Securities Lawyers Blog

Unsuitable Variable Annuity Sales A Continuing Concern for Regulators

July 18, 2014 | by Staff Attorney

As reported by InvestmentNews, A Financial Industry Regulatory Authority (FINRA) official recently expressed concern over the sale of variable annuities as the products continue to evolve and become more complex. Carlo di Florio, chief risk officer and head of strategy at FINRA was quoted as stating that variable annuities are now taking on features that resemble complex structured products. Structured products typically have features such as caps that limit returns during market rallies and floors that limit losses during market slumps. Now these features are appearing in variable annuity products. Variable annuities are already extremely complex products that are not suitable for all investors. Adding yet an additional level of complexity only heightens concerns that investors must understand what they are buying when they are recommended these vehicles.

As a background variable annuities are complex financial and insurance products. Recently the Securities and Exchange Commission (SEC) released a publication entitled: Variable Annuities: What You Should Know. The SEC encouraged investors considering a purchase of a variable annuity to “ask your insurance agent, broker, financial planner, or other financial professional lots of questions about whether a variable annuity is right for you.”

A variable annuity is a contract an investor makes with an insurance company where the insurer agrees to make periodic payments to you. A variable annuity may be purchased either in a single payment or a series of payments over time. In the annuity account the investor chooses investments and the value of the annuity “varies” over time depending on the performance of the investments chosen. The investment options for variable annuities are generally mutual funds.

FINRA Fines Merrill Lynch For Overcharging Mutual Fund Customers

July 17, 2014 | by Staff Attorney

On June 16, 2014, the Financial Industry Regulatory Authority (FINRA) announced that it fined Merrill Lynch, Pierce, Fenner & Smith, Inc. $8 million for charging excessive fees relating to the sales of mutual funds in retirement accounts. FINRA also ordered Merrill Lynch to pay $24.4 million in restitution to those customers who had been wrongfully overcharged. The mandated restitution was in addition to the $64 million Merrill Lynch has already paid to compensate disadvantaged investors.

Mutual funds offer several different classes of shares. Each class has separate and distinct sales charges and fees. Generally, Class A shares have the lowest fees as compared to Class B and Class C. Class A shares, however, charge customers an upfront sales charge. This initial sales charge, however, is usually waived for retirement accounts, with some funds also waiving these fees for charities.

Merrill Lynch’s retail platform offers a variety of different mutual funds. Most of those funds explicitly offered to waive the upfront sales charges and disclosed those waivers in their respective prospectuses. According to FINRA, despite these disclosures, Merrill Lynch did not actually waive the sales charges many times since at least January 2006. On various occasions, Merrill Lynch charged the full sales charges to certain customers who qualified for the waiver. In doing so, Merrill Lynch allegedly caused nearly 41,000 small business retirement plan accounts and 6,800 charities and 403(b) retirement accounts for ministers and public school employees to pay sales charges when purchasing Class A shares. Those that did not want to pay the fee for the Class A shares were forced to purchase other share classes that needlessly exposed them to greater ongoing costs and fees. According to FINRA, Merrill Lynch became aware of the fact that its small business retirement plan customers were being overcharged, but yet they continued to sell the costly mutual fund shares and never reported the issue to FINRA for over five years.

Former Sterne Agee Broker Dean Mustaphalli Alleged to Have Wrongfully Run $6 Million Hedge Fund

July 15, 2014 | by Staff Attorney

The attorneys at Gana Weinstein LLP are investigating claims that former Sterne Agee Financial Services Inc. (Sterne Agee) broker Dean Mustaphalli (Mustaphalli) solicited millions of dollars from investors running to run a $6 million hedge fund on the side without formerly disclosing the activity to his brokerage firm. As reported by InvestmentNews, the Financial Industry Regulatory Authority (FINRA) charged Mustaphalli for founding and receiving commissions from a hedge fund he created called Mustaphalli Capital Partners in or about 2011 without informing his. Mustaphalli sold the investment through his registered investment advisory firm, Mustaphalli Advisory Group.

According to allegations made, Mustaphalli solicited money for the fund from at least 25 investors over six months during 2011. The fund invested in publicly traded equity and debt securities has since declined by approximately 90% according to investors. At least some of Mustaphalli’s clients were direct customers of Sterne Agee as well. According to FINRA, Mustaphalli was not cooperating with the agencies requests to provide account statements for the hedge fund. Typically in these cases if a broker does not cooperate with FINRA’s department of enforcement and the agency proves he withheld information the broker would be barred from the securities industry among other remedies that could be imposed.

Mustaphalli disclosed the existence of the Mustaphalli Advisory to Sterne Agee but did not disclose that he was managing the hedge fund through the firm according to FINRA. However, under the FINRA rules, brokers must fully disclose hedge funds for approval to their member firm and be supervised by the firm under Rule 3040.

Wells Fargo Broker Michael Frew Accused of Running Fictitious “Real Estate” Scam

July 14, 2014 | by Staff Attorney

The attorneys at Gana Weinstein LLP are investigating claims that broker Michael Frew (Frew). Frew allegedly solicited millions of dollars from investors including his friends and family on claims that he said would use the money to invest in real estate to rehabilitate properties in areas hit by natural disasters. Frew has now accused been accused of orchestrating a Ponzi scheme and converting these funds. Recently, the Financial Industry Regulatory Authority (FINRA) has sanctioned and barred Frew concerning these allegations and for Frew’s failure to properly respond to the agencies investigation requests.

Our attorneys have significant experience recovering investor funds by holding brokerage firms and Ponzi schemer’s responsible. In a similar real estate related fraudulent investment scheme our attorneys obtained a $2.8 million award on behalf of a group of defrauded investors including $1.9 million in punitive damages. See Reuters, Arbitrator orders alleged Ponzi-schemer to pay $2.8 million (Aug. 8, 2013) and the Award here.

Frew entered the securities industry in 1975. From 1988 to 2003, Frew was associated with Prudential Securities Inc. In 2003, Frew became registered with Wells Fargo Advisors, LLC (Wells Fargo). According to FINRA, Wells Fargo permitted Frew to resign in January 2014 when Frew refused to provide the firm bank records the firm requested in their investigation into whether Frew had received funds from customers. In February 2014, FINRA began investigating whether Frew accepted loans from customers and potentially converted those funds. Thereafter, FINRA stated that between March and May 2014, Frew failed to fully respond to FINRA’s requests for documents and information and refused to appear for testimony. For failing to respond to FINRA’s requests, the agency imposed a permanent bar from the securities industry.

Bank Loan ETFs – Buyer Beware

July 11, 2014 | by Staff Attorney

A recent statement by BlackRock Inc (BlackRock) Chief Executive Larry Fink concerning leveraged exchange traded funds (Leveraged ETFs) has provoked a chain reaction from the ETF industry. Fink runs BlackRock, the world’s largest ETF provider. Fink’s statement that structural problems with Leveraged ETFs have the potential to “blow up the whole industry one day” have rattled other ETF providers – none more so than those selling bank loan ETFs. Naturally, sponsors of Leveraged ETFs, a $60 billion market, called the remarks an exaggeration.

As a background, leveraged ETFs use a combination of derivatives instruments and debt to multiply returns on an underlining asset, class of securities, or sector index. The leverage employed is designed to generate 2 to 3 times the return of the underlining assets. Leveraged ETFs can also be used to return the inverse or the opposite result of the return of the benchmark. While regular ETFs can be held for long term trading, Leveraged ETFs are generally designed to be used only for short term trading – sometimes as short as a single day’s holding. The Securities Exchange Commission (SEC) has warned that most Leveraged ETFs reset daily and FINRA has stated that Leveraged ETFs are complex products that are typically not suitable for retail investors. In fact, some brokerage firms simply prohibit the solicitation of these investments to its customers, an explicit recognition that a Leveraged ETF recommendation is unsuitable for virtually everyone.

Despite these dangers, bank loan Leveraged ETFs may be an easy sell to investors. Investors in fixed income instruments are compensated based upon the level of two sources of bond risk – duration risk and credit risk. Duration risk takes into account the length of time and is subject to interest rate changes. Credit risk evaluates the credit quality of the issuer. For example, U.S. Treasury’s have virtually no credit risk and investors are compensated based on the length of the bond. At the other end of the safety spectrum are low rated floating-rate debt – what bank loan Leveraged ETFs invest in. These funds are supposed to reset every 90 days in order to get exposure to the credit side but not take on much duration risk.

Broker Douglas Cmelik Sanctioned by FINRA Over Soliciting Penny Stock Purchases

July 10, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) has sanctioned broker Douglas Cmelik(Cmelik) concerning allegations that Cmelik improperly marked order tickets for penny stock purchases as “unsolicited” when the purchases were solicited. Cmelik’s conduct allegedly violated NASD Conduct Rule 3110 and FINRA Rule 2010.

Penny stocks are securities that carry significant investment risks. A “penny stock” is defined by the Securities and Exchange Commission (SEC) as a security issued by a company with less than $100 million in market capitalization. Penny stocks are also often called “low-priced securities” because they typically trade at less than $5 per share. Many penny stocks are very thinly traded and consequently liquidity for the stock can vary day-to-day.

Penny stocks are typically not suitable for many retail investors and consequently many firms prohibit their advisors from soliciting investments in these issuers. First, penny stocks may trade infrequently or very thinly making it difficult to liquidate a penny stock holding. Consequently, penny stocks often fluctuate wildly day-to-day. Penny stocks are often the target of unscrupulous individuals for fraudulent purposes. One scheme employed is the “pump and dump” scheme. In a pump and dump scheme, an unfounded hype for a penny stock the pumper already owns is created to boost the stock price temporarily. The penny stock pumper then sells their shares for a profit causing intense downward pressure on the penny stock and the security quickly loses value. The defrauded investors suffer huge losses as a result of the scheme.

Broker David Diehl Sanctioned by FINRA Over the Unauthorized Sale of Promissory Notes

July 9, 2014 | by Staff Attorney

Our law office is investigating potential customer complaints against David Diehl in the wake of the findings and sanctions by the Financial Industry Regulatory Authority (FINRA) concerning allegations that Diehl engaged in private securities transactions, often referred to as “selling away”, and an outside business activity without disclosing these activities to his firm, First Liberties Financial. According to FINRA, Diehl was able to raise approximately $480,000 from seven investors for a business which owned and operated three hamburger restaurants in the St. Louis, Missouri area. FINRA found that most of the investors were his brokerage firm client. By virtue of this conduct, FINRA determined that Diehl violated NASD Rules 3030 and 3040 concerning outside business activities.

Diehl has been registered with seven firms since 2004. From July 2010, through March 2012, Diehl was registered with First Liberties Financial (First Liberties). Thereafter, Diehl joined Sunbelt Securities Inc. but left that firm on shortly in April 2012. Diehl was also registered with investment advisors and established an RIA firm, Diehl Wealth Management Group, LLC, in October 2010, and terminated registration in August 2011. Diehl has had three regulatory findings against him including AWC (2012031952301) issued in December 2012 where Diehl was suspended in all capacities for four months and fined $7,500 for indirectly borrowing money from a customer without his firm’s approval and for failing to timely amend his Form U4 to disclose a tax lien totaling $292,965. A broker’s inability to manage his own finances is a relevant disclosure for investors and brokerage firm’s to apply heightened scrutiny the broker’s actions.

Here, FINRA found that Diehl was approached by a client who was a well-known sports figure who wanted to open local burger restaurants under the client’s name. FINRA found that during the latter half of 2010, Diehl participated in establishing the business, and the first of three restaurants opened in April 2011. The restaurants were managed by another individual brought into the business by Diehl. According to FINRA, the restaurant founders set up a corporate entity to own and operate the restaurants and two of Diehl’s close relatives were designated as corporate secretary and director. The address provided for the corporation was Diehl’s home address and the registration of a fictitious name for the restaurants identified Diehl’s office location as the address for the corporation.

Claus Foerster Barred Over Allegations Concerning Fictitious “S.G. Investments”

July 8, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) has sanctioned and barred broker Claus Foerster (Foerster) concerning allegations that Foerster solicited firm customers to invest in a fictitious fund “S.G. Investments” and converted approximately $3 million in funds from 13 customers for his personal use. FINRA rules provide that no person associated with a member shall make improper use of a customer’s securities or funds.

Foerster entered the securities industry in 1988 when he associated with J.C. Bradford & Co. Between 1997 and 2008, Foerster was associated with Citigroup Global Markets, Inc. (Citigroup). From 2008 until February 2013, Foerster was associated with Morgan Keegan & Co. Inc. Thereafter, and until June 2014, Foerster was last associated with Raymond James & Associates, Inc., (Raymond James) when his registration was terminated based on the conduct described by FINRA in the AWC.

FINRA alleged that beginning in 2000, Foerster solicited securities customers to invest in an entity called S.G. Investments. S.G. Investments was marketed by Foerster to investors as an income-oriented investment. As part of Foerster’s scheme, FINRA alleged that he instructed customers to move funds from their brokerage accounts to their personal bank accounts via wire or electronic funds transfer. After that, FINRA found that Foerster would then instruct the customers to write checks from their personal bank accounts payable to “S.G. Investments.” FINRA determined that S.G. Investments was not an investment fund but instead a bank account owned and controlled by Foerster. According to FINRA, Foerster hid his scheme by providing customers with fictitious account statements. In addition, FINRA found that in at least two instances Foerster provided customers with purported dividend payments on a monthly basis in typical Ponzi Scheme fashion. Through these actions, FINRA found that Foerster converted approximately $3 million from 13 customers.

Gana LLP Files Claim Against JHS Capital Advisors Concerning Broker Enver Alijaj’s Activities

July 7, 2014 | by Staff Attorney

On June 27, 2014, Gana Weinstein LLP filed a statement of claim against JHS Capital Advisors, LLC, formerly known as Pointe Capital Inc, on behalf of an Arkansas couple. The claims stem from the misconduct of Enver R. “Joe” Alijaj, a former Pointe Capital financial advisor who has worked at several different firms and has a record laden with customer complaints and FINRA violations. The statement of claim brought by Gana Weinstein LLP on Claimants’ behalf alleges (1) unsuitable recommendations, (2) failure to supervise, (3) breach of fiduciary duty, (4) fraudulent misrepresentation, and (5) breach of contract.

Around July 2008, Claimants, a couple from Arkansas nearing retirement, received a cold call from Mr. Alijaj—a broker with Respondent JHS. (A cold call is the solicitation of potential customers who were not anticipating such an interaction. Cold calling is a technique whereby a salesperson contacts individuals who have not previously expressed an interest in the products or services that are being offered). Mr. Alijaj aggressively pursued the Claimants’ business, promising them that he would preserve their retirement capital while providing them with increased returns.

Mr. Alijaj allegedly persuaded Claimants to give him approximately $250,000, which they believed was being safely and practically invested to accommodate their needs. Instead, Mr. Alijaj put all of Claimants’ funds into just three extremely thinly traded and highly volatile stocks. The three stocks were A-Power Energy Generation Systems Ltd. (“APWR”), Silicon Motion Technology Corp (“SIMO”), and Yingli Green Energy Holdings Co. (“YGE”). By January 2009, only five months after Mr. Alijaj made the purchases, APWR, SIMO, and YGE were each down 81%, 66%, and 59% respectively. At no point during this five-month freefall did Mr. Alijaj adjust the Claimants’ accounts or even communicate to them an explanation for the price depreciation or potential remedial action.

FINRA Sanctions Polar Investment Over Penny Stock Transactions

July 4, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) has sanctioned Polar Investment Counsel, Inc. (Polar Investment) concerning allegations from 2011 and 2012, a firm advisor of Polar recommended various low-priced securities (penny stocks) received a total of 14 purchase orders for those securities. FINRA alleged that the representative marked eight of the orders as “unsolicited,” meaning that the customer instructed the advisor to purchase the security without any prompting from the advisor. FINRA found that the unsolicited marking was incorrect given that the advisor had brought the securities to the customers’ attention. FINRA found that the mismarked orders caused the firm’s books and records to be inaccurate. In addition, FINRA determined that Polar Investments did not permit brokers to recommend penny stock transactions and mistakenly assumed that all 14 transactions were unsolicited and did not conduct a sufficient supervisory review of those transactions.

Polar Investment has been registered with FINRA since 1997, its main office is in Thief River Falls, Minnesota, and is also registered as an investment advisor with the SEC. Polar Investment has 18 registered representatives operating out of 12 branch locations.

FINRA alleged that throughout 2011 and 2012, Polar Investment’s written supervisory procedures prohibited representatives from recommending penny stocks to the firm’s customers. As a consequence, Polar Investments presumed that all penny stock transactions were unsolicited and the firm did not subject advisors to adequate supervisory review. Instead, FINRA found that the firm had the customer sign a penny-stock disclosure form. FINRA found that between June 2011 and April 2012, a Polar Investment advisor by the initials “MV” brought various penny stocks to the attention of some of his customers. The advisor’s actions, according to FINRA, resulted in at least 14 orders to buy those securities.