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Archive for January, 2010

Due Diligence on Medical Capital Notes at Issue in Massachusetts Case Against Securities America

In the Commonwealth of Massachusetts v. Securities America Inc, the United States is seeing the first instance of a state regulator bringing an enforcement case against a company over private placement deals.

The allegations contained in the initial complaint are partially based on the claim that Securities America failed to follow through with proper due diligence. A broker is required to perform due diligence on a product to ensure that it is a legitimate offering worthy of sale to clients. If there is evidence that the product, in this case Medical Capital private placement offerings, is fraudulent or otherwise unfit for would be investors, that product is abandoned.

The issue in the current case is that Securities America sold a private placement deal (Medical Capital Holdings Inc.) to hundreds of investors over multiple years despite incontrovertible evidence that the Medical Capital financial records were meritless.

Securities America clients were only one such group sold Medical Capital notes. Of the more than $1.7 billion worth of notes sold to investors, Securities America clients represent a capital investment of $697 million, or roughly 37% of the whole. It is worth noting that the enforcement case in Massachusetts is only applicable to residents of the Commonwealth who were sold Medical Capital notes through Securities America. However, given the damning evidence introduced by state regulators, the repercussions of this case will reach far beyond the 60 investors to which it applies.


Securities America CEO Steps Down Amid Growing Arbitration Claims

Last week Securities America CEO Steve McWhorter announced his decision to retire after 22 years of service. His stated reason for leaving is that he wishes to spend time with his family, and he has stressed that there is no underlying reason for his departure. Despite this, some are questioning the timing of his announcement as a spate of client arbitration claims hit the Financial Industry Regulatory Authority (FINRA).

This string of complaints stem from multiple Securities America products ranging from the now defunct Medical Capital Holdings Inc., to Tenants In Common (TIC) products that have failed. Medical Capital is perhaps the most flagrant managerial failure for Securities America as a court appointed receiver has demonstrated overt fraud in court filings on the part of the medical receivables company. Clients of Securities America have lost millions as a result of this and other product failures.

Despite these recent failures, McWhorter is praised for the growth of Securities America during his time there. He is expected to remain in his current position until a willing replacement is found, and given the great deal of disgruntled clients and scrutinizing regulators, he may be waiting quite some time.


Black Diamond Mining Company

Black Diamond Mining Company LLC, which produces coal in Central Appalachia, said it filed a plan with a U.S. bankruptcy court to emerge from Chapter 11 and an earlier motion to convert its case to a Chapter 7 liquidation had been withdrawn.

The company also said it plans to conduct a bankruptcy-court-supervised auction for substantially all of its assets within the next two months.

Black Diamond’s senior lenders will submit a bid for the assets, it said in a statement.

“If successful, the senior lenders would own a significant majority of the company’s equity upon emergence,” the company said in a statement.

Chief Executive Officer Larry Hull said, “I am optimistic that Black Diamond will exit bankruptcy as a going concern during the first half of 2009.”

Black Diamond was forced into Chapter 11 bankruptcy by its creditors in February last year.

Bull Creek Coal Corp, Floyd County Resources Inc and Prater Creek Coal Corp had filed a motion last December asking for a court order converting the case into a Chapter 7 liquidation.

New Salvo in Debate Over Fidiciary Duty Reform

The debate over the inclusion of a single fiduciary standard in financial reform legislation is now being hit with a new lobbyist assault under the guise of legislator education. The insurance industry lobbyist machine, perhaps the most vehement opposition to sweeping fiduciary reform, now wishes for the Senate to authorize a study over the implications of passing a single fiduciary standard for both broker/dealers and Registered Independent Advisors (RIAs). Currently, RIAs have a fiduciary duty to their clients that amounts to greater liability in the event of a bad investment. This duty requires them to act in the best interest of their client when giving recommendations and advice.

The call for a new study is seen by many as a stalling technique with the goal of dissuading current supporters of a single fiduciary standard in the interim. What makes this tactic more transparent is the fact that a currently published study conducted by the Rand Corporation addresses the need for the legislation being considered.

Investment News reports that in response to the call for a new study which would be paid for with tax-payer dollars, a letter was sent by a laundry list of financial industry associations arguing that insurance groups have made up “myths” in an attempt to dissuade a single fiduciary standard. The January 7th letter was signed by:

– Fund Democracy Inc.

– The Certified Financial Planner Board of Standards Inc.

– The Consumer Federation of America

– The Financial Planning Association

– The Investment Adviser Association

– The National Association of Personal Financial Advisors

– The North American Securities Administrators Association Inc.

The letter, which was sent to Senator Chris Dodd (D-Conn) and Senator Richard Shelby (R-Ala), charges that the insurance industry is engaging in, “a particularly virulent attack on the legislation, aimed at eliminating entirely the provision requiring a fiduciary duty for financial professionals and replacing it with an unnecessary study at taxpayer expense.” It remains to be seen whether or not the study will be authorized, but it is clear that the debate over inclusion of a single fiduciary standard in the financial reform legislation is far from over.

Behringer Harvard REITs Continue Trend in Non-Traded REIT Market

Investors who placed their money in unlisted REITs, including Behringer Harvard, have been awakened to the myriad of issues related to the nature of these products. Unlisted, or non-traded, REITS differ from listed REITs in that they are not traded on an open market. Rather, non-traded REITs are sold to investors who then hold the product until the end of an investment term.

Behringer Harvard and other non-traded REITs contain a fundamental flaw which is many times not evident at the time of purchase: their value is set by the very companies which sell them. To clarify, a listed, or public, REIT is valued daily based on the market in which it is traded whereas a non-traded REIT’s value is determined by the staff of the REIT, or sometimes by a third party consultant paid for by the REIT which it is supposed to objectively value. Obviously, a conflict of interest can easily develop in the standard valuation procedure of a non-traded REIT.

Another issue with non-traded REITs is that if one chooses to sell their shares, it must do so in conformity with the procedures of the REIT. The usual procedure is to sell shares through a redemption program; however, many such programs have been suspended due to adverse financial conditions when many investors attempt to redeem their shares at once. The consequence to investors is that they are stuck in the investment until the redemption program is reinstated.

When sold Non-traded REITs, many were not informed of these obvious drawbacks to the product. Some have posited that it might have something to do with the somewhat common 15% commission given to the selling party, or the broker. Though regrettable, many investors may be able to recover losses in such products, including Behringer Harvard, through arbitration. For a more detailed analysis of REITs, click here.


Senator Dodd on Fiduciary Duty: Can He Withstand the Lobbyists?

After Senator Christopher Dodd’s surprise announcement last week declaring he would not seek reelection, many have begun to wonder about the policy ramifications this development will have on the remainder of his term in office. Financial reform is one such area of policy reform that the senator is tackling with much speculation over his resolve concerning fiduciary duty reform.

The two bodies of thought that have emerged on both sides of the aisle favor either a strong or a weak fiduciary duty provision. The strong provision would clearly put broker-dealers under the current fiduciary duty requirements levied on registered independent advisors (RIAs) by requiring such brokers to register as RIAs. The weak provision would require brokers to be registered as RIAs, however, the Securities and Exchange Commission (SEC) would be given more authority to write the new fiduciary duty at some time in the future. This position is adamantly supported by the banking industry as it is far less definitive than the strong provision and is more likely to result in little change to the business model of broker-dealers than the alternative.

Dodd currently supports the so-called strong provision, this being in contravention of the House approved language in the Wall Street Reform and Consumer Protection Act of 2009. Many who advocate for the strong provision are hoping that by announcing his decision to relinquish his seat, Dodd will be freed from listening to the lobbyists of the banking industry and therefore will more steadfastly pursue the strong provision before his time in the Senate comes to a close.

Even if Dodd’s resolve remains unfazed by lobbyists’ attempts to change his position, it remains to be seen if other members of the Senate will act likewise.


FINRA Issues Regulatory Notice Aimed at Principal Protected Notes

FINRA has issued a regulatory notice this month that stresses the need for brokerage firms to disclose the risk to investors in so-called Principal-Protected Notes. The notice, which may be viewed here, cautions firms from overstating the level of protection inherent in this structured product.

When marketing this product, firms may overstress the principal protection feature of the product without adequately disclosing the fact that such a feature is contingent on the continued credit worthiness of the guarantor. Principal protection is often rendered moot in cases where the guarantor files for bankruptcy – case in point: Lehman Brothers.

Many investors were sold Lehman Principal Protected Notes through their respective brokerage firms. When Lehman Brothers filed for bankruptcy, these notes were effectively rendered worthless. This came as a surprise to many investors who thought they had purchased a product which guaranteed capital preservation.

A number of Financial Industry Regulatory Authority (FINRA) arbitration claims have been filed against brokerage firms who marketed and sold Lehman PPNs. One such arbitration claim has resulted in a favorable award an investor sold Lehman PPNs by their broker, UBS. Such an award provides hope that future claims may prove equally equitable for investors.


Wells Fargo Advisors unveils new bonus plan for brokers

In an effort to get its advisers to focus on snagging more of their existing clients’ assets, along with new clients, Wells Fargo Advisors LLC has introduced a new rewards program in its deferred-compensation plan.

Until Jan. 1, the firm’s 12,000 advisers were eligible for a bonus based on growth in revenue. Now the bonus will be based on bringing in new assets. “The focus for this coming year is organic growth and incentivizing FAs for their expertise in gathering assets from new and existing clients,” said Wells Fargo Advisors spokeswoman Teresa Dougherty. “This complements the base award that is production based and the recurring revenue award.” The minimum amount of net new assets to qualify for this award is $500,000, and the incentive is 2 percent of an adviser’s total revenue.

The award is also partially based on the tenure of the adviser. For example, said Ms. Dougherty, an adviser with seven years at the firm who brings in $600,000 in revenue and $750,000 in net new assets would receive a bonus of 2% on that $600,000, or $12,000. Wells Fargo is following the lead of larger broker-dealers that are rewarding their advisers based on new assets instead of growth in revenue, said Danny Sarch, president of Leitner Sarch Consultants. “New assets is the mantra going on in the retail brokerage firm arena,” he said. Broker-dealers have to focus their advisers on grabbing new assets because there are only so many millionaires out there, said Rick Peterson, a recruiter who has an eponymous Houston firm. “It’s going to be a struggle for these firms to grow their businesses going forward, because we have fewer people who technically qualify for high-net-worth society and we have just as many brokers going after that same delta,” Mr. Peterson said.

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