Articles Posted in Inadequate Supervision

The Financial Industry Regulatory Authority is ordering RBC Capital Market to pay restitution to customers for supervisory failures that allowed for the sale of reverse convertibles that were unsuitable for them. The firm must pay them about $434,000 plus a $1 million fine.

According to the self-regulatory organization, RBC lacked supervisory systems that were reasonably designed to identify transactions that warranted review when the reverse convertibles were sold to customers. This purported inadequacy is s a violation of FINRA’s rules and suitability guidelines.

Although RBC had guidelines for selling reverse convertibles, specific criteria were established regarding annual income, investment goals, liquid net worth, and investment experience. Because of this, the firm was unable to detect the sale of 364 reverse convertible transactions by 99 of its registered representatives. The transactions involved 218 accounts and they were not suitable for the account holders. The customers lost at least $1.1 million.

Morgan Stanley Smith Barney, LLC (MS) has settled civil charges by the U.S. Commodity Futures Trading Commission accusing the firm of records violations and inadequate supervision involving its know-your-customer procedures. Aside from a $280,000 fine, the broker-dealer will have to disgorge commissions from the subject accounts involved.

According to the regulator, Morgan Stanley did not diligently oversee its employees, officers, and agents when they opened firm accounts for a family of companies known as SureInvestment, which purportedly ran a hedge fund that was partially based in the British Virgin Islands-considered to be a risky jurisdiction. Because of this geographic circumstance, when the accounts were opened the firm should have subjected them to special observation pursuant to the its procedures, including watching out for red flags indicating suspect activities.

The CFTC’s order, however, notes that even though there were a number of red flags in the account opening documents for SureInvestments, Morgan Stanley failed to identify them. Later, it was discovered that SureInvestment doesn’t even exist and that its owner, Benjamin Wilson, was conducting a $35 million Ponzi scam based in the U.K. (Wilson, who has pleaded to criminal charges brought by the Financial Conduct Authority, has been sentenced to time behind bars.)

The Financial Industry Regulatory Authority has issued an enforcement action charging Feltl & Company for not notifying certain customers of the suitability and risks involving certain penny-stock transactions, as well as for failing to issue customer account statements showing each penny stock’s market value. The brokerage firm is based in Minneapolis, Minnesota.

FINRA claims that the firm failed to properly document transactions for securities that temporarily may not have fulfilled the definition of a penny stock and did not properly track penny-stock transactions involving securities that didn’t make a market.

Feltl made a market in nearly twenty penny stocks. The brokerage firm made $2.1 million from at least 2,450 customer transactions that were solicited in 15 penny stocks between 2008 and 2012. The SRO says it isn’t clear how much the firm made from selling penny stocks that it didn’t keep track of but that revenue from this would have been substantial.

Morgan Stanley Smith Barney LLC (MS) will pay a $5 million fine for supervisory failures involving its advisors soliciting shares in 83 IPOs to retail investors. The Financial Industry Regulatory Authority says that the firm lacked the proper training and procedures to make sure that salespersons knew the difference between “conditional offers” and “indications of interest.”

By settling, Morgan Stanley is not denying or admitting to the securities charges. It is, however, consenting to the entry of findings by FINRA.

FINRA believes these issues are related to Morgan Stanley’s acquisition of Smith Barney from Citigroup (C) a couple of years ago. In addition to inheriting more high net worth clients, the SRO contends that Morgan Stanley ended up with financial advisers who might not have gotten the needed training.

Berthel Fisher & Company Financial Services, Inc. and its affiliate, Securities Management & Research, Inc. are going to pay the Financial Industry Regulatory Authority a combined $775,000 for purported supervisory deficiencies related to leveraged and inverse exchange-traded funds and non-traded real estate investment trusts. The firm settled without deny or admitting to the allegations.

FINRA claims that from January 2008 to December 2012 Berthel Fisher had inadequate written procedures and supervisory systems to deal with the sale of alternative investment products, such as managed futures, non-traded REITs, oil and gas programs, managed futures, business development companies, and equipment leasing programs. The SRO says that the brokerage firm’s staff were improperly trained with regard to state suitability standards, and criteria wasn’t properly enforced in a number of alternative investment sales because the firm did not figure out the correct concentration levels of certain financial instruments.

FINRA also said that from 4/09 to 4/12, Berthel Fisher lacked a reasonable basis for certain ETF sales, resulting from numerous reasons, including a failure to properly review or research non-traditional ETFs before letting registered representatives make recommendations to customers. Inadequate sales training was not provided and some customers suffered losses because the brokerage firm did not monitor investment holding periods.

Foremost Trading LLC and has settled the securities charges filed against it by the US Commodity Futures Trading Commission. The regulator accused the introducing broker of failing to properly supervise the handling of specific trading accounts by employees, agents, and officers. To settle, Foremost must pay a $400K civil penalty and cease and desist from future CFTC regulation violations.

According to the agency’s order, the accounts involved were held by clients who were referred to the introducing broker via three unregistered entities that sold futures trading systems. Foremost and its staff are accused of disregarding warning signs that the systems-Systems Providers-were using fraudulent means and business practices to get these clients.

Clients complained to Foremost. However, contends the CFTC, the latter did not properly investigate claims or let other clients know about the allegations. Meantime, the introducing broker kept setting up accounts for clients referred to it by Systems Provider, even vouching for the latter’s track record when communicating with clients.

Wells Fargo Banker and 8 Others Accused of Alleged $8M Insider Trading Scam

The U.S. Attorney for the Western District of North Carolina is charging Wells Fargo (WFC) investment banker John Femenia and eight alleged co-conspirators with involvement in an alleged $11 million insider trading scam. Femenia is accused of stealing confidential data from his employer and its clients about acquisitions and mergers that were pending. He then either directly or via others tipped his co-conspirators, receiving kickbacks in return.

According to the N.C. government, the insider trading scam resulted in $11M in profits. While six of the co-conspirators opted to plead guilty to conspiracy to commit insider trading, Femenia and the other two have been indicted on multiple charges of conspiracy and insider trading. The same defendants, and another person, are also named in the SEC lawsuit over the scheme.

Goldman Sachs Fined$1.5 Inadequate Supervision in $118M Fraud
The Commodity Futures Trading Commission says that Goldman Sachs (GS) must pay $1.5M because it did not properly supervise trader Matthew Marshall Taylor, who allegedly got around internal systems to manually make fabricated trades that went straight to the financial firms’ records and books and not the exchange. Taylor is accused of defrauding the bank, which lost about $118.4M.

The agency says that Goldman failed to make sure that its risk management, supervision, and compliance programs were in alignment with its duties to diligently oversee its business as a registrant of the Commission. However, CFTC commissioner Bart Chilton has criticized the $1.5M fine, describing it as a wrist slap.

CFTC Names Firms and Individuals in Precious Metal Scam The Commission has filed a civil injunctive enforcement action against a number of firms, including Hunter Wise Credit, LLC, Lloyds Commodities Credit Company, Hard Asset Lending Group, Blackstone Metals Group, LLC, CD Hopkins Financial, Newbridge Alliance Inc., Harold Edward Martin Jr., United States Capital Trust, LLC, as well as related entities, and Fred Jager, Frank Gaudino, James Burbage, Chadewick Hopkins, Baris Keser, David A. Moore, and John King. They are accused of fraudulently marketing off-exchange commodity contracts that were illegal. Also, Hunter Wise Commodities, which allegedly orchestrated the fraud, is accused of having gotten least $46M in client funds since July of last year.

The defendants allegedly claimed that they were selling physical metals to retail clients in retail commodity transactions and that they would arrange loans for the balance of the purchase price. Customers were supposed to make down payments at 25% of the complete buying price for certain quantities of metal, which were to be placed in a safe depository. The CFTC contends, however, says that not only were certain statements found in the investment contract untrue, but also the transactions were merely paper transactions with no actual metals involved.

Defendants to Pay $1.8M in Off-Exchange Foreign Currency Scheme
Following a CFTC anti-fraud enforcement action, a permanent injunction order and default judgment has been issued against Forex Capital Trading Partners, Inc., Forex Capital Trading Group Inc., and Highland Stone Capital Management, LLC requiring that they pay a penalty of over $1.3M and disgorge $450,764 to benefit clients who were defrauded. The Commission says that the three firms made fraudulent solicitations to 106 clients that invested over $2.8M in forex trading.

These solicitations were allegedly made with false claims that they were engaging in this type of trading had been profitable for several years, including a falsely reported 51.94% customer gain in 2010, which was a year when the investors actually lost over 1.2M. In fact, says the Commission, customers actually lost over 93% of total invested principal via the defendants’ customer trading.

CFTC Press Room

More Blog Posts:
CFTC Commissioner Proposes Plan to Give Futures Customers SIPC-Like Protections, Stockbroker Fraud Blog, August 14, 2012

CFTC Files Texas Securities Fraud Against TC Credit Services and its Houston Owner Over $1.4M Commodity Pool Scam, Stockbroker Fraud Blog, July 17, 2012
SEC and CFTC Say They Found Out About JPMorgan’s $2B Trading Loss Through Media, Stockbroker Fraud Blog, May 31, 2012 Continue reading

Wells Fargo & Co. (WFC), UBS AG (UBSN), Morgan Stanley (MS), and Citigroup Inc. (C) have consented to pay a combined $9.1 million to settle Financial Industry Regulatory Authority claims that they did not adequately supervise the sale of leveraged and inverse exchange-traded funds in 2008 and 2009. $7.3 million of this is fines. The remaining $1.8 million will go to affected customers. The SRO says that the four financial firms had no reasonable grounds for recommending these securities to the investors, yet they each sold billions of dollars of ETFs to clients. Some of these investors ended up holding them for extended periods while the markets were exhibiting volatility.

It was in June 2009 that FINRA cautioned brokers that long-term investors and leveraged and inverse ETFs were not a good match. While UBS suspended its sale of these ETFs after the SRO issued its warning, it eventually resumed selling them but doesn’t recommend them to clients anymore. Morgan Stanley also had announced that it would place restrictions on ETF sales. Meantime, Wells Fargo continues to sell leveraged and inverse ETF. However, a spokesperson for the financial firm says that it has implemented enhanced procedures and policies to ensure that it meets its regulatory responsibilities. Citigroup also has enhanced its policies, procedures, and training related to the sale of these ETFs. (FINRA began looking into how leveraged and inverse ETFs are being marketed to clients in March after one ETN, VelocityShares Daily 2x VIX Short-Term (TVIX), which is managed by Credit Suisse (CS), lost half its worth in two days.)

The Securities and Exchange Commission describes ETFs as (usually) registered investment companies with shares that represent an interest in a portfolio with securities that track an underlying index or benchmark. While leveraged ETFs look to deliver multiples of the performance of the benchmark or index they are tracking, inverse ETFs seek to do the opposite. Both types of ETFs seek to do this with the help of different investment strategies involving future contracts, swaps, and other derivative instruments. The majority of leveraged and inverse ETFs “reset” daily. How they perform over extend time periods can differ from how well their benchmark or underlying index does during the same duration. Per Bloomberg, leveraged and inverse ETFs hold $29.3 billion in the US.

“These highly leveraged investments were – and still are – being bought into the accounts of unsophisticated investors at these and other firms,” said Leveraged and Inverse ETF Attorney William Shepherd. “Although most firms do not allow margin investing in retirement accounts, many did not screen accounts to flag these leveraged investments which can operate on the same principle as margin accounts.”

For investors, it is important that they understand the risks involved in leveraged and inverse ETFs. Depending on what investment strategies the ETF employs, the risks may vary. Long-term investors should be especially careful about their decision to invest in leveraged and inverse ETFs.

Finra Sanctions Citi, Morgan Stanley, UBS, Wells Fargo $9.1M For Leveraged ETFs, The Wall Street Journal, May 1, 2012
Leveraged and Inverse ETFs: Specialized Products with Extra Risks for Buy-and-Hold Investors, SEC
FINRA investigating exchange-traded notes: spokesperson, Reuters, March 29, 2012

More Blog Posts:
SEC to Investigate Seesawing Credit Suisse TVIX Note, Stockbroker Fraud Blog, March 30, 2012

Principals of Global Arena Capital Corp. and Berthel, Fisher & Company Financial Services, Inc. Settle FINRA Securities Allegations, Stockbroker Fraud Blog, April 6, 2012

Goldman Sachs to Pay $22M For Alleged Lack of Proper Internal Controls That Allowed Analysts to Attend Trading Huddles and Tip Favored Clients, Institutional Investor Securities Blog, April 12, 2012 Continue reading

Harry Friedman, a principal of Global Arena Capital Corp. has agreed to a bar that prevents him from associating with any Financial Industry Regulatory Authority member. Although he has not admitted to or denied the allegations against him, Friedman has consented to the sanction and the entry of findings accusing him of not properly supervising a number of employees who used improper markups in a fraudulent trading scheme that, as a result, denied clients of best execution and the most favorable market price.

It was Friedman’s job to make sure that the head trader provided accurate disclosure on order tickets, such as when they were received and executed, the role that the broker-dealer played, and how much compensation the financial firm would get from each securities transaction. According to FINRA, Friedman either knew or should have known that order tickets were not being marked properly.

FINRA also found that Friedman, whose job it was to supervise and review trading activity involving his firm, failed to reconcile daily positions and trades in principal accounts. Also, per the SRO, Global Arena Capital Corp., through Friedman, did not set up, maintain, and enforce supervisory control policies and procedures that were supposed to ensure that registered representatives and others were in compliance with securities regulations and laws. Also, for three years, Friedman allegedly falsely certified that the financial firm had the necessary processes in place and that they had been evidenced in a report that the CCO, CEO, and other officers had reviewed.

In other FINRA-related news, Berthel, Fisher & Company Financial Services, Inc. registered principal Marsha Ann Hill has been suspended from associating with any Financial Industry Regulatory Authority member for a year. She also will pay a $20,000 fine.

Hill is accused of allegedly making unsuitable recommendations to a customer regarding the purchase of a variable annuity for $110,418.97 and two private placement offerings for $10,000 each. Per the findings, the transactions were not suitable because over 90% of the client’s liquid net worth had been placed in the variable annuity, which was illiquid and had a seven-year surrender period. (The SRO says that the private placement offerings were not only high risk, but also they failed to meet the client’s investment objectives.) Hill is accused of misusing the customer’s funds when she delayed the investments, resulting in her firm violating SEC Rule 15c3-3.

She also allegedly sold a private placement to an unaccredited investor. When her supervisor noted that this was an accredited-only investment, Hill erased certain information on the Account Information Form and put different yearly income, liquid net worth, and net worth amounts without letting her client know. Hill is settling the securities fraud allegations against her without deny or admitting to them.

Broker-Dealers are Making Reverse Convertible Sales That are Harming Investors, Says SEC, Stockbroker Fraud Blog, July 28, 2011
Despite Reports of Customer Satisfaction, Consumer Reports Uncovers Questionable Sales Practices at Certain Financial Firms, Stockbroker Fraud Blog, January 7, 2012
SIFMA Wants FINRA to Take Tougher Actions Against Brokers that Don’t Repay Promissory Notes, Institutional Investor Securities Blog, January 17, 2012 Continue reading

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