Articles Posted in Securities Fraud & Unsuitable Investments

Investors nationwide have been on edge after the worst annual stock market performance in a decade. China trade war tensions, rising interest rates, and the partial government shutdown have caused more volatility. With these recent swings in the stock market, some investors may notice corroborating shifts in their investment portfolio. Even in volatile markets, significant losses in a conservative or moderative portfolio should raise serious concern. Nearly all investors should have a diversified investment portfolio for protection from long-term losses. Diversification is a capital-preserving risk management method that calls for an investment portfolio to carry a variety of investments within different asset classes, countries, sectors, and companies.

Diversification is essential because correlated securities within the same asset class, sector, and country will tend to follow similar patterns.  Meanwhile, selecting securities from different areas will reduce such resulting risk.  Investment portfolios should not only include investments that differ by asset class. For example, holding many different investments tied to just the real estate sector is not a diversified portfolio. Common sectors include financial, healthcare, energy, energy, utilities, technology, consumer staples, industrials, materials, real estate, telecommunications, and consumer discretionary. Within each of these sectors, there are many excellent choices.

An investment strategy that includes diversification will, on average, yield higher returns and lower risk than a singular holding. A diversified investment portfolio has a cumulative lower variance in return or risk than its lowest asset. In a properly diversified portfolio, the decline of a few of your holdings should be countered by the state of other unaffected holdings. On the other hand, heavy concentration in one investment will leave your portfolio’s increase or decline entirely dependent on fewer factors. For instance, investing all of your money into one stock in a company that goes under will result in the loss of all your money. Ownership of more types of shares over a long time has tended to produce around 5%-8% in returns historically.

We have previously written on the concept of “churning,” which is a fraud perpetrated by brokers who buy and sell securities for the primary purpose of generating a commission, and where that activity would be considered excessive in light of the investor’s investment goals.  But is it possible to have a churning claim when a broker sells you an insurance product or recommends swapping out one variable annuity policy for another?  And can a single transaction be considered “excessive” in the context of a churning claim?  The answer to both of these questions is yes.

The law appears to provide an opening for churning claims when it comes to investors, and in particular retirees, who find themselves “stuck” with an illiquid annuity in their portfolio.  Retirees, who tend to need access to capital more than other segments of the population (due to not working and the increased medical costs associated with getting sick and old), are often sold unsuitable variable annuities, which can tie up retirement funds for decades.  Technically the investor can get of the policy, but not without paying significant IRS tax penalties and steep surrender charges, sometimes as high as 10% to 15%.  Sadly, these costs and product features are often misrepresented and go undisclosed at the point of sale.

While not all annuities are considered securities under the law, variable annuities certainly are securities.  The SEC requires the seller of a variable annuity to possess a Series 6 or 7 brokerage license with the Financial Industry and Regulatory Authority (FINRA).  Variable annuities can be distinguished from fixed annuities in that their returns are not fixed, but rather determined by the performance of the stock market.  One characteristic of a variable annuity policy is that you get to choose a fund to invest in, much like you would with a mutual fund.  Variable annuities are highly complex investment products.  They are also costly to investors, in part because of the high commissions they generate for the brokers who sell them.  Regardless of whether you were sold a variable annuity or some other type, it should be noted that FINRA requires its member brokerage firms to monitor all products sold by their brokers.

While marijuana-related investments grow in popularity, the SEC has reportedly received more associated complaints from investors. As a result, the Securities and Exchange Commission warns individuals to be mindful of certain risks before investing in marijuana-related companies. The SEC released an investor alert with this warning after medical marijuana company owner, Richard Greenlaw settled charges for allegedly offering and selling unregistered securities to 59 investors.  Signs of fraud reportedly include unlicensed, unregistered sellers; guaranteed returns; and unsolicited offers. Chiefly, Richard Greenlaw was not registered nor licensed to sell his marijuana-related investments with the Securities and Exchange Commission.

The SEC complaint, filed with the United States District Court of Maine charged the owner of NECS, Richard Greenlaw and his 20 cannabis-related entities for violating the registration provisions of federal securities laws. The 20 cannabis-related entities charged in the SEC complaint are NECS LLC, MaineCS LLC, VTCS LLC, MassCS LLC, NHCS LLC, RICS LLC, CTCS LLC, FLCS LLC, ILCS LLC, IACS LLC, LOUCS LLC, MICS LLC, MNCS LLC, NDCS LLC, NJCS LLC, NYCS LLC, OHCS LLC, PennCS LLC, UPCS LLC, and WICS LLC. It is alleged that Richard Greenlaw posted advertisements on Craigslist to offer and sell subscription agreements for securities in his companies. In response to these charges, Mr. Greenlaw agreed to pay $400,000 and accept permanent injunctions from further violations of  Section 5(a) and 5(c) of the Securities Act of 1933.

Federal securities laws mandate that any offer and sale of a security must be registered with the SEC. A company registers a security by filing financial statements, business descriptions and other legally required information with the SEC. Otherwise, the securities offering must be found to be subject to exemption under Securities Act 1933. Offerings of securities that can be exempt include those of limited size, intrastate, private and more. Exemption requirements may also require that securities be only sold to accredited investors. Thus, investment salespersons would be prohibited from selling exempted securities to any investors who do not meet the requirements. In this case, Mr. Greenlaw’s marijuana-related investments were not registered nor qualified for exemption.

If you want to find trouble on Wall Street, follow the money.  A “troubled broker” is a broker more concerned for his or her commissions than the quality of the investments he or she recommends.  Finding investors for private placements can be very lucrative for a broker, but very risky for a client.  As complaints about a broker mount on his CRD, so does the lifespan of a broker and as their career prospects dwindle, they become more desperate. While not all private placements are bad investments, they must be approached with extreme caution and are not appropriate for all investors.  If you get presented with a private placement, the very prospectus states: you should consult an attorney before signing.  It’s a mandatory disclosure that regulators believe you should get and you should not ignore it.  You should always consult a good New York securities lawyer before you give large amounts of your money to a non-public company in its infancy.  Understanding the investment, the company and doing due diligence is the only way to protect your interests.   If you don’t want to spend time or money to do that, don’t invest.  The “next big thing” your broker might be selling you on may be your “next big problem.”  There’s no free lunch.

These concerns about the multi-billion-dollar private capital markets are sound, based on a Wall Street Journal report finding that firms selling private placements have a much higher proportion of “troubled brokers”. The study compared the percentages of brokers with customer complaints, regulatory investigations and other disclosures at firms selling private placements with industry norms.  Among the worried securities industry members include former FINRA enforcement chief, Robert Bennet who allegedly proclaimed private placements as a “perennial concern for regulators.”. Private placement is the offer and sale of unregistered securities to a limited number of investors for a company’s capital generation. Our securities fraud attorneys always knew that a higher prominence of “troubled brokers” is at firms selling private placements, now our belief has been confirmed.

According to the WSJ study, of the firms selling private placements, half had at least one troubled broker out of every ten brokers.  Conversely, of the included firms that didn’t sell private placements, over 75% had less than that amount. Additionally, the analysis shows that half of the firms expelled by FINRA since 1993 sold private placements, despite comprising a lesser amount of the total industry. The private capital market has continued to rise with a reported $750 billion in sales. Given this, any insights about private placements should be known by investors, securities fraud attorneys, brokers and other affected financial industry members.

Hector May, a former highly regarded member of the community in Rockland and Orange counties, is under investigation by several governmental entities. Reportedly, allegations include that Hector May misappropriated investor funds. In a Lohud/The Journal News article, Jenice Malecki, Esq. discusses how her clients and other investors have lost millions from Hector May in what she believes to exemplify a Ponzi scheme. Given her significant experience representing Ponzi scheme victims, Ms. Malecki finds many parallels with Hector May’s actions.

A Ponzi scheme is a type of investment fraud that relies on a constant money flow of new deposits to produce false “returns” to existing investors. New deposits are never actually invested and instead directly allocated to the schemer’s personal funds. Our clients, along with other investors, lost their retirement assets when Hector May sold unsophisticated investors what appears to be fictitious “tax-free” corporate bonds, an impossible investment.  Hector May continuously increased his personal wealth at the cost of clueless investors losing their hard-earned life-savings. Eventually, Ponzi victims stop receiving promised returns, collapsing the scheme. It is very likely that Hector May was exposed from not being able to return money to a large investor. Ponzi schemes typically endure for as long as new victims continue to “invest” into the produced returns; withdrawals collapse them.

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Wall Street is constantly crafting complex and volatile products that somehow end up in the investment accounts on Main Street.  The latest turbulence in the stock markets has already been in part attributed to one of the latest Wall Street machinations:  exchange-traded-products (ETPs) linked to volatile exchanges – specifically, products linked to the Chicago Board Options Exchange (CBOE) Volatile Index (VIX).  Today alone, the Dow Jones Industrial Average closed more than 1000 points down from yesterday, and due to the volatility that is still ongoing, the devastating fallout is largely unrealized and has left investors scrambling.

Since its inception in 1993, the VIX was one of the earlier attempts to create an index that broadly measured volatility in the market.  One such ETP linked to the VIX is Credit Suisse’s VelocityShares Daily Inverse VIX Short-Term ETN (ticker symbol XIV), which the issuer just announced it will be shutting down after losing most of its value earlier this week.  Products that may be at similar risk include Proshares SVXY, VelocityShares ZIV, iPATH XXV, and REX VolMaxx VMIN.  But the risks associated with these ETPs have been well known to professionals in the securities industry, and investors who were recommended these products should have received a complete and balanced disclosure of these risks at the time of purchase.

In October of 2017, the Financial Industry Regulatory Authority (FINRA) ordered Wells Fargo to pay $3.4 million in restitution to investors relating to unsuitable recommendations of volatility-linked ETPs.  FINRA also published a warning to other firms in Regulatory Notice 17-32 regarding sales practice obligations, stating that “many volatility-linked ETPs are highly likely to lose value over time” and “may be unsuitable to retail investors, particularly those who plan to use them as traditional buy-and-hold investments.”  This was not the first warning from the regulator.

  • Salesperson seems to openly live a lavish lifestyle: The most famous Ponzi schemers have been infamous for their extravagant lifestyles. Scott Rothstein, the mastermind in a $1.2million Ponzi scheme said, “We were living like rock stars; private jets, massive amounts of money. There were lots of things that kept fueling that,” in his 2011 deposition testimony (reported in Forbes 2014). Be cautious if you are approached by a broker or advisor who fits the bill. As an extra precautionary measure, check your broker out on FINRA’s BrokerCheck.
  • Their marketing/ sales documents look like they could have come out of a printer in their home! Robert Van Zandt, known as the Bernie Madoff of Bronx, who was criminally prosecuted for running a Ponzi scheme, distributed homespun brochures that said “Learn to Earn 9% On Your Investment.” The quality of their marketing materials could be a good indication of the credibility of the investment.
  • “Guarantees” with high returns: If it sounds too good to be true, it probably is. Look out for buzzwords like “High Return” or “Risk-Free” Investments. But in reality no investment is risk-free. In fact, higher probability of return is usually associated with higher risks, according to the risk-reward tradeoff principle. So if you are offered a guaranteed high return investment with no risks, the chances are that you are dealing with a financial scam.

Michael J. Breton of Massachusetts was banned from the securities industry by the SEC according to a recent InvestmentNews report.  According to the report, Mr. Breton cost his clients $1.3 million by “cherry-picking” trades – i.e., placing trades through one central account then allocating the profitable trades to himself and the losing trades to clients.  This practice reportedly continued from 2011 to July of this past year.

 

On Wednesday, the SEC filed charges against Mr. Breton and Strategic Capital Management, Mr. Breton’s firm, in federal court in Massachusetts.  Mr. Breton has agreed to plead guilty to criminal securities fraud and forfeit $1.3 million, per the report.  According to InvestmentNews, the US Attorney’s Office has agreed to recommend a maximum sentence of no more than three years.

Financial industry stakeholders are all locked in a guessing game about the fate of the DOL Fiduciary rule in the new Trump administration. In 2015, the Obama administration and the DOL had introduced the Fiduciary rule that requires financial advisers to always act in the best interest of their clients when handling their retirement savings and removing unnecessary fees. Wall Street had continued to oppose it on the grounds of excessive costs and paperwork. The initial implementation deadline for the rule is set for April 2017.

According to an Investment News report, industry lobbyists are now expecting a quick response from the seemingly “business first” Trump administration to delay this investment advice rule. They expect the Fiduciary rule to be one of the first targets of the new administration. This delay could come in the form of a directive to agency heads to review and delay regulations that are not operational.

There are two courses that are expected: the Trump administration may issue an order to delay the implementation of the fiduciary rule and have another regulation, an “interim rule” in its place. Or they could propose a delay but this would be tricky because for a rule that technically became effective last June, the administration is legally obligated under the Administrative Procedure Act to go through a public notice and comment period.

Last year, the Obama administration introduced the Fiduciary rule that requires financial advisers to always act in the best interest of their clients when handling their retirement savings. It was expected to be a big industry shakeup, making financial advice more reliable, compensating advisers with a flat-fee model and reasonable compensations, incentivizing them to really act on their client’s best interest as opposed to their own personal gain. The DOL’s Fiduciary rule was aimed at stopping the $17 billion a year that gets wasted in exorbitant fees.

The banks and Wall Street have continued to oppose this rule on grounds of lengthy paperwork and compliance expenses. Financial firms were anxious that once the rule is in effect, they will not be able to make as much money. Republicans have expressed that repealing this rule is on their agenda. Now with Trump as the President elect, and Republicans holding majority in both Houses, there is a fear that legislative action will be taken to kill the much-needed Fiduciary rule.

Joseph Peiffer of PIABA (Public Investors Arbitration Bar Association) was quoted in the InvestmentNews, “If he (Trump) wins, no one knows what the hell is going to happen.” Now that Trump has won, the fate of the rule hangs in the balance. There are others who think that the rule is here to stay, inspite of the unpredictability.