Churning

Why Your Broker Asking You to Sign A Comfort Letter is A Big Misconduct Red Flag

December 8, 2014 | by Staff Attorney

Your brokerage firm reviews customer accounts for misconduct and what does it find; bizarre and unreasonable trading activity. Maybe dozens of trades are being made every month or an account previously invested in plain vanilla mutual funds is now loaded up with speculative penny stocks and private placements. Whatever the cause, the firm has a system to monitor for unusual trading activity and sends the customer a letter. These letters go by many names including “happiness”, “comfort”, and more appropriately “Cover You’re A@!” (CYA).

A recent article by the Wall Street Journal explored how the purpose of these letters is to elicit an acknowledgment from the customer that they are satisfied with how the account is being handled in order to minimize future liability from a suit concerning the wrongful activity. To clarify, when a brokerage firm finds indications of possible misconduct their first action isn’t to stop the misconduct and help their client but to get the client to release the firm from liability.

Having reviewed dozens of these letters myself they are designed to be unreadable to the average investor and use industry jargon and legal lingo that is indecipherable to anyone but a securities attorney. These letters begin warmly enough by thanking you for your business and hoping that everything is well with you. Then the conversation becomes impersonal and maybe mentions that your investment choices have become more risky or aggressive recently. These sentences are code words for your investment objectives have completely changed from generating retirement income to you are now interested in potentially losing all your money with casino level risk. Maybe some information related to a “cost-to-equity ratio” or “turnover” is given. There is no explanation as to what these terms mean or why you should be concerned because they are just being provided for legal reasons that the customer should be unconcerned with.

Gana LLP Files Claim On Behalf of Customer Against Legend Securities for Churning and Unauthorized Trading

November 11, 2014 | by Staff Attorney

Gana Weinstein LLP recently filed a claim against Legend Securities, Inc. (Legend) on behalf of a customer with the Financial Industry Regulatory Authority (“FINRA”) alleging that Legend and Legend broker, Michael Guilfoyle, recommended unsuitable investments while churning his account and executing unauthorized trades in violation of FINRA rules and other applicable law.

In 2013, the customer received a cold call from Guilfoyle soliciting his business. Guilfoyle assured the client that he would only invest according to his investment objectives. In reliance upon Guilfoyle’s assurances, the client transferred his money to Legend. In early 2014, Guilfoyle and Legend also coaxed the client into investing his wife’s money, which she inherited from her parents. Soon after the client transferred the funds to Legend, Guilfoyle allegedly leveraged over concentrated the portfolio and began to churning the account. “Churning” is the Wall St. vernacular when there is unnecessarily high or excessive trading activity in an investor’s account, simply for the purpose of generating commissions for the broker. This is a violation of Securities and Exchange Commission (“SEC”) and FINRA rules.

More egregiously, Guilfoyle failed to contact the client concerning the trades being made in his account and acted without any prior authorization. Guilfoyle allegedly day-traded different stock positions earning fees for himself while providing no benefit to the client. For example, Guilfoyle concentrated the client’s account in speculative small cap stocks, such as Voxeljet AG (Voxeljet) that had only recently gone public. At the time, analysts warned that Voxeljet was a highly volatile stock, not suited for investors looking for long-term growth. Guilfoyle’s misconduct ultimately cost client nearly his and wife’s entire account value.

Broker Lorene Fairbanks Alleged to Have Made Unauthorized Trades in Client Accounts

October 14, 2014 | by Staff Attorney

According to broker Lorene Fairbank’s (Fairbank) Financial Industry Regulatory Authority (FINRA) BrokerCheck records the representative was recently sanctioned concerning allegations that From August 2006, through February 2012, she effected approximately 57-69 discretionary transactions for seven firm customers without written authorization from the customers or approval from the firm. In addition, Fairbanks was alleged to have mismarked approximately 54-70 order tickets as being “unsolicited” orders when the trades were “solicited” causing the firm to maintain inaccurate books and records.

Fairbanks entered the securities industry in 1996. From August 2006, to March 2012, she was registered Merrill Lynch. Pierce, Fenner & Smith Incorporated (Merrill Lynch). In February 2012, Merrill Lynch terminated Fairbanks and disclosed in a filing that she was discharged for taking discretion in client accounts and mismarking client orders. Since June 2012, Fairbanks has been associated with Ameriprise Financial Services, Inc. In addition, at least five customer complaints have been filed against Fairbanks alleging unsuitable investments, unauthorized trading, and excessive trading (churning).

NASD Rule 2510 prohibits brokers from exercising any discretionary power in a customer’s account unless there is written authorization and the account has been accepted by the member. NASD Rule 3110 and FINRA Rule 4511 provide that members must preserve books and records. FINRA alleged that Fairbanks was not approved by her firm to exercise discretion in any customer accounts but nonetheless effected approximately 57-69 discretionary transactions for seven customers. Also, FINRA alleged that Fairbanks mismarked approximately 54-70 order tickets in the same customers’ accounts as “unsolicited” meaning that the customer asked the broker to make the trade, when the trades were solicited, meaning that the broker brought the investment to the client’s attention.

SEC Cracks Down on Wrap Accounts to Prevent “Reverse Churning”

October 6, 2014 | by Staff Attorney

A recent InvestmentNews article explored The Securities and Exchange Commission’s (SEC) attempts to prevent conflicts of interest at registered investment advisers, a breach of their fiduciary duties, by focusing on potential misuse of popular flat-fee wrap accounts. The use of these accounts have given rise to claims of “reverse churning.” As we previously reported, “churning” is excessive trading activity or in a brokerage account. Churning trading activity has no utility for the investor and is conducted solely to generate commissions for the broker. By contrast “reverse churning” is the practice of placing investors in advisory accounts or wrap programs that pay a fixed fee, such as 1-2% annually, but generate little or no activity to justify that fee. Such programs constitute a form of commission and fee “double-dipping” in order to collect additional fees.

The SEC is looking into the practice by which clients pay an annual or quarterly fee for wrap products that manage a portfolio of investments. Investment advisors who place clients in such programs already charge fees based on assets under management (AUM) and the money management charges for wrap products are in addition to the AUM fee. According to InvestmentNews, the assets under these arrangements totaled $3.5 trillion in 2013, a 25% increase from 2012. Included in these numbers include separately managed accounts, mutual fund advisory programs, exchange-traded-fund (ETF) advisory programs, unified managed accounts, and two types of brokerage-based managed accounts.

Reverse churning can occur under these arrangements if there’s too little trading in the accounts in order to justify the high fees. In August, the SEC’s scrutiny of these products came to the forefront with the agency’s victory in a court case that revolved in part around an adviser’s improperly placing his clients into wrap programs. A jury decided in the SEC’s favor against the advisory firm Benjamin Lee Grant that the SEC argued improperly induced clients to follow him when he left the broker-dealer Wedbush Morgan Securities to his advisory firm, Sage Advisory Group.

Regulators On the Look Out for “Reverse Churning”

October 4, 2014 | by Staff Attorney

It is relatively easy to grasp the concept of excessive trading activity or “churning” in a brokerage account. Churning trading activity has no utility for the investor and is conducted solely to generate commissions for the broker. Churning involves both excessive purchases and sales of securities and the advisors control over the account. But regulators are also looking at another growing trend referred to as “reverse churning.” According to the Wall Street Journal (WSJ) the Securities and Exchange Commission (SEC) states that “reverse churning” is the practice of placing investors in advisory accounts that pay a fixed fee, such as 1-2% annually, but generate little or no activity to justify that fee. Regulators are watching for signs of “double-dipping” whereby advisers generate significant commissions in an investor’s brokerage account and then moves the client into an advisory account in order to collect additional fees.

As a background there are many standalone brokerage firms and investment advisor firms where the option does not exist for a client to be switched between types of accounts. However, there are also many dually registered firms which are both broker-dealers and investment advisers. These firms, and their financial advisors have tremendous influence over whether a customer establishes a brokerage or investment advisory account. In the WSJ, the SEC was quoted as saying that “This influence may create a risk that customers are placed in an inappropriate account type that increases revenue to the firm and may not provide a corresponding benefit to the customer.”

However, dumping a client account into an advisory account after the broker ceases trading is only one strategy that should be included in the category of “reverse churning.” There are many other creative ways that brokers can generate excessive commissions for themselves while providing no benefit to their clients. For example, if a broker recommends a tax deferred vehicle, such a as a variable annuity, in an IRA account there is no additional tax benefit for the client. While the recommendation would not result in excessive trading, the broker would earn a huge commission for an investment that cannot take advantage of one of its primary selling points.

Advisor Raymond Clark Suspended Over Allegations of Securities Related Misconduct

September 17, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned broker Raymond Clark (Clark) and imposed findings: (1) suspending the broker for three months and fined $6,000 for using his personal email account to communicate with a customer; (2) suspended for four months and fined $10,000 for making false statements to his firm; and (3) suspended for two months and fined $4,000 for failing to report a customer complaint to his firm. FINRA imposed the suspensions to run consecutively and suspended Clark for an additional three months in all supervisory capacities and ordered him to requalify by examination as a securities representative and securities principal.

According to Clark’s BrokerCheck, the broker was registered with Paulson Investment Company, Inc. from December 2008 through May 2009. From June 2007 through January 2009, Clark was registered with J.P. Turner & Company, L.L.C. From May 2009 until August 2010, Clark was registered with First Midwest Securities, Inc. Finally, from August 2010, through August 2014, Clark was registered with Dynasty Capital Partners, Inc. (Dynasty Capital). Clark’s background check also reveals two regulatory complaints and at least nine customer complaints. Only a relatively small percentage of brokers have any complaints on their records and fewer still have as many as Clark.

The complaints against Clark include claims of unauthorized trading, inappropriate use of margin, securities fraud, breach of fiduciary duty, unsuitable investments, churning, and misrepresentations.

Matthew Davis Barred Over Allegations of Conversion of Funds and Unauthorized Trading

August 25, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned and barred financial advisor Matthew Davis (Davis) concerning allegations that in connection with a FINRA investigation into allegations of misconduct in several customer accounts, FINRA staff scheduled Davis’ on-the-record (OTR) testimony and Davis failed to appear for the scheduled testimony and informed the agency that he would not appear at another time.

Davis was associated with Beneficial Investment Services, Inc. from November 2008, through April 2010. Thereafter, Davis was associated with OneAmerica Securities, Inc. (OneAmerica) from April 2010, through July 2013. He is not currently associated with a FINRA member.

FlNRA alleged that its staff requested that Davis appear and provide testimony on March 24, 2014, regarding allegations that Davis engaged in misconduct in several customer accounts. The allegations of misconduct included claims of conversion, misrepresentation of customer holdings and account value, forgery, discretionary unauthorized trading, attempts to settle a customer complaint without the firm’s knowledge, and unsuitable investment recommendations. Through Davis’ counsel, FINRA was informed that he would not appear for testimony.

Gana LLP Represents Seven Former Clients of Sean Sheridan Against JP Turner (Part II)

August 18, 2014 | by Staff Attorney

Continuing our prior post, the law office of Gana Weinstein LLP recently filed securities arbitration case on behalf of a group of seven investors against J.P. Turner Company, L.L.C. (JP Turner), Ridgeway & Conger, Inc. (Ridgeway), and Newbridge Securities, Corp. (Newbridge) concerning allegations that Sean Sheridan (Sheridan) churned claimants’ accounts through the use of excessive and unreasonable mutual fund switches, among other claims.

In addition to specifically finding that Sheridan committed fraud and made unsuitable recommendations in Claimants accounts, FINRA also found that JP Turner general sales practice with regard to non-traditional ETFs and mutual funds was inappropriate. On December 4, 2013, FINRA released a Letter of Acceptance, Waiver, and Consent (AWC) concerning JP Turner’s non-traditional ETFs sales practices and excessive mutual fund switches and fined the firm $707,559.53. FINRA v. J.P. Turner & Company, L.L.C., AWC No. 2011026098501 (FINRA, January 2013). According to FINRA’s investigation, JP Turner failed to establish and maintain supervisory systems related to leveraged and inverse ETF sales and mutual fund purchases.

In another churning related action, on November 8, 2013, the SEC issued a similar order against JP Turner finding that Michael Bresner (Bresner), as head of supervision, failed to properly supervise firm employees. The SEC Order found that JP Turner employed an Account Activity Review System (AARS) to monitor customer accounts for signs of churning. The SEC found that the average number of accounts flagged by the AARS system for churning was shockingly high for each quarter in 2008-2009 and was between 300 and 325 accounts and included more than 100 JP Turner registered representatives. In sum, the SEC discovered that no one at JP Turner was willing to take responsibility in determining whether churning took place in a client’s account – a problem that directly affected the claimants in this case.

Gana LLP Files Complaint on Behalf of Seven Former Clients of Sean Sheridan Against JP Turner

August 15, 2014 | by Staff Attorney

The law office of Gana Weinstein LLP has recently filed securities arbitration case on behalf of a group of seven investors against J.P. Turner Company, L.L.C. (JP Turner), Ridgeway & Conger, Inc. (Ridgeway), and Newbridge Securities, Corp. (Newbridge) concerning allegations that the firms failed to supervise and prevent Sean Francis Sheridan (Sheridan) from churning claimants’ accounts through the use of excessive and unreasonable mutual fund switches and generally making unsuitable recommendations to the clients. Both FINRA and the SEC have brought actions against JP Turner and the firm’s brokers on numerous and repeated occasions concerning the firm’s failure to protect its clients from the type of unscrupulous sales practices alleged in the complaint

As discovered by FINRA, from at least January 2007, through December 2009, Sheridan recommended approximately 205 unsuitable mutual fund switch transactions in the accounts of eight customers, including some of the Claimants in the filed case. See Department of Enforcement v. Sean Francis Sheridan, Disciplinary Proceeding No. 2009019209204, (FINRA, Feb. 12, 2013) (Sheridan Action). FINRA found that Sheridan recommended the unsuitable mutual fund switches in customers’ accounts and as a result of Sheridan’s activities in claimants’ and other customers’ accounts, FINRA barred Sheridan from the financial industry.

FINRA found that Sheridan only recommended Class A mutual fund shares that require customers to pay sales charges with each new purchase when Sheridan intended to effect the switches on a short-term basis. FINRA found that the average holding period for the mutual funds Sheridan sold was just four to five months. FINRA found that Sheridan exclusively recommended Class A mutual fund shares that charged front-end sales loads of 4-5% with each new purchase, an enormous cost. FINRA also found that Sheridan would randomly switch customers between fund categories such as Growth, Natural Resources, Gold, Emerging Markets, Science and Technology without a reasonable basis for doing so.

Gana LLP Files Complaint on Behalf of Five Customers Against JP Turner and National Securities Concerning Ralph Calabro’s Churning

August 12, 2014 | by Staff Attorney

Gana Weinstein LLP has recently filed securities arbitration case on behalf of a group of five investors against J.P. Turner Company, L.L.C. (JP Turner) and National Securities Corporation (National Securities) concerning the alleged complete lack of supervision at JP Turner and National Securities to monitor and prevent Ralph Calabro (Calabro) from churning customer accounts.

As a background, Calabro was expelled from the securities industry when on November 8, 2013, the SEC issued an order (SEC Order) finding that JP Turner registered representatives including Calabro, Jason Konner, and Dimitrios Koutsoubos churned customer accounts and Executive Vice President (EVP), Michael Bresner (Bresner), as head of supervision, failed to supervise the representative’s activities.

The SEC alleged that JP Turner knew that numerous accounts had a cost-to-equity ratio greater than 20%, a number sufficiently high to establish an inference of churning requiring close supervision and corrective action. The reports of these accounts resulted in an report being emailed to principals and the compliance office for review including Bresner. The SEC found that the average number of accounts being reviewed for high costs was shockingly high for each quarter in 2008-2009 and was between 300 and 325 accounts and included more than 100 JP Turner registered representatives. Even though these accounts bore the hallmarks of churning, Bresner testified that he could not recall closing an account, personally contacting any JP Turner customers, or even imposing a trading limitation.