Category Archives: Broker/dealer

The Internet and wireless technology have made it easier than ever for investors to review brokerage account information and initiate investment transactions on the go. At the same time, investors need to take certain precautions to help ensure the security of their brokerage accounts and prevent those accounts from becoming fodder for ID thieves.

Cases involving identity theft of brokerage accounts have become more frequent in recent years. In some instances, the person responsible for the theft is a close family member or friend of the victim – an ex-husband, trusted relatives, or caregiver. Sometimes the perpetrator is a complete stranger who has been able to hack into the victim’s computer and steal that person’s brokerage ID and password information.

By following a few simple steps, investors can make it much harder for unauthorized people to gain access to their brokerage accounts, says the Financial Industry Regulatory Authority (FINRA).

Read Your Account Statements. Don’t toss aside your monthly account statements. Read them thoroughly as soon as they arrive to make sure that the transactions shown are ones that you actually made, and check to see whether all of the transactions that you thought you made appear as well. Be sure that your brokerage firm has current contact information for you, including your mailing address and email address.

Lock the Door Behind You. It is very important to terminate each online session when you are finished – usually by clicking the “Log out” link on the site. This is the computer equivalent to locking the door when you leave the house. If you merely type in another address, or close or minimize the Web browser window, it may be possible for unauthorized users with access to the same computer to gain access to your account information. Retrieving this information could be as easy as clicking on the Internet browser icon, pressing the browser’s Back button, or calling up a browser’s Internet History.

Guard the Front Door. Recently, popular browsers such as Microsoft Internet Explorer and Mozilla Firefox have introduced a feature where the browser offers to “remember” your usernames and passwords to secure web sites. Think twice about using this feature as it may allow others who can access your computer to log in to your brokerage or other online account. Never allow the browser to remember user names and passwords when using a public, shared computer.

Contact Your Brokerage Firm. If you think that your personal information has been stolen and that your brokerage account has been hacked, notify the firm where you have the account immediately.

Securities Scams. Before you do business with any investment-related firm or individual, do your own independent research to check out their background and confirm whether they are legitimate. For step-by-step tips and links to helpful Web sites, read Check Out Brokers and Advisers from the Securities and Exchange Commission (SEC).

Do a Periodic ‘ID Theft’ Credit Report Check. It is a good idea to check your credit report at least once a year since it may signal problems ranging from unauthorized transactions to identity theft. You can obtain a free annual credit report from each of the three major credit bureaus – Equifax, Experian, and Trans Union – online at www.annualcreditreport.com.

LPL Financial LLC has been ordered by the Massachusetts Security Division to pay restitution of more than $2 million to investors who bought shares of non-traded real estate investment trusts (REITs).

In addition to the restitution order, Massachusetts regulators levied a $500,000 administrative fine against LPL. As reported Feb. 6 by Investment News, the settlement stems to allegations that LPL failed to supervise brokers who sold investments in non-traded REITs. LPL also agreed to review all other non-traded REITs offered to Massachusetts residents and to make restitution to investors in the state whose transactions violated Massachusetts or company rules.

LPL Financial and Ameriprise Financial are big players in the non-traded REIT world. They account for almost 20% of the industry’s annual sales of $10 billion. Recently, regulators have put non-traded REITs on their 2013 priority watch list, reviewing how the products are sold and whether advisers and broker/dealers may be misrepresenting the investments to clients.

In its consent order with Massachusetts regulators, LPL admitted to a series of statements of fact around the sales of the REITs. In doing so, however, the firm neither admitted nor denied allegations stemming from the training and oversight of sales of the products.

Every year, the Financial Industry Regulatory Authority (FINRA) takes note of key regulatory and examination issues that it plans to prioritize in the new year. In 2013, those priorities include a number of hot-button – and familiar – financial products, from structured investments, to non-traded REITs, to business development companies, or BDCs.

In a recent notice to investors, FINRA highlighted the following products and issues, along with an explanation as to why they merit top placement on FINRA’s 2013 watch list.

Structured Products: These products may be marketed to retail customers based on attractive initial yields and, in many cases, on the promise of some level of principal protection, according to FINRA. Moreover, structured products are often complex, and have cash-flow characteristics and risk-adjusted rates of return that are uncertain or hard to estimate. In addition, structured products generally do not have an active secondary market.

Suitability and Complex Products: FINRA’s recently revised suitability rule (FINRA Rule 2111) requires broker/dealers and associated persons to have a reasonable basis to believe a recommendation is suitable for a customer. FINRA says it is particularly concerned about firms’ and registered representatives’ understanding of complex or high-yield products, potential failures to adequately explain the risk-versus-return profile of certain products, as well as a disconnect between customer expectations and risk tolerances.

Business Development Companies (BDCs): BDCs are typically closed-end investment companies. Some BDCs primarily invest in the corporate debt and equity of private companies and may offer attractive yields generated through high credit risk exposures amplified through leverage. As with other high-yield investments – such as floating rate/leveraged loan funds, private REITs and limited partnerships – investors are exposed to significant market, credit and liquidity risks. In addition, fueled by the availability of low-cost financing, BDCs run the risk of over-leveraging their relatively illiquid portfolios, FINRA says.

Exchange-Traded Funds and Notes: In many instances, retail investors may not fully understand the differences among exchange-traded index products (i.e., funds, grantor trusts, commodity pools and notes) and the risks associated with these investments, particularly those that employ leverage to amplify returns. FINRA says it also is concerned about the proliferation of newly created index products that lack an established track record. Examples include products with valuations and performance tied to volatility, emerging markets and foreign currencies.

Non-Traded REITs: FINRA’s interest in non-traded REITs centers on the fact that many customers of non-traded REITs are unaware of the sales costs deducted from the offering price and the repayment of principal amounts as dividend payments in the early stages of a REIT program.

Private Placement Securities: Private placements will continue to be a key focus of FINRA’s investor protection efforts in 2013, with particular emphasis on sales and marketing efforts by broker/dealers. To improve its understanding of private placements, FINRA implemented Rule 5123, which requires member firms that sell an issuer’s securities in a private placement to individuals to file a copy of the offering document with FINRA.

FINRA also reminds member firms that the relative scarcity of independent financial information and the uncertainty surrounding the market- and credit-risk exposures associated with many private placements necessitates reasonable due diligence on prospective issuers. FINRA notes that due diligence should focus on the issuer’s creditworthiness, the validity and integrity of their business model, and the plausibility of expected rates of return as compared to industry benchmarks, particularly in light of the complex fee structures associated with many of these investments.

Independent broker/dealers continue to face a wave of legal and regulatory issues in 2013, with many expected to shutter their businesses.

As reported Jan. 20 by Investment News, the problems facing smaller B-Ds with 150 registered representatives or fewer include higher compliance costs, record low interest rates for money market accounts, competitive commission rates from large or discount broker-dealers and a tax increase that will cut available discretionary funds that investors can put to work in the stock market.

Small B-Ds make up the majority of firms registered with the Financial Industry Regulatory Authority (FINRA).  In the first 11 months of 2012, pressures on the industry reduced the number of FINRA-registered firms to 4,319 – down 97 firms from the prior year and a 14% decline since the end of 2007.

Regulatory and compliance issues are a key factor contributing to the reduction in smaller B-Ds. In a move to improve investor protections, the Securities and Exchange Commission (SEC) approved FINRA Rule 4524 in 2012, which mandated that broker/dealers file additional financial or operational schedules or reports as FINRA deemed necessary.

Many B-Ds to close up shop in the past few years have done so because of deals involving failed private placements, such as those connected to Provident Royalties LLC and Medical Capital Holdings LLC. The SEC charged both of those firms with fraud in July 2099, which in turn spurred a rash of investor lawsuits and arbitration claims. As a result, many broker/dealers were unable to contend with the litigation costs and subsequently shut down.

Non-traded real estate investment trusts (REITs) have traditionally been associated with independent broker/dealers – that is until last month when Merrill Lynch announced that its 17,000-plus registered reps would begin selling the Jones Lang LaSalle Income Property Trust to investors.

The move means Merrill Lynch becomes the first major wirehouse to sell a non-traded REIT. So far, the firm has raised about $50 million from interested clients.

Merrill Lynch’s foray into non-traded REIT territory is based on demand for an “attractive, direct core real estate investment product among mass-affluent investors,” said Keith Glenfield, head of alternative investments for Merrill Lynch, in a Jan. 2 article by Investment News.

“The primary investment objectives are designed to provide attractive current income, preserve and protect invested capital, achieve [net asset value] appreciation over time and enable stockholders to utilize real estate as a long-term portfolio diversifier,” Glenfield said.

Despite Merrill Lynch’s characterization of the Jones Lang Lasalle REIT as a safe source of income, investors may have plenty of reasons to be cautious. Non-traded REITs have been under the radar of state securities regulators for several years now, as have the sales practices of the broker/dealers that sell them.

Issues with non-traded REITs include their complex fee structure, high-risk factors, illiquidity and often inaccurate valuations. Moreover, early redemption of shares is typically extremely limited, and fees connected with their sale can be high and erode total return.

In 2012, the Financial Industry Regulatory Authority (FINRA) reissued an Investor Alert on nontraded REITs following an enforcement action against David Lerner & Associates. One of FINRA’s concerns with Lerner focused on the valuation irregularities that appeared on the monthly statements of investors who owned shares in Lerner’s Apple REITs. Specifically, shares of certain Apple REITs had been listed on the statements as $11 per share even after FINRA instructed broker/dealers in 2009 to adjust prices on the investments more frequently.

The Financial Industry Regulatory Authority (FINRA) marked several milestones in 2012 in the way of increased fraud preventions and arbitration judgments rendering a record amount of restitution to aggrieved investors. Part 1 of our blog on FINRA’s 2012 Year in Review focused on regulatory investigations and fines and disciplinary actions levied against brokers and firms. Part 2 highlights FINRA’s efforts to improve investor protections and enhance market transparency.

FINRA and the FINRA Investor Education Foundation successfully initiated several outreach strategies in 2012 to help investors better understand their investments, including the distribution of more than 630,000 educational brochures and other resources. In addition, the FINRA Foundation delivered its Outsmarting Investment Fraud curriculum to more than 9,000 investors at more than 170 live events nationwide.

Other notable achievements by FINRA in 2012 include the following:

• In November, FINRA unveiled data on the outcomes of cases heard under its all-public panel program. Implemented in February 2011, the program gives investors the option of a panel comprised of all public arbitrators vs. a panel made up of one arbitrator with securities industry experience (non-public arbitrator) and two public arbitrators. The all-public panel option represents an investor-friendly change to the program and is designed to ensure a fair playing field for all parties. To date, findings show the following: In cases decided by three public arbitrators, customers were awarded damages 51% of the time. In comparison, investors were awarded damages 32% of the time in cases decided by a panel comprised of one non-public arbitrator and two public arbitrators.

• In July, FINRA implemented a new suitability rule requiring a broker/dealer or their associated persons to have a “reasonable basis” to believe a recommended transaction is suitable for the customer, based on information obtained through “reasonable diligence” to understand a customer’s investment profile.

• The Securities and Exchange Commission (SEC) approved a rule requiring FINRA-regulated firms that sell an issuer’s securities in a private placement to file a copy of any private placement memorandum, term sheet or other offering document that the firm used within 15 days of the date of the sale with FINRA. The rule enhances FINRA’s oversight of firms’ sales activities in private placements and became effective in December 2012.

• FINRA increased investors’ ability to obtain information on financial professionals through BrokerCheck by including a zip code search and a combined search function that provides easy access to information on investment advisers from the SEC’s Investment Adviser Public Disclosure (IAPD) database. FINRA also obtained approval in September 2012 to file proposed rule changes to require firms to include a reference and a link to BrokerCheck on their Websites; to provide for disclosure of additional information through BrokerCheck; and to establish the legal and technical framework for the provision of BrokerCheck data.

Every year, consumers lose millions of dollars in bogus investment scams and Ponzi schemes. Now, a new Website aims to educate investors on how to avoid investment fraud, risky investments and unlicensed brokers.

The Website – BBB Smart Investing – was created through a partnership between the Better Business Bureau and the FINRA Investor Education Foundation. The site provides a wealth of tools, information and resources designed to help investors better protect and manage their money.

Consumer financial fraud is a serious problem in United States. According to the Federal Trade Commission and the Canadian Anti-Fraud Centre, consumers lost more than $1.5 billion to varioius types of scams in 2011. FINRA Foundation research shows that many investors are overconfident regarding their knowledge of financial management, particularly Baby Boomers who are often the target of investment scams.

One telephone survey found that 92% of individuals felt “somewhat” or “very confident” about managing their finances, with almost 80% describing themselves as “somewhat” or “very” knowledgeable about investing. But only 44% got a passing grade on a basic financial literacy knowledge test.

BBB Smart Investing hopes to help change that statistic, according to Carrie Hurt, President and CEO of the Council of Better Business Bureaus.

“This is a great partnership,” says Hurt. “Even though BBB has always investigated investment scams, this gives us a whole new portfolio of prevention tools to offer to consumers. The FINRA Foundation’s basic ‘Ask & Check’ message is exactly what consumers need to hear before they make investment decisions. We think this program will go a long way toward preventing investment scams that have become so much more prevalent in recent years as people more actively manage their own retirement funds.”

LPL Financial LLC is among five firms fined by the Financial Industry Regulatory Authority (FINRA) for failing to deliver mutual fund prospectuses.

As reported Jan. 2 by Investment News, LPL Financial LLC agreed to pay a $400,000 fine as part of the agreement; State Farm VP Management Corp., $155,000; Deutsche Bank Securities Inc., $125,000; Scottrade Inc., $50,000; and T. Rowe Price Investment Services Inc., $40,000.

In the settlement, FINRA stated that LPL relied on its brokers to deliver prospectuses, but had no procedures in place to determine if the documents were delivered late. Over FINRA’s review period of January 2009 through June 2011, LPL was required to deliver 3.4 million prospectuses.

According to the settlement, State Farm was responsible for delivering 154,129 prospectuses during that period, at first through its brokers and later through a service provider. In each case, however, the firm had inadequate supervision, FINRA said.

Scottrade failed to deliver prospectuses in about 14,000 transactions out of 300,000. Deutsche Bank Securities missed delivery in 3,800 cases out of nearly 71,000 trades, and T. Rowe Price had 2,500 failures in more than 68,000 transactions.

Last month, LPL Financial faced sales abuse charges tied to non-traded real estate investment trusts when Massachusetts Secretary of the Commonwealth William Galvin filed civil charges against the firm for failing to supervise LPL brokers who sold investments in seven non-traded REITs.

Non-traded REITs. Elder fraud. LPL Financial. Medical Capital Holdings. Tim Durham. Provident Royalties. Tenant-in-Common investments. Those were just a few of the investment topics to dominate the financial headlines in 2012.

In January, elderly investors found themselves caught up in scams involving Provident Royalties and Medical Capital Holdings. Both firms had previously been the subject of fraud charges by Securities and Exchange Commission (SEC) for scamming investors, many of whom were senior citizens, out of millions of dollars through bogus private placement deals.

A number of broker/dealers that sold investments in either Provident or Medical Capital found themselves facing regulatory investigations, as well as arbitration claims by investors. In late January, the Financial Industry Regulatory Authority (FINRA) ordered CapWest Securities to pay $9.1 million in damages and legal fees stemming from sales of private investments in both Medical Capital and Provident Royalties. The $9.1 million award is thought to be one of the single largest arbitration awards based on sales of failed private placements.

In February, tenant-in-common (TIC) investments and DBSI were big news. A one-time leader in the TIC industry, DBSI was now the focus of a criminal probe. DBSI founder and CEO Doug Swenson also faced charges of tax evasion, money laundering, racketeering and securities fraud.

DBSI, which filed for bankruptcy protection in 2008, left many of its 10,000-plus investors minus their life savings, while others took devestating financial losses. James Zazzaili, the court-appointed examiner in DBSI’s bankruptcy, stated that DBSI executives ran “an elaborate shell game, one that included improper and fraudulent use of investor money to prop up the company, to spend on pet projects, and to enrich themselves.”

In March, investors in several non-traded real estate investment trusts (REITs) received an unwelcome wake-up call when their investments unexpectedly declined sharply in value. Pacific Cornerstone Core Properties REIT fell by than 70%; investors in the non-traded REIT learned of the news via a letter from the REIT’s chairman that shares of Cornerstone, once priced at $8, were now worth $2.25.

Other REITs that followed down similar paths Cornerstone in 2012 included the Behringer Harvard Short-Term Opportunity Fund I LP and the Behringer Harvard Opportunity REIT I.

In April, shoddy private placements deals and the lawsuits that later ensued were behind the shuttering of yet another broker/dealer. On April 13, after losing an arbitration claim in March for $1.5 million, Cambridge Legacy Securities LLC filed its withdrawal request with FINRA. Several days later, the company sought bankruptcy protection.

April also witnessed the less-than-desirable IPO of Inland Western REIT. The REIT, now called Retail Properties of America, went public at $8 a share on April 5. The $8 per share price fell well below the expected price of $10 to $12. But that $8 valuation was the result of a 10-to-1 reverse stock split and distribution plan that may have cost pre-IPO investors as much as 70% of their initial investment.

In May, non-traded REITs again reared their ugly head when a FINRA arbitration panel ruled in favor of an investor’s claim against David Lerner Associates and the company’s Apple REIT Nine. FINRA further stepped up its scrutiny of the non-traded REIT sector in May by launching inquiries into several broker/dealers and their sales of the products.

In June, the SEC put life insurers on notice by instructing them to improve their product disclosures, protect legacy variable annuity clients and ensure that swapped benefits were indeed suitable for certain clients.

Investment scams involving financial aid, health insurance and Ponzi schemes also saw significant increases across the country in June.

Check back for Part 2 of our 2012 Year in Review wrap-up!

Troubles at large and smaller brokerage firms – from allegations of misappropriation of funds to bankruptcies – are leaving more investors with questions – and concerns – about the safety of their assets.

“There’s a big difference between doing business with a national or regional brokerage firm and a smaller one,” said Mark Maddox, founder of Maddox, Hargett & Caruso, P.C. in a Nov. 23 Wall Street Journal article. Maddox, an Indianapolis-based lawyer, has represented investors in arbitrations against both small and large brokerage firms.

Larger brokerages such as UBS or Morgan Stanley Wealth Management or online firms such as Fidelity Investments and Charles Schwab are often thought of as more secure and less likely to fail, experts say.

But, as the WSJ article points out, some investors prefer the homegrown touch of smaller brokerage firms to their bigger counterparts. To ensure their money stays safe, investors should consider several factors, according to the article.

Among those considerations: Choose the right type of account. A cash account compared to a margin account is safer. It’s also important to check the Broker Check Web site of the Financial Industry Regulatory Authority (FINRA) to view the history of regulatory actions or civil proceedings against a firm or broker.

In addition, research the firm’s reputation and balance sheet.

“If a firm is thinly capitalized, you want to stay away from it,” Maddox said in the Wall Street Journal article. Case in point: Hudson Valley Capital Management. Earlier this month, the New York-based firm was expelled from the securities industry after its chief executive allegedly used customer assets to cover up losses he sustained while day trading. As of Sept. 30, 2011, Hudson Valley Capital had only about $80,000 in assets.

Maddox also advises asking the brokerage firm if it has professional liability insurance. If it does, and it commits malpractice that costs clients money, they will be able to recover what is owed to them. Maddox recommends asking for a copy of the declaration page of the policy that summarizes the firm’s coverage.