Citigroup Sued Over B Share Disclosure
June 23, 2003
Financial services giant Citigroup is being sued by an investor who claims that she was duped into putting her money into a pricier share class of mutual funds.
In a class action complaint filed in a Manhattan federal court on June 12, Kathleen Fitzgerald of Great Neck, N.Y., alleged that she purchased more than $400,000 in class B shares of three mutual funds sponsored by Smith Barney, the brokerage and advisory arm of New York-based Citigroup.
The class action suit is being brought on behalf of all individuals or entities who invested $100,000 or more in B shares in one or more of Smith Barney Funds between June 6, 1998 to the present. As of March 2003, there were more than 100,000 purchases of Smith Barney B shares
In July 2000, Fitzgerald bought shares of the Smith Barney High Income Fund, Smith Barney Aggressive Growth Fund B and Smith Barney Strategic Income Fund. She argues that Smith Barney intentionally sold her B shares with the knowledge that she would pay higher sales charges and realize a smaller profit than if she had selected A or L class shares.
"Smith Barney collects excessive fees by preying on investors who do not understand the complicated class structure," contended Joel Bernstein, a partner at Goodkind Labaton Rudoff & Sucharow of New York and lead counsel for the plaintiff. Citigroup did not return phone calls seeking comment.
Typically, class B shares do not require a front-end sales load, which means all of the customer's dollars can begin investing immediately. However, B shares impose an asset-based sales charge or 12-b1 fee that could end up being higher than those that an investor would incur if he or she purchased A shares. They also normally carry a contingent deferred sales charge (CDSC), which is paid when investors redeem their shares.
While class A shares require an up-front sales charge, many funds offer breakpoint discounts if the purchase exceeds a certain dollar amount or if the investor already holds other mutual funds offered by the same fund complex. At Smith Barney, the front-end load for A shares is eliminated altogether for investments of $1 million and over.
The suit accuses the defendants of publishing "false and misleading" information in the company's prospectuses, which state that the performance of other classes "may be greater or less" than the class B shares' performance. Most mutual fund insiders are aware that B shares do not make economic sense for investments over $100,000. Some firms even place a cap on the amount that can be invested in B shares for that very reason. Smith Barney had no such restrictions in place. In doing so, Smith Barney violated the civil liability provisions in Sections 11 and 12 of the Securities Act of 1933, according to the suit.
"They're doing something that gets a higher commission for themselves and is detrimental to the customer," said Dan Boyd, a securities attorney and partner at Patton Boggs of Dallas. "Class A would have been just as good and the fees would have not been nearly as much for this type of customer."
The Securities and Exchange Commission brought a similar case against Todd Eberhard, chairman of New York's Park South Securities. The SEC charged Eberhard with engaging in a pattern of short-term trading and purchasing large blocks of B shares in an attempt to inflate commissions. Eberhard prevented his customers from taking advantage of the lower sales charges available through different fund classes, the SEC charged.
Elsewhere, the National Adjudicatory Council, a 14-member panel of the NASD, fined and suspended Wendell Belden, head of Southmark of Tulsa, Okla., last September for the unsuitable sale of more than $2.1 million of class B mutual fund shares to a customer. The plaintiff, a retiree whose name was withheld, invested more than $1 million in one particular fund family that would have entitled the customer to purchase class A shares with no front-end sales charge. Ultimately, Belden was fined, suspended and ordered to pay restitution.
More importantly, the NAC imposed a requirement to minimize the sales load that a customer pays for mutual fund shares when it's consistent with the customer's investment objectives. "That sets a pretty good precedent for the plaintiff," Boyd said. "If this is a widespread practice, then the defendant has got some trouble."
The stakes are higher in this instance because the plaintiff is seeking class-action status. "It's brought on a class basis primarily because it's a uniform non-disclosure," said Chris Keller, an associate at Goodkind Labaton specializing in class-action litigation. "It is a material fact that should have been disclosed in every single prospectus."