Investment Attorney

Accredited Investor Definition Revisited By SEC Part I

November 20, 2014 | by Staff Attorney

According to an InvestmentNews article, the Securities and Exchange Commission (SEC), for the first time in 32 years, is revisiting the idea of who should qualify as an accredited investor to be eligible to invest in private placements. The current accredited-investor standard limits private placement purchases to individuals who earn at least $200,000 annually or have a net worth of $1 million after excluding the primary residence. Recently, the SEC recommended considerable revisions on who should make to the definition of an accredited investor in order to broaden the potential pool and strengthen verification that they qualify.

Under the Dodd-Frank reform law, the SEC must review the accredited investor definition every four years. Under the current rules, about 8.5 million investors currently qualify. The Investor Advisory Committee (IAC) was also established by Dodd-Frank to represent retail investors to the SEC to propose rule recommendations.

The committee stated that relying on income and net worth oversimplifies the analysis of who has the wealth and liquidity to withstand the risks of private offerings. For instance, the thresholds fail to provide adequate protection for investors whose net worth is based on an accumulated retirement savings, illiquid holdings, or maybe a lump sum settlement from a lawsuit that is supposed to replace income.

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.

Gemini Real Estate Advisors Risk Investor Funds in Private Legal Dispute

November 15, 2014 | by Staff Attorney

As reported in InvestmentNews, three members of a real estate partnership that sells private placements in the real estate space are in the middle of a legal dispute that could potentially endanger millions of dollars in loans and investor capital as a result. The dispute is among the owners of Gemini Real Estate Advisors and began earlier this year when William Obeid, one of the partners, asked the other two partners, Christopher La Mack and Dante Massaro, to restructure the company to reflect certain areas of expertise. Those talks soon broke down and have now ended up in court.

Gemini Real Estate Advisors oversees a real estate portfolio of more than $1 billion and was founded in 2003. The complaint alleges that Mr. Obeid abused his position for personal gain through concealed unauthorized transfers of company funds and hiring of family members at inflated salaries. Thereafter, Mr. Obeid filed his own complaint in New York against Mr. La Mack and Mr. Massaro. alleging that the two other Gemini partners had proposed a business divorce and have acted in an effort to freeze him out in order to strengthen their negotiation position in discussions concerning a buyout of Mr. Obeid’s interest.

According to Mr. Obeid’s lawsuit, his partners’ strategy would harm Gemini and investors, by paralyzing Gemini’s operations, causing existing development projects to become distressed, and risk default on more than $97 million in loans and $15 million of investors’ equity.

Stifel Nicolaus Broker Robert Head Terminated and Barred for Unauthorized Trading

November 14, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) in an acceptance, waiver, and consent action (AWC) and barring former Stifel, Nicolaus & Company, Inc. (Stifel Nicolaus) broker Robert Head (Head) concerning allegations that between August 2013, and October 2013, Head exercised discretion, aka unauthorized trading, in the account of a customer without obtaining the customer’s prior written consent in violation of NASD Conduct Rule 2510(b) and FINRA Rule 2010. In addition, FINRA alleged that Head recommended transactions to the same customer between January 2010, and October 2013, that were qualitatively and quantitatively unsuitable for the customer.

From August 2008, until January 2014, Head was registered with Stifel Nicolaus. Since that time, Head has not been registered with any brokerage firm. In December 2013, Head was discharged from Stifel Nicolaus for alleged violation of the firm’s policy regarding exercising discretion in a client’s account without written authorization.

According to FINRA, Head managed a Stifel Nicolaus trust account for a customer from August 2008, until October 2013. The customer was retired with an original account application listing investment objectives of “Growth and Income” and “Speculation / Active Trading / Complex Strategies.” FINRA found that in November 2009, the account’s investment objective was changed to identify only ”Speculation / Active Trading / Complex Strategies.” FINRA found that the customer never gave Head written authorization to exercise his own discretion for her account.

Broker Spotlight – Mark Johanson’s Sale of Tenants-in-Common (TIC)

November 13, 2014 | by Staff Attorney

According to the Financial Industry Regulatory Authority’s BrokerCheck system, there have been four customer complaints filed against former Sigma Financial Corporation (Sigma) and current Charles Schwab broker, Mark Johanson (Johanson) stemming from unsuitable Tenants-in-Common (TIC) investments.

Sales of TICs exploded during the early 2000s from approximately $150 million in 2001 to approximately $2 billion by 2004. TICs are private placements that have no secondary trading market and are therefore illiquid investments. These products were promoted as appropriate section 1031 exchanges in which an investor obtains an undivided fractional interest in real property. In a typical TIC, the profits are generated mostly through the efforts of the sponsor and the management company that manages and leases the property. The sponsor typically structures the TIC investment with up-front fees and expenses charged to the TIC and negotiates the sale price and loan for the acquired property.

TIC investments entail significant risks. A TIC investor runs the risk of holding the property for a significant amount of time and that subsequent sales of the property may occur at a discount to the value of the real property interest. FINRA has also warned that the fees and expenses associated with TICs, including sponsor costs, can outweigh the any potential tax benefits associated with a Section 1031 Exchange. That is, the TIC product itself may be a defective product because its costs outweigh any potential investment value for a customer. FINRA also instructed members that they have an obligation to comply with all applicable conduct rules when selling TICs by ensuring that promotional materials used are fair, accurate, and balanced.

SEC Approves Changes to Value of Non-Traded REITs on Account Statements

November 6, 2014 | by Staff Attorney

The Securities and Exchange Commission (SEC) approved a rule change proposed by the Financial Industry Regulatory Authority (FINRA) that will give investors greater insight into the costs of purchasing shares of non-traded real estate investment trusts (Non-Traded REITs).

As reported by InvestmentNews, the SEC approved FINRA’s proposal on October 10. The rule change would require broker-dealers to include a per-share estimated value for an unlisted direct participation program (DPP) or a REIT on customer statements in addition to other related disclosures. The current practice is to list the value of Non-Traded REITs at a per-share price of $10, or simply the purchase price of the investment.

As a background, a Non-Traded REIT is a security that invests in different types of real estate assets such as commercial real estate properties, residential mortgages of various types, or other specialty niche real estate markets such as strip malls, hotels, and other industries. REITs can be publicly traded and when they are, can be 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 and are illiquid, have no market, and can only be liquidated on terms dictated by the issuer, which may be changed at any time and without prior warning.

FINRA Declines Rule Requiring Brokerage Firms To Carry Insurance

November 5, 2014 | by Staff Attorney

According to a recent report, the Financial Industry Regulatory Authority (FINRA) has decided it cannot force firms to carry insurance for payment of awards granted by arbitration panels on behalf of investors who have lost money.

As a background, every investor who opens a brokerage account with an investment firm agrees to arbitrate their dispute before the FINRA. Even if an investor did not open an account with a brokerage firm the claim can still be arbitrated under the industries rules. FINRA is the investment industries self-regulatory organization for all brokerage firms operating in the United States, overseeing approximately 4,700 brokerage firms and 635,000 registered representatives. FINRA both enforces its own rules through regulatory actions and administers an arbitration forum for securities disputes.

Our firm has noticed a recent trend where small and even mid-sized firms fail to keep sufficient funds on hand to pay investors due to misconduct at the firm. These smaller firms sometimes fail to enact proper supervisory procedures and regulatory controls to prevent their brokers from engaging in wrongful conduct. Sometimes these firms simply do not have the resources to properly engage in the securities business lines they attempt to engage in. As a result investors are harmed and due to their small size, cannot be compensated. In 2012, brokerage firms failed to pay $50 million in awards to customers. In 2011, the number of unpaid awards totaled $51 million.

Broker Stephen Campbell Sanctioned Over Churning Claim

October 31, 2014 | by Staff Attorney

The Financial Industry Regulatory Authority (FINRA) sanctioned broker Stephen Campbell (Campbell) concerning allegations that the broker engaged in churning in a client account. Campbell has been a broker since 1978. From November 12, 2004 through November 12, 2013, Campbell was registered with Oppenheimer & Co., Inc. (Oppenheimer).

Investment churning is trading activity characterized by purchasing and selling activity that is excessive and serves no practical purpose for the investor. Brokers engage in churning solely to generate commissions without regard for the client’s interests. In order to establish a churning claim the investor must show that the trading was first excessive and second that the broker had control over the investment strategy. Certain commonly used measures and ratios used to determine churning help evaluate a churning claim. These ratios look at how frequently the account is turned over plus whether or not the expenses incurred in the account made it unreasonable that the investor could reasonably profit from the activity.

In Campbell’s case, FINRA found that one of his customers was a 55 year old single mother who initially opened an account with Campbell in 2000. FINRA alleged that from January 2009, through September 2011, while exercising control over her accounts, Campbell excessively and unsuitable traded her accounts inconsistently with her investment objectives, financial situation and needs. FINRA determined that the trading activity resulted in an annualized turnover ratio of 15 and an annualized cost-to-equity ratio of 59% in her IRA account, and an annualized turnover ratio of 21 and an annualized cost-to-equity ratio of 120% in her individual account. During this period, FINRA determined that Campbell’s improper trading resulted in a collective loss of approximately $62,000, while generating total gross commissions of approximately $64,000.

Why Wall Street Fights Against the Fiduciary Standard

October 30, 2014 | by Staff Attorney

In the wake of the financial crisis of 2008, the Dodd-Frank legislation authorized the Securities Exchange Commission (SEC) to pass a fiduciary duty rule that would apply to brokers, as opposed to only financial advisors. Most investors do not realize and are usually shocked to learn that there broker only has an obligation to recommend “suitable” investments, and not to work in their client’s best interests. Currently, the fiduciary duty rule only applies to financial advisors (and brokers under certain circumstances) – more commonly recognized by the public as advisors who charge a flat fee for their services as opposed to commissions.

The fact that the investing public has absolutely no clue how crucial the fiduciary duty is to protecting their retirement futures and holding Wall Street accountable for mishaps has prevented any serious public debate to combat the millions of dollars the industry has and will spend to kill this part of the law. True to form, recently the House of Representatives passed a budget that would prevent the SEC from imposing a fiduciary standard on brokers during the upcoming federal fiscal year beginning in October.

What’s the big deal you may ask? Why is the fiduciary standard important to me? Well there are many reasons but maybe one story will highlight how the brokerage industry is currently allowed to operate to put their interests ahead of their clients. As recently reported in Bloomberg and InvestmentNews, an undercover U.S. Labor Department economist exposed how brokerage firms sought out federal workers to roll over their 401(k)’s with the government to IRAs with the brokerage firm even though the result could increase the client’s annual costs by as much as 50 times!

Regulator Finds that Center Street Securities Made Unsuitable Recommendations of GWG Renewable Secured Debentures Part II

October 29, 2014 | by Staff Attorney

This post continues our story on the allegations made by the Financial Industry Regulatory Authority (FINRA) against Center Street Securities, Inc. (Center Street). As previously reported, FINRA sanctioned the firm concerning a multitude of rule violations in the sales of GWG Renewable Secured Debentures, an illiquid and high-risk private placement investment.

FINRA found that in order to purchase the GWG Debentures, Center Street customers were required to complete an account application, GWG subscription forms, and a “Compliance Alternative Investment (Non-Reg D) Suitability.” FINRA found that the compliance form required brokers to obtain information about customers’ existing assets, the concentration of the alternative investment as percentage of net worth, the customer’s age, and the customer’s investment objectives. Once completed, FINRA alleged that these documents were submitted to Center Street’s compliance department for supervisory and suitability review.

FINRA found that these forms were the only items the firm relied upon in reviewing and assessing Debenture sales. FINRA determined that Center Street had three employees of in their compliance department who conducted supervisory and suitability review of all transactions recommended to customers. FINRA alleged that the primary employee responsible for conducting the review of GWG Debenture received no training from the firm regarding the unique characteristics and risks of the GWG Debentures. The employee was also unaware of the firm’s guidelines concerning concentration of alternative products as well as state specific suitability requirements.