Articles Posted in Consumer Protection

shutterstock_94127350The Financial Industry Regulatory Authority (FINRA) announced that it has fined eight brokerage a total of $6.2 million for failing to supervise sales of variable annuities (VAs).  Five of the firms were required to pay more than $6 million to customers who purchased L-share variable annuities that came with potentially incompatible, complex and expensive long-term minimum-income and withdrawal riders.

FINRA’s enforcement actions were against the following firms.

  • VOYA Financial Advisors Inc. – fined $2.75 million.
  • Cetera Advisor Networks LLC – fined $750,000.
  • Cetera Financial Specialists LLC – fined $350,000.
  • First Allied Securities, Inc. – fined $950,000.
  • Summit Brokerage Services, Inc. – fined $500,000.
  • VSR Financial Services, Inc. – fined $400,000.
  • Kestra Investment Services, LLC – fined $475,000.
  • FTB Advisors, Inc. – fined $250,000.

FINRA ordered the firms to pay the following to investors.

The L-share VAs are complex investment products that combine insurance and investment features designed for short-term investors willing to pay higher fees in exchange for shorter surrender periods.  L-shares also have the potential to pay greater commissions to brokers than traditional share classes.

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imgresIn the short term, a Donald Trump presidency might help markets. That’s right, all the cataclysmic talk of the markets immediately seizing are likely inaccurate. However, in the long term, the United States may have some serious fiscal issues. First, Donald Trump the new rule from the Department of Labor requiring brokerage firms to act in the best interests of their clients in 401(k) plans will likely be repealed.

Barbara Roper, the director of investor protection at the Consumer Federation of America says, Republicans “have made it clear that rolling back those protections will be on the agenda of a Republican administration.”

Second, President-elect Trump has pledged to reduce taxes exponentially across the board. Currently, the tax rate for married couples filing jointly is seven separate tax brackets with the highest being 39.6% for all income earned over $466,951. Trump proposes a 3 tax brackets with the highest being 33% for all income earned over $225,000. Trump has also proposed eliminating the estate tax, which currently taxes 40% on all money inherited over $5.45 million and reducing business taxes from 35% to 15%. Forty-seven percent of these tax cuts will go to the richest 1% according to Forbes.

shutterstock_52426963The securities fraud lawyers of Gana LLP are investigating customer complaints against brokerage firms and advisors for selling them structured CDs – a class of structured products.  Brokerage firms and banks are selling record numbers of the so called “CDs” that are extraordinarily complex products that are nothing like CDs and contain substantial risks.

These CDs are usually market-linked or structured so that their performance depends on a basket of stocks or other assets instead of a flat interest rate like traditional CDs.  When they mature CD holders get their original money back plus a return based on the performance of certain assets or benchmarks.

Banks love these CDs because they are an inexpensive sources of funding that generate huge fees all the way down the chain. The issuer gets fees and the financial adviser gets paid more for selling a market-linked CD than a conventional CD or a mutual fund.  Typically, an adviser who sells the CD can get commissions of up to 3% of the CD’s value.

However, brokers are getting paid to recommend an investment that does not perform as well as traditional CDs and other safe investments.  It’s even difficult to determine how structured CDs perform but an analysis by the Wall Street Journal found that after analyzing investment returns data on hundreds of market-linked CDs created by Barclays PLC, that many under performed conventional CDs because upside gains on the underlying assets are limited by the terms of the investment.

According to the article, of the 325 Barclays CDs reviewed more than half of those returns were lower than an investor would have earned from an average five-year conventional CD.  In addition, of the 118 structured CDs issued at least three years ago only one-quarter posted returns better than those of an average five-year conventional CD and about 25% produced no returns at all.  Similarly, an analysis of 147 market-linked CDs issued since 2010 by Bank of the West, a subsidiary of BNP Paribas SA, revealed that 62% produced returns lower than an investor would have received from a five-year conventional CD.

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shutterstock_64025263As one of the largest non-traded real estate investment trust (Non-Traded REIT) company, AR Capital, closes shop on new offerings, a growing non-traded product lines up to take retail investor’s money. Enter the non-traded business development company (BDCs). BDCs have been a growing asset class that markets itself to investors as a non-stock market, non-real estate, high yield alternative investment. However, BDCs appear to be just as speculative, suffer from high commissions and fees, and are inappropriate for most investors just like Non-Traded REITs. Indeed, according to a Wealth Management Article front-end load fees on Non-Traded BDCs are typically around 11.5 to 12 percent. In addition, BDCs also usually have an incentive compensation following the “two and twenty” rule where the fund charges two percent of assets in management fees and 20% of capital gains based upon performance.

As we have reported in the past, BDCs make loans to and invest in small to mid-size, developing, or financially troubled companies either broadly or in a particular sector, such as oil and gas. BDCs have stepped into a role that many commercial banks left during the financial crisis due to capital raising requirements. In sum, BDCs lend to companies that may not otherwise get financing from traditional sources. Non-Traded BDCs offer investors similar risks as Non-Traded REITs including higher fees, less liquidity, and less corporate transparency. The major difference is that Non-Traded BDCs are regulated under the 1940 Act that governs mutual funds and that a BDC is valued quarterly.

The largest player in this space is Franklin Square Capital Partners which manages multiple Non-Traded BDC funds including the FS Investment Corporation (FSIC) FS Investment Corporation II (FSIC II), FS Investment Corporation III (FSIC III), FS Investment Corporation IV (FSIC IV), FS Energy and Power Fund (FSEP), and FS Global Credit Opportunities. Franklin Square’s BDC assets were approximately $14.5 billion under management as of March 31, 2015. Other firms seeking to capitalize on the BDC wave including CNL Securities’ Corporate Capital Trust, ICON Investment’s CĪON Investment Corporation fund (CĪON); and American Realty Capital’s Business Development Corporation of America II.

The growth of Non-Traded BDCs comes while the largest Non-Traded REIT marketer, AR Capital is existing the business. According to the New York Times, AR Capital built by Nicholas S. Schorsch and William M. Kahane stated that it would stop creating new investment products and close existing ones to new investors to focus on managing the $19 billion it has in current investments. AR Capital’s current offerings include Business Development Corporation of America II, ARC Healthcare Trust III, New York City REIT II, ARC Hospitality Trust and ARC Global Trust II.

According to the article there were a couple of reasons for closing the funds to investors including serious problems with their lack of transparency and the interrelationship with affiliated companies. In addition, the proposed new fiduciary standards for advisers and mandated fee disclosures is causing the industry to question whether these products can be sold anymore. Basically, the industry is worried that Non-Traded REITs are not in investors best interests, an opinion our firm has echoed before. See Controversy Over Non-Traded REITs: Should These Products Be Sold to Investors? Part I

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shutterstock_153667856The Financial Industry Regulatory Authority (FINRA) announced its approval of a rule in a press release to help brokerage firms protect seniors citizens and other vulnerable adults from financial exploitation. The heart of the proposal allows a firm to place a temporary hold on a disbursement of funds or securities and notify a customer’s trusted contact when the firm has a reasonable belief that the customer may be the subject of financial exploitation. According to FINRA, an average of 10,000 Americans will turn 65 every day for the next 15 years.

In our practice, often time accountants, attorneys, or children of elderly investors contact our firm when they suspect that there has been elder abuse or unfair trade practices in the handling of an elderly persons’ accounts. As long time readers of our blogs know senior abuse is an ongoing concern in the securities industry. See Massachusetts Fines LPL Financial Over Variable Annuity Sales Practices to Seniors; The NASAA Announces New Initiative to Focus on Senior Investor Abuse; The Problem of Senior Investor Abuse – A Securities Attorney’s Perspective; Senior Abuse in the Securities Industry A Major Ongoing Concern

In the past, regulators have expressed worry that brokers may be placing seniors in risky investments that chase yield such as inappropriate nontraditional investments like variable annuities, non-traded real estate investment trusts (Non-Traded REITs), structured products, and other alternative products. Regulators have warned brokers that the dangers of seniors’ chasing yield through alternative investments comes from the fact that they don’t have as much time as other clients for them to pay off. In addition, if these investments fail the result is a major loss of irreplaceable life savings.

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shutterstock_124613953The Massachusetts Office of the Secretary of Securities Division filed complaints against brokerage firm Securities America, Inc. (Securities America) and one of its financial advisors Barry Armstrong (Armstrong) concerning allegations that in 2014, Securities America authorized Armstrong to run a deceptive AM radio advertising campaign. According to the complaint, the advertising campaign was designed to target vulnerable Massachusetts senior citizens by trumpeting the looming dangers of Alzheimer’s disease and implying that the brokerage firm has special access to medical information and support.

Massachusetts found that the advertising campaign was a classic “bait and switch” in which callers inquired about Alzheimer’s support and information and instead were solicited solely for brokerage and financial planning services. Massachusetts found that advertising used alarmist language designed to pull in senior citizens with concerns about Alzheimer’s disease while failing to disclose the nature of the services Armstrong actually offers. Indeed, when callers contact the number provided the only information concerning Alzheimer’s that is provided is a Fact Sheet published by the National Institute of the Aging and some other publicly available free information about Alzheimer’s.

Massachusetts found Securities America’s approval of the advertising used “astounding” stating that as a national-scale broker-dealer the firm failed to make “substantive comment or follow up of any kind” when reviewing Armstrong’s advertising materials. In sum, Massachusetts alleged that “Securities America failed to prevent or even flag glaringly unethical conduct.”

Armstrong has been registered with Securities America since January 2007 and entered the securities industry in 1984. According to the BrokerCheck records kept by Financial Industry Regulatory Authority (FINRA) Armstrong has been the subject of at least three customer complaints, one employment separation, and one criminal matter.

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shutterstock_27710896This post continues our investigation into whether or not brokerage firms have a basis to continue to sell non-traded real estate investment trusts (Non-Traded REITs). Non-Traded REIT sales have exploded becoming the latest it product of Wall Street. However, experts and regulators have begun to question the basis for selling these products. And if Non-Traded REITs are to be sold, should there be a limit on the amount a broker can recommend.

As reported in the Wall Street Journal, Craig McCann, president of Securities Litigation & Consulting Group, a research and consulting company, “Nontraded REITs are costing investors, especially elderly, retired, unsophisticated investors, billions. They’re suffering illiquidity and ignorance, and earning much less than what they ought to be earning.” In conclusion, “No brokerage should be allowed to sell these things.”

According to his analysis, shareholders have lost about $50 billion for having put money into Non-Traded REITs rather than publicly exchange-traded funds. The data comes from a study of the difference between the performance of more than 80 Non-Traded REITs and the performance of a diversified portfolio of traded REITs over two decades. The study found that the average annual rate of return of Non-Traded REITs was 5.2%, compared with 11.9% for the Vanguard REIT Index Fund.

What’s the culprit here causing investor under performance? According to the analysis the high upfront fees your broker earns make all the difference. The true costs of the high fees are then masked from investors through the opaque nature of Non-Traded REITs that helps to cloak their dismal performance. “If you’re selling a high-cost product, typically you make it opaque,” McCann said.

Regulators have recognized that the increased sales of Non-Traded REITs are a problem but, as usual, have taken only baby steps to protect investors. FINRA has issued investor alerts telling investors to “Perform a Careful Review Before Investing” in Non-Traded REITs and have enacted rule changes on how Non-Traded REIT values are listed on account statements. But these actions do little to nothing to protect investors faced with a broker intent on making a sale.  As reported by InvestmentNews, Peter Maftieu, a compliance consultant and principal at Sound Compliance Services, stated that Non-Traded REIT sales guidelines should be reformed and that FINRA should be doing more to police them.

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shutterstock_112362875As longtime readers of our blog know we have reported numerous instances of sales and other practice violations regarding how brokers and brokerage firms sell non-traded real estate investment trusts (Non-Traded REITs). See list of articles below. As Non-Traded REITs have become the latest darling product of the financial industry experts and regulators have begun to question the basis for selling these products. And if Non-Traded REITs are to be sold, should there be a limit on the amount a broker can recommend.

As a background, a Non-Traded REIT is a security that invests in different types of real estate assets such as commercial, residential, or other specialty niche real estate markets such as strip malls, hotels, storage, and other industries. There are publicly traded REITs that are bought and sold on an exchange with similar liquidity to traditional assets like stocks and bonds. However, Non-traded REITs are sold only through broker-dealers, are illiquid, have no or limited secondary market and redemption options, and can only be liquidated on terms dictated by the issuer, which may be changed at any time and without prior warning.

Investors are also often ignorant to several other facts that would warn against investing in Non-Traded REITs. First, only 85% to 90% of investor funds actually go towards investment purposes. In other words, investors have lost up to 15% of their investment to fees and costs on day one in a Non-Traded REIT. Second, often times part or almost all of the distributions that investors receive from Non-Traded REITs include a return of capital and not actual revenue generated from the properties owned by the REIT. The return of capital distributions reduces the ability of the REIT to generate income and/or increases the investment’s debt or leverage.

Yet, despite the significant risks and draw backs to these products, the Non-Traded REIT industry has grown by leaps and bounds in large part due to a concerted effort by the brokerage industry to increase sales of these products in order to pad their bottom lines. According to an Investment News report independent broker dealers saw a 13.2% year over year increase in revenue in 2013 with chief executive of Cambridge Investment Research explaining, “There were two reasons for last year’s results. The stock market was up 30%, and there was an unusually high percentage of dollars in alternatives and REITs being sold.”

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shutterstock_179203754The Financial Industry Regulatory Authority (FINRA) issued a press release concerning two settlements fining Morgan Stanley Smith Barney, LLC (Morgan Stanley) $650,000 and Scottrade, Inc. $300,000 for failing to implement reasonable supervisory systems to monitor the transmittal of customer funds to third-party accounts. The settlements included allegations that both firms had weak supervisory systems after FINRA examination teams reviewed the firms in 2011, but neither took necessary steps to correct the supervisory gaps.

Brad Bennett, Executive Vice President and Chief of Enforcement, was quoted in the press release as stating that, “Firms must have robust supervisory systems to monitor and protect the movement of customer funds. Morgan Stanley and Scottrade had been alerted to significant gaps in their systems by FINRA staff, yet years went by before either firm implemented sufficient corrective measures.”

In the Morgan Stanley settlement, FINRA alleged that from October 2008, to June 2013, three Morgan Stanley brokers in two different branch offices converted a total of $494,400 from thirteen customers by creating fraudulent wire transfer orders and checks to third-party accounts. In one example, the brokers moved funds from multiple customer accounts to their own personal bank accounts. FINRA found that in these instances Morgan Stanley’s supervisory systems and procedures to review and monitor transmittals of customer funds through wire transfers were not reasonable and could not detect multiple customer account transfers to the same third-party accounts and outside entities. In sum, FINRA found that the supervisory failures allowed the conversions to go undetected.

As for the Scottrade settlement, FINRA found that the firm failed to establish a reasonable supervisory system to monitor for wires to third-party accounts. FINRA alleged that from October 2011, to October 2013, Scottrade did not obtain any customer confirmations for third-party wire transfers of less than $200,000. FINRA also found that Scottrade failed to ensure that the firm obtained confirmations for third-party wire transfers of between $200,000 and $500,000. FINRA found that these failures led to the firm processing over 17,000 third-party wire transfers totaling more than $880 million without adequate supervision.

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shutterstock_103079882As long time readers of our blogs know senior abuse is an ongoing concern in the securities industry. See Massachusetts Fines LPL Financial Over Variable Annuity Sales Practices to Seniors; The NASAA Announces New Initiative to Focus on Senior Investor Abuse; The Problem of Senior Investor Abuse – A Securities Attorney’s Perspective.

Recently, a number of regulatory agencies have begun new initiatives against investment fraud targeted at seniors with the intent to provide resources to seniors and financial advisors. Regulators fear senior abuse in the investment sector will be a growing trend over the next couple of decades if not addressed soon.

According to a National Senior Investor Initiative report cited by the Financial Industry Regulatory Authority (FINRA), the Social Security Administration estimates that each day for the next 15 years, an average of 10,000 Americans will turn 65. According to the U.S. Census Bureau in 2011, more than 13 percent Americans, more than 41 million people, were 65 or older. By 2040, that number is expected to grow 79 million doubling the number that were alive in 2000.

Often times older clients are lucrative targets for brokers because they tend to amass substantial retirement assets as compared to younger investors. But coinciding with increased assets are substantial risks that advisors and other non-licensed persons may try to take advantage of vulnerable seniors. An aging population has caused regulators and brokerage firms to increase their training with investment advisers and brokers to protect senior investor.

For example, the National Senior Investor Initiative report includes observations and practices that focus on how firms conduct business with senior investors. The examinations focused on the types of securities purchased by senior investors, the suitability of investments, training of representatives, marketing, communications, account documentation, risk disclosures, and supervision.

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