Massachusetts Secretary of State William Galvin is suing RBC Capital over sales of leveraged and inverse exchange-traded funds (ETFs), accusing the firm of selling the products to clients who didn’t understand what they were buying.

As reported July 20 by Bloomberg, Galvin contends that RBC Capital and Michael D. Zukowski, a former RBC agent, used “dishonest practices” in selling the investments. The lawsuit seeks restitution to Massachusetts investors, a cease and desist order, and an administrative fine.

“The point of the complaint is not that the investors lost money,” Galvin said in a statement. “The dishonesty here is that the investors, and indeed the agent soliciting their investment, did not understand the workings of these funds.”

Galvin’s probe into leveraged and inverse ETFs began in July 2009, shortly after the Financial Industry Regulatory Authority (FINRA) issued a warning about the products and their suitability for long-term investors. Leveraged ETFs use swaps or derivatives to amplify daily index returns; inverse funds are the reverse – they move in the opposite direction of their benchmark.

Galvin alleges that RBC’s Zukowski sold clients “non-traditional” ETFs without proper training or supervision and that RBC failed to have practices in place to prevent unsuitable sales until Dec. 22, 2009, six months after FINRA’s warning.

The Financial Industry Regulatory Authority (FINRA) has fined SunTrust Robinson Humphrey (SunTrust RH) and SunTrust Investment Services (SunTrust IS) $5 million for violations connected to sales of auction-rate securities.

According to FINRA, SunTrust RH, which underwrote the investments, failed to adequately disclose to investors the fact that the auctions for the products could fail. Moreover, the company did not share material non-public information with investors, use sales materials that properly described the risks associated with auction-rate securities or have adequate supervisory procedures and training in place concerning the sales and marketing of auction-rate securities.

FINRA says SunTrust IS also had deficient ARS sales material, procedures and training.

Beginning in late summer 2007, FINRA says that SunTrust RH became aware of certain stresses in the ARS market and the risk that auctions might fail. At the same time, SunTrust RH was told by its parent, SunTrust Bank, to reduce its use of the bank’s capital and to examine whether it had the financial capability in the event of a major market disruption to support all ARS in which it acted as the sole or lead broker/dealer.

As the stresses in the ARS market increased, FINRA says SunTrust failed to adequately disclose those increased risks to its sales representatives. Instead, it encouraged them to sell SunTrust RH-led ARS issues in order to reduce its inventory. Consequently, certain SunTrust RH sales representatives continued to sell auction-rate securities as safe and liquid investments.

In February 2008, SunTrust RH stopped supporting ARS auctions, knowing that those auctions would fail and the auction-rate securities would become illiquid.

Additionally, FINRA found that on Feb. 13, 2008, SunTrust RH shared material non-public information regarding the potential refinancing of certain ARS issuers with SunTrust Bank, which were contemplating investing in ARS. This information was material because SunTrust Bank was assured that if the auction market froze, it would likely be able to dispose of the illiquid investments on the date the auction-rate securities were refinanced.

Lured by false promises of big yields and high returns, investors often make the mistake of putting their money into one investment basket – one that contains risky and obscure financial products that fail to live up to their hype.

On July 25, the Financial Industry Regulatory Authority (FINRA) issued an Investor Alert on this very subject. In the alert, FINRA offers insight on why more investors are “chasing returns,” meaning they are putting their assets into more and more riskier investments.

Many investors do not realize they could be taking on more risk if they invest in products with higher returns, FINRA says. Those investments include non-traded real estate investment trust (REITs), high-yield bonds, structured products and floating-rate loan funds.

Before investors consider moving their assets to another investment, FINRA suggests that they ask themselves the following questions:

• Does the higher return from the investment come with increased risk? In most cases, the answer is “yes,” FINRA says.
• Do you thoroughly understand how the investment operates? A number of investments come with an unwanted surprise, such illiquidity, exit fees, loss of principal or the return of the investment in a form other than cash.
• Are there costs and fees associated with the new investment? Not only is the promise of higher return associated with greater risk, but some of these investments have higher costs, as well.
• Is the product callable? A callable investment means that after a period of time, the issuer can redeem the investment prior to the investment reaching maturity.
• Could the new investment be fraudulent? Legitimate investments that promise returns of 30, 50 or even 100% annually without any risk to your principal exist only in fantasy land. To confirm the status of an individual broker or firm, use FINRA’s BrokerCheck. To check the status of an investment adviser or firm, use the Investment Adviser Public Disclosure database.

The bottom line: It’s important to read and understand the fine print about an investment before deciding to put your money into it. In almost every instance, a product that promises high yields and returns also comes with considerably more risk – and a greater potential for financial loss.

To learn more about various investments that investors are turning to as a way to “chase returns,” go to tiny.cc/z6kty.

Non-traded real estate investment trusts (REITs) known as Apple REITs are facing a mountain of legal complaints by investors and regulators alike. In June, the Financial Industry Regulatory Authority (FINRA) filed a disciplinary action against broker/dealer David Lerner Associates in connection to the investments.

For months, clients of Lerner have been receiving account statements showing the value of several Apple REITs as $11 each. Unfortunately, those account statements failed to reveal the true problems behind the investments.

As reported June 2 by the New York Times, Apple REIT No. 8 had to make mortgage payments on four hotels it owns, and may have to surrender the properties to the lenders. Yet, it had not written down the values of those hotels on its financial statements.

In its disciplinary action against Lerner, FINRA accuses the company of misleading investors in selling the current Apple REIT, No. 10. It said Lerner was “targeting unsophisticated and elderly customers with unsuitable sales of this illiquid security” and misled them regarding the record of earlier Apple REITs. FINRA further stated that shares were sold to customers for whom such risky investments were unsuitable; it also claims there was deception in the way the shares were marketed.

In 2009, FINRA issued a notice to broker/dealers on non-traded REITs and the fact that they were being listed at original value long after the values should have been changed. As a result, amendments were made requiring the investments to be valued based on information no more than 18 months old.

One day following FINRA’s most recent action against Lerner, an investment management company announced a tender offer to buy up to 5% of the outstanding Apple No. 8 shares. The offer wasn’t for $11, however. It was for $3.

Non-traded REITs are registered with the Securities and Exchange Commission (SEC), but they are not publicly traded. The Apple REITs will repurchase a small number of shares each year, but most investors must wait five years or more to get their money back. That happens when the REIT either liquidates or begins to trade publicly.

In 2010, sales of non-traded REIT shares by sponsors raised $8.3 billion from investors, according to figures compiled by Blue Vault Partners, a research firm.

Shares of non-traded REITs are sold by broker/dealers like Lerner, which gets big commissions from the sales. In the case of the Apple REITs, 10% of the purchase price went to Lerner, according to the New York Times story. Meanwhile, Glade M. Knight, chief executive of the Apple REITs, collected a 2% commission for every hotel purchased by the REIT. That’s on top of the advisory fees he was paid. He can collect another 2% when the hotels are sold.

David Lerner Associates gets the majority of its income from selling the Apple REITs.

If you are an investor in the Apple REITs through David Lerner Associates, please contact us to tell your story.

An Apple REIT a day is keeping investors at bay. With apologies to the childhood saying, investors who own shares in Apple Real Estate Investment Trusts are finding out their investments may be worth far less than they ever imagined.

A disciplinary complaint was filed last month by the Financial Industry Regulatory Authority (FINRA) against David Lerner Associates, the sole brokerage that sells Apple REIT shares. In its complaint, FINRA says that Lerner failed to comply with the industry’s stringent due-diligence standards when it sold shares in the $2 billion Apple REIT 10, which launched in January.

FINRA goes on to say that Lerner targeted unsophisticated and elderly customers to buy Apple 10 shares. Moreover, FINRA says Lerner cited the distributions of previous Apple REIT companies on its Web site but failed to reveal that many of the distribution rates had dropped and distributions had exceeded funds from operations at Apple REITs 6 through 9.

As reported July 20 by the Virginia Business Journal, those distributions totaled $118.1 million in 2010 at Apple REIT Nine, while its funds from operations totaled only $60.2 million.

FINRA also stated in its complaint against Lerner that shares in Apple REITs 6 through 9 had been valued at $11 a share since their initial offerings. However, after a California firm made a tender offer of $3 a share for shares of Apple REITs 7 and 8 in June, the Apple REITs revised the $11 figure – stating in a filing that the shares had a book value of $7.57 each.

Glade M. Knight is the founder, chairman, and CEO of Apple REIT Cos. His company has issued nearly $6.8 billion in securities to about 122,600 customers, according FINRA. Both Knight and Apple REIT Cos. have been named in at least two class action lawsuits filed in June 2011 against David Lerner Associates.

If you are an investor in the Apple REITs through David Lerner Associates, please contact us to tell your story.

Clients of David Lerner Associates who own shares in non-traded REITs created by Apple REIT Cos. are not happy campers these days. When their account statements arrived in the mail last month, the value of their Apple REIT shares was designated as “not priced.”

The wording comes as a shock because for years shares of the non-traded REIT were listed at $11. As reported July 17 by Investment News, David Lerner continued to list the same price even after the Financial Industry Regulatory Authority (FINRA) instructed broker/dealers in 2009 to adjust prices on the investments more frequently.

Moreover, FINRA prohibited broker/dealers from using information more than 18 months old to estimate the value of a non-traded REIT.

FINRA filed a complaint against David Lerner in May, alleging that the firm has misled investors, as well as marketed unsuitable investment products to them.

In total, David Lerner has recommended and sold nearly $6.8 billion in Apple REIT shares since 1992, according to FINRA’s records.

A broker/dealer that switches a security’s value to “not priced” isn’t unheard of, but it is far from the norm, attorneys say.

“The price of $11 per share is most likely a misrepresentation of its true value, which is almost impossible to ascertain and price,” said Phil Aidikoff, a plaintiff’s attorney who has been following the David Lerner case but has no investors with the firm as clients in the Investment News article.

“Issues of pricing have been going on for a long time in the securities business,” Aidikoff said.

FINRAs complaint against David Lerner has sparked new concerns among broker/dealers about the sales of illiquid investments such as non-traded REITs and private placements.

Elder financial fraud is a hidden but growing crime in the United States. Each year, victims are financially abused by family members, friends, strangers and businesses to the tune of $2.9 billion, according to a new study by MetLife Inc. Experts says the figure actually may be much higher, because some 80% of the cases are never reported to authorities.

According to the MetLife study, women are twice as likely as men to be victims of elder financial abuse. Most victims are between the ages of 80 and 89, living alone, and require some level of help with either health care or home maintenance. Nearly 60% of the perpetrators of elder financial fraud are men, mainly between the ages of 30 and 59.

During the holidays the number of news articles increase and the character of elder financial abuse changes, according to the study. Of the 1,128 articles on elder abuse identified through the newsfeeds between November 2010 through January 2011, 354 (31%) concerned elder financial abuse. At least one-quarter (27%) of the cases reported were random, predominantly single-event crimes accounting for relatively small monetary rewards and characterized by a high level of brutality and disregard for human life. Reports of elder financial abuse perpetrated by strangers and by friends and families showed similar results (47% vs. 45%, respectively).

As reported July 17 by Investment News, financial advisers play a key role in detecting potential elder financial fraud because they are the ones who should be regularly reviewing the financial accounts of their elderly clients. Older clients also might be more willing to open up to their adviser about financial scams for which they have become victims — even when they’re unwilling to tell their own family members.

Advisers also have the financial knowledge to review investment opportunities for older clients who might not understand the risk of certain products, according to the Investment News article.

Senior citizens are especially vulnerable to financial fraud because they may be cognitively impaired or simply confused by complex financial products. Research from behavioral economist David Laibson shows that as people age they tend to make poorer financial decisions. In other instances, older people are often lonely and therefore more willing to talk to strangers.

Signs that an elderly person is being targeted for financial fraud include efforts to hide recent financial losses, a boost in transactions, or requests to change the names on accounts, says Sandra Timmermann, director of the MetLife Mature Market Institute, which conducted the MetLife study.

“These could indicate a “sweetheart scam’ or the financial demands of a neighbor or caregiver,” she says.

Broker/dealer Raymond James Financial has agreed to pay a $1.7 million fine and buy back $300 million in auction-rate securities from clients as part of a settlement with eight states and the Securities and Exchange Commission (SEC).

Broker/dealers have been dealing with the auction-rate securities debacle since February 2008, when the market froze for the products came to a standstill. As a result, thousands of individual and institutional investors were left holding illiquid investments.

In August 2008, Raymond James announced that it was the subject of several investigations by state securities regulators over the auction-rate securities its registered reps had sold to clients.

As reported June 29 by Investment News, the states leading the charges against Raymond James’ settlement are Florida and Texas. Other states involved include Indiana, Missouri, New York, North Carolina, Pennsylvania and South Carolina.

Like many broker/dealers, Raymond James’ registered representatives and financial advisers allegedly characterized auction-rate securities as “cash equivalents” and “highly liquid” short-term investments to customers. In reality, the supposedly “cash-like products” became illiquid investments after the Wall Street firms that once supported the auction-rate market pulled out entirely.

Soured investments in real estate deals and private placements involving Medical Capital and Provident Royalties have caused a number of broker/dealers to go belly up this year. Closures of broker/dealers, in fact, are outpacing new entrants into the market. Between May 2010 and May 2011, a total of 336 broker/dealers notified the Financial Industry Regulatory Authority (FINRA) that they were closing their doors for business. By comparison, 190 new B-Ds came on board.

And there appears to be more bad news ahead. As reported June 23 by Investment News, the Compliance Department predicts that the broker/dealer industry could see an 11% net loss of broker/dealers by 2014.

The dwindling number of broker/dealers came to a head this year, highlighted by the failures of such names as GunnAllen Financial, QA3 Financial Corporation and Jesup & Lamont Securities.

Other well known B-Ds like Securities America also have come under fire because of legal troubles connected to private-placement sales in Medical Capital Holdings and Provident Royalties. Both companies were charged with fraud by the Securities and Exchange Commission (SEC) in July 2009.

Most recently, California-based MCL Financial Group filed its broker/dealer withdrawal form with FINRA. Last year, the receiver for bankrupt real estate syndicator DBSI sued MCL in an attempt to recover commissions generated from sales of tenant-in-common exchanges (TICs). According to court documents, MCL collected $210,000 in commissions from selling TICs issued by DBSI.

Earlier this month, WFP Securities of San Diego, California, also notified FINRA of its plans to shutter. WFP is facing more than $14 million in legal claims, after having sold more than $27 million of private placements issued by Medical Capital Holdings and $6.8 million issued by Provident Royalties.

Investors are suing David Lerner Associates, claiming the company acted negligently in the sale and underwriting of more than $6.8 billion in shares of Apple Real Estate Investment Trusts.

According to the complaint, Lerner allegedly misstated the business model of the REITs in question and misrepresented the value of shares and returns to investors.

As reported June 20 by Bloomberg, David Lerner has collected more than $600 million in fees and commissions over the past seven years while five Apple REITs have made more than $6 billion in proceeds. According to the story, the firm marketed the REITs as appropriate for conservative investors, stating they had never lost money by investing in hotels.

In reality, however, investors who acquired interests in the Apple REITs incurred substantial unrealized losses because their interests are now worth far less than the price paid to acquire them.

This isn’t the first time David Lerner Associates has faced legal issues. Last month, the Financial Industry Regulatory Authority (FINRA) accused the company of overcharging customers regarding sales of municipal bonds and mortgage securities. In 2004, Lerner was fined by the National Association of Securities Dealers over sales contests that promoted proprietary mutual funds and certain variable annuity and variable life insurance products.

Then, a year later, Lerner was fined for airing advertisements that exaggerated the brokerage’s investing record.

In 2006, Lerner was fined $400,000 for violating disclosure rules in the sale of variable life insurance and annuities. In each of the settlements, David Lerner neither admitted or denied any wrongdoing.