by Lawrence C. Melton, Esq., lmelton@dhayeslaw.com
THE HAYES LAW FIRM, www.dhayeslaw.com
On June 6, 2007, the NASD fined Citigroup Global Markets, Inc., $3 million to settle charges relating to the use of misleading materials in retirement seminars and meetings for BellSouth employees in North and South Carolina. Additionally, NASD ordered Citigroup to pay $12.2 million in restitution to over 200 former BellSouth employees. (See NASD News Release: Citigroup Global Markets to Pay Over $15 Million to Settle Charges Relating to Misleading Documents and Inadequate Disclosure in Retirement Seminars, Meeting for BellSouth Employees, June 6, 2007)
Citigroup failed to adequately supervise a team of brokers based in Charlotte, NC, who used misleading sales materials during dozens of seminars and meetings for hundreds of employees of BellSouth Corporation. Most of the employees were early retirees. The employees cashed out their pensions and 401(k) accounts, and invested these proceeds with Citigroup. More than 400 BellSouth employees opened over 1,100 accounts with the Citigroup brokers. (See NASD News Release, June 6, 2007).
People who retire early, such as the BellSouth employees, need to tap into their retirement savings at an earlier date. As such they are susceptible to pitches from broker dealers that guarantee comfortable early retirements. During such pitches, the broker or investment adviser may promise high levels of withdrawals and high rates of return. The investor should be wary, as early retirement pitches almost always promise too much. That is what happened in this case. The sales pitch of Citigroup was laden with fraud and deception.
Essentially three Citigroup brokers, Jeffrey Sweitzer, Mathew Muller and Joseph Zentner contrived a 72(T) scam. From 1994 to 2002, Sweitzer conducted 40 seminars, alone or with Muller. As a result of the sales presentations many of the BellSouth employees came to believe that they could afford to retire early by relying upon monthly withdrawals from their retirement savings pursuant to Section 72(t) of the Internal Revenue Code. (See NASD News Release, June 6, 2007).
TEN PERCENT TAX ON EARLY IRA WITHDRAWALS: As a policy matter, the federal government does not want retirees to withdraw and spend their retirement savings too quickly. This is why the Internal Revenue Service imposes an additional 10 percent tax on early withdrawals from a qualified retirement plan. The 10 percent tax is in addition to the income tax you pay on most retirement plan withdrawals.
72(T) EXCEPTION TO TAX ON EARLY WITHDRAWALS: There is a way one can avoid paying the 10% tax penalty. Section 72(t) of the Internal Revenue Code allows early retirees who withdraw money from their Individual Retirement Accounts (IRA) before age 59 1/2 to avoid the 10 percent penalty. The early withdrawals must be taken in equal periodic payments.
DEPLETION OF PRINCIPAL: Brokers frequently tell retirees that they can take an unreasonably high level of annual withdrawals from their IRA without depleting their principal. This presupposes the market will grow at a steady rate. Of course, in reality, the market often declines for extended periods of time. The broker may tell the client, the market return is 10 %, and we are taking out 8 %, so your money will grow and we will not have to touch your principal. Some time later the market goes down, and you are still taking withdrawals at a high level. This will eventually lead to the depletion of your principal investment. Of course, the broker did not convey this possibility to you when you first set up the 72(T) withdrawals. The NASD has stated:
While there is no perfect consensus on what this withdrawal rate should be, the uncertainty of return, market fluctuations and increased life expectancies among other factors argue for being conservative with your withdrawals, especially during the first years of retirement. While NASD can make no recommendation, many experts recommend withdrawal rates between 3-5% per year--considerably less than the 7-9% withdrawal rates NASD saw being recommended in the scheme above.
NASD Investor Alert, Look Before You Leave: Don't Be Misled By Early Retirement Investment Pitches That Promise Too Much, September 14, 2006.
Using charts, graphs, handouts and other documents at the seminars, the Citigroup brokers led the BellSouth employees to expect that for 30 years they could earn 12 percent annually and withdraw 9 percent annually, all without touching their principal. This projection, of course, was far-fetched. (See NASD News Release, June 6, 2007).
The Citigroup brokers projected the amount a generic 53-year-old BellSouth employee would earn from an initial investment of $300,000. They said that this typical employee would earn more than $1.8 million, could withdraw from $27,000 to $69,000 annually, and still have more than $770,000 in principal remaining 30 years later, at age 83. (See NASD News Release, June 6, 2007).
Sweitzer told one couple: "I'm going to tell you by way of expectations that you should be able to expect 12%. That is not guaranteed, but I fell like good times, bad times, ugly times, beautiful times, we should be able to average 12...We expect to earn 12%. We pay 9%....[b]asically, 10 years down the road you are looking at doubling your money...We may do 15, may do 18 or 20. But good times, bad times, I think that we would do 12%." (See NASD News Release, June 6, 2007).
Of course things did not go as planned. Over 200 BellSouth employees saw the principal in their accounts decline by a total of approximately $12.2 million. (See NASD News Release, June 6, 2007).
NASD found that the brokers' sales materials and presentation failed to adequately disclose the following:
- The expected 12 percent annual net returns exceeded the historical average return of the S&P 500 index over 70 years, and that for many periods during that time the S&P 500 returned far less than 12 percent.
- The recommended investments could decline in value so much as to deplete the customers' principal investment.
- The customers would pay fees of two to three percent, requiring them to earn 14 to 15 percent annually to achieve the expected 12 percent return.
- The recommended investments exposed BellSouth employees to greater market risk that the employees would have faced had they opted to retain their fixed annuity pension payments from BellSouth.
NASD found that Citigroup failed to supervise the activities of the brokers. Citigroup should have known the brokers were holding seminars and using misleading, unapproved sales material. Citigroup branch auditors did not require Sweitzer to produce samples of the materials he was using at his seminars. They did not even confirm that the seminars and related documents had been approved. (See NASD News Release, June 6, 2007).
Liability can be traced to Citigroup's failure to respond to several red flags. Citigroup's compliance officials had an opportunity to review one of the team's seminar handouts in 2001, but failed to detect and follow up on the misstatements and omissions. (See NASD News Release, June 6, 2007).
If you believe your broker has defrauded you, please contact THE HAYES LAW FIRM at 1-866-332-3567 and visit our web site at www.dhayeslaw.com
Send an email to the author of this article at lmelton@dhayeslaw.com
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