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Wells Fargo Advisors Financial Network, LLC and Wells Fargo Clearing Services, LLC have been ordered by the Financial Industry Regulatory Authority (FINRA) to pay over $3.4 million as restitution to customers relating to “unsuitable recommendations of volatility-linked exchange traded products (ETPs) and related supervisory failures.” It was discovered by FINRA that Wells Fargo’s registered representatives, from July 1, 2010 until May 1, 2012, recommended such products without fully understanding their features and risks.

While “volatility-linked ETPs are generally short-term trading products that degrade significantly over time and should not be used as part of a long-term buy-and-hold investment strategy,” some Wells Fargo representatives believed that “the products could be used as a long-term hedge on their customers’ equity positions in the event of a market downturn.” In summary, FINRA found that Wells Fargo failed to institute a reasonable system to supervise solicited sales of volatility-linked ETPs.

FINRA makes it clear that “volatility-linked ETPs” are complex products that could be misunderstood and improperly sold by registered representatives,” and has issued Regulatory Notice 17-32 to member firms reminding that heightened supervision is required regarding these products. Susan Schroeder, Executive Vice President of FINRA’s Department of Enforcement stated that member firms “soliciting sales of volatility ETPs should already be well aware of the unique risks that they pose” and explained that “FINRA’s Regulatory Notice 17-32 is intended to further educate the industry so that member firms can assess their own practices and take appropriate remedial action if necessary.”

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Morgan Stanley Smith Barney, LLC was fined by the Financial Industry Regulatory Authority (FINRA) for “failing to supervise its representatives’ short-term trades of unit investment trusts (UITs).”  Approximately 3,000 of Morgan Stanley Smith Barney’s customers were affected. The firm was required by FINRA to pay approximately $3.5 million in fines and $9.78 million in restitution to the affected customers.

As outlined by FINRA, a “UIT is an investment company that offers units in a portfolio of securities that terminates on a specific maturity date, often after 15 or 24 months. UITs impose a variety of charges, including a deferred sales charge and a creation and development fee, that can total approximately 3.95 percent for a typical 24-month UIT. A registered representative who repeatedly recommends that a customer sell his or her UIT position before the maturity date and then “rolls over” those funds into a new UIT causes the customer to incur increased sale charges over time, raising suitability concerns.”

It was discovered by FINRA, that hundreds of representatives for Morgan Stanley “executed short-term UIT rollovers, including UITs rolled over more than 100 days before maturity, in thousands of customer accounts” during a period from January 2012 to June 2015. FINRA found that representatives’ sales were not adequately supervised, and that Morgan Stanley did not provide sufficient guidance to Morgan Stanley supervisors on how to review UIT transactions to discover unsuitable short-term trading. Furthermore, FINRA determined that Morgan Stanley did not have adequate training regarding UITs or a supervisory system in place to detect short-term UIT rollovers.

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It was announced this week by the Financial Industry Regulatory Authority (FINRA) that J.P. Morgan Securities, LLC has been fined $1.25 million “for failing to conduct timely or adequate background checks on approximately 8,600, or 95 percent, of its non-registered associated persons from January 2009 through May 2017.” As outlined by Susan Schroeder, Executive Vice-President of FINRA’s Department of Enforcement, FINRA member firms like J.P. Morgan “play an important gatekeeper role in keeping bad actors from harming investors.” She further explained that these firms “have a clear responsibility to appropriately screen all employees for past criminal or regulatory events that can disqualify individual from associating with member firms, even in a non-registered capacity.” This federal requirement to conduct fingerprint screening of certain associated persons that work in a non-registered capacity is absolutely necessary in helping to identify individuals who could possibly be a risk to customers in light of their positions with the firm.

During their investigation, FINRA discovered that over a period of 8 years J.P. Morgan had failed to timely fingerprint 2,000 of its non-registered associated persons which prevented them from discovering whether such persons would be disqualified from employment with the firm. Furthermore, it was learned that the firm was limiting its screening of non-registered associated persons to convictions relating to federal banking laws and other crimes on a list J.P. Morgan created internally. Again, pursuant to federal law, however, J.P. Morgan was supposed to have screened for all felony convictions and for disciplinary actions taken by financial regulators. Unfortunately, in total, J.P. Morgan failed to appropriately screen approximately 8,600 non-registered persons in the appropriate manner.

J.P. Morgan neither admitted nor denied the FINRA allegations, but did consent to the entry of the findings by FINRA.

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The Securities Arbitration Commentator (SAC) recently took notice of a new investor education project that was spearheaded by our own Jason Doss.  Mr. Doss is a recent past president of the Public Investors Arbitration Bar Association, or PIABA, and the current president of the PIABA Foundation.  PIABA is an association of attorneys from around the country who represent investors against brokerage firms and their financial advisors. These investment-related disputes are resolved in arbitration proceedings and are often centered around investment fraud.  The damage done to victims of investment fraud – both financial and emotional – can be devastating.

Having seen the devastation up close for many years, Mr. Doss wanted to help alleviate as much of it as possible.  “Wouldn’t it be a good if we could help investors before they became victims,” he said.

Mr. Doss helped create the PIABA Foundation and has led the organization as its President to fulfill its mission of educating and protecting investors.  Mr. Doss and the PIABA Foundation then collaborated with the Alliance for Investor Education (AIE) in producing a National Investor Town Hall Meeting on October 29 in San Diego that SAC blogged about.  Mr. Doss also co-authored a book entitled “The Investors Guide to Protecting Your Financial Future,” and a short documentary entitled “Trust Me.”  The video uses the inability of government to prevent repeated financial collapses as a starting point for learning how investment fraudsters operate and what investors can do to protect themselves.  The video features the accounts of two actual investment fraud victims and commentary by several investor attorneys.

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A South Carolina grand jury has indicted a Greenville broker named Claus Foerster for defrauding his clients out of $2.8 million.  According to news reports, the indictments states that Foerster persuaded clients to invest in a fictitious company called SG Investment Management.  According to the Associated Press, Foerster provided his clients with bogus earnings statements that falsely indicated their funds were invested and earning profits.

Foerster allegedly perpetrated this fraud over a 14 year period from 2000 to 2014 while he was associated with three different brokerage firms.  Foerster was associated with Raymond James & Associates, Inc. from February 2013 to June 2014; Morgan Keegan & Company, Inc. from February 2008 to February 2013; and Citigroup Global Markets, Inc. d/b/a Smith Barney from July 1997 to February 2008.

In 2014, the Financial Industry Regulatory Authority (FINRA) barred Foerster from the securities industry due to allegations that he was running a Ponzi scheme.  Foerster was terminated by Raymond James in 2014 after he admitted that he had misappropriated client funds.

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Following up on our previous blog post, broker dealers that sold UDF non-traded REITs to investors include, but are not limited to, IMS Securities Inc., Berthel Fisher & Co. Financial Services Inc., Centaurus Financial Inc., and VSR Financial Services, Inc.

These firms have a history of regulatory violations and customer complaints:

  • The Financial Industry Regulatory Authority (“FINRA”) has fined and/or reprimanded IMS Securities Inc. twice for failure to supervise and once for allowing a registered representative to sell securities in Texas without being licensed in Texas.
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Following up on our previous blog post, United Development Funding IV was organized on May 28, 2008.  UDF IV shares began trading on the NASDAQ under the symbol “UDF” on June 4, 2014.  Prior to June 4, 2012, UDF IV was a public non-traded REIT.

An investment in a public non-traded REIT is essentially an investment in in an illiquid start-up real estate company that must accumulate assets quickly and is subject to significant risks. Such an investment is unsuitable for most investors.  Non-traded REITs are typically sold to unsuspecting retail (“mom and pop”) investors who are seeking yield in the low-interest rate environment.  They get pitched to investors by financial advisers who are incentivized to sell non-traded REITs by getting paid outsized commissions from the company.

Shares of UDF IV were initially sold through a securities brokerage firm named Realty Capital Securities, LLC (“RCS”), as the Dealer Manager of the securities offering, and possibly through various other Soliciting Dealers – securities brokerage firms that may have been retained by RCS to sell shares of UDF IV.  RCS reportedly raised over $1 billion from retail investors and was paid commissions and fees for selling UDF IV to retail investors.

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Shares of United Development Funding IV collapsed 55% to $3.20 per share on Thursday, February 18, before trading was halted.  UDF IV is a publicly traded REIT.  The collapse occurred after the FBI raided the company’s offices in Texas.  A prominent hedge fund manager had previously accused UDF IV of essentially operating as billion dollar Ponzi scheme.  In addition, the firm’s independent accounting firm resigned and has not been replaced, according to reports.  Shareholder class action lawsuits have been filed.

What investors need to know is this.  Class actions lawsuits are designed to take a large group of investors with very small losses and aggregate them into a single lawsuit.  At the end of the process, the recovery is typically small.  There is another, better path for investors with significant losses, and that is filing a securities arbitration claim against the brokerage firm that sold the investment.

Investment advisers, brokers and their firms have a legal duty to understand and communicate to investors all the material facts about an investment, including the risks, before the investment is made.  In other words, they have a duty not to misrepresent or fail to disclose any important facts before the investment is made.  In addition, they have a duty not to recommend an investment that is unsuitable for the investor based on the investor’s investment objective, risk tolerance and time horizon.  If any of these duties is breached, and losses occur, the investor has a compelling claim to recover those losses in arbitration.

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F-Squared Investments, Inc., a SEC registered investment adviser firm, filed a Chapter 11 bankruptcy petition in July 2015 after paying $35 million and admitting wrongdoing to settle SEC charges that it falsified its advertised track record of investment performance, giving investors the false impression that its performance results were significantly better than they really were. Its AlphaSector investment strategies were used by other investment advisor firms, including Wells Fargo Advisors.

F-Squared’s AlphaSector strategies belong to a group of managed account strategies known as ETF managed portfolios.  According to Morningstar, in the typical ETF managed portfolio, more than 50% the assets are invested in exchange-traded funds.  Money managers like F-Squared package portfolios of ETFs into investment strategies to meet a variety of investment objectives.

Appealing to thousands of individual investors who were burned by the 2008-2009 market declines, F-Squared held out its algorithm-driven AlphaSector investment strategies as a way to manage risk in volatile financial markets.  However, the SEC accused F-Squared of presenting false and misleading performance numbers in its advertising and marketing materials, and also charged its co-founder and ex-CEO, Howard Present, with making false and misleading statements to investors.

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On March 15, 2013, the SEC announced that S.A.C. Capital Advisors affiliate hedge fund advisory firm, CR Intrinsic Investors, has agreed to pay more than $600 million to settle SEC charges that it participated in an insider trading scheme involving a clinical trial for an Alzheimer’s drug being jointly developed by two pharmaceutical companies. This settlement is the largest ever in an insider trading case, requiring CR Intrinsic to pay $274,972,541.00 in disgorgement, $51,802,381.22 in prejudgment interest, and a $274,972,541.00 penalty.

The SEC charged CR Intrinsic with insider trading in November 2012, alleging that one of the firm’s portfolio managers Mathew Martoma illegally obtained confidential details about the clinical trial.

The SEC’s complaint alleged that CR Intrinsic and Dr. Gilman tipped Martoma with safety data and eventually details about negative results in the trial about two weeks before they were made public in July 2008. Martoma and CR Intrinsic then caused several hedge funds to sell more than $960 million in Elan and Wyeth securities in a little more than a week.