Skip to main content


Representing Individual, High Net Worth & Institutional Investors

Offices in Indiana and New York City


Home > Blog > Monthly Archives: January 2012

Monthly Archives: January 2012

Investors Jump on Board All-Public Arbitration Panels

All-public arbitration panels have proved to be a popular combination for investors who’ve filed securities-related complaints with the Financial Industry Regulatory Authority (FINRA).

From February 2011 to Jan. 26, 2012, more than 76% of investors have chosen the all-public option, says FINRA, the internal watchdog of Wall Street. Prior to that time, investor cases were heard by three-person arbitration panels containing two public arbitrators and one arbitrator associated with the financial industry.

FINRA has been evaluating and compiling data on the all-public pilot program following its launch on October 6, 2008.  As of Jan. 1, 2012, 12% of the cases in the pilot program were still pending. Accordingly, data-including award data-are not yet fully complete.

Based on the data available, of the 49 pilot program awards issued by all-public panels, investors were awarded damages in 26 of 40 cases, or 65% of the time.  Another 23 pilot program awards were issued by panels with one non-public arbitrator. Investors received financial relief 13 times, or a 62% win rate, in those instances.

As reported Jan. 29 by Investments News, win rates were lower in non-pilot cases. In 2009, arbitrators awarded damages to investors in 49% of cases; in 2010, the win rate was 48%.

At the time FINRA launched the all-public two-year pilot program in October 2008, the program included 14 firms that had voluntarily agreed to participate and applied only to investor cases that did not involve individual brokers. The creation behind the all-public program was in response to criticism that the presence of an industry representative on arbitration panels created bias, as well as sympathy for the defense in cases brought by investors.

In 2010, FINRA proposed making the all-public option permanent. In February 2011, the Securities and Exchange Commission (SEC) approved FINRA’s rule change for all customer cases in which a list of potential arbitrators had not yet been sent to the parties involved in the dispute.

Senior Citizens Easy Target for Private-Placement Scams

Senior investors are an easy and vulnerable target for financial fraud. Individuals 65 or older manage a large percentage of the nation’s liquid assets and, most important to the perpetrators of financial fraud schemes, they are often more susceptible to money schemes and deception due to physical or mental limitations.

Many senior citizens who become victims of financial exploitation suffer in silence, never reporting the crimes to authorities out of fear or embarrassment. Other victims are afraid of losing their independence or that family members may move them into a nursing home.

According to the AARP, financial scammers cheat investors out of some $40 billion a year, and seniors are the most common targets. As reported by the North American Securities Administrators Association (NASAA), some of the most popular financial scams involve “investment pools” to collect money that is then used to purchase and renovate distressed real estate properties. In reality, however, these so-called flips are often Ponzi-like schemes in which the scammer takes the investor’s money to pay off previous investors. Like most Ponzi schemes, the ruse eventually falls apart when there are not enough new investors to continue the scheme.

Another popular investment scam targeting the elderly involves certain promissory notes or private placement investments. The note itself may promise high returns through a private investment, according to NASAA. But in reality, unregistered promissory notes can be a cover for Ponzi schemes or another type of financial fraud.

One prominent case that resulted in investors losing millions of dollars in fraudulent oil and natural gas private placements was that of Provident Royalties, LLC.

The Securities and Exchange Commission (SEC) filed fraud charges against Provident and three company founders in the summer of 2009 for their role in the scheme, which turned out to be an elaborate $485 million Ponzi scheme.

Investors of any age encouraged to always check with their state securities regulator to determine if an investment involving promissory notes or private placements and its sponsors are properly registered.

Complex Investment Products in Hot Water With FINRA

Brokerage firms and registered reps selling private placements, inverse and leveraged exchange traded funds (ETFs), structured notes and other complex investment products have been put on notice by the Financial Industry Regulatory Authority (FINRA). In a newly issued regulatory notice, FINRA outlined certain due-diligence and supervisory policies and procedures that firms must have in place when selling such products and that the investments themselves can be expected to face greater regulatory scrutiny in the future.

“Registered representatives should compare a structured product with embedded options to the same strategy through multiple financial instruments on the open market, even with any possible advantages of purchasing a single product,” Regulatory Notice 12-03 said in part.

As in previous notices issued by FINRA, Notice 12-03 reiterated the fact that firms should consider whether less complex products can achieve the same objectives for investors. The notice further stated that post-approval follow-up and review are particularly important for any complex investment product.

In recent years, regulators have issued a number of enforcement and disciplinary actions in cases involving complex investments. Two high-profile cases occurred in 2009, when the Securities and Exchange Commission (SEC) filed fraud charges against Medical Capital Holdings and Provident Royalties LLC over the private placements issued by both entities.

Several state regulators, including Massachusetts, also have filed regulatory actions against various broker/dealers that sold Medical Capital and Provident private placements to investors.

CapWest Ordered to Pay $9M Over Failed Private Placements

Clients of CapWest Securities received a vindication of sorts today when an arbitration panel of the Financial Industry Regulatory Authority (FINRA) ordered the broker/dealer to pay $9.1 million in damages and legal fees stemming from sales of failed private investments in Medical Capital Holdings and Provident Royalties LLC.

The problem is that CapWest closed last year, so the likelihood of investors receiving any substantial financial recovery from the award is slim.

Both Medical Capital and Provident Royalties were charged with fraud by the Securities and Exchange Commission (SEC) in 2009.  Investors across the country lost millions of dollars from investments in private placements from the entities.

The $9.1 million award is believed to be one of the single largest arbitration awards based on sales of failed private placements, according to a Jan. 19 article by Investment News.

ETFs: Look Beneath the Surface

The world of exchange-traded funds may look like a mass of liquidity and fast profits but lurking just beneath the surface is an array of potential risks and financial mayhem.

Exchange-traded funds are baskets of investments such as stocks, bonds, commodities, currencies and options that track market indexes. But in recent years, traditional ETFs have become increasingly complex, delving into esoteric and risky areas that involve swaps, futures contracts and other derivative instruments.

Leveraged and inverse ETFs are two of those esoteric products. Leveraged ETFs are designed to deliver “multiples” of the performance of the index or benchmark they track. Its cousin, the inverse ETF, works in the reverse by trying to deliver returns that are the opposite of the index’s returns.

The problem many investors make with leveraged and inverse ETFs is that they hold these investments for longer than one trading day. Leveraged and inverse ETFs are not designed for long-term returns. Rather, they try to achieve their stated performance objectives on a daily basis. Holding a leveraged or inverse ETF for any longer may not get you the multiple of the index return you were expecting – and instead create a financial nightmare.

As reported Jan. 13 by Businessweek, ETFs surpassed $1 trillion in assets globally in 2009. The growth has not gone unnoticed by regulators, especially as more complex and riskier versions of the ETF emerged in the market.

For example, the Securities and Exchange Commission (SEC) began examining whether ETFs that use derivatives to amplify returns may have contributed to equity-market volatility in May 2010, when the Dow Jones Industrial Average plunged some 1,000 points in one hour. At the time, the SEC stated that any new ETFs that made substantial use of derivatives would not be approved.

Congress also has taken an interest in the more complex and riskier versions of ETFs, holding several hearings in 2011 on synthetic ETFs and their transparency, leverage and use of derivatives.

So in a nutshell: Leveraged and inverse ETFs aren’t for everyone. In fact, they may not be suitable investments for most retail investors. Not only are these synthetic products complex, highly risky and lack transparency, but they require detailed knowledge and constant monitoring. And while there could be instance where certain trading and hedging strategies justify holding a leveraged or inverse ETF for longer than a single trading day, there’s an even higher probability of losing money.

Leveraged, Inverse ETFs: A Jekyll & Hyde Investment?

Leveraged and inverse exchange-traded funds (ETFs) are getting a bad – and perhaps well deserved – reputation. Critics have coined an endless array of negative descriptors for these products, from “toxic,” to “dangerous,” to “pumped-up investment vehicles with a mountain of risks.”

The characterizations are not without some merit. The Securities and Exchange Commission (SEC), the North American Securities Administrators Association and the Financial Industry Regulatory Authority have issued separate and joint warnings to investors about leveraged and inverse exchange-traded funds. Among their concerns: the growing complexity of the products, their lack of transparency and the potential for investors to experience significant financial losses if they hold onto their funds for more than one trading day.

The first exchange traded fund was launched in 1993. As the products evolved, so did the level of risk. In 2006, ETFs became more aggressive with the introduction of leveraged and inverse exchange-traded funds to the market.

Exchange-traded funds are baskets of investments such as stocks, bonds, commodities, currencies, options, swaps, futures contracts and other derivative instruments that are created to mimic the performance of an underlying index or sector. Leveraged and inverse ETFs, however, are something altogether different. They are not your standard variety of exchange-traded funds.

Leveraged ETFs seek to deliver “multiples” of the performance of the index or benchmark they track. Inverse ETFs do the reverse. They try to deliver the opposite of the performance of the index or benchmark being tracked.

Many investors are under the mistaken belief that a leveraged ETF will give them twice the daily return of the underlying index over the long term. In reality, nothing could be further from the truth.

In recent years, there’s been an increase in arbitration claims and investor lawsuits involving leveraged and inverse exchange-traded funds. The trend is likely to continue in 2012. Moreover, the number of ETFs that have been shut down or liquidated is on the rise, up 500% in each of the past three years over 2007 levels, according to a recent investor alert by the North American Securities Administrators Association. That amounts to one ETF a week.

For investors, these liquidations often prove costly in the form of termination fees, as well as lost opportunity costs if the providers convince investors to stay in the fund through the liquidation process to save on commission costs.

The bottom line: Not all ETFs are the same. While some may be appropriate for long-term holders, others require daily monitoring. The best advice: Know your investment objectives and risk tolerance levels before making the ETF leap.


Top of Page