Monthly Archives: March 2014

A March 21, 2014 article in The Wall Street Journal (“The New Hedge-Fund-Like Retail Funds”) both highlights the expanding array of mutual funds that are offering hedge-fund like strategies to the investing masses and the risks that may make these investments unsuitable for retail investors.

In fact, this article notes that assets invested in these alternative funds, which are being managed by both Wall Street firms (including Morgan Stanley and Goldman Sachs) and independent investment advisors, have increased from $41 billion at the end of 2008 to $286 billion in 2013.

But while the marketing of these funds may tout their purported ability to “re-create the secret sauce of hedge-fund investing” and to offer that “secret sauce” to ordinary investors with their minimal entry level of as low as $1,000 per investment, investors are cautioned that they should not “rush to join the club.”

In the words of Harry Markowitz, who shared the Nobel Prize in economics in 1990 for his research on how investors should allocate their assets to get the best balance between risk and reward, “I wouldn’t touch it with a 10-foot pole.”

These alternative funds are often complicated to understand, are commonly unclear as to their holdings and the conflicts/fees that may be associated with them and, of equal if not greater importance, may be forced to liquidate their assets at unfavorable prices in order to meet investor redemption requests.

When you add in the reality that the performance of alternative funds has often lagged the market in general and that their returns have not yet been “tested” in a declining market environment, the “secret-sauce” being touted brings with it the caution, as noted in this article, that while “it’s getting easier to invest like a hedge fund, that doesn’t necessarily mean you should.”

The Financial Industry Regulatory Authority (FINRA) announced today that it has fined LPL Financial LLC $950,000 for supervisory deficits related to the sales of alternative investment products, including non-traded real estate investment trusts (REITs), oil and gas partnerships, business development companies (BDCs), hedge funds, managed futures and other illiquid pass-through investments.

Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, “In order to sell alternative investments, a broker-dealer must tailor its supervisory system to these products. LPL exposed customers to unacceptable risks by not having an adequate system in place that could accurately review whether a transaction complies with suitability requirements imposed by the states, the product issuers and the firm itself – and it failed to train its registered representatives to apply all the suitability guidelines appropriately.”

As part of the sanction, LPL must also conduct a comprehensive review of its policies, systems, procedures and training, and remedy the failures.

On Monday, FINRA confirmed that it had removed a Santa Barbara, CA arbitrator  James H. Frank from its roster of arbitrators. Arbitrator Frank had sat on nearly 40 arbitrations in California over the past 15 years. A FINRA spokeswoman confirmed that Frank claimed to be a lawyer and member of the bar in several states, when in reality he was not. It is unlikely that Frank’s revelation will have any effect on the many cases in which he presided, as parties have only 90 days after an arbitration award is issued to appeal such results to a court.

Five of Bernie Madoff’s former employees have been found guilty of aiding and profiting from the largest Ponzi scheme in American history, estimated at $20 Billion. A New York City jury rejected their defenses that they were duped by Bernie Madoff and didn’t know about the scam. As the clerk read the 31-count indictment, the jury foreman replied with “guilty” 59 times. The sentencing hearing has been scheduled for the week of July 28^th, where these 5 could face sentences of decades in prison.

A one in five ratio, is today’s survival rate for trainees across financial firms. They quickly eliminate candidates from their large pool of trainees who can’t keep up the pace. With these facts, the long term does not look appealing to most candidates. So how does the Financial Industry identify and attract the next generation of advisers?

With the ever changing role of the financial adviser, it is hard to specifically define the skill set and behaviors of the ideal adviser candidate. Important traits such as hunger, drive, resilience are traditionally used, but new terms are developing. Candidates should be able to collaborate, problem solve, and provide a new level of customer service. Successful brokers come from varying employment and educational backgrounds and there hasn’t seemed to be a specific source of talent.

To narrow the field, firms should start looking at a new breed of advisers developing in over 200 colleges, who offer degrees or certification programs in personal financial planning. These students upon graduation should have several career options and the high risk, high reward potential model that exists at many firms could be a deterrent. During the hiring process firms will need to understand the appeal of the positions they offer over other choices.

A Wall Street Journal article recently highlighted the significant problem of stock brokers omitting bankruptcies, unpaid debts, and criminal charges from their regulatory records.  FINRA, the organization that regulates brokers and brokerage firms, requires members to disclose these events on their records so investors can know the type of person handling their money.  However, the Journal looked at a database and discovered that, out of 500,000 brokers, the regulatory records of over 1,500 failed to report personal bankruptcies.  Furthermore, the records of 150 brokers omitted criminal charges or convictions.  The Journal found that brokers with unreported bankruptcies typically had more customer complaints.  While a broker’s bankruptcy or criminal convictions can raise red flags for their clients who trust the broker with their money, ignoring the regulatory requirements and failing to reports these events can raise even larger issues.

The Journal also found some disturbing instances where the brokerage firms failed to discover a broker’s criminal convictions during the hiring process.  Moreover, there was at least one instance where a brokerage firm was a named defendant in a broker’s bankruptcy, but failed to report it.  These instances demonstrate that the reporting process is far from perfect and FINRA needs to be tougher in enforcing certain omissions from brokers’ records.

Avoiding brokers who have bankruptcies and criminal convictions may help you avoid scams and unsuitable recommendations.  Despite the fact that bankruptcies and convictions may not be disclosed on a broker’s regulatory record, it is still important for investors to research their brokers.  FINRA’s BrokerCheck is a useful tool on the organization’s website to help investors to do just that.  FINRA’s BrokerCheck.  Additionally, if an investor believes that they’ve been wronged by their broker, it is best to contact an attorney who can conduct more thorough research into the broker’s background.

A Wall Street Journal analysis shows more than 1,600 stockbrokers have bankruptcies or criminal charges in their past that weren’t reported. Brokers and the firms that employ them are required to report these issues to the regulatory body commonly called FINRA. Investors can look up brokers on a FINRA website called “BrokerCheck” and discover a broker’s professional history. The Securities and Exchange Commission, oversees the Wall Street self-regulator, has said in rulings on disciplinary proceedings that FINRA, “must depend on its members to report to it accurately” because its membership of over 4,000 firms and 635,000 brokers means it “cannot investigate the veracity of every detail in each document filed with it.”

FINRA, the “first line of defense” to protect investors, can impose penalties including fines and exclusion from the industry for reporting failures. Last year FINRA took disciplinary action against 129 brokers and firms for “reporting and filing violations.” A FINRA spokeswoman said for the year 2014, “They will ensure the database is updated and will focus on bringing disciplinary actions where appropriate.” said a spokeswoman. Reporting gaps aren’t confined to brokers at small firms. The 10 largest brokerage firms in the Journal’s analysis employ at least 450 people with bankruptcy filings that should have been reported, but weren’t.