The Financial Industry Regulatory Authority (FINRA) recently sanctioned Capstone Asset Planning Company (CAPCO) alleging that from 2010 through 2012, CAPCO distributed communications to the public concerning the Capstone Fund that failed to accurately reflect the change in the fund’s performance. In addition, FINRA alleged that the Capstone Fund’s website contained a misleading statement concerning the fund’s redemption policy and compared church bonds to corporate bonds without disclosing the material differences between them. As a result, FINRA found that CAPCO violated the content and communications standards under Rules 2210(d)(1)(A), 2210(d)(2)(B), and 2210(d)(2)(B).
CAPCO is a brokerage firm with one office in Houston, Texas, and 22 registered representatives. CAPCO is a mutual fund underwriter and is a subsidiary of Capstone Financial Services, Inc. CAPCO served as the principal underwriter and distributor of shares of the Capstone Church Capital Fund (Capstone Fund). Capstone Fund’s holdings were approximately 87% church mortgage bonds and 13% church mortgage loans. From 2009 to 2012, the net assets of the Capstone Fund declined as a result of the decrease in the fair value of the fund’s assets. The Capstone Fund stopped accepting sales on January 24, 2013.
Under NASD Rule 2210(d)(1)(A) communications must be “based on principles of fair dealing and good faith,” “fair and balanced,” and must “provide a sound basis for evaluating the facts in regard to any particular security.” Similarly, NASD Rule 2210(d)(1)(B) prohibits members from making “false, exaggerated, unwarranted or misleading statement or claim in connection with any communication.”
From 2009 to 2012, Capstone Fund’s net assets declined significantly due to a decrease in the fair value of the assets in the fund and large repurchases requested by investors. On September 30, 2009, the Capstone Fund’s net assets were $57,207,337 and declined to $32,927,615, by September 30, 2012. In 2010, the fund experienced difficulty in obtaining the necessary cash to satisfy its quarterly repurchase requests. In November 2010, the Capstone Fund changed its policy from allowing investors to make quarterly repurchases to allowing only annual repurchase requests.
FINRA alleged that from September 2010, to August 2012, CAPCO violated NASD Rule 2210(d)(1)(A) by omitting details and information about the Capstone Fund’s distressed holdings in on the fund’s website and the Fund Fact Sheet. Meanwhile, the fund disclosed through a Preliminary Proxy Statement filed with the SEC that “the Fund has not been successful in raising cash through sale of additional shares. Also, a significant portion (24% of the Fund’s net assets as of August 31, 2010) of the Fund’s mortgage bond and mortgage loan holdings have missed a coupon payment or are more than 60 days delinquent on their monthly sinking fund payments…Moreover, the secondary market for church mortgage bonds and loans has become even more illiquid, so the Fund is unable to raise sufficient cash by selling portfolio securities. At the same time, the Fund’s holdings of short-term money market instruments have been depicted…and payments from the Fund’s portfolio securities to provide the cash necessary to repurchase 5% of the Fund’s shares each quarter.”
Yet, according to FINRA, the fund’s website and Fund Fact Sheet did not provide any similar information about the deterioration of the Capstone Fund’s holdings. In addition, from January 2009 to May 2009, FINRA found that the Capstone Fund’s disclosure documents failed to identify non-income producing holdings. At least 18 bonds in the Capstone Fund were non-income producing securities. Further, from September 2010 to August 2012, FINRA alleged that the Capstone Fund’s website stated that it was an interval fund and periodically offers to buy back its shares from shareholders. FINRA alleged that this statement was misleading because it omitted any explanation of the Capstone Fund’s difficulty in 2010 in obtaining cash to satisfy its quarterly repurchase requests and the potential that an investor may not be able to sell his shares.
Finally, FINRA found that the Capstone Fund’s website stated that the fund was appropriate “for investors seeking the opportunity for…high quality secured church mortgage bonds & church mortgage loans.” The Fund Fact Sheet also stated that the “Capstone Church Capital Fund is for investors seeking the opportunity for:…Investment consisting primarily of high quality secured church mortgage bonds and church mortgage loans.” FINRA alleged that due to the deterioration in value of the Capstone Fund’s holdings the description of the church mortgage bonds and church mortgage loans as “high quality” was false, exaggerated, unwarranted and/or misleading.
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