Category Archives: Uncategorized

Each year, FINRA publishes its Annual Regulatory and Examination Priorities Letter to highlight issues of importance to FINRA’s regulatory programs, Regulatory and Examination Priorities Letter.

Many of the concerns in last year’s letter remain priority again for 2016. With the recent increase in interest rates, FINRA reiterates the worries mentioned in last year’s letter regarding interest rate-sensitive products. Firms are urged to evaluate their product offerings to determine where heightened concerns about interest rate sensitivity are relevant.

FINRA Chairman & CEO Richard Ketchum says, “Firm culture, ethics and conflicts of interest also remain a top priority for FINRA. A firm’s culture contributes to, and is also a product of, a firm’s supervision and its approaches to identifying and managing conflicts of interest and the ethical treatment of customers. Given the significant role culture plays in how a firm conducts its business, this year the letter addresses how we will formalize our assessment of firm culture to better understand how culture affects a firm’s compliance and risk management practices.”

As noted in a December 31, 2015 article in The Wall Street Journal (“The Year the Hedge-Fund Model Stalled on Main Street”), more “liquid alternative” mutual funds closed in 2015 than in any year on record, according to research firm Morningstar Inc., due, in significant part, to increased market volatility.

In all, according to Morningstar, 31 liquid-alternative funds closed in 2015, up from 22 a year earlier, as inflows dwindled and performance weakened.

The results show that enthusiasm is fading for what had emerged in recent years as one of the hottest products in asset management – funds that combine hedge-fund strategies like shorting stock with the daily liquidity of mutual funds.

Assets in liquid-alternative funds grew to $310.33 billion at the end of 2014 from $124.44 billion at the end of 2010. But the inflows have slowed as performance faltered in 2015 – in fact, it is estimated, according to the WSJ article, that just $85.1 million flowed into liquid-alternative funds in 2015.

The host of funds liquidated this past year included strategies run by J.P. Morgan Asset Management, Guggenheim Partners LLC and Whitebox Advisors LLC. The closed funds were a range of unconstrained bond funds; managed future funds, which bet on futures contracts in a number of markets; and equity funds that bet on stocks rising and falling – are of which tend to have highly concentrated bets that expose investors to riskier assets than typical mutual funds do.

If you are an individual or institutional investor who has any concerns about your investment in any liquid alternative fund, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

As noted in a December 24, 2015 article in The New York Times (“Obscure Corner of Wall St. Draws Skepticism from Investors”), one obscure sector of the stock market – Business Development Companies (“BDCs”) – has been the subject of increasing controversy over some of its results and fees.

BDCs are firms that were created by Congress in 1980 to encourage investment in small businesses whose growth may generate jobs. They sell stock to the public and then use some of the proceeds to make loans to emerging businesses for a variety of needs. The category has grown tenfold over the last decade, to $64 billion in assets. That is partly because business development companies offer higher yields in exchange for the high-risk nature of their assets, and partly because they cater to a market that big banks have retreated from since the financial crisis.

One of the most criticized business development companies, however, is Prospect Capital Corporation (NASDAQ: PSEC). With $6.6 billion in assets as of September 30, 2015, Prospect is a large player in the category. But in the last year and a half, its stock price and net-asset value per share have been steadily sinking. Even before the recent junk-bond market upheaval, Prospect has traded at a discount to net-asset-value of more than 30 percent this year, well below the average of less than 20 percent for such firms.

Some analysts have accused Prospect of charging what they say are conspicuously high fees, even as investor returns have faltered. And others have taken issue with the compensation paid its chief executive, John F. Barry III — more than $100 million annually in recent years, according to estimates by former employees and an outside analyst.

Prospect invests in high-yield, high-risk assets like stocks, loans and bonds of companies through private equity buyouts, finance companies, debt pools like collateralized loan obligations, real estate investment trusts, aircraft leasing and even online loans – a significant portion of which are leveraged. Prospect’s fees, however, like those of many business development companies, are similar to those of private equity funds. Its external manager charges a 2 percent annual management fee on all assets plus an incentive fee of 20 percent of certain income gains — and administrative expenses — at the high end of the sector. For its fiscal year that ended in June, the Barry-owned manager received fees and expenses totaling $240 million, or about 3.5 percent of its total assets, according to the company’s annual report.

Some analysts say Prospect has often paid out dividends above its earnings, and sold stock below its book value, both of which can hurt investors. Both moves have helped Prospect raise its assets tenfold since 2008, also increasing fees. With its shares down 34 percent in the last 17 months, Prospect has curtailed new stock sales. As a result, growth of its assets slowed to 5 percent in its latest fiscal year from an annual rate of 58 percent over the previous five years.

One reason for Prospect’s big discount to net-asset value, now 28 percent, is that some investors are skeptical of the value Prospect reports for some assets – commonly referred to as “Level 3” assets – which means that, rather than being priced based on actual trade prices, these investments are valued by management based on their own estimates and valuation models.

The combination of leverage, questionable Level 3 valuations and excessive fees are, more often than not, an indication of potential significant concern – especially in a rising interest rate environment.

If you are an individual or institutional investor who has any concerns about your investment in Prospect Capital Corporation or any other Business Development Company (“BDC”), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

On July 28, 2015, The Investment News reported on the firm’s recent annual meeting for its advisers at which executives of the firm purportedly commented that the firm is “close to resolving significant enforcement actions.” (“LPL Financial CEO Mark Casady says Firm Close to Finish Line with Fines and Settlements”)

As noted in the article, “LPL has been in the spotlight over the past few years due to its host of problems with the Financial Industry Regulatory Authority Inc. as well as state regulators. Two products that have caused LPL to pay fines or restitution to clients have been non-traded real estate investment trusts, a popular alternative investment, and variable annuities.”

Among the recent regulatory actions, cited in the article, is the Financial Industry Regulatory Authority (“FINRA”) matter in May of 2015 which ordered LPL to pay $11.7 million in fines and restitution for what it deemed “widespread supervisory failures” related to sales of complex products between 2007 and April of 2015. According to the FINRA settlement, LPL failed to properly supervise sales of certain investments, including certain exchange-traded funds, variable annuities and non-traded REITs, and also failed to properly deliver more than 14 million trade confirmations to customers.

The article also notes that, earlier this month, FINRA ordered LPL to pay $6.3 million in restitution to clients after it allegedly failed to waive sales loads for certain mutual fund shares sold between July 2009 and the end of 2014.

If you are an individual or institutional investor who has any concerns about investments having been recommended for purchase in either your retirement or non-retirement accounts by LPL Financial, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Steven B. Caruso, the Resident Partner in the New York City office of Maddox Hargett & Caruso, P.C., has been invited to participate as a speaker at the 2015 Practicing Law Institute (PLI) conference program that will be held on Thursday, July 30, 2015.

The PLI Securities Arbitration program will be held at the PLI New York Center and will also be broadcast online by webcast.  The program brings together leading legal professionals and securities industry regulators to discuss hot topics in the securities arbitration practice area.

For more information on this conference, visit:

http://www.pli.edu/re.aspx?pk=59146&t=THF5_SARB5

On July 21, 2015, The Wall Street Journal reported on a growing number of hedge funds who are looking to profit from an anticipated decline in the prices of exchange-traded bond funds (ETFs) and liquid alternative funds. (“Hedge Funds Gear Up for Another Big Short”)

Among the hedge funds, cited in the article, who are reportedly lining up in anticipation of potential trouble at some “alternative” mutual funds and bond exchange-traded funds that have boomed in popularity among retirees and other individual investors are Leon Black’s Apollo Global Management LLC, Oaktree Capital Management LP and Reef Road Capital LLC.

The predicate for their investment thesis is that the junk bonds, bank loans and esoteric investments held by some of those funds will be extremely hard to sell if the market turns, leaving prices pummeled in a rush for the exits.

As noted in the article, “critics said both sets of products suffer from a similar weakness. They promise investors the ability to trade in and out as they would with a stock, but the underlying securities trade far less frequently, meaning there may not be buyers waiting when the funds line up to sell.”

If this prediction should come to pass, the hedge funds would then offer the liquid-alternatives funds and bond ETFs cut-rate prices for thinly traded holdings like low-rated corporate debt and bank loans when they are forced to sell to meet daily redemptions.

Just last month, for example, it has been reported that BlackRock, Inc. asked the SEC for permission to borrow from some of its mutual funds to pay redemptions in others. A spokeswoman for BlackRock is quoted as having said the firm’s liquid-alternative products were among those it may use to take advantage of the practice. The SEC decision is pending.

If you are an individual or institutional investor who has any concerns about Bond ETF or Liquid Alternatives investments having been recommended for purchase in either your retirement or non-retirement accounts, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

The New York Stock Exchange halted trading around 11:32am today, stating it was due to technology issues. We will be investigating cases for investors that had losses related to the events that happened today, July 8, 2015. Follow this link to learn more on this developing story.

http://money.cnn.com/2015/07/08/investing/nyse-suspends-trading/index.html

The SEC is examining J.P. Morgan for guiding clients to their own proprietary products and away from offerings by other firms. Generally leading to higher fees for the bank, the practice, while not banned, is closely watched by regulators. The bank says they have been responding and cooperating with the authorities. Regulators continue to monitor brokers selling their clients the right product for them, or whether they push the ones that make the firm the most money. Finance Advisers can operate under different rules depending on whether they register as an investment adviser with the SEC. If so, adherence to a fiduciary standard requiring them to recommend only those investment products that are in the best interests of their clients is required. The Government, along with industry participants have been working on policies to address alleged conflicts of interests on Wall Street for years. This April, the Labor Department released a proposal that would require brokers giving retirement advice to make recommendations in their clients’ best interests. The JP Morgan settlement with the SEC, containing their fine could happen later this summer.

Operating in the $3.7 trillion muni market, 36 municipal bond underwriters ordered collectively to pay about $9 million in compensation over fraudulent offerings, as part of the first pact of its kind with U.S. regulators.

Link to the SEC’s orders and penalty amounts:

• The Baker Group, LP – $250,000
• B.C. Ziegler and Company – $250,000
• Benchmark Securities, LLC – $100,000
• Bernardi Securities, Inc. – $100,000
• BMO Capital Markets GKST Inc. – $250,000
• BNY Mellon Capital Markets, LLC – $120,000
• BOSC, Inc. – $250,000
• Central States Capital Markets, LLC – $60,000
• Citigroup Global Markets Inc. – $500,000
• City Securities Corporation – $250,000
• Davenport & Company LLC – $80,000
• Dougherty & Co. LLC – $250,000
• First National Capital Markets, Inc. – $100,000
• George K. Baum & Company – $250,000
• Goldman, Sachs & Co. – $500,000
• Hutchinson, Shockey, Erley & Co. – $220,000
• J.P. Morgan Securities LLC – $500,000
• L.J. Hart and Company – $100,000
• Loop Capital Markets, LLC – $60,000
• Martin Nelson & Co., Inc. – $100,000
• Merchant Capital, L.L.C. – $100,000
• Merrill Lynch, Pierce, Fenner & Smith Incorporated – $500,000
• Morgan Stanley & Co. LLC – $500,000
• The Northern Trust Company – $60,000
• Oppenheimer & Co. Inc. – $400,000
• Piper Jaffray & Co. – $500,000
• Raymond James & Associates, Inc. – $500,000
• RBC Capital Markets, LLC – $500,000
• Robert W. Baird & Co. Incorporated – $500,000
• Siebert Brandford Shank & Co., LLC – $240,000
• Smith Hayes Financial Services Corporation – $40,000
• Stephens Inc. – $400,000
• Sterne, Agee & Leach, Inc. – $80,000
• Stifel, Nicolaus & Company, Inc. – $500,000
• Wells Nelson & Associates, LLC – $100,000
• William Blair & Co., L.L.C. – $80,000

The latest “hot” product being offered from Wall Street to Main Street investors is an investment in Business Development Companies (BDCs) which are either publicly registered or non-traded entities that provide financing to small and mid-sized businesses – some of which are experiencing significant financial or business difficulties.

BDCs seek to generate a higher amount of current income and, to a lesser extent, capital appreciation, through direct originations of secured debt, including first lien, first lien/last-out unitranche and second lien debt, unsecured debt, including mezzanine debt and, to a lesser extent, investments in equities.

Unfortunately, many financial advisors have pitched these products to their retail clients without having conducted the necessary due diligence on them or, of equal importance, without having an informed appreciation for the potential pitfalls of BDCs as their higher yields are typically also associated with significantly higher risks – many of which are being concealed from investors.

Notwithstanding the sales pitch that an investor may receive, it should be clear that investing in BDCs involves a high degree of risk, including credit risk, derivative risk and the risk of the use of leverage which could potentially magnify losses, and that they are, without exception, highly speculative. The securities in which BDCs invest will generally not be rated by any rating agency, and if they were rated, they would be below investment grade. Moreover, these securities, which may be referred to as “junk bonds,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal.

One of the most immediate concerns associated with BDCs, however, is the potential impact that the much anticipated increase in interest rates later this year by the Federal Reserve will have on both their business activities and their valuations since the majority of their debt investments will be long-term and will be tied to various floating rates such as the London Interbank Offer Rate (“LIBOR”), the Euro Interbank Offered Rate (“EURIBOR”), the Federal Funds Rate or the Prime Rate.

In fact, it is widely recognized that general interest rate fluctuations may have a substantial negative impact on many BDC investments (as increased interest rates from their historically low present levels may make it more difficult for their portfolio companies to service their debt) and, accordingly, this may also have a material adverse effect on the rate of return on invested capital, net investment income and the fair value determination of the net asset values of BDCs.

If you are an individual or institutional investor who has any concerns about BDC investments having been recommended for purchase in either your retirement or non-retirement accounts, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).