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Archive for December, 2009


Proposed Financial Reform Endangered by “Hat Switching” Provision

The investment adviser world is frenzied over a provision included in the financial services reform legislation recently approved by the House of Representatives. The so-called, “hat switching,” provision is one sentence long and buried within the expansive legislation. The provision, part of H.R. 4173, reads as follows:

“Nothing in this section shall require a broker or dealer or registered representative to have a continuing duty of care or loyalty to the customer after providing personalized investment advice about securities.”

This can be read as meaning that the fiduciary standard owed to a client disappears once investment advice is given.

The move towards creating a single fiduciary standard would be greatly hindered if such a provision makes it into the final language of the bill. The provision would protect discount brokerage firms from a continued fiduciary relationship with a client after initial advice and/or sale of a product.

It can be expected that this is not the last time we will hear of this provision.

FINRA – Private Placement Enforcement Cases to Come

James Shorris, executive director of enforcement at the Financial Industry Regulatory Authority (FINRA) has been quoted by Investment News as saying that enforcement cases on multiple private placement deals can be expected to begin by next year.

Private placement memorandum (PPM) deals, also known as Reg D offerings, have come under increased scrutiny after enjoying a period of great popularity. Issues that have been brought to the attention of FINRA include:

– Potential misrepresentations made by brokers regarding the sale of PPMs
– Due Diligence issues, including conflicts of interest over the authorship of due diligence reports
– Whether or not the PPM was suitable for many of the clients holding them

These and other issues are currently being examined by FINRA in connection with multiple PPM offerings.

House Kills Amendement Aimed at Expanding FINRA’s Power

The House passed an amendment killing a proposal that would have given the Securities and Exchange Commission (SEC) the power to allow the Financial Industry Regulatory Authority (FINRA) to carry out oversight on investment advisers working at broker-dealer firms.

The amendment, submitted by Republican Representative Spencer Bachus, R-Alabama, was part of the Investor Protection Act of 2009. The bill, which also includes a single fiduciary standard for registered investment advisers and independent broker-dealers, is one part of a move by Congress to reform the financial industry.

Bauchus agreed with the decision to scrap the amendment, but indicated that he would investigate alternatives to regulate advisers.

Brookstreet and CEO Charged with Fraud

The Securities and Exchange Commission (SEC) has charged California-based Brookstreet Securities Corporation and its President/CEO, Stanley Brooks, with fraud. The charges stem from Brookstreet’s habitual selling of risky mortgage-backed securities to clients with conservative investment objectives.

This risky and unsuccessful strategy was part of an internal Brookstreet program aimed at selling collateralized mortgage obligations (CMO) to clients, many of whom were categorically ill-suited to hold such investments. Through the internal CMO program, approximately $300 million of client funds were invested, a great deal of which were ultimately lost.

As markets deteriorated, CMOs being hit particularly hard, Brookstreet customers found themselves taking massive losses. Many clients lost their savings, homes, and retirements because of the program, and eventually, Brooks lost his company. Brooks, for his part, was warned multiple times about the errant logic in his program.

Brooks was personally warned on multiple occasions regarding the risk inherent in the CMO program with whistleblowers including his own Compliance Department, registered representatives, and institutional bond traders…among others.

Brookstreet and its CEO have been charged under the antifraud provisions of the Exchange Act.

UBS Held Liable In Lehman PPN FINRA Arbitration

According to the WSJ today:

In what will likely be a closely studied ruling, a retail investor was awarded $200,000 after a Financial Industry Regulation Authority arbitration panel decided the investor’s UBS AG (UBS) broker inappropriately sold her risky Lehman Brothers principal protected notes.

The case is one of the first involving the Lehman notes to be heard by a Finra arbitration panel. While the arbitration ruling won’t set a precedent, it could be an indicator of how future rulings on similar cases will play out.

There are “many pending similar cases,” said Jacob Zamansky, of Zamansky & Associates, who represented the investor in the arbitration case. Zamansky stated he is representing a dozen clients in a similar situations around the country.

As in most arbitration awards, the three-person arbitration panel didn’t give reasons for its findings. Other panels that hear similar cases don’t have to follow precedent so they could rule in different ways on nearly identical cases. Still, the case will likely be cited by other plaintiff lawyers.

The case, submitted for arbitration a year ago, was brought against UBS Financial Services, a unit of UBS, which is also being investigated by numerous regulators for alleged issues around its selling of these notes. Zamansky’s client was seeking $300,000 in compensatory damages because the broker recommended structured products. Zamansky argued that the notes were “speculative derivative securities” and were “unsuitable” for unsophisticated investors, according to the Finra claim statement.

The broker purchased two notes for his client: a $225,000 guaranteed principal protection note and a $75,000 return optimization note. The panel ruled that the client should be compensated $150,000 plus interest and attorney fees on the principal protected note; there was no compensation for the $75,000 note.

UBS said in a statement it “is disappointed the arbitration panel in this case awarded the claimant any damages, even if it was the only half the compensatory losses she was seeking. UBS maintains that any client losses were the direct result of the unexpected and unprecedented failure of Lehman Brothers, which affected all Lehman bondholders.”

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