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Home > Blog > Monthly Archives: January 2013

Monthly Archives: January 2013

Legal Issues Continue to Follow B-Ds in 2013

Independent broker/dealers continue to face a wave of legal and regulatory issues in 2013, with many expected to shutter their businesses.

As reported Jan. 20 by Investment News, the problems facing smaller B-Ds with 150 registered representatives or fewer include higher compliance costs, record low interest rates for money market accounts, competitive commission rates from large or discount broker-dealers and a tax increase that will cut available discretionary funds that investors can put to work in the stock market.

Small B-Ds make up the majority of firms registered with the Financial Industry Regulatory Authority (FINRA).  In the first 11 months of 2012, pressures on the industry reduced the number of FINRA-registered firms to 4,319 – down 97 firms from the prior year and a 14% decline since the end of 2007.

Regulatory and compliance issues are a key factor contributing to the reduction in smaller B-Ds. In a move to improve investor protections, the Securities and Exchange Commission (SEC) approved FINRA Rule 4524 in 2012, which mandated that broker/dealers file additional financial or operational schedules or reports as FINRA deemed necessary.

Many B-Ds to close up shop in the past few years have done so because of deals involving failed private placements, such as those connected to Provident Royalties LLC and Medical Capital Holdings LLC. The SEC charged both of those firms with fraud in July 2099, which in turn spurred a rash of investor lawsuits and arbitration claims. As a result, many broker/dealers were unable to contend with the litigation costs and subsequently shut down.


In a First, Merrill Lynch Offers a Non-Traded REIT

Non-traded real estate investment trusts (REITs) have traditionally been associated with independent broker/dealers – that is until last month when Merrill Lynch announced that its 17,000-plus registered reps would begin selling the Jones Lang LaSalle Income Property Trust to investors.

The move means Merrill Lynch becomes the first major wirehouse to sell a non-traded REIT. So far, the firm has raised about $50 million from interested clients.

Merrill Lynch’s foray into non-traded REIT territory is based on demand for an “attractive, direct core real estate investment product among mass-affluent investors,” said Keith Glenfield, head of alternative investments for Merrill Lynch, in a Jan. 2 article by Investment News.

“The primary investment objectives are designed to provide attractive current income, preserve and protect invested capital, achieve [net asset value] appreciation over time and enable stockholders to utilize real estate as a long-term portfolio diversifier,” Glenfield said.

Despite Merrill Lynch’s characterization of the Jones Lang Lasalle REIT as a safe source of income, investors may have plenty of reasons to be cautious. Non-traded REITs have been under the radar of state securities regulators for several years now, as have the sales practices of the broker/dealers that sell them.

Issues with non-traded REITs include their complex fee structure, high-risk factors, illiquidity and often inaccurate valuations. Moreover, early redemption of shares is typically extremely limited, and fees connected with their sale can be high and erode total return.

In 2012, the Financial Industry Regulatory Authority (FINRA) reissued an Investor Alert on nontraded REITs following an enforcement action against David Lerner & Associates. One of FINRA’s concerns with Lerner focused on the valuation irregularities that appeared on the monthly statements of investors who owned shares in Lerner’s Apple REITs. Specifically, shares of certain Apple REITs had been listed on the statements as $11 per share even after FINRA instructed broker/dealers in 2009 to adjust prices on the investments more frequently.

Wells REIT Offerings Come to Halt

Non-traded real estate investments (REITs) have caused the undoing of several high-profile firms and broker/dealers in recent years, especially following the collapse of the commercial real estate market and the credit crisis of 2008. Now, one prominent non-traded REIT player – Wells Real Estate Funds – is at least temporarily saying goodbye to the non-traded-REIT industry.

As reported Jan. 15 by Investment News, Leo Wells announced his departure in a letter dated Jan. 11 to broker/dealer executives. In it, Wells said his firm would not register any new investment products at this time but may in the future. The firm will continue to serve existing clients in its line-up of real estate investment trusts and private real estate funds.

Wells attributes his pullback to a lack of clarity surrounding the regulation of REITs.

“As most of you are aware, [the Financial Industry Regulatory Authority] has been working toward producing new transparency guidelines for alternative investments, which they expect to become effective mid-2014,” Wells said in the letter. “As a result, I do not believe it is prudent to register a new product that may or may not meet the new regulatory requirements.”

According to Wells, the Wells Real Estate Investment Trust II is moving to become an independent company early this year and the Wells Core Office Income REIT will close to new investments in June. The Wells Timberland REIT also is looking toward “its appropriate exit strategy.”

The Investment News article says Wells Real Estate Funds does not intend to close its wholesaling broker/dealer, Wells Investment Securities Inc.

Last year, FINRA imposed a $300,000 fine against Wells Investment Securities over misleading marketing tied to Wells Timberland REIT. In reaching the settlement, Wells Investment Securities neither admitted nor denied the charges.

Wells Real Estate Funds is one of the biggest sponsors of investments in the non-traded REIT industry, with $11 billion in assets and 300,000 investors.  As the Investment News article points out, the man behind the company is known as an outspoken and colorful figure in the non-traded REIT world.  In October 2003, FINRA’s precursor, NASD, sanctioned Wells Investment Securities for improperly rewarding broker/dealer reps who sold the firm’s REITs. Among those rewards: High-end entertainment parties and lavish dinners that included one at a Civil War fort complete with costumed Civil War heroes, fireworks, fife and drum players, skydivers and a cannon re-enactment.

The regulator also censured Wells and suspended him from acting in a principal capacity for one year.


FINRA: A Year in Review, Part 2

The Financial Industry Regulatory Authority (FINRA) marked several milestones in 2012 in the way of increased fraud preventions and arbitration judgments rendering a record amount of restitution to aggrieved investors. Part 1 of our blog on FINRA’s 2012 Year in Review focused on regulatory investigations and fines and disciplinary actions levied against brokers and firms. Part 2 highlights FINRA’s efforts to improve investor protections and enhance market transparency.

FINRA and the FINRA Investor Education Foundation successfully initiated several outreach strategies in 2012 to help investors better understand their investments, including the distribution of more than 630,000 educational brochures and other resources. In addition, the FINRA Foundation delivered its Outsmarting Investment Fraud curriculum to more than 9,000 investors at more than 170 live events nationwide.

Other notable achievements by FINRA in 2012 include the following:

  • In November, FINRA unveiled data on the outcomes of cases heard under its all-public panel program. Implemented in February 2011, the program gives investors the option of a panel comprised of all public arbitrators vs. a panel made up of one arbitrator with securities industry experience (non-public arbitrator) and two public arbitrators. The all-public panel option represents an investor-friendly change to the program and is designed to ensure a fair playing field for all parties. To date, findings show the following: In cases decided by three public arbitrators, customers were awarded damages 51% of the time. In comparison, investors were awarded damages 32% of the time in cases decided by a panel comprised of one non-public arbitrator and two public arbitrators.


  • In July, FINRA implemented a new suitability rule requiring a broker/dealer or their associated persons to have a “reasonable basis” to believe a recommended transaction is suitable for the customer, based on information obtained through “reasonable diligence” to understand a customer’s investment profile.


  • The Securities and Exchange Commission (SEC) approved a rule requiring FINRA-regulated firms that sell an issuer’s securities in a private placement to file a copy of any private placement memorandum, term sheet or other offering document that the firm used within 15 days of the date of the sale with FINRA. The rule enhances FINRA’s oversight of firms’ sales activities in private placements and became effective in December 2012.


  • FINRA increased investors’ ability to obtain information on financial professionals through BrokerCheck by including a zip code search and a combined search function that provides easy access to information on investment advisers from the SEC’s Investment Adviser Public Disclosure (IAPD) database. FINRA also obtained approval in September 2012 to file proposed rule changes to require firms to include a reference and a link to BrokerCheck on their Websites; to provide for disclosure of additional information through BrokerCheck; and to establish the legal and technical framework for the provision of BrokerCheck data.

FINRA: A Year in Review, Part 1

The Financial Industry Regulatory Authority (FINRA) has released its end-of-the-year report card on various regulatory achievements it made in 2012, along with progress highlights in detecting fraudulent activity, increasing transparency of securities markets and protecting investors.

Among FINRA’s key accomplishments in 2012:

  • Fines totaling $68 million were assessed.
  • A record $34 million in restitution to harmed customers was ordered.
  • 1,541 disciplinary actions (an increase of 53 from 2011) were brought against FINRA-registered individuals and firms.
  • 30 firms were expelled from the securities industry; 294 individuals were barred; and 549 brokers were suspended from association with FINRA-regulated firms.
  • 692 matters involving potential fraudulent conduct were referred by FINRA’s Office of Fraud Detection and Market Intelligence (OFDMI) to the Securities and Exchange Commission (SEC) and other federal or state law enforcement agencies, including 347      insider trading referrals and 260 fraud referrals.

Disciplinary actions levied by FINRA in 2012 entailed several high-profile cases involving complex financial products, including exchange-traded funds (ETFs), structured products and non-traded REITs, as well as research analyst conflicts, inadequate disclosure and mispricing.

Among the 2012 cases: David Lerner Associates. FINRA sanctioned David Lerner Associates, the firm’s founder, President and CEO, and the firm’s head trader in an action related to the non-traded Apple REITs involving suitability and supervision violations. The settlement also consolidated numerous matters, including a municipal and CMO markup case, a pending enforcement investigation of more recent municipal and CMO markups, and 10 pending market regulation matters involving municipal markups identified through surveillance reviews.

FINRA also sanctioned Citigroup Global Markets, Inc; Morgan Stanley & Co., LLC; UBS Financial Services; and Wells Fargo Advisors, LLC a total of more than $9.1 million for selling leveraged and inverse ETFs without reasonable supervision and for not having a reasonable basis for recommending the securities. Fines totaling more than $7.3 million were levied against the firms, which were required to pay a total of $1.8 million in restitution to certain customers who made unsuitable leveraged and inverse ETF purchases. Similar cases were brought by FINRA against Merrill Lynch and Scott & Stringfellow.

Finally, Merrill Lynch was fined $450,000 for supervisory failures relating to sales of structured products to retail clients. The firm relied upon automated exception-based reporting systems to flag transactions and/or accounts that met certain pre-defined criteria, but did not specifically monitor for potentially unsuitable concentration levels.

Check back for Part 2 of FINRA’s 2012 Year in Review and the various investor protection and transparency initiatives launched in 2012.

Elder Fraud by the Numbers

$2.9 billion: Estimated cost of financial exploitation and fraud for older U.S. adults in 2010.

69: Average age of an investment fraud victim.

2x: The rate at which older women are fraud victims compared to men. Most victims are between 80 and 89 of age, live alone, and need help with either health care or home maintenance issues.

51%: Estimated share of elder fraud committed by strangers. Thirty-four percent of fraud is committed by family, friends or neighbors. The business sector accounts for 12 percent.

84%: Estimated share of victims who do not report elder fraud because they are embarrassed or ashamed.

SOURCES: MetLife Mature Market Institute, AARP Foundation, Investor Protection Trust.

BBB, FINRA Foundation Launch Website to Help Prevent Investment Scams

Every year, consumers lose millions of dollars in bogus investment scams and Ponzi schemes. Now, a new Website aims to educate investors on how to avoid investment fraud, risky investments and unlicensed brokers.

The Website – BBB Smart Investing – was created through a partnership between the Better Business Bureau and the FINRA Investor Education Foundation. The site provides a wealth of tools, information and resources designed to help investors better protect and manage their money.

Consumer financial fraud is a serious problem in United States. According to the Federal Trade Commission and the Canadian Anti-Fraud Centre, consumers lost more than $1.5 billion to varioius types of scams in 2011. FINRA Foundation research shows that many investors are overconfident regarding their knowledge of financial management, particularly Baby Boomers who are often the target of investment scams.

One telephone survey found that 92% of individuals felt “somewhat” or “very confident” about managing their finances, with almost 80% describing themselves as “somewhat” or “very” knowledgeable about investing. But only 44% got a passing grade on a basic financial literacy knowledge test.

BBB Smart Investing hopes to help change that statistic, according to Carrie Hurt, President and CEO of the Council of Better Business Bureaus.

“This is a great partnership,” says Hurt. “Even though BBB has always investigated investment scams, this gives us a whole new portfolio of prevention tools to offer to consumers. The FINRA Foundation’s basic ‘Ask & Check’ message is exactly what consumers need to hear before they make investment decisions. We think this program will go a long way toward preventing investment scams that have become so much more prevalent in recent years as people more actively manage their own retirement funds.”

LPL Financial Fined Over Mutual Fund Issues

LPL Financial LLC is among five firms fined by the Financial Industry Regulatory Authority (FINRA) for failing to deliver mutual fund prospectuses.

As reported Jan. 2 by Investment News, LPL Financial LLC agreed to pay a $400,000 fine as part of the agreement; State Farm VP Management Corp., $155,000; Deutsche Bank Securities Inc., $125,000; Scottrade Inc., $50,000; and T. Rowe Price Investment Services Inc., $40,000.

In the settlement, FINRA stated that LPL relied on its brokers to deliver prospectuses, but had no procedures in place to determine if the documents were delivered late. Over FINRA’s review period of January 2009 through June 2011, LPL was required to deliver 3.4 million prospectuses.

According to the settlement, State Farm was responsible for delivering 154,129 prospectuses during that period, at first through its brokers and later through a service provider. In each case, however, the firm had inadequate supervision, FINRA said.

Scottrade failed to deliver prospectuses in about 14,000 transactions out of 300,000. Deutsche Bank Securities missed delivery in 3,800 cases out of nearly 71,000 trades, and T. Rowe Price had 2,500 failures in more than 68,000 transactions.

Last month, LPL Financial faced sales abuse charges tied to non-traded real estate investment trusts when Massachusetts Secretary of the Commonwealth William Galvin filed civil charges against the firm for failing to supervise LPL brokers who sold investments in seven non-traded REITs.

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