Long before the current market “correction”, the SEC and the Financial Industry Regulatory Authority (FINRA) have been hot on the heels of stockbrokers and financial advisors over their sales of risky investments. Prophetically, the SEC released its long awaited analysis of sales of these so-called structured products. The results are scary.
A structured product is usually a complex and often risky security. They are typically associated with derivatives. Once the exclusive domain of institutional investors, billions of dollars of structured products can now be found in the portfolios of regular investors.
The SEC and FINRA have repeatedly published guidance both to stockbrokers and to the public. Too many advisors are putting clients into these very complex and risky investments. In many instances neither the broker nor the client can explain exactly how these investments work. The public was warned that many of these exotic derivatives were risky and illiquid meaning it isn’t always easy to sell if you need access to your money.
Despite repeated warnings, billions continue to flow into structured investment products.
SEC Comprehensive Study of Structured Products
Finally, the SEC decided to conduct a comprehensive study into how these products were being sold and who was investing in them. Yesterday the agency said it examined 10 branch offices of registered broker dealers and analyzed 26,600 transactions worth about $1,250,000,000.00. The results of the study are depressing.
The agency said, “Among other things, the examinations revealed several significant deficiencies in the areas of suitability and supervision with respect to all of the examined firms’ sales of [structured securities products (“SSPs”) to retail investors. Specifically, all of the examined firms:
- Failed to maintain and/or enforce adequate controls relating to determining the suitability of SSP recommendations; and
- Failed to conduct both compliance and supervisory reviews of registered representatives’ (“representatives”) determinations of customer suitability in the SSPs, as required by their internal controls.”
Every firm audited failed. In auditing the many structured products, the SEC found that many were advertised or touted as offering total principal protection, a claim that makes them particularly attractive to elderly investors, retirees and those nearing retirement.
As we have noted many times, stockbrokers have a legal duty to fully understand their customer’s needs, financial acumen, risk tolerance and wealth picture. You can’t make recommendations to a client without knowing what they want and need.
Once brokers fully understand their customer’s needs, they must only make recommendations that are suitable to those clients. For example, selling junk shale bonds, complex derivatives, or illiquid real estate investments trusts to a person who needs access to her money to fund her retirement is simply wrong. So is selling a structured product that you can’t explain or don’t understand. Ditto for misrepresenting some of these investments as offering “full principal protection”.
At one brokerage firm the agency found $96 million of structured investment products made to investors who claimed to be conservative yet just $11 million to those who claimed to have a high risk tolerance. The results were opposite of what they should have been. (Brokers like many of structured securities products because they offer higher than normal commissions.)
At another firm, the agency found these products were being offered heavily to non-English speaking customers. Worse, at two of the firms the SEC found these products were being pushed to elderly investors.
At one firm, compliance was so lax that brokers were altering client portfolios after the sale to make it appear the clients had asked for aggressive or risky investments!
In yet another finding, the SEC found that many times when structured products were liquidated they were sold well below their face value. Why? As noted above, there is often no ready secondary market for these investments making them difficult to sell. If you need your money in a hurry you may soon learn that your $50,000 retirement portfolio is really only worth $20,000.
Because there have been so many abuses, some states have imposed concentration limits for certain products. Although a customer is always free to purchase whatever he or she wants, stockbrokers can’t make recommendations that exceed the concentration limits. For example, this could mean that a broker is prohibited from recommending that an conservative, elderly investor invest more than 20% in certain speculative, illiquid alternative investments.
The concentration limits make perfect sense and even though only a few states have adopted them, many brokerage firms have adopted internal concentration limits to better protect their clients. Unfortunately, the SEC found that at one firm, more than 1800 of 3,000 structured product transactions exceeded the firm’s internal limits.
In other words, the brokerage firm’s own internal compliance controls failed miserably.
Until now, many brokerage firms simply paid lip service to the many warnings from the SEC. Like the housing bubble of 2007, as long as the market keeps going up, compliance issues simply got buried. Everybody was making money. Until now.
Now that the market has slowed down, we are already hearing from investors who have been burned by bad advice. From worthless junk shale bonds, to nontraded REITs that suddenly can’t be sold to structured products that became worthless over the last few days, the day of reckoning has come for many.
If you lost your hard earned money because of an unsuitable investment, outright stockbroker fraud or even simple negligence by your broker, call us. Both stockbrokers and the firms that employ them can be held responsible for losses. Act quickly, however, especially if you purchased from a small brokerage firm. Many firms may not be around for much longer in the present market.
For more information, contact attorney Brian Mahany at or by telephone at (414) 704-6731 (direct dial). There is never a charge for initial consultations and most cases can be handled on a contingent fee basis.
MahanyLaw – America’s Stockbroker Fraud Lawyers