Advertising for private-placement securities offerings has been given the green light to move forward following approval by the Securities and Exchange Commission (SEC) last week.

In a 4-1 vote, the SEC’s action opens the door for private-equity funds, hedge funds and brokers selling unregistered securities to market the investments to the general public.

Sales will be limited to accredited investors, who are defined as individuals with a net worth of at least $1 million, excluding the value of their home, or earn at least $200,000 annually. Nearly 9 million U.S. households meet the net-wealth criteria to be accredited investors.

As reported July 14 by Investment News, as the general public is introduced to private-securities offerings through advertising, investment advisers are likely to see more demand from clients who want to take advantage of such opportunities. That then puts the onus on advisers to evaluate these often-risky and complex investments and decide whether their clients have the sophistication to thoroughly understand the risks they are taking on.

“It does put more onus on an adviser to make sure someone is an appropriate investor,” said Jennifer Openshaw, president of Finect, a compliant social-media network for the financial industry, in the Investment News story.

“Today, it’s easy to meet the $1 million threshold as an accredited investor,” she added. “But that doesn’t mean they’re sophisticated.”

The SEC’s ruling implements a provision of a law that was enacted in April 2012 – the Jumpstart Our Business Startups Act. The measure eases securities regulations for small companies.

Supporters of the law say it will help entrepreneurs raise capital. Critics, however, contend that the SEC is lifting the advertising ban without including sufficient measures to protect investors. In response to those concerns, SEC Chairman Mary Jo White recently offered a separate regulatory proposal designed to tighten the rules surrounding private-placement solicitation.

The one dissenter of the SEC who voted against dropping the 80-year-old ban on advertising is skeptical about the potential investor safeguards.

“Any protections from today’s proposal will come too late – if they ever come at all – for investors,” said SEC member Luis A. Aguilar. Aguilar added that the SEC is moving “recklessly” and is “allowing fraudsters to cast a wider net” through private-placement advertising.

A. Heath Abshure, Arkansas’ securities commissioner and president of the North American Securities Administrators Association, echoes those sentiments.

“The decision to lift the ban without simultaneous adoption of appropriate limits, guidance and investor protections for the most common product leading to enforcement actions by state securities regulators underscores the prospect that investors and issuers alike will be exposed to an indeterminate gap in protection,” Abshure said in a statement.

The culprits behind a massive multimillion-dollar private-placement fraud will soon be heading to jail. On July 3, U.S. District Judge Marcia A. Crone handed down sentences for four former executives of Provident Royalties – a $500 million oil and gas Ponzi scheme that was sold through a network of independent broker/dealers. Unable to pay the litigation costs by investors who later sued over the phony investments, many of those broker/dealers involved with the Provident offerings ultimately were forced to shutter their business.

Brendan Coughlin, 46, and Henry Harrison, 47, were sentenced to 21 months in federal prison. They founded and controlled Provident along with Joseph Blimline, 35, who already had been sentenced to 12 years in prison. Paul Melbye received a sentence of 18 months in prison.

W. Mark Miller, 59, Provident’s chief financial officer and later president, was sentenced to six months in federal prison and six months in home confinement.

In addition, the four executives were ordered to pay $2.3 million in restitution. Each had earlier pleaded guilty to conspiracy to commit mail fraud.

According to the Justice Department, the Provident executives entered into what was essentially a cover-up. Investors lost money due to Blimline’s “manipulation of investor capital prior to his departure in late 2008,” reads a statement from the Justice Department.

“From Jan. 1, 2009, to Feb. 3, 2009, even after discovering what [Mr.] Blimline had done, [Mr.] Coughlin, [Mr.] Harrison, and [Mr.] Melbye failed to disclose the dire state of the company to investors in order to take in an additional $2.3 million, while [Mr.] Miller, who knew that the crime had occurred, authorized lulling payments to investors to conceal the crime from discovery.”

The sentencing of the four men follows a recent announcement by the Securities and Exchange Commission (SEC) approving a rule to allow advertising for private-placement offerings such as the one associated with Provident Royalties. The SEC’s ruling lifts an 80-year prohibition on the practice.

That decision has many concerned. As reported July 11 by Investment News, following the vote, Commissioner Luis A. Aguilar warned that the SEC was moving “recklessly.” He further warned that the regulator’s backing of private-placement advertising would allow fraudsters “to cast a wider net.”

 

 

Sales involving alternative investment products sold to elderly investors has an unleashed an investigation by Massachusetts securities regulators into 15 brokerage firms. The firms include LPL Financial LLC, Morgan Stanley, Merrill Lynch, UBS Securities LLC, Fidelity Brokerage Services LLC, Charles Schwab & Co. Inc., Wells Fargo Advisors, TD Ameritrade Inc., ING Financial Partners Inc.,  Commonwealth Financial Network, MML Investor Services LLC, Investors Capital Corp., Signator Investors Inc., Meyers Associates LP, and WFG Investments Inc.

As reported yesterday, the Massachusetts securities division has sent subpoenas to the firms being targeted, asking for information on sales of the products to state residents who are 65 or over.  Among the non-traditional investments included on the list:  Oil and gas partnerships, private placements, structured products, hedge funds and tenant-in-common offerings.

Massachusetts is demanding information on any such products that have been sold over the past year, the investors who purchased them, the commissions generated, how the sales were reviewed, and all relevant compliance, training and marketing materials used for marketing and sales purposes.

The firms have until July 24 to respond.

This isn’t the first time that Massachusetts has come down hard on broker/dealers for alleged improper sales of certain alternative investments. In May, the state settled cases involving non-traded REITs with Ameriprise Financial Services; Commonwealth Financial Network; Lincoln Financial Advisors Corp., Royal Alliance Associates; and Securities America. The five firms agreed to pay a total of $6.1 million in restitution to investors, as well as fines totaling $975,000.

In February, Massachusetts reached a similar settlement with LPL Financial, which agreed to pay at least $2 million in restitution and $500,000 in fines related to sales of non-traded REIT investments.

The REIT investigations “heightened my concern that the senior marketplace is being targeted for the sales of these high-risk, esoteric products,” said Massachusetts Secretary of the Commonwealth William F. Galvin in a statement yesterday.

“While these products are not unsuitable in and of themselves, they are accidents waiting to happen when they are sold to inexperienced investors by untrained agents who push the products to score … large commissions.”

Last week, the Ohio Division of Securities State regulators issued a cease-and-desist order involving the non-traded real estate investment trust (REIT), Steadfast Income REIT Inc., for announcing price changes two months before they took effect.

As reported earlier by Investment News, Steadfast Income REIT disclosed its estimated value of $10.24 per share on July 12, 2012, but continued to sell the shares at a lower value of $10 per share until Sept. 10.

“Steadfast’s decision to publicly announce an offering price increase 59 days prior to implementation of the price increase created a sale period that may have artificially increased investor demand for its securities,” said the cease-and-desist order, which does not prohibit sales of the REIT in Ohio but calls a halt to the valuation practice.

The Steadfast Income REIT focuses on multifamily real estate and apartment houses, and has more than $690 million in total assets. The REIT was launched in 2009.

Announcing future valuation changes of a REIT can hurt shareholders because it undercuts the REIT’s current value, industry observers say.

“It creates a window for a discounted sales price,” according to Mark Heuerman, registration chief counsel for the Ohio Division of Securities. “It’s in the best interest of prior shareholders that the REIT sells shares for what it’s worth.”

Ohio does not have the authority to issue fines in such cases, and no restitution to investors was ordered.

Steadfast isn’t the first non-traded REIT to issue a new share valuation and then wait a period of time to change it. Earlier this year, real estate investor Tony Thompson attempted to ramp up sales for his TNP Strategic Retail Trust by highlighting the REIT’s rising valuation and lower per-share price.

In a note to broker/dealers at the beginning of January, Thompson stated the REIT’s current net asset value as 6% higher than its share price. “As of Nov. 9, 2012, estimated NAV increased to $10.60. Shares continue to be offered at $10,” the note said.

In March, the REIT halted paying dividends to investors. Today, Thompson is under investigation by the Financial Industry Regulatory Authority (FINRA) for allegedly failing to turn over documents to the regulator.

Incidents involving bad brokers or corrupt financial reps are becoming increasingly common. Most recently is the case of a mutual fund executive in Florida who promised investors early shares of Facebook and Groupon but instead used their money to buy himself lavish cars, a waterfront home and expensive jewelry.

The individual, John Mattera, was sentenced to 11 years in prison.

As reported June 21 by the Associated Press, U.S. District Judge Richard Sullivan ordered Mattera to forfeit $11.8 million. An additional restitution amount will be set within the next month.

“You’ve left a lot of wreckage in your past and you have to be punished for that. These crimes were just so selfish, so callous toward the victims,” said Judge Sullivan in addressing Mattera.

Mattera was arrested in November 2011 on charges of conning more than 100 people who invested millions of dollars with his British Virgin Islands-based Praetorian Global Fund Limited. He pleaded guilty in October to conspiracy, securities fraud, money laundering and wire fraud.

One of Mattera’s victims, Marisa Light Cain, was present at Mattera’s sentencing hearing. She stated that Mattera squandered the $100,000 she had saved to pay for college for her two sons.

Mattera has four previous convictions for similar crimes in Kentucky and Florida. He has been imprisoned since his guilty plea, a proceeding that was delayed by a day when he missed his flight from Florida. He also was found in contempt in a civil case brought by the Securities and Exchange Commission (SEC), according to the AP story.

The bottom line: Investment scams and fraudulent investments come in many forms. Falling victim to a scam can mean losing anywhere from a few hundred dollars to your life savings. At the end of the day, if the investment offer sounds too good to be true, it probably is.

Late last month, Citigroup agreed to settle a lawsuit by the Federal Housing Finance Agency that accused the nation’s third-largest bank of misleading investors and peddling more than $3.5 billion in securities backed by defective residential mortgages to Fannie Mae and Freddie Mac over a 20-month period starting in September 2005.

Financial terms of the settlement were not disclosed.

The FHFA, in its role as conservator for Fannie Mae and Freddie Mac, sued Citigroup and 17 other financial institutions in 2011. The FHFA charged Citigroup with misstating facts about the quality of the underlying mortgage loans and the practices used to originate them.

Meanwhile, the FHFA remains active in settlement discussions with other banks that are subjects of similar lawsuits.

Alternative mutual funds have exploded in popularity in recent years. But there is a dark side to alternative mutual funds. Last week, the Financial Industry Regulator (FINRA) warned investors about this very issue, cautioning them in an Investor Alert titled “Alternative Funds Are Not Your Typical Mutual Funds.” Among other things, the alert stressed the complex trading strategies and the unique characteristics and risks associated with alternative mutual funds.

“The strategies alternative mutual funds employ tend to fall on the complex end of the spectrum,” FINRA said in its Investor Alert. “Examples include hedging and leveraging through derivatives, short selling and ‘opportunistic’ strategies that change with market conditions as various opportunities present themselves.”

As their name implies, alternative mutual funds are quite different from their traditional counterparts. Alt funds typically use more exotic strategies, including options and leverage, as well as more complex asset mixes.  Alternative funds might invest in assets such as global real estate, commodities, leveraged loans, start-up companies and unlisted securities that offer exposure beyond traditional stocks, bonds and cash.

Some alt funds employ a single strategy. For instance, they may offer 100% exposure to currencies or distressed bonds. Some funds might employ a market-neutral or “absolute return” strategy that uses long and short positions in stocks to generate returns. Others may employ multiple strategies such as a combination of market-neutral strategies and various arbitrage strategies. Still others are structured as a fund containing numerous alternative funds or a special type of “fund of hedge funds,” according to FINRA.

Although the strategies and investments of alternative funds may appear similar to those of hedge funds, the two should not be confused, FINRA says. Alternative mutual funds are regulated under the Investment Company Act of 1940, which limits their operations in ways that do not apply to unregistered hedge funds. These protections include limits on illiquid investments; limits on leveraging; diversification requirements, including limits on how much may be invested in any one issuer; and daily pricing and redeemability of fund shares.

FINRA cautions investors who are considering investing in alternative mutual funds to carefully consider their investment objectives, performance history and fund manager of alternative funds before doing so.

Sales of non-traded real estate investment trusts (REITs) have once again come under the radar of securities regulators, with Massachusetts Secretary of the Commonwealth William Galvin announcing settlements with five leading independent broker/dealers that will pay at least $7 million in fines and restitution over improper sales of non-traded REITs.

The firms in the settlement include Ameriprise Financial Services, the broker/dealer arm of Ameriprise Financial Inc.; Commonwealth Financial Network; Royal Alliance Associates; Securities America; and Lincoln Financial Advisers Corp.

“Our investigation into the sales of REITs, triggered by investor complaints, showed a pattern of impropriety on the sales of these popular but risky investments on the part of independent brokerage firms where supervision has historically been difficult to monitor,” Galvin said in a statement.

Ameriprise Financial Services will pay $2.6 million in restitution and a fine of $400,000; Commonwealth Financial Network will pay $2.1 million in restitution and a $300,000 fine; Royal Alliance Associates will pay $59,000 in restitution and a $25,000 fine; Securities America will pay $778,000 in restitution and a $150,000 fine; and Lincoln Financial Advisors will pay $504,000 in restitution and a $100,000 fine.

REITs are financial products that invest in commercial real estate, including hotels, malls and other commercial buildings. Non-traded REITs do not trade on securities exchanges and therefore can be illiquid and difficult to sell in secondary markets. They also typically carry higher fees.

Earlier this year, Massachusetts regulators settled a similar complaint involving non-traded REITs with LPL Financial Holdings, alleging it failed to properly supervise brokers who sold non-traded REIT products to investors.

In total, Galvin’s office has garnered more than $11 million in restitution for Massachusetts investors and levied $1.4 million in fines from independent broker/dealers so far this year.

 

Investors who are planning to invest in municipal bonds need to do their homework; if not, they may unknowingly give their first year’s worth of income to their broker. A June 7 article by the Wall Street Journal sheds a spotlight on the murky world of today’s municipal bond market – and what investors can and should do to minimize their risks and maximize their net returns.

As the article points out, “yields on the highest-quality, widely traded munis, triple-A-rated, 10-year “general obligation” bonds have risen by 0.45 percentage point since May 1.  And while U.S. Treasury yields also have risen recently, muni yields have truly skyrocketed.”

But before jumping on the municipal bond bandwagon, investors should proceed with caution,  industry experts say. Unlike what happens with stocks, you don’t pay a commission when buying a municipal bond. Rather, you pay a “markup,” which is the difference between a broker’s cost and the price an investor pays.

The markups themselves can be astronomical. And, unfortunately, most brokers don’t disclose their markup. Regulators and market analysts agree that many retail investors have no idea how much they’re getting charged on muni trades.

Securities Litigation and Consulting Group, a research firm in Fairfax, Va., recently analyzed nearly 14 million trades of long-term, fixed-rate munis over a period between 2005 and April 2013. (You can review the SLCG report here.)

The study found that on one out of 20 trades, people who bought $250,000 or less in municipal bonds paid a markup of at least 3.04%, or approximately a full year’s worth of interest income at today’s rates. By comparison, you will pay less than $10 in commission to buy a stock at most online brokers, or 0.004% on a $250,000 purchase; a typical mutual fund charges management fees of about 1% a year.

SLCG founder Craig McCann estimates that investors paid at least $10 billion in what he considers excessive markups since 2005. That is at least twice the normal cost to trade a given bond.

“That’s more than a billion dollars a year needlessly transferred from investors to dealers’ pockets,” McCann said in the Wall Street Journal story.

Brokers have a duty to treat their customers in a good faith manner and to execute all direct orders by those customers in a precise and accurate manner. The duty that is owed to clients – often considered to be a fiduciary duty – creates varying levels of broker responsibility based on the sophistication of the customer, the customer’s prior investment experiences, the representations of the broker, and the ability of the customer to verify the broker’s representations.

Sometimes, however, the responsibility of representing the best interests of a client goes by the wayside, as was apparently the case of Ronald Wayne Nichter. Two months ago, Nichter, a former broker with Cantella & Co. Inc., was accused of allegedly forging letters of authorization by signing customers’ names without their knowledge or consent. Cantella’s clearing firm subsequently issued checks made payable to the customers in question.

Nichter admitted to fraudulently endorsing the checks and then depositing them into his own account, thereby converting funds for his own personal use and benefit. According to the Broker Check Web site of the Financial Industry Regulatory Authority (FINRA), Nichter misappropriated approximately $140,000 from 10 customers.

Nichter was employed with Cantella from 2006 to 2013. After learning of Nichter’s actions, Cantella terminated his employment with the firm. In addition, FINRA barred Nichter from associating with any FINRA firm in any capacity.