According to a March 21, 2013 article in the New York Times, LPL is facing a flood of complaints from state regulators and customers over lax compliance and supervision of its 13,300 brokers, many of whom work out of small offices and are responsible for paying their own rent and staff. Although the LPL financial advisors are independent contractors, LPL nonetheless is responsible for making certain that the advisors comply with securities laws and rules and actually understand and properly represent the investments they recommend. According to one securities regulator quoted in the New York Times article, LPL has allowed “egregious problems” to continue, including the sale of complex real estate investment trusts (non-traded REITs) to unsophisticated clients.

LPL has certainly had its share of problems through the years, including failing to detect Ponzi schemes and other blatantly fraudulent conduct by certain of its brokers. The good news is that if firms skimp when it comes to supervising their brokers, they cannot escape being held liable for their wrong-doing. The bad news is that clients who suffer losses generally must take it upon themselves to hire counsel and bring FINRA arbitration claims in order to make firms realize the true cost of being penny wise and pound foolish.

A Google search reveals that prior to his fall from grace, Mr. Boleancu was known for his posh life style, his two million dollar San Francisco condo and Napa estate, and his really bad inspirational poetry. Exhibit A to the charge of bad poetry is entitled “Positive Self,” which encourages us “May your warm thoughts flow…long, smooth, and surreal as the Nile. May your inner self be filled with positive Karma, sooner and for a long while!” In the same poetic spirit, I offer “Not So Positive Self.” “If the widow’s money gives you the itch, you ought to remember that Karma’s a bitch!”

The story here is a sad but familiar one. The temptation for brokers to tamper with other people’s money is substantial. The most basic obligation of brokerage firms is to protect a client’s assets. The question that lingers is how Mr. Boleancu got away with his fraud for so long. Brokers are supposed to be supervised by their firms. For the sake of all the trusting widows out there, let’s hope that FINRA examines the question of just how much or how little Wells Fargo supervised Mr. Boleancu.

• the tax benefits of TICs are insignificant when compared to the  tremendous costs and fees (often 15% or more) tacked onto TIC investments by sponsors and brokers:
• income projections for TICs are often wildly over-optimistic; and
• TICs are illiquid investments, meaning there is no way to sell an interest in an under-performing TIC.

FINRA, which regulates broker-dealers, classifies TICS as non-conventional investments, meaning that they are offered as alternatives to conventional equity and fixed income investments (like stocks or bonds) and often have complex features that make them difficult to understand. In Notice to Members 05-18, FINRA pointed to some of the special problems presented by TICs:

Before recommending a TIC exchange, members must have a clear understanding of the investment goals and current financial status of the investor. In many cases, a TIC interest will constitute a significant portion of an investor’s total assets. Because of the favorable tax treatment, investors often elect to invest the entire proceeds from the sale of an investment property in a TIC exchange. Concentration of an investor’s assets in a single asset class, however, is not suitable for many investors. Members must, with respect to each customer for whom they make a recommendation, consider the risks from over-concentration against the benefits of tax deferral and the investment potential of the underlying real estate asset(s).

TIC interests are illiquid securities. [FINRA] is not aware of any secondary market for TIC interests. Moreover, the tenant-in-common form of ownership may require unanimous use consent to sell a TIC interest. The subsequent sale of TIC interests may only be possible at a significant discount to the net asset value of the undivided interest in the real estate. As fees charged in connection with a TIC exchange increase, the money saved as a consequence of tax deferral will be offset. Accordingly, members should consider the effect of fees on each TIC exchange.

Brokers who sell TICs have serious obligations to look after the best interests of their clients. Simply obtaining the client’s consent to an unsuitable investment is no defense. Likewise, the duty of a broker to make a fair and balanced presentation of an investment, especially a complex one, is not satisfied by just handing the client a prospectus or private placement memorandum. 

Many TIC investments have turned into financial disasters for clients. Rental payments have been cut or eliminated and properties have gone into foreclosure. Investors who wanted and needed safe income producing investments should not have been persuaded to invest significant portions of their assets in TICs. If you believe that you were not given full disclosure about the risks of TICs and/or that you were solicited to buy TIC investments that were not suitable for your investment needs and objectives, you may have a way to recover your losses through FINRA arbitration against the brokerage firm that recommended the investment.

• the tax benefits of TICs are insignificant when compared to the  tremendous costs and fees (often 15% or more) tacked onto TIC investments by sponsors and brokers:
• income projections for TICs are often wildly over-optimistic; and
• TICs are illiquid investments, meaning there is no way to sell an interest in an under-performing TIC.

FINRA, which regulates broker-dealers, classifies TICS as non-conventional investments, meaning that they are offered as alternatives to conventional equity and fixed income investments (like stocks or bonds) and often have complex features that make them difficult to understand. In Notice to Members 05-18, FINRA pointed to some of the special problems presented by TICs:

Before recommending a TIC exchange, members must have a clear understanding of the investment goals and current financial status of the investor. In many cases, a TIC interest will constitute a significant portion of an investor’s total assets. Because of the favorable tax treatment, investors often elect to invest the entire proceeds from the sale of an investment property in a TIC exchange. Concentration of an investor’s assets in a single asset class, however, is not suitable for many investors. Members must, with respect to each customer for whom they make a recommendation, consider the risks from over-concentration against the benefits of tax deferral and the investment potential of the underlying real estate asset(s).

TIC interests are illiquid securities. [FINRA] is not aware of any secondary market for TIC interests. Moreover, the tenant-in-common form of ownership may require unanimous use consent to sell a TIC interest. The subsequent sale of TIC interests may only be possible at a significant discount to the net asset value of the undivided interest in the real estate. As fees charged in connection with a TIC exchange increase, the money saved as a consequence of tax deferral will be offset. Accordingly, members should consider the effect of fees on each TIC exchange.

Brokers who sell TICs have serious obligations to look after the best interests of their clients. Simply obtaining the client’s consent to an unsuitable investment is no defense. Likewise, the duty of a broker to make a fair and balanced presentation of an investment, especially a complex one, is not satisfied by just handing the client a prospectus or private placement memorandum. 

Many TIC investments have turned into financial disasters for clients. Rental payments have been cut or eliminated and properties have gone into foreclosure. Investors who wanted and needed safe income producing investments should not have been persuaded to invest significant portions of their assets in TICs. If you believe that you were not given full disclosure about the risks of TICs and/or that you were solicited to buy TIC investments that were not suitable for your investment needs and objectives, you may have a way to recover your losses through FINRA arbitration against the brokerage firm that recommended the investment.

According to Ketchum, while there is no legal definition of a complex product, a security “might be considered complex if the average retail investor probably will not understand how its features will interact under different market conditions, and how that interaction might affect potential risk and return.”  In other words, a complex product is a financially engineered investment with an elaborate and often confusing structure. He pointed to recent FINRA enforcement actions in which firms were sanctioned for selling complex products such as leveraged and inverse ETFs, asset-backed securities, collateralized mortgage obligations and so-called structured notes. He warned firms that “if you are going to offer these types of products to retail investors, you must supervise them at every stage…It would be foolish for any firm …to distribute complex products to retail investors without ensuring that products are vetted, reps are trained and supervised and risks are disclosed in a way that the average investor can understand.”

It is essential for retail investors to understand that often complex securities are so confusing that the even the advisors and brokerages selling them are frequently at a loss to thoroughly understand them.  Local news sources have publicized the more commonly known complex products like mortgage backed securities (MBS), collateralized mortgage obligations (CMO), asset backed securities (ABS), and collateralized debt obligations (CDO) which sometimes makes investors feel more familiar with them than they actually are. This familiarity can be misleading leaving retail investors as easy prey for investment firms who quickly convince that these securities are practically a sure thing.

Although Ketchum stated that the complexity of certain products did not make them inherently unsuitable for all investors, in our experience, brokerage firms are far too quick to mass market complex products that might be suitable as a small holding for a  severely limited number of ultra-sophisticated clients to every Tom, Dick, and Harriett and their IRAs.  Our experience in representing aggrieved investors has shown us that brokerage firms like to sell complex products because they are often stuffed with hidden fees that go to the firm and its affiliates and appear to offer a magic formula for marrying higher return with lower risk.  But a wise investor knows that fees to your broker come at your expense and high returns always come with high risks.  An investor whose wisdom comes from having been burned should know that losses caused by fraud, misrepresentation, failure to disclose risks, or unsuitable sales of complex financial products may be recovered through FINRA arbitration. If you have learned your lesson the hard way, feel free to give us a call to see if we can help.

Phyllis C. Borzi, Assistant Secretary of Labor for Employee Benefits Security;

Dorothy Brown, Professor of Law, Emory University;

Naomi Karp, Policy Analyst, Consumer Financial Protection Bureau Office for Older Americans; and

Vicki Elisa, Director of Community Education (Atlanta), Women’s Institute for a Secure Retirement

Brian’s presentation touched on illegal or unwise investments such as Ponzi schemes, bogus promissory notes, index annuities, hedge funds, private placements, free lunch seminars for seniors, and load mutual funds.

A photo gallery from the event held on Spelman’s campus in Atlanta can be found on the U.S. Department of Labor’s website at http://www.dol.gov/dol/media/photos/slideshows/20120428-ebsa-forum.htm.  The Labor Department intends to post a webcast of the entire program in the near future.

Elderly Investor Recovers Losses Tied to UIT

After a four day hearing, a panel of FINRA arbitrators awarded $130,000.00 in compensatory damages to our clients.  The damages were for losses incurred by an elderly woman with Alzheimer’s disease whose funds were invested primarily in high-risk securities, including a Claymore Unit Investment Trust (“UIT”).

UITs are similar to mutual funds, but there are some big differences. Unlike many mutual funds, the trustee of a UIT does not manage the holdings in the portfolio. If the manager of an actively managed mutual fund decides that the prospects for a particular holding are poor, he or she can sell and replace it. UIT trustees, however, may be able to sell poor performing holdings, but they generally cannot replace them. Another difference is that mutual funds can continue into perpetuity, but UITs have built-in expiration dates. When the expiration date hits, the securities in the UIT are sold, and the proceeds are distributed to investors. This means that the UIT trustee may have to sell its positions during a deep decline in the market. This can be calamitous if the UIT’s holdings are concentrated in a sector that falls out of favor. On the other hand, mutual fund managers can selectively trade securities whenever they feel the time and price is right.

While UITs and mutual funds both hold baskets of securities, there is no evidence that UITs perform any better than mutual funds. To the contrary, UITs generally carry very high fees and expenses which reduce their yield to investors. Those UITs that own mutual funds are weighed down by the double burden of their own expenses plus those of their mutual fund holdings.

At bottom, there are not many good arguments for buying UITs, but there is one big incentive for those who sell them—very high sales charges (i.e., 2.5 to 3%). The broker who sells a UIT typically gets a substantial chunk of this charge, which is good for him, but not so good for you. And since the UIT will terminate at a specified date, the broker has a built-in opportunity to sell his client a new UIT, with yet another sales charge.

Many UITs don’t charge a commission up front; instead, they impose what is referred to as a contingent deferred sales charge (“CDSC”). This means that if you want out of your UIT before its termination date, you may have to pay a sales charge. The CDSC is typically based on the value of the UIT when you bought it, not when you sell it. This means that if you paid $100,000 for a UIT which has a 3% sales charge, and the UIT has lost 50% of its value when you want to sell, it will cost you $3,000 (6%) to get out of a poorly performing investment. Talk about adding insult to injury! In contrast, many of the best performing mutual funds are no-load, meaning they have no sales charges.

UITs are not favored by sophisticated investors or those who understand securities markets. In fact, Jane Bryant Quinn, one of the country’s foremost financial writers, describes UITs as “Absolutely Awful Investments” in her book Making the Most of Your Money Now (Simon and Schuster, 2010).

The only good news for those who have been duped into buying money-losing UITs is that it may be possible to recover your losses through the arbitration process. In fact, Smiley Bishop & Porter LLP recently handled a FINRA arbitration for an 87 year old Alzheimer’s victim whose Wachovia/Wells Fargo broker invested 70% of the money she needed for assisted living in a single UIT. After a hotly contested FINRA arbitration hearing, the arbitrators awarded the client all of her losses back.

Smiley Bishop & Porter LLP represents individual and institutional investors in securities arbitration and business litigation. The firm focuses on cases involving defrauded investors, suitability claims, and mismarketeted investment products. Smiley Bishop & Porter LLP is available for a free initial consultation. Please visit us at www.sbpllplaw.com to obtain additional information or call us at 770-829-3850 or toll-free (800) 697-4514.

Wells Securities is a Norcross, Georgia based broker-dealer which makes most of its revenue from selling Real Estate Investment Trusts (“REITs”) and direct participation agreements. FINRA, which regulates broker-dealers, has just fined Wells $300,000 for using misleading marketing materials in selling its real estate funds. As is typical in regulatory settlements, Wells paid the fine but “neither admitted nor denied liability.”

The story behind the settlement should be an eye-opener for investors. FINRA charged that over a two year period, Wells Securities approved 116 misleading advertising and sales materials for the Wells Timberland REIT which invested in timber-producing property. The firm’s promotional materials indicated that Timberland would qualify under federal tax laws as a REIT by December 31, 2006. In reality, however, it did not qualify until the end of 2009-almost three years later. This misled investors into believing that Timberland qualified for the favorable tax treatment the IRS allows for REITs.

In addition to deceiving investors about the tax status of Timberland, FINRA alleged that sales materials falsely implied that Timberland would make distributions and redeem shares at times when it was prohibited from doing so by virtue of agreements with its lenders. FINRA also asserted that Wells made unwarranted and exaggerated claims that Timberland’s holdings were diversified when it actually only owned one property.

This case is notable because it involves an increasingly problematic investment called non-traded REITs. Non-traded REITs do not trade on the New York Stock Exchange or any other organized market. Although non-traded REITs must make SEC filings that disclose important details about their financial condition, unlike traded REITs the lack of an organized trading market makes it hard to understand their real value and harder still to liquidate them at good prices. Non-traded REITs are also plagued with high front-end fees, which basically pay the brokers who sell them and rob investors of yield.

And if high costs and low liquidity are not enough reason to avoid non-traded REITs, consider also the fact that some of the distributions they make to investors may be made with borrowed money or even a return of the investor’s own money. The bottom line on most non-traded REITs is they are great for the brokers who sell them and bad for those who invest in them.

If you have sustained losses as a result of investments in non-traded REITs which were not properly represented to you or were not appropriate for your investment needs and objectives, please contact us for a free initial consultation.