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Archive for April, 2014

Finra board approves requirement of background checks for brokers

The Financial Industry Regulatory Authority (FINRA) announced today that its Board of Governors approved amendments to FINRA’s supervision rule that would expand the obligations of firms to check the background of applicants for registration, including first-time applications as well as transfers, to verify the accuracy and completeness of the information contained in an applicant’s Form U4. Firms would also be required to adopt written procedures in this area that include searching public records.

The Form U4 is the Uniform Application for Securities Industry Registration or Transfer used by FINRA, other self-regulatory organizations (SROs) and states to elicit employment background, disciplinary and other information to register individuals with appropriate SRO(s) and/or jurisdiction(s).

Separately, FINRA also plans to perform an initial search of public financial records for all registered representatives. Additionally, FINRA will conduct a search of publicly available criminal records for all registered individuals who have not been fingerprinted within the last five years. Once these searches are completed, FINRA will conduct periodic reviews of public records to ascertain the accuracy and completeness of the information available to investors, regulators and firms. These efforts also better position FINRA to assess firm and registered individual compliance with reporting requirements.

FINRA is also considering whether additional data from the CRD system used by regulators should be included in BrokerCheck. FINRA’s Chief Economist has initiated a study to see if there is a meaningful relationship between that data – which includes failed examinations – and broker misconduct.

Richard Ketchum, FINRA Chairman and Chief Executive Officer, said, “These are important initiatives to improve the accuracy and totality of details reported on a registered individual’s Form U4. FINRA would require firms to use publicly available records to verify that information such as criminal and bankruptcy records, civil litigations, judgments and liens are properly reported upon a registered individual’s application. FINRA encourages every investor to use BrokerCheck to research the background of individuals they are trusting to invest their money.”

The amendments to the supervision rule will be submitted to the Securities and Exchange Commission for review and approval.

FINRA Board Rules Against Charles Schwab in Class Action Waiver Dispute

The Board of Governors of the Financial Industry Regulatory Authority (FINRA) issued a decision today finding Charles Schwab & Co., Inc. violated FINRA rules when the firm attempted to keep investors from participating in judicial class actions by adding waiver language to customer account agreements.

The ruling by the Board affirms in part and reverses in part an earlier FINRA Hearing Panel decision. The Hearing Panel found that Schwab’s waiver violated FINRA rules that limit the language that firms may place in predispute arbitration agreements but concluded that FINRA could not enforce those rules because they were in conflict with the Federal Arbitration Act (FAA). The Board overturned this finding and determined that the FAA does not preclude FINRA’s enforcement of its rules.

In addition, the Board upheld the Hearing Panel’s determination that Schwab’s attempt to prevent FINRA arbitrators from consolidating more than one party’s claims in a FINRA arbitration forum violated FINRA rules. The Board decision would have remanded the case to the Hearing Panel for a determination of appropriate sanctions. However, Schwab instead entered into a settlement, agreeing to pay a fine of $500,000 and to notify all of its customers that the Class Action Waiver requirement has been withdrawn from its customer account agreements and is no longer in effect. This fully resolves the matter.

View the Decision


SEC halts Ponzi scheme targeting Dominican and Brazilian immigrants

The Securities and Exchange Commission today announced that on Tuesday it filed charges against the Massachusetts-based operators of a large pyramid scheme that mainly targeted Dominican and Brazilian immigrants in the U.S.  The charges were filed under seal, in connection with the Commission’s request for an immediate asset freeze.  That asset freeze, which the U.S. District Court in Boston ordered on Wednesday, secured millions of dollars of funds and prevented the potential dissipation of investor assets.  After the SEC staff implemented the asset freeze, at the SEC’s request the court lifted the seal today, permitting public announcement of the SEC’s charges.

The SEC alleges that TelexFree, Inc. and TelexFree, LLC claim to run a multilevel marketing company that sells telephone service based on “voice over Internet” (VoIP) technology but actually are operating an elaborate pyramid scheme.  In addition to charging the company, the SEC charged several TelexFree officers and promoters, and named several entities related to TelexFree as relief defendants based on their receipt of investor funds. 

According to the SEC’s complaint, the defendants sold securities in the form of TelexFree “memberships” that promised annual returns of 200 percent or more for those who promoted TelexFree by recruiting new members and placing TelexFree advertisements on free Internet ad sites.  The SEC complaint alleges that TelexFree’s VoIP sales revenues of approximately $1.3 million from August 2012 through March 2014 are barely one percent of the more than $1.1 billion needed to cover its promised payments to its promoters.  As a result, in classic pyramid scheme fashion, TelexFree is paying earlier investors, not with revenue from selling its VoIP product but with money received from newer investors.

DBSI principals convicted of fraud

A federal jury in Boise today returned guilty verdicts against four DBSI principals, Douglas L. Swenson, Mark Ellison, David D. Swenson, and Jeremy S. Swenson on multiple fraud charges, announced U.S. Attorney Wendy J. Olson. The jury convicted Douglas Swenson, 65, of Eagle, Idaho, on thirty-four counts of wire fraud and forty-four counts of securities fraud.

The jury convicted Ellison, 65, of Boise, David Swenson, 36, of Boise, and Jeremy Swenson, 41, of Meridian, on forty-four counts of securities fraud.

The jury returned not guilty verdicts on the thirty-four wire fraud counts against Ellison, David Swenson and Jeremy Swenson and on two conspiracy counts. During the forty-two day trial, the United States presented evidence that the defendants publicly represented that DBSI was a profitable company and had a net worth in excess of $105 million when they knew that DBSI’s real estate and non-real estate business activities were universally unprofitable.

 No sentencing date has been set.

Finra abandons effort to become RIA regulator

Finra chairman and CEO Richard G. Ketchum said the regulator is no longer interested in expanding its oversight to financial advisers.  Mr. Ketchum told the Wall Street Journal on Thursday, “We are not pursuing it at the present time.”

“We don’t perceive any likelihood that it would be successful,” Mr. Ketchum told the WSJ, referring to the regulator’s efforts, which began in 2012 when it made a strong push for congressional approval of a bill that would shift financial adviser oversight.

Advisers resisted the legislation, fearing that Finra, an industry-funded regulator, would fill the role and the measure died. Finra backed down when the new Congress convened last year and the champion of the SRO bill, Rep. Spencer Bachus, R-Ala., relinquished his seat as chairman of the House Financial Services Committee.

Mr. Ketchum reiterated the regulator’s belief that adviser oversight should be increased, telling the newspaper that Congress should provide the SEC with the resources necessary to increase adviser examinations. The SEC examines about 8% of the nearly 11,000 registered investment advisers each year.

Finra files complaint against two ex-MetLife advisors

The Financial Industry Regulatory Authority has filed a regulatory complaint against two former MetLife Securities Inc. brokers for allegedly engaging in a seven-year scheme to inflate commissions by encouraging customers to switch $21 million in annuities, Reuters reports.

According to the FINRA complaint, Christopher Birli and Patrick Chapin, who were both employees of MetLife in Williamsville, New York, focused their efforts on advising employees of the State University of New York who participated in its retirement plan.  FINRA alleges that between 2004 and 2007, Birli and Chapin recommended to 45 of their customers that they switch the MetLife variable annuities held in their retirement accounts for new variable annuities held in individual retirement accounts outside of the university plan, Reuters reports.

The pair carefully structured these deals in order to circumvent one of MetLife’s policies that prohibits exchanging the two types of variable annuities. According to FINRA, this was done by advising clients to first cash in their retirement plan annuities and then purchase a different security within the plan to hold for 90 days. Clients were subsequently instructed to sell that security in order to buy a variable annuity through an IRA.

FINRA fines LPL Financial $950,000 for alternative investment supervisory failures

The Financial Industry Regulatory Authority (FINRA) announced that it has fined LPL Financial LLC $950,000 for supervisory deficiencies related to the sales of alternative investment products, including non-traded real estate investment trusts (REITs), oil and gas partnerships, business development companies (BDCs), hedge funds, managed futures and other illiquid pass-through investments. As part of the sanction, LPL must also conduct a comprehensive review of its policies, systems, procedures and training, and remedy the failures.

Many alternative investments, such as REITs, set forth concentration limits for investors in their offering documents. In addition, certain states have imposed concentration limits for investors in alternative investments. LPL also established its own concentration guidelines for alternative investments. However, FINRA found that from January 1, 2008, to July 1, 2012, LPL failed to adequately supervise the sales of alternative investments that violated these concentration limits. At first, LPL used a manual process to review whether an investment complied with suitability requirements, relying on information that was at times outdated and inaccurate. The firm later implemented an automated system for review, but that database contained flawed programming and was not updated in a timely manner to accurately reflect suitability standards. LPL also did not adequately train its supervisory staff to analyze state suitability standards as part of their suitability reviews of alternative investments.

Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, “In order to sell alternative investments, a broker-dealer must tailor its supervisory system to these products. LPL exposed customers to unacceptable risks by not having an adequate system in place that could accurately review whether a transaction complies with suitability requirements imposed by the states, the product issuers and the firm itself – and it failed to train its registered representatives to apply all the suitability guidelines appropriately.”

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

SEC stops pyramid scheme targeting Asian and Latino communities

The Securities and Exchange Commission today announced charges and asset freezes against the operators of a worldwide pyramid scheme targeting Asian and Latino communities in the U.S. and abroad.  The SEC alleges that three entities collectively operating under the business names WCM and WCM777 are posing as multi-level marketing companies in the business of selling third-party cloud computing services, which can include website hosting, data storage, and software support.  The entities are based in California and Hong Kong and controlled by “Phil” Ming Xu, who is a resident of Temple City, California. 

According to the SEC’s complaint filed in federal court in Los Angeles, WCM and WCM777 have raised more than $65 million since March 2013 by falsely promising tens of thousands of investors that the return on investment in the cloud services venture would be 100 percent or more in 100 days.  Investors were told they would receive “points” for making investments or enrolling other investors.  The points would be convertible into equity in initial public offerings of high-tech companies their money would help launch.  However, rather than building out cloud services or incubating high-tech companies, Xu and the WCM entities used investor funds to make Ponzi payments of purported investment returns to some investors.  They also spent investor money to purchase golf courses and other U.S.-based properties among other unauthorized expenditures. 

The court has granted the SEC’s request for an asset freeze and the appointment of a temporary receiver over the assets of WCM, WCM777, and several other entities named as relief defendants for the purpose of recovering money from the scheme in their possession. 

According to the SEC’s complaint, WCM and WCM777 sell their products exclusively to investors and have no other apparent sources of revenue.  Their offerings and operations depend almost entirely on the recruitment of new investors and purchases by existing investors to provide the money for returns.  On its website, WCM777 specifically addressed the question “Is WCM777 a Ponzi Game?” by writing, “In summary, we are not a Ponzi game company. We are creating a new business model.” 

The SEC alleges that Xu and his entities made various false claims to investors about purported partnerships with more than 700 major companies such as Siemens, Denny’s, and Goldman Sachs – in some instances falsely representing that they had permission to use their logos.  Meantime, besides buying two golf courses with investor money, Xu and his entities also purchased a warehouse, vacant land, and several single family homes  They also used investor funds to play the stock market and make other related investments through intermediary companies, such as an oil and gas offering.  They also sent investor money to a rough diamond jewel merchant in Hong Kong and another unrelated company affiliated with Xu.

The SEC’s complaint alleges that WCM, WCM777, and Xu violated Sections 5(a), 5(c), and 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934, and Rule 10b-5.  The complaint further alleges that Xu violated Section 20(a) of the Exchange Act.  In addition to the asset freezes and appointment of a temporary receiver, the Honorable Christina A. Snyder also granted the SEC’s request for an order prohibiting the destruction of documents and requiring the defendants to provide accountings. A court hearing has been scheduled for April 10, 2014.

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