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Auto-Callable Structured Products – the Wall Street House Always Seems to Win

The Wall Street Journal, on September 12, 2018 (“FANG Stock Play Can Fall Short”), noted that investors looking to reap the gains of highflying technology stocks while avoiding risk – through the purchase of “auto-callable” structured note products – are finding they can’t do both.

These structured notes “are often sold to mom-and-pop investors seeking higher-yielding alternatives to government debt, which is reliably safe. Offering documents say that buyers can earn fixed payouts of as much as 25% of the purchase price annually without taking on the risk of outright common-share ownership. Yet many of these FANG-linked notes fail to produce returns anywhere near that stated range, according to an analysis of securities filings by The Wall Street Journal. Many times, the upfront fees that banks collected were higher than the total returns earned by investors.”

“That is partly because the notes – dubbed ‘auto-callable’ because a rise in the stock price contractually triggers their redemption – are often redeemed in less than a year, and sometimes in as little as a month. In many cases, the auto-callable provision leads investors to earn scant returns and receive their money back long before the stated term of the investment.”

As noted in the article, auto-callable notes “are unlike common shares, which offer purchasers unlimited potential gains as well as the risk of total loss. They are also unlike U.S. Treasuries, which pay out periodic ‘coupons’ and entitle holders to full repayment at maturity. Instead, the notes offer gains up to a certain, specified threshold and protect against only certain, specified equity losses. Typically, if the linked stock or basket of stocks trades below a designated barrier – say, 75% of its initial value – when the notes mature, investors can lose a share of their principal on par with losses on the stock or basket.”

The Wall Street Journal specifically notes that Citigroup Inc., UBS Group AG and Royal Bank of Canada are among the banks this year that have issued more than $1 billion of auto-callable structured notes that are linked to one or more of the four FANG stocks: Facebook, Amazon, Netflix and Google parent Alphabet.

So how does the Wall Street house win with these investments? Consider just the following 2 examples that were cited in this article:

“When Citigroup sold $16.3 million of auto-callable notes tied to Amazon.com shares in mid-February, the firm advertised a 10% potential annual coupon for three years. Three months later, Amazon shares were up more than 20% – but the note was called, meaning that investors who purchased it received a total payout of 2.5%” while Citigroup “collected 3.5% in fees.”

Similarly, “in March, UBS issued a $150,000 note tied to Netflix. It paid 20.58% annually as long as shares of Netflix weren’t above the effective purchase price on monthly review dates. After one month, the stock was up 5.9%. The note was called, paying a coupon of 1.7% of the purchase price” while UBS reportedly “collected 2.7% in fees.”

If you are an individual or institutional investor who has any concerns about your auto-callable or structured product investments with any brokerage firm, 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).

Wedbush Securities Inc. and Edward William Wedbush

A judgment issued by the United States Court of Appeals for the Ninth Circuit became final in which the firm was fined $300,000. Mr. Wedbush was fined $50,000 and suspended from association with any FINRA® member in any principal capacity for 31 days. The United States Court of Appeals for the Ninth Circuit denied the firm and Mr. Wedbush’s petition for review. The sanctions were based on findings that, for five-and-a-half years, the firm committed 158 regulatory reporting violations. Specifically, the firm reported a total of 129 events late on Forms RE-3, Uniform Application for Securities Industry Registration or Transfer (Form U4) and Uniform Termination Notice for Securities Industry Registration (Form U5), and Rule 3070 Reports; reported 18 events inaccurately; and failed to file a total of 11 Forms RE-3, U4 and U5. The findings stated that the firm and Mr. Wedbush failed to reasonably supervise regulatory reporting, failed to effectively and reasonably implement the firm’s supervisory system related to regulatory reporting, failed to act decisively to detect and prevent future regulatory reporting rule violations and failed to implement corrective measures that were timely and sufficient to address the regulatory reporting failures.

The suspension is in effect from August 20, 2018, through September 19, 2018. (FINRA Case # 2007009404401)

Jonathan George Sweeney (Oceanside, California)

An AWC was issued in which Sweeney was barred from association with any FINRA member in all capacities. Without admitting or denying the findings, Sweeney consented to the sanction and to the entry of findings that he made material misrepresentations and omitted material information in an unsuitable recommendation 14 Disciplinary and Other FINRA Actions July 2018 to his customer. The findings stated that Sweeney caused the customer to surrender two variable annuities and use the proceeds to purchase two new variable annuities. Sweeney, in order to convince the customer to accept his recommendation, intentionally misrepresented material facts to the customer. Specifically, Sweeney falsely represented that the new annuities provided her with the same benefits as the original annuities. In addition, Sweeney knew, yet intentionally omitted to disclose, several material adverse facts to the customer. Sweeney did not tell the customer that she would lose the enhanced living and death benefits to which she was entitled under the original annuities if she surrendered the original annuities if she surrendered the original annuities, nor did he tell her the value of these enhanced benefits. Sweeney also did not tell the customer that she would forfeit the enhanced growth features of the original annuities by switching to the new annuities, and that the accumulation values for her living and death benefits under her original annuities were higher than the cash surrender values, or that cashing out her original annuities would cause her to realize certain losses based on the performance of her various subaccount investments that she would not otherwise incur. The findings also stated that Sweeney effected the annuity exchanges without having a reasonable basis to believe that such sales and purchases were suitable for the customer in view of her age, retirement status, financial needs, and her desire to have guaranteed lifetime income streams and enhanced death benefits to pass on to her beneficiaries. Sweeney also did not have a reasonable basis to believe that his recommendation to the customer was suitable because he knew that the new annuities did not provide her with product enhancements or improvements, but rather caused her to forfeit significant benefits and become subject to a new surrender period. As a result of this conduct, Sweeney violated FINRA Rules 2111, 2330(b) and 2010. The findings also included that. Sweeney reused original signatures from forms his customers had signed to complete new forms that his customers had not signed. He then submitted the new forms to his firm as original documents. (FINRA Case #2016050142601)

Laidlaw & Company (UK) Ltd. (London, England)

An AWC was issued in which the firm was censured, fined $25,000 and required to provide a written certification to FINRA that its systems, policies and procedures, with respect to each of the areas and activities cited in the AWC, are reasonably Disciplinary and Other FINRA Actions 3 July 2018 designed to achieve compliance with applicable securities laws, regulations and rules. Without admitting or denying the findings, the firm consented to the sanctions and to the entry of findings that it failed to establish and maintain a supervisory system and WSPs reasonably designed to ensure that representatives’ recommendations of leveraged and inverse exchange traded funds (non-traditional ETFs) complied with applicable securities laws and NASD and FINRA rules. The findings stated that the firm did not have a supervisory system reasonably designed to enable the firm’s supervisory personnel to review non-traditional ETF transactions. The firm’s WSPs did not require supervisors to review open positions in non-traditional ETFs held for extended periods of time, or resulting in unrealized losses and did not impose product-specific limitations on firm representatives’ ability to recommend trading in or holding non-traditional ETFs. Additionally, prior to July 2015, the firm relied on supervisors to conduct a manual blotter review to detect potentially unsuitable non-traditional ETF transactions. Beginning in July 2015, the firm began using an exception report showing transactions in all ETFs, including non-traditional ETFs. This exception report did not show holding periods for non-traditional ETFs. (FINRA Case #2015043362701)

Reef Securities, Inc. and Paul Frank Mauceli Jr.

A Letter of Acceptance, Waiver and Consent (AWC) was issued in which the firm was censured and fined $40,000. Mauceli was fined $5,000 and suspended from association with any FINRA® member in any principal capacity for four months. Without admitting or denying the findings, the firm and Mauceli consented to the sanctions and to the entry of findings that the firm, acting through Mauceli, the firm’s president, failed to notify investors in a timely manner of a right of rescission following the issuance of an updated general partners audited balance sheet and approval of a revised prospectus. The findings stated that the firm served as the broker-dealer selling an oil and gas drilling and income fund limited partnership for an issuer. The firm, acting through Mauceli and the issuer, decided not to send the revised prospectus and a notice offering each investor an opportunity to confirm or rescind his or her investment decision, despite the requirements of the prospectus, due to low prices in the oil and gas market. FINRA discovered that the firm had not provided the revised prospectus and notice to the vast majority of the investors in the income fund. After FINRA raised the issue, the firm eventually sent the revised prospectus and notice to the remaining investors, whereupon several investors rescinded their investment. The findings also stated that the firm distributed communications related to a real estate investment trust offering to investors that failed to provide balanced presentation or a sound basis for evaluating the investments being promoted, contained misleading and unwarranted claims and, in addition, made prohibited investor profit projections. The suspension is in effect from May 7, 2018, through September 6, 2018. (FINRA Case #2015043469001)

Dennis Ernest Beeby (San Diego, California)

An AWC was issued in which Beeby was assessed a deferred fine of $10,000, suspended from association with any FINRA member in all capacities for eight months and ordered to pay deferred disgorgement of commissions received in the amount of $55,000, plus interest. Without admitting or denying the findings, Beeby consented to the sanctions and to the entry of findings that he never disclosed his participation in private securities transactions in writing or otherwise to his member firm and never received its approval to participate in the transactions. The findings stated that the firm’s relevant WSPs prohibited representatives from engaging in any private securities transaction without its prior express written permission. Beeby recommended the purchase of securities in the form of oil and gas working interests in the development of an oil and gas lease by a corporation to several of his customers. The working interest securities were not offered through Beeby’s firm. Four customers purchased a sum total of $700,000 in oil and gas working interests. Beeby handled all aspects of the sales, including recommending the investment, providing paperwork for investors to sign, signing some of the transaction documents and managing ongoing communications regarding the investment. Beeby also received a commission of $55,000 for the sales.

The suspension is in effect from April 2, 2018, through December 1, 2018. (FINRA Case #2016052305501)

LPL Financial LLC (Boston, Massachusetts)

An AWC was issued in which the firm was censured and fined $375,000. Without admitting or denying the findings, the firm consented to the sanctions and to the entry of findings that it failed to implement a supervisory system reasonably designed to ensure that its registered representatives were trained on all material risks and features of brokered certificates of deposit (CDs) and that it adequately disclosed all material risks and features of the brokered CDs to customers. The findings stated that in particular, the firm failed to take reasonable steps to ensure that its registered representatives or fixed income desk employees received or had meaningful access to issuer-prepared disclosure documents prior to their sales of these products. In response to FINRA Notice to Members 02-69, the firm prepared and delivered to customers who purchased brokered CDs a generic CD disclosure statement that described the general risks and characteristics of brokered CDs. The firm, however, did not consistently provide its customers, prior to or at the time of sale, with issuer-prepared disclosure documents, despite the firm’s obligation to do so under its selling agreements with the brokered CD issuers, and did not otherwise have a process to disclose fully all material risks and features of the brokered CDs to customers. Because of the firm’s deficient supervisory system, one of the firm’s registered representatives made material misrepresentations to elderly customers regarding the limitations on the ability, upon death, of their estates to redeem their 20-year brokered CDs at par value. The elderly customers or their estates suffered losses of approximately $75,000 because they were unable to fully redeem the brokered CDs and had to sell the brokered CDs on the secondary market. The firm subsequently remediated these customers’ losses. (FINRA Case #2015045703001)

FINRA takes new enforcement action against Charles Acheson Laverty

Laverty was named a respondent in a FINRA complaint alleging that that during consecutive associations with several member firms, he borrowed $1,350,000 from an elderly married couple in violation of each firm’s policies. The complaint alleges that three of the firms prohibited their representatives from borrowing money from their customers.

Although a firm permitted loans between representatives and customers under limited circumstances, any such loan required the written approval of the chief compliance officer. The firm’s chief compliance officer never provided any such approval to Laverty. The complaint also alleges that Laverty concealed the loans from his firms and falsely stated on annual compliance questionnaires and on a heightened supervision attestation that he had not borrowed money from customers. For an example, Laverty lied on a firm’s compliance questionnaires concerning soliciting or accepting a loan from or making a loan to a client and having a judgment against him. On a firm’s annual compliance questionnaire, Laverty’s answers were false because earlier he had borrowed $45,000 from the elderly couple. Moreover, the Superior Court of California, County of Riverside, entered a judgment against Laverty for $114,456.25 in a lawsuit by the Security Bank of California against him arising from his failure to repay a promissory note. Laverty was aware of this judgment.

The complaint further alleges that Laverty concealed the loans from FINRA and provided false on-the-record (OTR) testimony during a previous FINRA investigation into his borrowing activity. During an OTR taken in that investigation, FINRA questioned Laverty about loans from five particular customers, and then asked, “Mr. Laverty, did you borrow from any other customers?” Laverty answered, “No” and insisted that he had only borrowed from these five customers. Laverty’s answers were false. Laverty had, in fact, also borrowed from the elderly couple. In addition, Laverty executed a $1.4 million promissory note for the loans that the elderly couple had extended to him and quickly breached the agreement by making none of the required monthly payments. The elderly couple filed a Statement of Claim against Laverty and the firms through which he registered. One of the firms filed a Form U5 Amendment disclosing the Statement of Claim and informing FINRA, for the first time, that Laverty had improperly solicited and accepted loans from the elderly couple. Neither of these elderly customers lived to see their claims resolved. Nevertheless, days before a scheduled arbitration, the elderly couple, through their successor in interest, settled their claim against Laverty. Soon thereafter, Laverty breached his obligations under the settlement by failing to make a required payment. FINRA suspended Laverty for failure to comply with the settlement. In addition, the complaint alleges that Laverty willfully failed to update his Form U4 to disclose an unsatisfied judgment entered in the Security Bank of California lawsuit and a federal tax lien.

FINRA Sanctions Fifth Third Securities, Inc., $6 Million

The Financial Industry Regulatory Authority (FINRA) announced today it has fined Fifth Third Securities, Inc., $4 million and required the firm to pay approximately $2 million in restitution to customers for failing to appropriately consider and accurately describe the costs and benefits of variable annuity (VA) exchanges, and for recommending exchanges without a reasonable basis to believe the exchanges were suitable. This is the second significant FINRA enforcement action against Fifth Third involving the firm’s sale of variable annuities.

Variable annuities are complex investments commonly marketed and sold to retirees or people saving for retirement. Exchanging one VA with another involves a comparison of the complex features of each security. Accordingly, VA exchanges are subject to regulatory requirements to ensure that brokers have a reasonable basis to recommend them, and their supervisors have a reasonable basis to approve the sales.

FINRA found that Fifth Third failed to ensure that its registered representatives obtained and assessed accurate information concerning the recommended VA exchanges. It also found that the firm’s registered representatives and principals were not adequately trained on how to conduct a comparative analysis of the material features of the VAs. As a result, the firm misstated the costs and benefits of exchanges, making the exchange appear more beneficial to the customer. By reviewing a sample of VA exchanges that the firm approved from 2013 through 2015, FINRA found that Fifth Third misstated or omitted at least one material fact relating to the costs or benefits of the VA exchange in approximately 77 percent of the sample. For example:

  •  Fifth Third overstated the total fees of the existing VA or misstated fees associated with various additional optional benefits, known as riders.
  • Fifth Third failed to disclose that the existing VA had an accrued living benefit value, or understated the living benefit value, which the customer would forfeit upon executing the proposed exchange.
  • Fifth Third represented that a proposed VA had a living benefit rider even though the proposed VA did not, in fact, include a living benefit rider.

FINRA found that the firm’s principals ultimately approved approximately 92 percent of VA exchange applications submitted to them for review. However, in light of the firm’s supervisory deficiencies, the firm did not have a reasonable basis to recommend and approve many of these transactions.

Susan Schroeder, FINRA’s Executive Vice President and Head of Enforcement, said, “FINRA remains vigilant in examining how member firms market variable annuities, which are complex products pitched to retirees and people saving for retirement. Returning $2 million in restitution to harmed investors is a key part of FINRA’s investor protection mission.”

In addition, FINRA found that Fifth Third failed to comply with a term of its 2009 settlement with FINRA. In the 2009 action, FINRA found that, from 2004 to 2006, Fifth Third effected 250 unsuitable VA exchanges and transactions and had inadequate systems and procedures governing its VA exchange business. For more than four years following the settlement, the firm failed to fully implement an independent consultant’s recommendation that it develop certain surveillance procedures to monitor VA exchanges by individual registered representatives.

In settling this matter, Fifth Third neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.

Clifton Stanley Ponzi scheme charges brought by SEC

On April 6, 2018, the Securities and Exchange Commission charged two Texas companies and their principals in a $2.4 million Ponzi scheme and in a related, $1.4 million offering fraud targeting retirees.

The SEC’s complaint alleges that, from 2010 to 2017, Clifton E. Stanley ran a Ponzi scheme through his retirement planning and real estate investment business, The Lifepay Group, LLC. Stanley is alleged to have lured at least 30 elderly victims to invest approximately $2.4 million of their retirement savings with baseless promises and claims of outsized investment returns. He kept the scheme afloat for years by paying early investors with later investors’ funds and by convincing investors to roll over their investments.  The SEC further alleges that Stanley pilfered from the estate of an elderly woman’s family trust, diverting nearly $100,000 to fund the Lifepay Ponzi scheme. In addition, the SEC’s complaint alleges that, beginning in 2015, Stanley and Michael E. Watts orchestrated a second offering fraud through a company they controlled, SMDRE, LLC. Stanley and Watts allegedly used a collection of misrepresentations and empty promises to convince a group of predominantly elderly victims to invest roughly $1.4 million in SMDRE.

Stanley is alleged to have used roughly $1.3 million of the Lifepay offering proceeds for personal expenses, including country club memberships, daily living expenses, travel, and entertainment expenses. In addition, Watts and Stanley allegedly engaged in shell game transactions so they could use the vast majority of SMDRE investor funds for personal expenses and to keep the Lifepay Ponzi scheme afloat.

The SEC’s complaint charges Stanley, Watts, Lifepay, and SMDRE with violating the registration and antifraud provisions of the federal securities laws. Stanley was also charged for conduct stemming from his role as an unregistered broker.


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