due diligence

Moloney Securities Fined Over Supervisory Failures Concerning Non-Traditional (Leveraged) ETFs

July 3, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) has sanctioned Moloney Securities Company, Inc. (Moloney Securities) concerning allegations Moloney Securities failed to establish and maintain a supervisory system, including written policies, regarding the sale of leveraged, inverse and inverse leveraged exchange-traded funds (Non-Traditional ETFs) that was reasonably designed to meet the requirements under the securities laws.

ETFs attempt to track a market index, sector industry, interest rate, or country. ETFs can either track the index or apply leverage in order to amplify the returns. For example, a leveraged ETF with 300% leverage attempts to return 3% for every 1% the underlying index returns. Nontraditional ETFs can also be designed to return the inverse or the opposite of the return of the benchmark. In general, Leveraged ETFs are used only for short term trading. The Securities Exchange Commission (SEC) has warned investors that most Non-Traditional ETFs reset daily and are designed to achieve their stated objectives in a single trading session. In addition to the risks of leverage, Non-Traditional ETFs held over the long term can differ drastically from the underlying index or benchmark during the same period. FINRA has also acknowledged that leveraged ETFs are complex products that carry significant risks and ”are typically not suitable for retail investors who plan to hold them for more than one trading session, particularly in volatile markets.”

FINRA found that from January 2011, through December 2012, Moloney Securities allowed its representatives to recommend and sell Non-Traditional ETFs to customers. At this time, FINRA found that Moloney’s written supervisory procedures did not address the sale or supervision of Non-Traditional ETFs. In addition, FINRA alleged that Moloney Securities did not conduct due diligence of Non-Traditional ETFs before allowing financial advisors to recommend them to customers. Despite the unique features and risk factors of Non-Traditional ETFs that FINRA has noted, FIRNA found that Moloney Securities did not provide its brokers or supervisors with any training or specific guidance as to whether and when Non-Traditional ETFs would be appropriate for their customers. FINRA also found that Moloney Securities did not use any reports or other tools to monitor the length of time that customers held open positions in Non-Traditional ETFs or track investment losses occurring due to those positions.

Carolina Financial Fined by FINRA Over Private Placement Due Diligence

June 26, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned brokerage firm Carolina Financial Securities, LLC (Carolina Financial) concerning allegations that the firm failed to conduct proper due diligence on private placements sold by the firm.

Carolina Financial has been FINRA member since 1997 and operates out of Brevard, North Carolina. The firm has 12 registered representatives and derives generates revenues through the sale of private placements. The firm has two other prior disciplinary actions including a FINRA action in July 2010, concerning allegations that Carolina Financial failed to ensure that an escrow account was established for a contingent offering.

NASD Rule 3010 requires brokerage firms to establish, maintain, and enforce a supervisory system reasonably designed to comply with the securities laws and the FINRA rules. As part of a brokerage firm’s responsibility includes conducting due diligence on its securities products in order for the firm to understand the risks of these products and to have a reasonable basis to believe these products are suitable for at least some customers. FINRA stated in its complaint that due diligence is especially important for alternative investments such as private placement offerings under Regulation D where there is no registration of the securities with the SEC.

Ameriprise Slammed With $1.17 Million Decision Concerning Tenants-in-Common (TIC) Investments

June 17, 2014 | by Staff Attorney

A Financial Industry Regulatory Authority (FINRA) arbitration panel recently ordered Ameriprise Financial Services Inc. (Ameriprise) to pay two elderly California investors $1.17 for recommending the investments in Tenants-in-Common (TIC), real estate related investments that eventually failed.

Brokerage firms, such as Ameriprise, having increasingly turned to alternative investment products such as TICs in recent years. The sales of TIC interests grew from approximately $150 million in 2001 to approximately $2 billion by 2004. FINRA has warned brokerage firms to put investors on notice of the risks of these illiquid investment for which no secondary market exists. In addition, subsequent sales of TIC property may occur at a discount to the value of the real property interest causing the investor substantial losses. FINRA has also warned that the fces and expenses charged by the TIC sponsor can outweigh the potential tax benefits associated with the IRS Section 1031 Exchange. FINRA requires that all member brokerage firms have an obligation to comply with all applicable conduct rules when selling TICs. These rules include the obligation to conduct proper due diligence and to ensure that promotional materials used are fair, accurate, and balanced.

In a recent InvestmentNews article, it was reported that in May, a FINRA arbitration panel in San Francisco ruled that Ameriprise had inappropriately advised two retired schoolteachers to invest a total of $1.03 million into three TICs in office complexes and hotels in early 2008. One of the TICs has subsequently failed and the two others have suffered declines in value. According to the investors, the couple lost most of their life savings. The couple invested in TICs known as ARI-Onyx Office Plaza Tenant In Common; Moody Springhill Suites Pittsburgh Tenant in Common; and Moody Marriott TownePlace Suites Portland Scarborough Tenant in Common.

Hantz Financial Services Sanctioned Over Non-Traded REIT Due Diligence Failures

March 27, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned and fined Hantz Financial Services, Inc. (Hantz Financial) $75,000 concerning allegations that between April 2004, until April 2011, Hantz Financial violated FINRA rules by failing to properly enforce its written supervisory procedures for conducting due diligence with respect to a non-exchange traded real estate investment trust (REIT) and by failing to establish and maintain a supervisory system reasonably designed for conducting ongoing due diligence of REITs.

Hantz Financial has been a member of FINRA since 1999 and is headquartered in Southfield, Michigan. The firm employees 276 registered representatives and conducts a general securities business.

A REIT is a corporation or trust that owns income-producing real estate. REITs pool the capital of numerous investors to purchase a portfolio of properties that may include office building, shopping centers, hotels, and apartment buildings that the average investor would not otherwise be able to purchase individually. Shares of non-traded REITs do not trade on a national securities exchange and are generally illiquid for periods of eight years or more. The risks of non-traded REITs are significant and FINRA has issued an Investor Alert warning investors of some of the potential risks.

FINRA Alleges Royal Securities Company Failed to Supervise the Sale of Church Investments – Part II

March 6, 2014 | by Staff Attorney

This article continues the findings of The Financial Industry Regulatory Authority (FINRA) that led to sanctions against Royal Securities Company (Royal Securities) concerning allegations Royal lacked adequate supervision and controls in several areas. FINRA found that from 2009 through 2011, Royal Securities failed to establish adequate supervisory systems to ensure due diligence, training, and fair pricing of church bonds and funds sold by its representatives.

FINRA alleged that Royal Securities acted as the lead underwriter for three churches who were issuing church bonds. From May 2009, through October 2011, according to FINRA Royal Securities sold approximately $4.3 million in church bonds to customers. FINRA also found that Royal Securities was also involved in the sale of secured certificates of participation in a fund that raised capital for Christian churches. The church fund was sold primarily by another broker-dealer but FINRA found that Royal Securities had a secondary clearing arrangement with the broker-dealer where 151 church fund sales occurred in 65 accounts with a total of approximately $2,908,000 in sales.

FINRA found that Royal Securities failed to adopt reasonable written supervisory procedures and supervisory controls to govern church bonds and church funds lines of business. Specifically, FINRA found that Royal Securities procedures did not address specific suitability considerations, particularly supervision of issues, or any required due diligence of church bonds underwritten.

SEC Staff Issues Risk Alert on Alternative Investments Due Diligence

February 15, 2014 | by Staff Attorney

The Office of Compliance Inspections and Examinations (OCIE), in coordination with other Securities and Exchange Commission (SEC) staff released guidance and observations concerning investment advisers due diligence process for selecting alternative investments. The OCIE has observed that investment advisers are increasingly recommending alternative investments to their clients in lieu of other investment options. Investment advisers are fiduciaries and must act in their clients’ best interests. Since an investment adviser exercises discretion to purchase alternative investments on behalf of clients the adviser must determine whether the investments: (i) meet the clients’ investment objectives; and (ii) are consistent with the investment principles and strategies that were disclosed to the client by the manager to the adviser.

Alternative investments include a variety of non-traditional investments including hedge funds, private equity, venture capital, real estate, and funds of private funds. The commonality amongst alternative investments is that they employ unique investment strategies and assets that are not necessarily correlated to traditional stock and bond indexes.

The OCIE staff examined the due diligence process processes of advisers to pension plans and funds of private funds in order to evaluate how advisers performed due diligence, identify, disclose, and mitigate conflicts of interest, and evaluate complex investment strategies and fund structures. The OCIE noted indicators that led advisers to conduct additional due diligence analysis, request the manager to make appropriate changes, or to reject the manager or the alternative investment.

Investor Tips to Avoid Losing Money in Private Placements and Alternative Investments

January 16, 2014 | by Staff Attorney

Private Placements are considered alternative investments and are issued under Regulation D under the Securities Act of 1933. Regulation D contains rules for issuing securities that provide exemptions from the more rigorous Securities and Exchange Commission (SEC) registration requirements and allows companies to issue securities without normal disclosures.

Investors who are recommended private placements must meet the “accredited investor” standard under Rule 501. Rule 501 defines “accredited investor” as any person who has a net worth in excess of $1,000,000, excluding residence, or annual income in excess of $200,000, $300,000 if filing jointly with a spouse, in the two most recent years.

According to a 2008 estimate, companies issued approximately $609 billion of securities through Regulation D offerings. While the private placement market allows many small companies to raise capital, regulators have raised a number of issues with due diligence procedures and brokerage firm sales efforts when selling private placements to investors. The North American Securities Administrators Association says private placements are one of the most common cause of regulatory action by state regulators. States brought more than 200 enforcement actions involving private placements in 2011, more than doubled the number of action in2007.

Coker & Palmer Broker Sanctioned Over Allegations of Failure to Conduct Due Diligence on Private Placement Offering

November 26, 2013 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) recently sanctioned broker Michael A. Barina (Barina) over allegations that Barina failed to conduct reasonable due diligence into the offering a private placement security. In addition, FINRA alleged that the broker commingled certain funds.

Barina first became registered with FINRA in 1999. Barina was registered from November 13, 2009, through November 14, 2011, with Coker & Palmer, Inc. (Coker & Palmer). In November 2011, Barina became registered with Aegis Capital Corp. until May 2013. Thereafter, Barina was registered with Merrimac Corporate Securities, Inc. until October 2013.

Brokerage firms and brokers are responsible for conducting due diligence on all securities recommended by a broker. The due diligence requirement is heightened where the investment recommendation is a private placement offering or other type of non-public offering where there is no public information available and brokerage firm is acting as the underwriter of the securities.