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FINRA Moves to Focus Attention on Suitable Investment Recommendations

On January 22, 2019, FINRA released its “2019 Risk Monitoring and Examination Priorities Letter” which identifies topics that FINRA will focus on in the coming year.

As always, suitability remains one of FINRA’s top priorities in the coming year.

Some of the specific areas on which FINRA may focus in 2019 include: (1) deficient quantitative suitability determinations or related supervisory controls; (2) overconcentration in illiquid securities, such as variable annuities, non-traded alternative investments and securities sold through private placements; and (3) recommendations to purchase share classes that are not in line with the customer’s investment time horizon or hold for a period that is inconsistent with the security’s performance characteristics (which could include, for example, a recommendation to purchase and hold a security that is intended for short-term trading or to engage in short-term trading in products designed primarily for long-term holding).

In addition, as the exchange-traded product (ETP) market continues to grow with novel and increasingly complex products, FINRA will evaluate whether firms are meeting their suitability obligations and risk disclosure obligations when recommending such products. These include leveraged and inverse exchange-traded funds (ETFs), floating-rate loan ETFs (also known as bank-loan or leveraged loan funds) and mutual funds that invest in loans extended to highly indebted companies of lower credit quality.

FINRA also noted that it remains concerned about securities products that package leveraged loans (e.g., collateralized loan obligations). Although these products are typically sold via private placement to qualified institutional buyers, firms that may be selling them to retail investors will be subject to review as to how such firms are supervising such transactions to ensure their compliance with applicable sales restrictions.

If you are an individual or institutional investor who has any concerns about your 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 Founder Edward Wedbush Consent to Censure and $900,000 Fine by NYSE

NYSE Regulation filed a Statement of Charges on behalf of NYSE Arca, Inc. (“NYSE Arca” or “Exchange”) naming Edward W. Wedbush and Wedbush Securities, Inc. as Respondents. In order to resolve the matter, the Exchange entered into an Offer of Settlement and Consent with each Respondent. By stipulation of the parties, the Statement of Charges is amended to conform to the agreed upon terms of each Respondent’s Offer of Settlement and Consent.

In addition to serving as the president of Wedbush Securities, Mr. Wedbush spent several hours each trading day actively managing and trading in a number of accounts held by approximately 20 client relationships, including multiple discretionary customer accounts over which he had power of attorney (including accounts for relatives, friends, and Firm employees), as well as personal and proprietary accounts for affiliates of Wedbush Securities and Wedbush, Inc., the Firm’s parent company (of which Mr. Wedbush was also the largest shareholder) (collectively, the “EW Controlled Accounts”).

Despite Mr. Wedbush’s active trading in the EW Controlled Accounts, Respondents failed to implement adequate processes to monitor or supervise Mr. Wedbush’s order entry, trade executions, or trade allocations in the EW Controlled Accounts.  The absence of adequate monitoring or supervision of his trading activities allowed Mr. Wedbush to handle the EW Controlled Accounts in a manner that was not permitted for other traders at the Firm.

Mr. Wedbush’s trading violated numerous Securities Exchange Act of 1934 (“Exchange Act”) and NYSE Arca rules, including:

  • Exchange Act and NYSE Arca rules regarding account designation;
  • Exchange Act and NYSE Arca rules requiring firms to make and retain books and records;
  • NYSE Arca rules regarding order marking;
  • Rules relating to price adjustments on equity securities without formal processes or review; and
  • Rules relating to margin requirements.

Respondents’ violations resulted, in large part, from the Firm’s failure over a period of years to (i) establish and maintain a supervisory system, including written supervisory procedures (“WSPs”), reasonably designed to ensure compliance with laws, regulations, and rules relevant to Mr. Wedbush’s trading in the EW Controlled Accounts, and (ii) devote the resources required to supervise and monitor Mr. Wedbush’s trading in the EW Controlled Accounts.   In addition to the above violations, Wedbush Securities, for more than three years, also failed to implement adequate internal controls, including a system of follow-up and review, reasonably designed to detect and prevent potentially manipulative activity at the Firm more generally, including but not limited to wash sales, marking the open, and marking the close.

SEC Compliance Exam and Inspection Priorities for 2019

On December 20, 2018, the Securities and Exchange Commission’s Office of Compliance Inspections and Examinations (“OCIE”) announced its 2019 examination priorities. OCIE publishes its exam priorities annually to promote transparency of its examination program and provide insights into the areas it believes present potentially heightened risk to investors or the integrity of the U.S. capital markets.

As noted by the SEC in this report, in 2019 “particular emphasis” will be on “matters of importance to retail investors” including the protection of retail investors in the following areas of concern:

Senior Investors and Retirement Accounts and Products: OCIE will conduct examinations that review “how broker-dealers oversee their interactions with senior investors, including their ability to identify financial exploitation of seniors. In examinations of investment advisers, OCIE will continue to review the services and products offered to seniors and those saving for retirement. These examinations will focus on, among other things, compliance programs of investment advisers, the appropriateness of certain investment recommendations to seniors, and the supervision by firms of their employees and independent representatives.”

Proper Disclosure of Fees & Expenses: OCIE will conduct examinations that review “firms with practices or business models that may create increased risks of inadequately disclosed fees, expenses, or other charges. With respect to mutual fund share classes, OCIE will continue to evaluate financial incentives for financial professionals that may influence their selection of particular share classes. In addition, OCIE remains focused on investment advisers participating in wrap fee programs, which charge investors a single bundled fee for both advisory and brokerage services. Continued areas of interest include the adequacy of disclosures and brokerage practices.”

Conflicts of Interest: OCIE will conduct examinations that review firms that “provide incentives for financial professionals to recommend certain types of products and services” and advisers who “in some cases utilize services or products provided by affiliated entities.”

Mutual Funds and Exchange Traded Funds: OCIE will conduct examinations that review “mutual funds and exchange traded funds (ETFs) which are the primary investment vehicles for many retail investors” and “will assess industry practices and regulatory compliance in various areas that may have significant impact on retail investors” including “risks” that are associated with “index funds that track custom-built or bespoke indexes; ETFs with little secondary market trading volume and smaller assets under management; funds with higher allocations to certain securitized assets; and funds with aberrational underperformance relative to their peer groups.”

If you are an individual or institutional investor who has any concerns about your accounts or 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).

FINRA Elevates Focus on the Failure to Conduct Proper Due Diligence on Private Placements

On December 7, 2018, the Financial Industry Regulatory Authority (“FINRA”) issued a comprehensive report (“Report on FINRA Examination Findings”) which “focuses on selected observations from recent examinations that FINRA considers worth highlighting because of their potential significance, frequency, and impact on investors and the markets.”

Among the issues discussed in this report were significant concerns about some firms that failed to conduct reasonable diligence on private placements and failed to meet their supervisory requirements – especially in those circumstances when firms have an obligation to conduct a “reasonable investigation” through evaluation of the issuer and its management; the business prospects of the issuer; the assets held by or to be acquired by the issuer; the claims being made; and the intended use of proceeds of the offering.

In particular, FINRA has observed instances where some firms’ reasonable diligence was not sufficient in scope or depth to be considered a “reasonable investigation of the issuer and the securities.”

According to FINRA, these regulatory examinations revealed that “some firms failed to perform reasonable diligence on private placement offerings prior to recommending the offerings to retail investors” and that, “in some instances, firms performed no additional research about new offerings because they relied on their experience with the same issuer in previous offerings.”

In other instances, FINRA noted that “some firms reviewed the offering memorandum and other relevant offering documentation, but did not discuss the offering in greater detail with the issuer or independently verify, research or analyze material aspects of the offerings. FINRA also observed that some firms did not investigate red flags identified during the reasonable diligence process.”

Finally, FINRA stated that “where some firms obtained and reviewed due diligence reports provided by due diligence consultants, experts or other third-party vendors, they sometimes did not independently evaluate the third parties’ conclusions, respond to red flags or significant concerns noted in the reports, or address concerns regarding the issuer or the offering that were apparent outside the context of the report.” Of equal concern was the fact that “some firms used third-party due diligence reports that issuers paid for or provided in their due diligence analysis. While some of these reports provided valuable and relatively objective information, in some cases, firms did not consider the related conflicts of interest in their evaluation and assessment of the reports’ conclusions and recommendations.”

If you are an individual or institutional investor who has any concerns about your private placement 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).

BBB Corporate Bonds – How Many Are Close to Default?

In 2008, in the aftermath of the financial crisis, the Federal Reserve began its “quantitative easing” program, a determined effort to lift the economy by lowering the cost of borrowing. It bought up trillions of dollars in Treasury and other debt securities, effectively reducing long-term interest rates. Debt issuance exploded. In the last decade, the amount of corporate bonds outstanding almost doubled to $9 trillion, from $5.5 trillion.

Much of that surge has come in the form of bonds rated BBB, near the riskier end of the investment-grade spectrum — meaning that the money borrowed remains at some danger of not being paid back. There is now nearly $2.5 trillion of United States corporate debt rated in the BBB category, almost three times the amount that existed in 2008 and making up an ever increasing portion of the investment grade bond market at almost half of its overall size bond market.

The changing composition of the bond universe introduces extra risks for investors tracking the broad market. Lower-rated bonds tend to fall more sharply if sentiment deteriorates, and are more likely to default or be downgraded to junk, which can prompt some forced selling.

General Electric Co. (GE) is an example of a high-profile company with a lower investment-grade rating that has struggled. Yields on GE bonds due in 2025 have moved to 6.4% from below 3%.  What happens in the corporate bond market has wider implications, since rising credit spreads can feed through to the rest of the economy.

S&P 500 Drops To New 2018 Low, DJIA Closes Down 500 Points

Stocks tanked on Monday, pushing the S&P 500 to a new low for the year amid growing concerns that the Federal Reserve’s plan to raise interest rates could be too much for the economy and stock market to handle.

The Dow and S&P 500, which are both in corrections, are on track for their worst December performance since the Great Depression in 1931, down more than 7 percent so far for the month. The S&P 500 is now in the red for 2018 by 4 percent.

Shares of Amazon and Goldman Sachs led the declines.

DoubleLine Capital CEO Jeffrey Gundlach said Monday that he believes the S&P 500 will drop below the early 2018 lows. All 30 stocks in the Dow and all 11 sectors in the S&P 500 posted losses on Monday.

Concentrated Position Risk Drawing Regulatory Scrutiny

On December 7, 2018, the Financial Industry Regulatory Authority (“FINRA”) issued a comprehensive report (“Report on FINRA Examination Findings”) which “focuses on selected observations from recent examinations that FINRA considers worth highlighting because of their potential significance, frequency, and impact on investors and the markets.”

Among the issues discussed in this report were significant concerns about some firms that “maintained customer accounts that were concentrated in complex structured notes or sector-specific investments, as well as illiquid securities, such as non-traded real estate investment trust (“REITs”), which were unsuitable for customers and resulted in significant customer losses.”

A concentrated account is commonly considered to be an account which contains a significant percentage of its assets in one product, type of product or sector which exposes the account to excessive amounts of risk – especially during periods of extreme volatility as the markets have recently experienced in greater frequency.

In particular, FINRA noted that “some registered representatives recommended structured notes or sector-specific investment strategies to customers who may not have had the sophistication to understand their features and without considering the customer’s individual financial situation and needs, investment experience, risk tolerance, time horizon, investment objectives, liquidity needs and other investment profile factors.”

Some of the “recommendations involved illiquid securities with limited price transparency, which made it difficult for investors to know the true value of their investment and led them to believe that their investments would not fluctuate in value. In some instances, firms did not have procedures or systems reasonably designed to identify and supervise the concentration of such products in customers’ accounts.”

If you are an individual or institutional investor who has any concerns about your concentrated 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).

LPL Financial settles with Indiana over failure to supervise allegations

Indiana Secretary of State Connie Lawson today announced she has agreed to a settlement with LPL Financial which includes a civil penalty of $450,000.  The settlement stems from an investigation by the Securities Division of the Secretary of State’s office regarding various deficiencies related to LPL’s supervision of its Indiana operations.

The settlement specifically focuses on email review and branch audit requirements.  Over the past several years, a software glitch caused LPL supervisors to not properly review a select number of emails.  When the Secretary of State’s office uncovered the glitch, LPL was contacted and the glitch was corrected.  The investigation also found that LPL did not conduct annual compliance exams of its Indiana branches as required by law.

“Broker-dealers and financial firms are often the first line of defense against fraud.” said Secretary Lawson. “If a firm does not have, or does not follow its own supervisory procedures, Hoosiers could be at risk.”

In addition to the $450,000 civil penalty, LPL agreed to a conduct a 3rd party compliance review of its policies and procedures in Indiana to ensure that they comply with Indiana law.  LPL will provide a report to the Securities Commissioner in 180 days for review.

“Our office is dedicated to keeping Hoosiers’ money safe, and to that end we will hold firms accountable if they do not establish and enact strong supervisory systems.” said Securities Commissioner Alex Glass.  “The law is clear.  A firm must properly and effectively supervise its business in Indiana.”

FINRA Concerned About Volatility-Linked Investment Products

On December 7, 2018, the Financial Industry Regulatory Authority (“FINRA”) issued a comprehensive report (“Report on FINRA Examination Findings”) which “focuses on selected observations from recent examinations that FINRA considers worth highlighting because of their potential significance, frequency, and impact on investors and the markets.”

Among the issues discussed in this report were significant concerns about the suitability of investments that are being recommended to retail investors.

In fact, FINRA observed situations where “registered representatives did not adequately consider the customer’s financial situation and needs, investment experience, risk tolerance, time horizon, investment objectives, liquidity needs and other investment profile factors when making recommendations.”

In some cases, FINRA noted that “unsuitable recommendations involved complex products (such as leveraged and inverse exchange-traded products (ETPs), including exchange-traded funds (ETFs) and notes (ETNs)). In other cases, they involved overconcentration in illiquid securities, variable annuities, switches between share classes, and sophisticated or risky investment strategies.”

One of the products that was specifically discussed in this report was “volatility-linked” products that are being marketed to retail investors. As stated by FINRA, their examinations of firms indicated that, “despite prospectuses and other materials that included risk disclosures, including explicit warnings about sales to retail customers, some firms nevertheless marketed volatility-linked products to retail customers who did not understand those products’ unique risks and made recommendations that were inconsistent with the investors’ investment profile, including risk tolerance and investment time horizon (e.g., in many of those instances, customers held the securities far longer than the holding periods – frequently one trading day – that were recommended in the product’s prospectus).”

If you are an individual or institutional investor who has any concerns about your volatility-linked 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).

Does the Corporate Debt Market Signal the End of the Party on Wall Street?

On November 26, 2018, in an editorial in the New York Times (“When Blue Chip Companies Pile on Debt, it’s Time to Worry”), it was noted that “fueled by cheap credit, American corporations have been gorging on acquisitions” and that “the party may soon be over.”

In fact, in the low interest-rate environment that has persisted for the last decade, “debt issuance exploded” as “the amount of corporate bonds outstanding nearly doubled to $9 trillion, from $5.5 trillion.”

This editorial observed that “much of that surge has come in the form of bonds rated BBB, near the riskier end of the investment-grade spectrum – meaning that the money borrowed remains at some danger, albeit low, of not being paid back. There is now nearly $2.5 trillion of United States corporate debt rated in the BBB category, close to triple the amount of 2008, making up half of the investment-grade bond market.”

As interest rates rise and the economy appears to be slowing, the potential for debt default has become “a fear that has started to cause disturbing ripples in the debt and equity markets.”

One of the examples discussed in this article concerns General Electric (NYSE: GE) which has a reported $115 billion of outstanding debt, about $20 billion of which is due within a year. In October, “S&P lowered G.E.’s credit rating to BBB, and the cost of buying insurance against a default on G.E.’s bonds, so-called credit default swaps, has soared in November. That’s a sign of investors becoming nervous that G.E. might default.”

Another example is AT&T (NYSE: T) which has “about $183 billion of debt outstanding” and “is now one of the most indebted companies on the planet, thanks to its recent acquisitions of DirecTV and TimeWarner, which were paid substantially with debt. AT&T’s debt is also rated BBB, although only about $11 billion is coming due within a year.”

This editorial concludes that “there’s a lot at risk here. If these BBB-rated companies get downgraded further into ‘junk’ status — a distinct possibility if a slowing economy makes a dent in their profits or if their big acquisitions do not pay off — a vicious cycle is nearly inevitable. That means higher borrowing costs when it comes time to refinance or to obtain a new credit line and an increasing risk of default.”

If you are an individual or institutional investor who has any concerns about your fixed income 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).


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