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Home > Blog > Category Archives: Investor Beware

Category Archives: Investor Beware

FINRA Targets Business Development Companies (BDCs)

The Financial Industry Regulatory Authority (“FINRA”) has launched an examination sweep of non-traded business development companies (“BDCs”), the latest alternative investment product to receive increased scrutiny from the broker-dealer regulator.

An examination letter, posted on FINRA’s website on August 4, 2016, stated that “FINRA is conducting an inquiry with respect to non-traded Business Development Companies (BDCs)” and it requests that brokerage firms provide documents and information to the regulator “by no later than September 9, 2016.”

Non-traded BDCs are investment vehicles that typically make loans to small and medium-size companies with less than stellar credit. They reportedly attracted $22 billion from investors over the past several years, as interest rates near zero sent investors in search of higher yields.

Many of the brokerage firms that are selling non-traded BDCs to their retail clients had previously been involved with the marketing of non-traded Real Estate Investment Trusts (“REITS”) – another high commission alternative product with a questionable track record and limited liquidity.

Among the documents and information that brokerage firms have to provide to FINRA in response to this examination sweep are “the firm’s due diligence procedures and, if not already included in the due diligence procedures, a written description of the due diligence that the firm conducts of the BDC initially and on an ongoing basis as well as a written description of the due diligence that the firm conducts of participating broker-dealers with which the firm has a selling agreement.”

An article in the Investment News (“FINRA Launches Exam Sweep of Business Development Companies”), quoting a high-ranking FINRA official, indicates that “the regulator is targeting the increasingly popular BDCs to assess how they’re marketed and sold” and that “given the complexity and high-risk nature of this product, there is concern that retail customers may not fully understand the risks and the potential impact on their portfolios” of this investment product.

A copy of the firm’s due diligence procedures and, if not already included in the due diligence procedures, a written description of the due diligence that the firm conducts of the BDC initially and on an ongoing basis as well as a written description of the due diligence that the firm conducts of participating broker-dealers with which the firm has a selling agreement.

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Oppenheimer & Co. – Widespread Culture of Corruption?

Oppenheimer & Co., one of the most sanctioned and criticized brokerage firms on Wall Street, has been once again the subject of a massive regulatory fine (“FINRA Sanctions Oppenheimer & Co. $2.9 Million for Unsuitable Sales of Non-Traditional ETFs and Related Supervisory Failures”) according to a release issued by the Financial Regulatory Authority, Inc. (“FINRA”) on June 8, 2016.

This latest enforcement proceeding was the result of Oppenheimer having sold “leveraged, inverse and inverse-leveraged exchange-traded funds (non-traditional ETFs) to retail customers without reasonable supervision, and for recommending non-traditional ETFs that were not suitable.”

According to the FINRA release, notwithstanding the fact that “Oppenheimer’s procedures prohibited solicitation of non-traditional ETFs,” between August 2009 and September 30, 2013, “more than 760 Oppenheimer representatives executed more than 30,000 non-traditional ETF transactions totaling approximately $1.7 billion for customers.”

FINRA also found that “Oppenheimer failed to conduct adequate due diligence regarding the risks and features of non-traditional ETFs and, as a result, did not have a reasonable basis to recommend these ETFs to retail customers. Similarly, Oppenheimer representatives solicited and effected non-traditional ETF purchases that were unsuitable for specific customers.”

A complete copy of this latest regulatory enforcement proceeding can be accessed through the FINRA website at http://disciplinaryactions.finra.org/Search/ViewDocument/66217.

Moreover, a cursory review of the FINRA BrokerCheck report for Oppenheimer & Co. indicates that the firm has now been the subject of at least 83 regulatory enforcement proceedings and hundreds of customer-initiated arbitration proceedings.

Of equal and perhaps greater importance, a recent academic study (“The Market for Financial Adviser Misconduct”) found that more than one in seven financial advisers at Oppenheimer & Co. “have engaged in misconduct in their past” and that “almost one in five financial advisers at Oppenheimer & Co. have been disciplined for misconduct in the past.”

If you are an individual or institutional investor who has any concerns about your accounts and/or investments with Oppenheimer & Co., please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

A Warning Shot Across the Bow for Investors in Business Development Companies (“BDCs”)

An April 10, 2016 article in The Wall Street Journal (“A $2.5 Billion BDC Halts Redemptions After Limit Reached”) describes how volatile markets have prompted a “rush of investors” to attempt to redeem their investments in non-traded Business Development Companies.

The Business Development Corporation of America (“BDCA”), a $2.5 billion fund, said in a securities filing last month that it is halting redemptions for the quarter after the fund’s pre-established limit was hit. The move comes as volatile markets have hurt some of the value of the underlying assets of such funds, prompting investors to flee over the past several months.

Even in normal times, non-traded business development companies typically only allow investors to cash out every three months. This, however, appears to be the first time one has bumped up against internal restrictions that limit the amount of shares a fund is able to redeem at one time, experts say. The fund had limited redemptions to 2.5% of its outstanding shares per quarter, which is typical for its peers.

Investors had reportedly asked to cash in about 7.4 million shares, but the fund allowed only 41% of those redemptions, according to the filing dated March 11.

The fund’s net asset value fell by 7.9% last year. The shares that were redeemed were worth about $28 million, the filing shows.

Non-traded BDCs make loans to small and medium-size companies with less than stellar credit. They attracted $22 billion from investors over the past several years, as interest rates near zero sent investors in search of higher yields.

BDCA, which invests in loans to midsize companies in the U.S., is among the largest. In addition to halting redemptions in its latest offering, the fund recently changed its policy to allow withdrawals only twice a year rather than once a quarter. Investors will be able to cash in as much as 5% of the fund’s outstanding shares in each of those periods.

Investors pulled a total of $64 million from non-traded BDCs in the fourth quarter of 2015, the latest data available, up from withdrawals of $47 million in the third quarter, setting another industry record, according to Summit Investment Research.

More funds are likely to hit the redemption limit if the trend towards escalating redemptions should continue.

As noted in the article, although the funds typically promise protection from market volatility and yields as high as 8%, they include a number of risks to investors which include withdrawal limits, upfront fees of at least 10% and the opinion that non-traded BDCs also are considered to be less transparent than regular mutual funds.

Sales also have been slowing as performance among the funds has dropped with the net asset value of non-traded BDCs having reportedly declined by an average of a 12.5% in 2015.

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Will Energy Master Limited Partnerships (MLPs) Decimate Unsuspecting Investors?

Recent statistics indicate that there are over 110 MLPs trading on major exchanges, with oil & gas midstream activities – gathering, processing, natural gas compression, pipelines, storage, refining, distribution, and marketing – representing the dominant activity.

The latest U.S. Securities & Exchange Commission filings by a number of Energy Master Limited Partnerships (“MLPs”), however, provide yet another example of the treacherous income tax ramifications that could potentially whip saw investors if oil and natural gas prices continue to be depressed.

A case in point is clearly illustrated, for example, by the specific risk factor disclosures that were contained within the annual report (“Form 10-K”) that was filed by Energy Transfer Partners, L.P. (NYSE:ETP) on February 29, 2016 for its fiscal year that ended on December 31, 2015.

These risk factor disclosures included the following two (2) specific warnings:

Unitholders may be required to pay taxes on their share of our income even if they do not receive any cash distributions from us.

“Unit-holders will be required to pay any federal income taxes and, in some cases, state and local income taxes on their share of our taxable income even if they receive no cash distributions from us. Unit-holders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from the taxation of their share of our taxable income.

In response to current market conditions, we may engage in transactions to delever the Partnership and manage our liquidity that may result in income and gain to our Unit-holders without a corresponding cash distribution. For example, if we sell assets and use the proceeds to repay existing debt or fund capital expenditures, you may be allocated taxable income and gain resulting from the sale without receiving a cash distribution. Further, taking advantage of opportunities to reduce our existing debt, such as debt exchanges, debt repurchases, or modifications of our existing debt could result “cancellation of indebtedness income” (also referred to as “COD income”) being allocated to our Unit-holders as taxable income. Unit-holders may be allocated COD income, and income tax liabilities arising therefrom may exceed cash distributions. The ultimate effect of any such allocations will depend on the Unit-holder’s individual tax position with respect to its units.”

– and –

Tax gain or loss on disposition of our Common Units could be more or less than expected.

“If Unit-holders sell their Common Units, they will recognize a gain or loss equal to the difference between the amount realized and the tax basis in those Common Units. Because distributions in excess of the Unit-holder’s allocable share of our net taxable income result in a decrease in the Unit-holder’s tax basis in their Common Units, the amount, if any, of such prior excess distributions with respect to the units sold will, in effect, become taxable income to the Unit-holder if they sell such units at a price greater than their tax basis in those units, even if the price received is less than their original cost. In addition, because the amount realized includes a Unit-holder’s share of our nonrecourse liabilities, if a Unit-holder sells units, the Unit-holder may incur a tax liability in excess of the amount of cash received from the sale.

A substantial portion of the amount realized from the sale of your units, whether or not representing gain, may be taxed as ordinary income to you due to potential recapture items, including depreciation recapture. Thus, you may recognize both ordinary income and capital loss from the sale of your units if the amount realized on a sale of your units is less than your adjusted basis in the units. Net capital loss may only offset capital gains and, in the case of individuals, up to $3,000 of ordinary income per year. In the taxable period in which you sell your units, you may recognize ordinary income from our allocations of income and gain to you prior to the sale and from recapture items that generally cannot be offset by any capital loss recognized upon the sale of units.”

The common sense interpretation of this complicated legalese – investors in MLPs may owe taxes, in some instances substantial taxes, on income that they never received.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership investment, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Business Development Companies (BDCs) – Are Astute Investors Heading for the Exits?

As reported by The Wall Street Journal on March 19, 2016 (“These High-Fee, Unlisted, Junk-Based Funds Aren’t Working Out”), investors who poured $22 billion into an obscure Wall Street investment product known as “Non-Traded Business Development Companies (BDCs)” are now pulling out record sums.

BDCs are built out of loans to small and medium-size companies with less than stellar credit, but are less transparent than regular mutual funds, typically make investors pay upfront fees of at least 10% and only accept withdrawal requests once a quarter.

According to an analysis reported by the WSJ, “the move to the exits is accelerating. Investors pulled $47.3 million out of nontraded BDC’s in the third quarter of 2015, up from $25.7 million in the second quarter” and “performance has been slipping, too. Across the industry, the value of the funds’ assets at the end of September was on average 16% lower than their initial offering price to investors.”

Non-traded BDCs were part of a fast-growing class of alternative, high-commission investments sold to individual investors in recent years. Marketing materials promised steady dividends, yields as high as 8% and a haven from volatile markets, according to fund documents and executives.

The fees, though, exceed those of most products pitched to retail investors. For example, one non-traded BDC, cited in the WSJ article, said in its disclosures that its 10% sales load and likely 2% offering expenses mean only $88 of every $100 of shares bought “will actually be invested in us…you would have to experience a total return on your investment of between 14% and 18% in order to recover these expenses.”

Meanwhile, “Wall Street continues to push the products while regulators are watching closely.” Paul Mathews, Finra’s vice president for corporate financing, was quoted in the WSJ article as having said the products are an ‘ongoing concern’ for the regulator and that ‘firms must ensure they are suitable for an investor’s risk profile and investment strategy.’

Part of what concerns regulators is that non-traded BDCs are being sold using many of the same networks of brokerage firms and typically charging the same high upfront commissions as non-traded real estate investment trusts – another product with a multitude of significant issues.

“It’s kind of like weeds,” said William Galvin, the top Massachusetts securities regulator. “You whack them in one part of the garden, but they come up in another.”

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company (BDC), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Master Limited Partnerships (MLPs) – Income Tax Liabilities Could Decimate Investors

On March 9, 2016, the Wall Street Journal reported that investors in energy-related Master Limited Partnerships (“MLP Investors Face Tax Hit on Top of Big Losses”) face the prospect of “worse things than going to zero” as a prospective “wave of expected bankruptcy filings and debt restructurings could trigger taxes for investors at a number of energy firms”

Master Limited Partnerships (MLPs) are a corporate structure that do not pay any taxes at the corporate level, but instead pass along their income – and certain tax burdens – to shareholders.

Unfortunately, the “collapse in oil and gas prices has exposed the structure’s double-sided risk: Investors with potentially worthless shares – or units, as they are known – may nonetheless owe taxes on debt that is forgiven in a bankruptcy or an out-of-court restructuring” since “debt forgiven in a restructuring counts as noncash income, or cancellation of debt income, which creates a tax liability for investors without an associated cash distribution.”

As noted by the Wall Street Journal, “the roughly 60% plunge in oil prices since the summer of 2014 already has sent a number of energy companies into bankruptcy court, and more are expected to follow.”

Clearly investors have soured on MLPs, which sometimes yielded more than 10% a year at a time when Treasury bonds were yielding pennies on the dollar, as many of them have cut or halted their distributions to investors. For example, the “Alerian MLP Index, which tracks about 50 large energy partnerships, has lost nearly half its value over the past 18 months.”

Among the energy vulnerable MLPs cited in the article, whose “debt is trading at distressed levels,” are Linn Energy LLC (NASDAQ – LINE), Breitburn Energy Partners LP (NASDAQ – BBEP) and Atlas Resource Partners LP (NYSE – ARP).

Many retail investors clearly “weren’t told they were buying a high-risk product with potential tax traps” and a number of industry professionals openly have questioned whether MLPs should ever have been recommended to investors in an account that was not tax-deferred (such as a retirement account) which would have shielded them from the negative tax implications.

As Merrill Lynch recently noted in a February 17th research report (“Master Limited Partnerships: Malaise, Loathing, Pessimism”) which accompanied the downgrading of 7 MLPs, this is a “humiliated asset class” for which “the humiliation continues.”

For many retail investors, the question remains just how expensive will their financial humiliation ultimately be.

If you are an individual or institutional investor who has any concerns about your investment in any Master Limited Partnership (MLP), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Fitch Rating Downgrades Hit Business Development Companies (BDCs)

Earlier this week, Fitch Ratings announced the completion of its periodic review of Business Development Companies (BDCs) – publicly traded firms that mostly make loans to mid-sized companies.

The review, which was comprised of 10 publicly rated firms, resulted in one-half of the 10 companies being either downgraded or otherwise assigned a negative outlook.

As noted by Fitch in its announcement, “Fitch’s outlook for the BDC sector is negative and reflects competitive underwriting conditions, earnings pressure, underperforming energy investments, unsustainable asset quality metrics, increased activist pressure, and limited access to growth capital. While some firms are better positioned, given their more conservative financial profiles and portfolio characteristics, others are likely to see rating pressure over the outlook horizon.”

Among the actions that were taken as a result of this peer review were the following:

– American Capital, Ltd. (NASDAQ – ACAS): Its ratings were placed on Rating Watch Negative;

– Apollo Investment Corporation (NASDAQ – AINV): Its Long-term Issuer Default Rating (IDR) was downgraded to ‘BBB-‘ from ‘BBB’ with a Rating Outlook of Negative;

– BlackRock Capital Investment Corporation (NASDAQ – BKCC): Its Long-term Issuer Default Rating was affirmed at ‘BBB-‘ with a Rating Outlook of Negative;

– Fifth Street Finance Corp. (NASDAQ:FSC): Its Long-term Issuer Default Rating was downgraded to ‘BB’ from ‘BB+’ with a Rating Outlook of Negative; and

– PennantPark Investment Corporation (NASDAQ: PNNT): Its Rating Outlook was revised to Negative from Stable.

If you are an individual or institutional investor who has any concerns about your investment in any Business Development Company (BDC), please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Business Development Companies – A High Wire Balancing Act Without A Safety Net?

A March 7th article in the Sarasota Herald Tribune (“Business Development Companies: Good Income Investment or Trap”) properly noted that, “in today’s historically low interest rate environment, investors hungry for higher yields have stumbled upon a somewhat obscure class of securities called Business Development Companies (BDCs).”

BDCs, investment entities that were created by Congress in 1980, are traded on stock exchanges and are required to invest at least 70 percent of their assets in the non-public debt and equity of small and middle-market U.S. companies. They annually distribute at least 90 percent of their income to stockholders.

Investors may be failing to appreciate that there are a number of risks intrinsic to BDCs, however, including their: underlying company credit and investment risk; leverage risk, as BDCs borrow money to make investments; illiquidity risk, as the underlying companies may have no ready market; and capital-markets risk, as BDCs rely on being able to easily borrow money to make new investments.

The shorter-term performance of BDC’s has been disappointing with the average BDC down about 10 percent since the beginning of 2016, more than the S&P 500. The catalysts for this decline range from fears of rising interest rates to concerns about the soundness of their underlying investments.

Although, historically, BDCs have yielded over 1.5 percentage points more than high-yield bonds and 7 percent more than 10-year U.S. Treasury securities, BDCs are quite volatile investments compared with U.S. stocks in general and even more so with high-yield bonds. They have, for example, about 2.5 times the volatility of high-yield bonds.

Investors need to carefully analyze any BDC’s prospects before investing. Additionally, investors need to be confident they can deal with BDC’s high volatility. In short: BDCs are only suitable for aggressive investors.

If you are an individual or institutional investor who has any concerns about your investment in any BDC product, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Energy Related Bonds & Structured Notes – A Potential Wolf in Sheep’s Clothing?

As noted in a February 5, 2016 article in The Wall Street Journal (“The Oil Rout’s Surprise Victims”), the epic collapse in the price of oil, from more than $100 per barrel less than two years ago to below $30 last week, has “crushed investors in the futures market, energy partnerships, high-yield corporate bonds and the shares of oil and gas companies.”

But there is another sector of the energy market – short term bonds and structured notes issued by major investment firms whose returns are linked to the price of oil or other energy-related assets – that could also be decimated in the coming months unless there is a significant recovery in oil prices.

These securities, which have been sold to wealthy families and individual investors who want to limit the risk or amplify the return of more-conventional investments, often carry such alluring nicknames as “Phoenix,” “Plus,” “Enhanced Return” or “Accelerated Return.” They typically mature in two years or less and pay commissions of about 2% to the brokerages that sell them which has included units of Bank of America, Citigroup, Credit Suisse, Goldman Sachs, J.P. Morgan Chase, Morgan Stanley and UBS.

Unfortunately, they use intricate combinations of options contracts to skew the payoffs from changes in energy prices: investors can make a lot of money if oil goes up a little, and they can lose much or all of their money if it goes down a lot. At current prices, most of these securities are underwater and there will have to be a significant increase in the price of oil (estimated at 50% to 100%) for them to return to their original value.

As noted by Craig McCann, principal at Securities Litigation and Consulting Group, a research firm in Fairfax, Virginia and one of the leading experts in the securities field, “this is not really an investment strategy so much as a wager on which way oil prices are going” and “some of the risks and costs of that wager are masked by the complexity of it.”

Furthermore, there isn’t any secondary trading in most of these securities, meaning that the issuing bank may often be the only buyer which, more often than not, does not benefit the investors who own them.

If you are an individual or institutional investor who has any concerns about your investment in any energy related bonds or structured notes, please contact us for a no-cost and no-obligation evaluation of your specific facts and circumstances. You may have a viable claim for recovery of your investment losses by filing an individual securities arbitration claim with the Financial Industry Regulatory Authority (FINRA).

Breaking Bad, the Junk Bond Edition

Junk bonds, better known as high-yeild debt have seen much better days and strategists say that investors may be focusing too much on the role energy has played in the decline while underestimating other risks.

According to Matthew Mish, global credit strategist at UBS “Energy, bond valuations are pricing in an uplift in underlying commodities, so there’s more downside risk if prices hold at these levels for a long time or go lower,” And elsewhere, he added, “we do not see a marginal buyer for lower-quality credit.”

David Kotok, chairman and chief executive of Cumberland Advisors, worries more about the currency risk. “Foreign currencies — even those in developed markets such as Canada — have been crushed under a strong United States dollar. Over the past year, the Canadian loonie has fallen 17 percent against the American currency; the Brazilian real has plummeted 34 percent”, says Kotok.

Joseph F. Kalish, chief global macro strategist at Ned Davis Research concern is for the market damage seems to be spreading beyond commodities. Kalish says, “That’s what has gotten me more concerned this time around, compared to the generalized, risk-off sell-off we had in the middle of last year,”.


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