to invest in these hedge fund products.
Mary L. Schapiro, NASD's Vice Chairman and President Regulatory Oversight, said: "Communications by our members with the investing public must provide a sound basis for evaluating an investment and must adequately disclose the risks."
She added: "This is no less true for hedge funds than for any other investment product. Today's enforcement action is part of NASD's broader review of hedge fund sales practices and reinforces NASD's commitment to ensuring adherence to the highest standards of good faith and fair dealing."
Among the items that Altegris failed to disclose about the specific hedge funds were the following:
* The fund is speculative and involves a high degree of risk.
* The fund may be leveraged.
* The fund's performance can be volatile.
* An investor could lose all or a substantial amount of his or her investment.
* The fund manager has total trading authority over the fund. The use of a single advisor applying generally similar trading programs could mean lack of diversification and, consequentially, higher risk.
* There is no secondary market for the investor's interest in the fund and none is expected to develop.
* There may be restrictions on transferring interests in the fund.
* The fund's high fees and expenses may offset the fund's trading profits.
* A substantial portion of the trades executed for the fund takes place on foreign exchanges.
Although some or all of these risks may have been described in offering documents to investors, such disclosure did not cure these violations of NASD's advertising rules. These rules require that each piece of sales literature independently comply with the rules' standards.
Two of the pieces of sales literature distributed by Altegris were research reports on specific hedge funds that were written by a registered representative at another member firm. These research reports contained several exaggerated and unwarranted statements and claims. For example:
* The first research report characterised the hedge fund as "an ideal fund for conservative investors." However, the Offering Memorandum indicated that the fund has a limited operating history, is speculative and involves a high degree of risk.
* In the second research report, the author made the following unwarranted projection of future performance: "Is he likely to continue to give us 12-14% years over the next 4-5 years? In my opinion, I think it is likely he will."
* The second research report inaccurately stated that the hedge fund was "subject to NASD inspection" and that "the NASD will audit the fund as well." The research report went on to say, "For some, this layer of regulatory oversight is comforting." The statement is false since NASD does not and will not audit the hedge fund.
A hedge fund can be described generally as a private and unregistered investment pool that accepts investors' money and employs hedging and arbitrage techniques using long and short positions, leverage and derivatives, and investments in many markets.
This enforcement action is NASD's first in its recent and ongoing focus on hedge funds. As a result of a recent review of members that sell hedge funds and registered products (closed-end funds) that invest in hedge funds, NASD has become concerned that some members may not be fulfilling their sales practice obligations when selling and marketing these instruments, especially to retail customers.
As part of this focus, NASD issued an Investor Alert in August of last year Investor Alert - Funds Of Hedge Funds - Higher Costs And Risks For Higher Potential Returns and a Notice to Members in February of this year advising members of their suitability obligation to investors whenever recommending or selling hedge, http://www.nasdr.com/pdf-text/0307ntm.pdf .
In settling this matter, Altegris and Amedeo neither admitted nor denied the allegations, but consented to the entry of findings. Altegris also agreed to obtain pre-approval from NASD Department of Advertising Regulation before distributing future advertisements and sales literature.
Background Note: NASD is the leading US private-sector provider of financial regulatory services, dedicated to bringing integrity to the markets and confidence to investors 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.