Non-traditional ETFs

World Equity Group Alleged to Have Sold Private Placements Without Proper Due Diligence Part III

March 20, 2015 | by Staff Attorney

This post continues our firm’s investigation concerning the recent allegations brought by The Financial Industry Regulatory Authority (FINRA) sanctioning brokerage firm World Equity Group, Inc. (World Equity) concerning at least seven different allegations of supervisory failures that occurred between 2009 through 2012. FINRA’s allegations include failures to implement an adequate supervisory system and concerned both internal processes at the firm and procedures and in the handling of customer accounts in the areas of suitability of transactions in non-traditional ETFs, private placements, and non-traded REITs.

FINRA requires firms preserve for at least 6 years all communications relating to its business and to provide for ways to store electronic media. FINRA found that in May 2011, the World Equity opened a new branch office at 311 W. Monroe Street, Chicago, Illinois. FINRA alleged that errors in the process of transferring several representatives at that branch to World Equity emails of the representatives were not maintained and preserved before April 13, 2012. In addition, FINRA found that the firm failed to maintain business related emails for ten representatives who used their personal emails for business purposes.

FINRA also alleged that World Equity failed to conduct due diligence in connection with private placements offering from July 2009, through January 2012. During that time FINRA alleged that the firm conducted at least eight private placements including a product called Newport Digital Technologies, Inc. (NDT) and sold more than $6 million in these offerings. In addition, FINRA found that from August 23, 2010 to July 17, 2012 the firm conducted at least five Non-Traded REIT offerings and sold more than $3 million in these offerings.

World Equity Group Supervisory Failures Explored Part II

March 18, 2015 | by Staff Attorney

As we previously reported, The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm World Equity Group, Inc. (World Equity) concerning at least seven different allegations of supervisory failures that occurred between 2009 through 2012. These failures included failures to implement an adequate supervisory system reasonably designed to detect and prevent potential rule violations concerning both internal processes and procedures and in the handling of customer accounts in the areas of suitability of transactions in non-traditional ETFs, private placements, and non-traded REITs.

FINRA alleged that World Equity failed to implement an adequate system to ensure the suitability of Non-Traditional ETFs. As a background, Non-Traditional ETFs are registered unit investment trusts or open-end investment companies whose shares represent an interest in a portfolio of securities that track an underlying benchmark, index, commodity, or other instrument. Shares of ETFs are typically listed on national exchanges and trade at established market prices. Non-Traditional ETFs are different from traditional ETFs in that they return a multiple of the performance of the underlying index or benchmark or the inverse performance.

Non-Traditional ETFs may use swaps, futures contracts, and other derivative instruments in order to create leverage to achieve these objectives. In addition, most Non-Traditional ETFs are designed to achieve their stated objectives in one trading session. Between trading sessions the fund manager generally rebalances the fund’s holdings in order to meet the fund’s objectives. For most Non-Traditional ETFs the rebalancing happens on a daily basis. Further, because the correlation between a Non-Traditional ETF and its linked index or benchmark is inexact there is typically tracking error between a fund and its benchmark becomes compounded over longer periods of time. In addition, the tracking error effect becomes more pronounced during periods of volatility in the underlying index or benchmark. FINRA advised brokerage firms in June 2009 due to the effect of compounding the performance of Non-Traditional ETFs over longer periods of time can differ significantly from the performance of their underlying index or benchmark during the same period of time and because of these risks and the inherent complexity of the products, FINRA advised broker-dealers and their representatives that the products are typically not suitable for retail investors who plan to hold them for more than one trading session.

World Equity Group Fined $225,000 Over Supervisory Failures Part I

March 17, 2015 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm World Equity Group, Inc. (World Equity) alleging that between 2009 through 2012, the firm failed to implement an adequate supervisory system reasonably designed to detect and prevent potential rule violations including: (1) failure to preserve emails; (2) failure to establish and maintain account records and obtain suitability information; (3) failure to implement a supervisory system to ensure suitability of transactions in non-traditional ETFs; (4) failure to properly document adequate due diligence in connection with private placements and non-traded REITs; (5) failure to establish an adequate supervisory system for the review of activity for options activity in unapproved accounts; (6) failure to have a reasonable supervisory system to ensure compliance with Section 5 of the Securities Act of 1933; and (7) failure to adequately enforce information barrier procedures.

World Equity is a full service broker dealer and has been a FINRA member since 1992. The firm is based in Illinois and has approximately 160 brokers operating out of 68 registered branch offices.

One of the offerings FINRA investigated at World Equity was Newport Digital Technologies, Inc. (NDT). In 2008, according to FINRA, World Equity hired a new syndicate manager by the initials MN to lead the business line out of the firm’s Spokane office. During MN’s tenure as syndicate manager, World Equity was involved in several private offerings including the NDT offering for which the firm acted as the placement agent. NDT had been registered with the SEC since 2000 and originally was known as Golden Choice Foods Corporation and then as International Food Products Group, Inc. (IFPG). These companies were in the consumer food business until December 2008.

Broker Allen Green Alleged to Have Made Unsuitable Investment Recommendations Based a Theory of Economic Collapse

March 6, 2015 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) has filed a complaint against broker Allen Green (Green) concerning allegations that Green violated FINRA’s suitability rule by making unsuitable recommendations to a disabled customer, and also by having no reasonable basis to recommend non-traditional exchange traded funds (Non-traditional ETFs) to his customers.

Green has been in the securities industry since 1976 and also has been a registered principal since 2003. From May 2006, until November 2009, Green was associated with Cullum & Burks Securities, Inc. Thereafter, from November 2009 until April 2013, Green was registered with Royal Securities Company (Royal Securities). According to FINRA, Green was the supervising principal for one of Royal Securities’ Michigan branch offices and did business in that branch under the name A Green Financial Group.

FINRA alleged in the complaint that Green believed that the world economy was on the precipice of catastrophe and that certain asset classes would increase in value due to the resulting “world chaos” that would result. As a result of his view, FINRA alleged that Green recommended to virtually all of his customers that they invest almost exclusively in securities with exposure to precious metals, natural resources, commodities, and energy as part of a comprehensive investment strategy.

FINRA Sanctions Felt & Company Over Leveraged ETF Recommendations to Clients

February 16, 2015 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Felt & Company (Felt) alleging that between January 2009, and September 2012, Felt failed to establish and supervisory system that was reasonably designed to ensure that sales leveraged or inverse exchange-traded funds (Non-Traditional ETFs) complied with all applicable securities laws.

Feltl is headquartered in Minneapolis, Minnesota, has approximately 114 registered representatives operating out of eight branch offices in Minnesota and Illinois. Felt derives revenue from securities commissions, underwriting, and investment company activity and has been a FINRA member since 1975. This most recent FINRA action is not the first time the regulatory has brought an action concerning issues of how Felt sells securities products to investors. As we previously reported, FINRA sanctioned Feltl and imposed a $1,000,000 fine concerning allegations that the firm, between January 2008, and February 2012. failed to comply with the suitability, disclosure, and record-keeping requirements engaging in a penny stock business.

In the most recent disciplinary action, FINRA alleged that the securities laws requires a firm to have a reasonable basis for believing that a product is suitable for any customer before recommending any purchase of that product. In order to meet this requirement, a firm must understand the terms and features of the product including how they are designed to perform, how they achieve that objective, and the impact that market volatility on the product. In the case of Non-Traditional ETFs the use of leverage and the customer’s intended holding period are significant considerations in recommending these products.

Overconcentrated in Oil and Gas Investments?

January 22, 2015 | by Staff Attorney

A strengthening dollar and increased global supply of oil has sent crude oil prices tumbling in the second half of 2014. Recently, crude futures for delivery in February 2015 fell to $52.69 a barrel, the lowest finish since April 2009. Some experts are saying that if production volume continues to be as high as it currently is and demand growth weak that the return to $100 a barrel is years away.

As a result, in recent months investors have contacted our firm about being concentrated in various oil and gas exposed investments including private placements, stocks, and ETFs. On the private placement side alone the Securities Exchange Commission (SEC), has stated that since 2008, approximately 4,000 oil and gas private placements have sought to raise nearly $122 billion in investor capital. However, these oil and gas private placements suffer from enormous risks that often outweigh any potential benefits including securities fraud, conflicts of interests, high transaction / sales costs, and investment risk.

In addition, investor accounts may be overconcentrated in oil and gas stocks or ETFs. Some of these ETFs may be leveraged or non-traditional ETFs. These leveraged ETFs seek to increase the return on the oil and gas index by using leverage to amplify returns exposing the investor to greater volatility during an already volatile period in the oil market. Below are some of oil and gas related ETFs.

Broker Spotlight: Calton & Associates Broker Kenneth Popek

January 11, 2015 | by Staff Attorney

Broker Kenneth Popek (Popek) has had four customer complaints filed against him over his career as a financial advisor. That many claims are rare. According to InvestmentNews, only about 12% of financial advisors have any type of disclosure event on their records. These disclosures do not necessarily have to include customer complaints but can include IRS tax liens, judgments, and even criminal matters. In Popek’s case the broker has four customer complaints and one bankruptcy.

Popek was registered with Ameriprise Financial Services, Inc. from December 2006 until May 2008. Thereafter, Popek was registered and still is registered with Calton & Associates, Inc.

One of Popek’s complaints went to hearing where a panel awarded the customers $342,956 concerning allegations of suitability, misrepresentations, churning, and breach of fiduciary duty. According to the award the causes of action involved, in part, investments in General Motors, Lehman Brothers, and Washington Mutual stocks that all went bust.

SEC Rejects Bids by Funds to List Nontransparent ETFs

November 19, 2014 | by Staff Attorney

In a rare move of true consumer protection, the Securities and Exchange Commission (SEC) denied applications by fund managers BlackRock Inc. and Precidian Investments to offer nontransparent exchange-traded funds (ETFs) to investors by stating that such products were not in the public’s interest. The SEC stated that the proposals could inflict substantial costs on investors, disrupt orderly trading, and damage market confidence in trading of ETFs.

The fund managers have argued that opening up actively managed ETFs to full transparency would lead to front running, a strategy where other investors trade ahead to gain a benefit. As a result, the funds argue that their trading strategies are rendered obsolete by the market’s knowledge of them. Thus, the solution the industry devised was to deprive the investing public of disclosure of fund holdings.

However, the SEC said that daily transparency is necessary to keep the market prices of ETF shares at or close to the net asset value per share of the ETF. But as usual, the industry losses a battle but will eventually win the war. Others funds such as American Funds, T. Rowe Price Group Inc. and Eaton Vance Corp. all have applications pending for similar nontransparent ETFs where the SEC could rule on various alternative proposals. In addition, Precidian’s chief executive, Daniel J. McCabe, told InvestmentNews he believed the SEC’s objections can be worked though and that it will merely take longer to get approval because the funds are not standard.

Gana LLP Investigation – Former RBC Capital Markets Broker Michael Zukowski

September 18, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned broker Michael Zukowski (Zukowski) concerning allegations that Zukowski recommended unsuitable transactions in inverse and inverse-leveraged Exchange Traded Funds (Non-Traditional ETFs) in the accounts of his customers.

Zukowski first became registered with FINRA as a securities representative in 1989. Thereafter, from July 2005 to November 2010, he was registered in that same capacity through RBC Capital Markets, LLC (RBC) where he worked in the firm’s Massachusetts office. On December 23, 2010, RBC filed a Termination Notice (Form U5) stating that Zukowski was permitted to resign for “failure to meet Firm expectations.”

On August l8, 2011, RBC filed a an amended disclosure stating that an Administrative Complaint filed by the Massachusetts Securities Division (MSD) stated that: “The Massachusetts Securities Division alleged Michael Zukowski made unsuitable recommendations to brokerage and advisory clients regarding the purchase and sale of leveraged, inverse and inverse-leveraged exchange traded funds.” Thereafter, on November 12, 2012, Zukowski entered into a Consent Order with the MSD concerning the allegations of unsuitable recommendations where Zukowski consented to sanctions including a Cease and Desist and a five year bar to act as a “broker-dealer agent, investment adviser, investment adviser representative and issuer-agent” in the State of Massachusetts. Finally, on November 16, 2012, RBC filed another amended Form U5 and disclosed a written complaint by two customers indicating that the “Clients allege material omissions and unsuitable advice regarding non-traditional ETFs, in period 2/2009 to 12/2009.”

Oak Ridge Financial Services Sanctioned Over Non-Traditional ETF Sales Practices

September 15, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned brokerage firm The Oak Ridge Financial Services Group, lnc. (Oak Ridge) in connection with allegations that Oak Ridge failed to establish and maintain a supervisory system regarding the sale of leveraged, inverse and inverse leveraged exchange-traded funds (Non-Traditional ETFs) that were reasonably designed to achieve compliance with the securities laws.

Oak Ridge became a FINRA member in 1997 and is headquartered in Golden Valley, Minnesota. Oak Ridge engages in a general securities business, employs 57 registered representatives, and operates out of a single office.

Non-Traditional ETFs contain drastically different characteristics, including risks, from traditional ETFs that simply seek to mirror an index or benchmark. Non-Traditional ETFs use a combination of derivatives instruments and debt to multiply returns on underlining assets. The leverage employed by Non-Traditional ETFs is designed not simply to mirror the index but to generate 2 to 3 times the return of the underlining asset class. Non-Traditional ETFs can also be used to return the inverse or the opposite result of the return of the benchmark.