On January 28, 2010, FINRA Education Foundation announced grants to create law school clinics at Florida International University, Howard University, Pepperdine University, and Suffolk University to provide legal assistance to “underserved investors involved in securities disputes.” These grants are intended to “help fill the gap in legal representation for investors with small claims who do not have the financial resources to obtain legal counsel.”
SEC AND FINRA ISSUE AN ALERT REGARDING LEVERAGED AND INVERSE ETFs
August 19, 2009 By
On August 18, 2009, the SEC staff and FINRA jointly issued an Alert regarding the confusion investors may have about the performance objectives of leveraged and inverse exchange-traded funds (“ETFs”). The Alert states that “[s]ome investors might invest in these ETFs with the expectation that the ETFs may meet their stated daily performance objectives over the long term as well. Investors should be aware that performance of these ETFs over a period longer than one day can differ significantly from their stated daily performance objectives.” (Emphasis added).
The SEC further cautioned: “While there may be trading and hedging strategies that justify holding these investments longer than a day, buy-and-hold investors with an intermediate or long-term time horizon should carefully consider whether these ETFs are appropriate for their portfolio. As discussed above, because leveraged and inverse ETFs reset each day, their performance can quickly diverge from the performance of the underlying index or benchmark. In other words, it is possible that you could suffer significant losses even if the long-term performance of the index showed a gain. ” (Emphasis added).
FINRA has also published a Non-Traditional ETF FAQ.
FINRA’S Notice to Firms That “Inverse and Leveraged ETFs That Reset Daily Typically Are Unsuitable for Retail Investors Who Plan to Hold Them for Longer Than One Trading Session”
August 3, 2009 By
On June 11, 2009, FINRA issued Regulatory Notice 09-31 regarding “Non-Traditional ETFs” stating:
Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track—or both—are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatilemarkets.
This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met.
FINRA FINES BROKER-DEALERS FOR FAILURE TO SUPERVISE SHORT-TERM SALES OF CLOSED-END FUNDS IN IPO’s
July 28, 2009 By
On July 28, 2009, FINRA fined two broker-dealers for failures to supervise which resulted in the unsuitable short-term sales of closed-end funds (“CEF”) purchased at the funds’ IPO. CEFs are investment companies that sell a fixed number of shares in an IPO with built-in sales charges. Thus, after the IPO, the shares trade in the secondary market, generally at a discount from the IPO price. The CEFs at issue had sales charges of 4.5 percent, as well as a “penalty bid period” of generally 30 to 90 days immediately following the IPO.
FINRA noted that “Closed-end funds possess complex features that can give rise to unsuitability for short-term investors, particularly when purchased at the initial public offering.” During the relevant period, brokers would lose their sales commission if their clients sold the CEFs purchased at the IPO. FINRA found that despite knowledge that CEFs purchased at the IPO are more suitable for long-term investments, the broker-dealers did not have adequate supervisory systems and procedures designed to detect and prevent unsuitable short-term trading of CEFs.
FINRA SANCTIONS BROKER FOR ENGAGING IN PONZI SCHEME INVOLVING BROKER DEALER’S CUSTOMERS
July 27, 2009 By
On July 27, 2009, FINRA announced that it sanctioned a broker for conducting a Ponzi scheme involving his broker-dealer’s customers as well as his family, friends and fellow church members.
According to FINRA, the registered representative “conducted an elaborate Ponzi scheme, fraudulently inducing at least 25 brokerage customers, family and fellow church members to participate in a fictitious ‘St. Louis Investment Club’ and to invest in the non-existent real estate investment trust, the ‘St. Charles REIT.’” To conceal the scheme, the broker typically had investors make payments to his wife in small increments to avoid bank scrutiny. The broker also prepared false invoices for the REIT purchases that were designed to appear like official ownership certificates.
FINRA FINES BANK BROKER-DEALERS $1.65 MILLION FOR FAILURE TO SUPERVISE
July 26, 2009 By
On July 23, 2009, FINRA announced that it had fined five bank broker-dealers a total of $1.65 million for deficient supervision and procedures. Brokers at each of the firms operated out of branches of affiliated banks and sold variable annuities (“VA”), mutual funds or unit investment trust (“UIT”) transactions to bank customers. The brokerage customers were referred by bank personnel, and sales of these products represented a significant portion of each firm’s business. FINRA made numerous findings of inadequate supervision related to these products.
• At one firm a former broker “made 32 unsuitable sales to 25 elderly bank customers, recommending each customer purchase a VA with an enhanced death benefit rider. The customers, all 78 years old or older, were either too old to be eligible for the rider, or very close to the ineligible age. Those customers who purchased the VA with the enhanced death benefit rider received little or no benefit from the rider despite paying higher fees for it over the life of the annuity.” FINRA found that the firm “failed to take adequate remedial steps in response to red flags indicating that the broker was engaging in unsuitable VA transactions, including nine customer complaints filed against the broker about her annuity sales, and the broker’s practice of consistently engaging in a pattern of selling elderly bank customers the same variable annuity with the same enhanced death benefit rider.”
• At another firm which used trade blotters to assess suitability and approve VA and mutual fund transactions. FINRA found that such procedures “did not capture key information, such as the customer’s investment time horizon, risk tolerance and other financial assets – all details that are necessary for the principal to conduct an adequate suitability review.” Further, “important suitability information on the blotters was presented in a way that did not reflect customers’ true income or net worth; the blotter reflected only the highest number in the range of values from which it was taken.”
• Another firm “instructed its principals to consider factors such as a customer’s source of funds, health and investment time horizon without collecting or recording all the information necessary for principals to assess suitability and to consider factors such as the client’s age, need for tax deferral and liquidity without providing guidance on how to apply such factors in their suitability review.”
• Still, other firms “provided no factors to guide principals in determining suitability.”
In settling these matters, none of the firms admitted nor denied the charges, but consented to the entry of FINRA’s findings.
LEVERAGED EXCHANGE TRADED FUNDS OR ETF’s RESTRICTED BY BROKER-DEALERS
July 25, 2009 By
On July 24, 2009, it was reported that LPL Investment Holdings Inc. of Boston and Ameriprise Financial Inc. (AMP) of Minneapolis were following in the footsteps of Edward Jones & Co. by placing restrictions or entirely prohibiting the sale of leveraged exchange-traded funds or ETFs. ETFs trade daily on exchanges. Leveraged versions of ETF’s somtimes called “ultra” use futures or derivatives to multiply the daily returns of an index. The ETFs include short funds which can be used to bet against the market. The funds use derivatives to increase market exposure.
One commentator has raised particular concerns that retail investors may not understand how leveraged ETFs work, particularly short ETFs.
FLORIDA EXPANDS ENFORCEMENT AUTHORITY FOR VIOLATIONS OF FLORIDA SECURITIES AND INVESTOR PROTECTION ACT
June 30, 2009 By
On June 29, 2009, the Governor of Florida signed into law legislation to expand the jurisdiction of Florida’s Office of Statewide Prosecution by adding violations of the Florida Money Laundering Act and the Florida Securities and Investor Protection Act (“FSIPA”) to the list of offenses that may be considered by a statewide grand jury. Further, the legislation provides additional investigation and enforcement authority of the Florida Attorney General for securities violations, and authorizes the Attorney General to recover costs and attorney fees.
The law also expands the class of persons related to or associated with an applicant for registration as a dealer, associated person, or issuer of securities or registrant for which specified violations may result in adverse actions taken against registrations. Additionally, the law authorizes the Office of Financial Regulation (“OFR”) to bar specified persons from submitting applications or notifications for license or registration under specified circumstances.
The law allows the OFR to impose an emergency suspension in cases where a dealer, associated person, or issuer of securities fails to provide books and records requested by the OFR pursuant to its authority. The OFR is authorized to consider the following as a ground for a denial, suspension, or revocation action:
• A finding of a violation of Chapter 517, F.S., in an arbitration proceeding;
• A conviction of, or entrance of a plea of guilty or nolo contendere to, a crime contemplated under this subsection will be considered regardless of whether adjudication has been withheld;
• Whether the registrant is arrested for a crime which would be the basis for a denial, revocation, or suspension under s. 517.161(1), F.S.
FINRA PROPOSES ADDITIONAL DISCLOSURE IN BROKERCHECK
May 16, 2009 By
On April 27, 2009, FINRA announced that it was proposing the expansion of its BrokerCheck service to make records of final regulatory actions against brokers permanently available to the public. Under current rules, a broker’s record generally becomes unavailable to the public two years after he or she leaves the securities industry and is therefore no longer under FINRA’s jurisdiction. BrokerCheck is derived from which is the securities industry online registration and licensing database, referred to as the Central Registration Depository or “CRD.”
