It seems like every day there is a new “hot stock” being pushed by financial pundits and brokerage houses alike.  Seadrill Limited (ticker symbol, SDRL) was once one of these hot stocks, but it has since fallen from grace, with wide reports that it will be declaring chapter 11 bankruptcy by early next week.  SDRL’s stock was known for its generous quarterly dividend, and, to the detriment of retiree investment portfolios, benefited from excessive promotions it received from those within the brokerage and investment industry.

SDRL is an offshore deep-water drilling contractor in the oil and gas sector.  It was founded in 2005 by John Fredriksen, a Norwegian-born billionaire, who was well-known for his triumphs in the oil and shipping industry during the 1980s.  The company grew quickly by way of aggressive management and acquisitions, and its stock price in September of 2013 surged to its high of over $47 per share.  However, SDRL has since spectacularly nosedived, falling by more than 99% in value to its current trading price of $0.23 per share.

As early as February 2012, Mad Money’s Jim Cramer was bullish on SDRL.  But so were big name brokerage firms like Morgan Stanley, which issued a research report in November 2013 that confidently touted SDRL as an overweight value stock.  In a subsequent research report from March 2014, Wells Fargo Securities named Seadrill’s subsidiary, Seadrill Partners, LLC (ticker symbol, SDLP), its “top Marine MLP Pick” and predicted “solid distribution growth” through 2015.  Notably, SDLP’s investment performance took a similar trajectory to its parent SDRL, at one-point trading over $34 per share in August of 2014, but now sitting barely above $3 per share today.

This is Part 2 of an article we posted last week on former NBA-great, Tim Duncan, where we introduced the investing lessons that could be gleaned from Duncan’s relationship with his former financial adviser, Charles A. Banks, who was permanently barred from the securities industry and is now serving a four-year prison term after pleading guilty to wire fraud.

For background on this story, it is a good idea to read Part 1 of this series, where we revealed our first lesson, which was to be wary of the financial adviser who constantly brings you deals.  While this might create the impression that your adviser is knowledgeable and has the inside scoop, it is frequently a sign of an adviser who is exposing you to unnecessary risk and trying to earn commissions or undisclosed fees that will eat away at your principal.

A second lesson from this sad story is to recognize a common fraud tactic, which may seem innocent, but should set off alarm bells and have you looking for a new financial adviser.  This is when an adviser asks a customer to sign a blank form or just a signature page, as Banks did with Duncan.  The adviser will often justify the practice as a time-saver and present it to the customer as a convenience, such as dropping blank forms in the mail with affixed post-it-notes that simply point the investor where to sign.  This request often sounds benign or reasonable to an investor, but it is in fact illegal and happens more often than many people realize.  Though this practice may seem harmless, signing forms in the absence of one’s adviser deprives the investor of an in-person interaction to ask useful questions and to have the adviser explain all the investment risks and hidden fees that may be associated with the investment.

Last month we learned that Tim Duncan’s financial adviser was sentenced by a federal court to four years in prison for defrauding the NBA legend of $7.5 million.  Duncan earned over $220 million during his playing career, so he is by no means financially ruined, but there are some good lessons to learn about investing and placing too much trust in the person who manages your money.

Tim Duncan is an accomplished, 15-time NBA All-Star and future Hall of Famer.  He retired in July 2016 after playing nineteen seasons of professional basketball with the San Antonio Spurs.  In today’s age of free agency and mega-million-dollar commercial endorsements, it is a rarity for a player to play his entire career with a single franchise.  As one of the greatest to ever play the game, Duncan could have sought greener pastures and taken his talents to the highest bidder in any city of his choosing.  Instead, he was noted for having taken yearly pay cuts to stay in San Antonio to allow the Spurs to remain under the league salary cap while paying for talent at other positions.  Duncan was generally known for his loyalty and being the consummate teammate and role model for fans and younger players.  His loyalty on the court perhaps says a lot about how he conducted himself off the court, where he showed similar trust and loyalty to the people in his daily life, including his financial adviser.

Last month, Duncan’s financial adviser, Charles A. Banks, IV, made headlines when a federal court in Texas issued a judgment against Banks, convicting him of wire fraud, and sentencing him to 48 months in prison followed by three years of supervised release.  The court also ordered Banks to pay $7.5 million in restitution.

It takes a lot of courage to report illegal or fraudulent misconduct by one’s own employer.  This is because being a whistleblower carries significant risks.  Whistleblowers not only risk their current employment, but possible ongoing retaliation that can harm their industry reputation and ability to find work with employers in the future.  Reporting wrongdoing can also invite significant emotional hardship and threats to one’s personal safety.  So why would anybody want to be a whistleblower?

For most with a moral compass, often doing the right thing is reward enough.  But there are an increasing number of laws, which now provide additional incentives – both in terms of anonymity and financial remuneration.  Depending on where one lives in the United States, there are various state whistleblower laws that could apply.  Federal laws tend to provide the most financial incentive, and in particular, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), which was signed into law in 2010, as a measure to address the 2008 collapse of the financial services market.

Dodd-Frank was a notable expansion on pre-existing federal whistleblower laws for several reasons.  The earlier Sarbanes-Oxley Act of 2002 (SOX), which was a measure in its own right to address the failings that led to the 2001 financial crisis, provides civil protections to employees (including officers or subcontractors) of a publicly traded company against any kind of retaliation by the employer.  While SOX has led to multi-million-dollar financial verdicts for the whistleblower, Dodd-Frank expanded eligibility of who could become a whistleblower, from employees under SOX, to anybody.  Section 78u-6(a)(6) of Dodd-Frank defines a whistleblower as follows:

Financial exploitation of the elderly by a financial advisor can take many shapes and forms, and it is indeed possible to recover one’s financial losses from the broker or financial institution who carried out and supervised the misconduct.  Wrongdoing by a financial professional can be difficult to expose because it often arises out of relationships built on trust, and can go undetected for many years by the affected senior and family members.

Some types of broker misconduct are easier to identify than others.  Cases of outright fraud, for instance, could include the broker forging an elderly customer’s signature, falsely representing the worth or activity in an account, omitting the risks of a particular investment, recommending and selling unnecessary investment products (e.g., certain annuities), or trading excessively in a customer account solely to generate commissions (otherwise known as “churning”).  Regardless of motive or intent, an investor’s financial losses from the misconduct can be no less catastrophic.  If anything, this should point to the incidence rate of financial abuse amongst the elderly to be more prevalent than many people realize.  Indeed, research has shown that American senior citizens lose over $36 billion per year from financial exploitation.  That number is only expected to rise with increasing life expectancy and the expanding demographic of senior citizens within the United States.

Financial elder abuse is also greatly underreported.  According to the National Adult Protective Services Association, only 1 in 44 cases of financial abuse is reported.  The National Center for Elder Abuse points to studies that have identified feelings of shame as being one reason for the underreporting, in part related to the embarrassment of having fallen victim to financial fraud, but also to the embarrassment of having to disclose that one is suffering from age-related memory loss or cognitive decline.  On this latter point, memory impairment of an elderly investor only adds to the underreporting of broker misconduct.

Can I Sue My Brokerage Firm for Filing a False Form U5?

Financial firms that deal in securities do carry legal liability for filing a Form U5 with false information, and financial advisors can indeed sue their former firms for filing an inaccurate Form U5.

Whenever a brokerage firm terminates the employment of a broker or financial advisor, the firm must file a Form U5 – the Uniform Termination Notice for Securities Industry Registration – with the Financial Industry Regulatory Authority (FINRA) within thirty days of termination.  The Form U5 is differentiated from the Form U4 – the Uniform Application for Securities Industry Registration or Transfer – which is filed upon a broker’s registration with a firm, whereas the Form U5 is filed upon the broker’s termination. The Form U5 requires a firm to provide accurate answers to various questions, including the reason for a broker’s termination.

The short answer is no.

When a customer opens an investment account with a brokerage firm, he or she is typically given the option to choose between a discretionary or non-discretionary account.  A discretionary account gives the assigned broker or financial advisor the latitude, or discretion, to buy or sell securities in the account without the customer’s prior authorization.  In non-discretionary accounts, a broker does not have that discretion and must obtain the customer’s permission prior to each transaction.

For reasons that may seem obvious, discretionary accounts are somewhat of a rarity in the brokerage world, in part because they require much more supervisory oversight than non-discretionary accounts.  Discretionary accounts are naturally prone to a higher risk for abuse or mismanagement of funds, as there is less customer input and oversight of the trading.  Thus it should be no surprise that the securities laws for discretionary accounts are especially geared towards investor protection.

As reported in the Wall Street Journal, there has been a recent trend at big brokerages of shifting the power from the headquarters to brokers and branch managers. Apparently big brokerages like Bank Of America, UBS Group, and Merrill Lynch are “unleashing” their brokers and moving power closer to the brokers and their managers, both to keep brokers from leaving their firms and to increase revenues.

These modifications come in the wake of declining revenues and broker exoduses several big brokerages have experienced after the financial crisis. They have also witnessed that brokers who dislike or disagree with their managers and find them unhelpful tend to leave the brokerages more easily. The big brokerages have had to deal with rising regulatory costs and competing with an increasing number of independent advisers. According to research conducted by consulting groups, the registered investment adviser model is more successful as it is a smaller and more tightly integrated groups. Taking a cue from that, the zillion dollar brokerages are making changes aimed at empowering, training and giving their brokers more control over day to day decisions over clients, growth, and resource allocation. Merrill Lynch has plans to restructure the brokerage leadership, emphasize more on productivity and training, and reduce the number of divisions. UBS also made similar changes last year.

There are plans underway to also automate investment advisory and make use of robos to cater to a younger clientele so that the brokers can be freed up to deal with high net worth clients. All in all, this gradual shift is geared towards taking things back to how they were before the financial crisis hit, when the field agents and managers had more autonomy to structure their branches, price and sell services, be less accountable to corporate headquarters, hold more power and sway.

man-and-woman-holding-money-300x300Broker Deborah D. Kelley is allegedly one of the key figures in the $184 billion New York pension fund “pay-for-play” bribery scandal. She was reportedly arrested in December 2016 in San Francisco on charges of securities fraud, conspiracy to commit securities fraud, and conspiracy to obstruct justice in an SEC investigation. This week she was barred by the Financial Industry Regulatory Authority (FINRA).

The salacious allegations in this scandal involves the NY retirement pension fund and Navnoor Kang, its former director of fixed income and portfolio strategy, not only made newspaper headlines but was reported in prominent magazines such as Vanity Fair. Allegedly, Mr. Kang received more than $100,000 in bribes, including prostitutes, bottle service, drugs, vacations and weekend trips, expensive watches, VIP tickets to concerts from Ms. Kelly and another broker Gregg Schonhorn, in exchange for promoting the interest of Deborah Kelley’s broker-dealer. It is reported that Navnoor Kang deposited $2 billion with Ms. Kelly’s broker-dealers. Wall Street Journal reportedly quoted U.S. attorney Preet Bharara calling this a “classic case of quid pro quo corruption.”

As per FINRA records, she was registered with Sterne, Agee & Leach Inc.in 2014 and subsequently with Stifel, Nicolaus & Co. Inc. after Stifel bought the former broker-dealer. She was reported fired by Stifel for bribing the pension fund manager with entertainment and gifts to further business opportunities and misrepresentation of these expenses, as noted in the FINRA proceedings that led to her disbarment.

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There is an interesting point in this week’s Wall Street Journal titled “Brokerage Files Don’t Give The Full Pictures,” which talks about the how brokerage firms and individual brokers are held to different standards, when it comes to their BrokerCheck records. BrokerCheck, the online search tool from FINRA for brokers and brokerages, reports arbitration decisions that are not in a securities firm’s favor but not the negotiated legal settlements, whereas every settlement in a broker’s record is clearly delineated. So why does this gap exist in reporting and how does it continue to happen?

FINRA is not a government body, but it is overseen by the Securities and Exchange Commission (SEC). Within 30 days of reaching a settlement, brokerage firms are obligated to report agreements to FINRA, if the amount meets a certain threshold. However, BrokerCheck records pull information from an SEC document named “Form BD” that doesn’t ask brokerage firms about negotiated settlements. The agreement that gets reported to FINRA in the event of a settlement is not currently a part of SEC approved list of documents. This loophole in communication and reporting allows brokerage firms to maintain clean BrokerCheck records, without disclosing settlements to investors. As far as brokers are concerned, the BrokerCheck information comes from a different FINRA form that does require brokerages to disclose if they paid settlements on behalf of any employees over $15,000. It should be noted that many or most settlement payouts for brokers are actually paid for by brokerage firms and these firms are listed as co-defendants or only defendants in the FINRA arbitration proceedings.

Many individuals in the securities industry feel that data about brokerage firms should be more transparent so that they can be ranked based on this information. There are others who are “shocked” by this gaping hole in the BrokerCheck that does not paint the “full picture”, as per the WSJ story. Those in favor of the current scenario, argue that brokerage firms settle for many reasons without admitting to wrongdoing, so reporting settlements would create an unfair perception about the brokerage firm in an investors’ mind.