SEC Chairman Mary Schapiro's recent speech to the securities industry, entitled, "The Road to Investor Confidence," certainly was not designed to win over friends from Wall Street. Prefacing her remarks by blaming Wall Street for the "recent crisis" (it didn't understand or simply ignored the risks) and by blaming the SEC (for being asleep at the wheel), she described how the SEC is going about restoring investor confidence and protection.  Let's review the more important initiatives and reforms.

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SNSFE is investigating exchange-traded funds, known as ETFs.  Both the regulators and class action lawyers are paying close attention to that category of exchange-traded funds that are known as leveraged or inverse.  These funds made heavy bets either on the direction of an index or through the use of leverage and many have suffered dramatic losses.  To date, approximately nine class actions have been filed and SNSFE continues to investigate.  The defendants so far have included ProShares as well as Direxion.

On another front, exchange-traded funds that are so-called 2010 "glide-paths" also have experienced losses.  Indeed, in a recent Morningstar report, Morningstar pointed out that there is a great disparity in the glide-paths -- which is the ratio of stocks to bonds that is held by a target-date series as it changes over time -- between funds each labeled 2010.  The glide-paths for the 2010 funds have diverged sharply.  At the upper end, two fund families have more than 70% of their 2010 funds' assets placed in equities. Conversely, three families have fewer than 30% of their 2010 investments in stocks. This divergence in asset allocation resulted in a wide difference in performance during the dramatic 2008 market, when losses in the 2010 category ranged from a modest 9% to a breathtaking 41%.  Query whether investors in those funds, and unfortunately whether employees who held these funds in their 401(k) plans, adequately were disclosed the risk of holding such funds.

SNSFE continues to investigate this fund category and other later series.

Source:  Morningstar

The Financial Industry Regulatory Authority fined Scottrade $600,000 for failing to have adequate anti-money laundering procedures in place to detect and report suspicious transactions.  In a statement, FINRA noted that as an online brokerage executing more than 150,000 trades daily, Scottrade's business model makes it vulnerable to heightened risks of identity theft, unauthorized access to customer accounts, or even money laundering activities.  The Bank Secrecy Act of 1970 requires brokerages to have anti-money laundering programs tailored to their own unique business models.  "Despite the large volume of online trading at Scottrade, the firm failed to establish any systematic or automated surveillance until 2005," FINRA executive vice president and chief of enforcement Susan Merrill said in the  statement.  "Then the automated system the firm implemented remained inadequate because it focused only on suspicious trading that was accompanied by suspicious money movement." According to Scottrade, it is taking this matter very seriously and it has made enhancements to its anti-money laundering program.

Source: InvestmentNews

Stifel Financial Corp., which has been expanding its Stifel Nicolaus & Co. retail-brokerage business, is about to make a push into serving registered investment advisers.  The firm has hired a veteran from Merrill Lynch and Pershing to run its Century Securities Associates independent broker-dealer affiliate and add a custodial unit for RIAs.  The venture, likely to be called Century Advisor Services, will be marketed to fee-only RIAs and "hybrid" advisers who want to supplement their fee-based practices with commissions.  A spokesman said that the new unit is focusing on RIAs with a minimum of about $50 million of client assets.

Lawyers at SNSFE frequently review brokerage and custodial agreements for firms.  Advisers should consider hiring competent counsel to review their agreements before signing on.

Source: InvestmentNews

Schwab Adviser Services is eliminating fees on a database that helps advisers sell and buy other firms, a move that's part of a broader effort to enhance its business consulting services for independents.  In addition to eliminating fees tied to that database service,  Schwab also announced it added a scorecard that lets advisers measure and track whether their employees are using Schwab online tools.  Schwab also said it is now giving advisers preferred pricing on its Client Audit: Enterprise product, which helps advisers identify referral opportunities and measure client loyalty.

Meanwhile, Fidelity has slashed custodial prices and fees.  In a move designed to capture business from RIAs looking to switch custodians, Fidelity Investments is initiating a sweeping series of price reductions for fees, services and products associated with its custodial service platform.

Source:  FinancialAdvisor Magazine

The real estate boom and bust is hanging over many independent broker-dealers and their financial advisers as the market for non-traded REITs soured this year.  According to an InvestmentNews article, investing largely in commercial real estate, many of the largest non-traded real estate investment trusts have had a tough year, slashing dividends to investors and shutting redemption programs.  Some independent broker-dealers and their registered representatives have significant exposure to the non-traded REITs, which are illiquid, high-commission products.

An analysis of leading independent broker-dealers shows that non-traded REITs accounted for as much as 12% of a handful of firms' revenue last year.  Some independent broker-dealers didn't sell the product, according to a listing in an industry publication, while non-traded REITs accounted for 2% to 6% of other firms' gross revenue last year.

REITs are designed to pay investors a dividend, which in the past has averaged 6% to 7%.  Stock sell-offs in the broader market don't lower the value of shares during the life of the investment.  That changed this year according to InvestmentNews, as some of the biggest and most prominent non-traded REITs cut dividends.  Among the largest that have made the cuts are Behringer Harvard REIT I, Inland America Real Estate Trust, Inland Western Retail Real Estate Trust and Piedmont Office Realty Trust.  Some of the REITs are even more illiquid than usual, worth perhaps 30% to 40% less than their price, and dividends have gone down the drain, many observers said.

Commonwealth Financial Network is one of the biggest sellers of non-traded REITs among independent broker-dealers.  Revenue from non-traded REITs accounted for about 2% of its gross revenue of $519 million last year. 

REITS that have too much debt also could struggle, industry observers said. Holding on until better days will be more difficult for highly leveraged REITS, especially those with debt maturing over the next two to three years.

Regulators have taken an interest in the product.  In March, the Financial Industry Regulatory Authority reviewed broker-dealers' sales and promotion of non-traded REITs, and asked firms for a variety of information, including descriptions of sales contests and cash and non-cash incentives.  To date, FINRA hasn't taken any enforcement action based on that information, according to a spokesman.

SNSFE continues to investigate non-traded REITs. 

Source:  InvestmentNews

Risky Reg D deals worry state regulators according to a recent InvestmentNews article.

The collapse of two high-risk private placement deals over the summer has shed light on the process by which broker-dealers bring these deals to market.  Many are questioning the due diligence performed on private placements - known as "Reg D" offerings because of how they are filed with the SEC - as well as the fees earned by broker-dealers for such work.

Broker-dealers often leave the actual analysis of the offerings to outside, third-party due-diligence firms. Those shops typically consist of attorneys who are paid by the issuer to write a report that evaluates the viability of the issuer's deal.

In addition to a possible conflict arising from receiving fees from the companies they analyze, due-diligence firms often produce superficial reports that provide only the most cursory review of the issuers and their finances, say industry executives and lawyers.

The concept behind broker-dealers being paid a due diligence fee, usually 1%, when they sell the deal, is for "time spent and to read the report and to ask questions," according to an industry source.  The reality is often different, he added, echoing other brokerage executives.  "A lot of firms don't even bother reading the due-diligence reports."

Despite such concerns, both the market and investors' appetites for such deals have ballooned.  According to the Alabama Securities Commission, 26,485 Reg D offerings were filed last year with the SEC which requires scant information about the private placements.  That compares with more than 11,000 such offerings in 1996.  According to a report this year from the SEC, the division of corporate finance identified total estimated offerings last year of $609 billion. 

What's more, private deals are expensive, lack liquidity and carry risk - while being lightly regulated and receiving little oversight.  More deals are showing signs of stress, brokerage insiders and securities regulators say, particularly real estate deals and some involving oil and gas that could be harmed by the weak overall economy.

The types of Reg D offerings and private placements are all over the map, and they have had a history of problems.  Brokerage executives still recall with dread the disastrous Prudential Securities private placements.  In the late 1980s, more than 100,000 investors put $1.4 billion into Prudential Securities limited partnerships that wound up being worth almost nothing. 

And Reg D offerings aren't the small potatoes that the SEC perhaps imagined back in 1982.  For example, Stanford International Bank filed its certificates of deposit offerings with the SEC under Reg D.  In 2007, the bank filed a $2 billion offering with the agency.  In February, the SEC said that the bank's parent company, Stanford Financial Group, which claimed to have $8.5 billion in assets, was running a "massive Ponzi scheme" based, in large part, on publicizing and promising phony returns on its CDs.  In July, the SEC charged two firms with fraud relating to large private-placement deals with an estimated value of $2.7 billion.

On July 7, the SEC charged Provident Royalties LLC and a number of its related entities with operating a fraud and a Ponzi scheme in the sale of $485 million of preferred stock and limited-partnership offerings in oil and gas deals.  The deals were sold from 2006 to 2009.  About a week later, the SEC charged Medical Capital Holdings with fraud in the sale of $77 million of private securities in the form of notes.  Since then, a court appointed receiver has said that $543 million worth, or about 87%, of all the accounts receivable Medical Capital controlled are nonexistent.  In total, Medical Capital sold $2.2 billion in notes from 2003 to 2008.

Registered reps and advisers typically earn an extremely high commission when they sell Reg D private placements, which often deliver commissions of 5% to 8%.  By comparison, in a mutual fund transaction, a rep can earn between 1% and 4% of the sale.  There's no way to tally the potential cost to broker-dealers who sold clients the Provident and Medical Capital deals.  Investors have begun to file arbitration claims against the firms who sold the private placements, with plaintiff's lawyers looking for a windfall.

Investors beware of private placement problems.

Source:  InvestmentNews

The Securities and Exchange Commission (SEC) recently fined a broker-dealer and investment adviser $100,000 for failing to protect the privacy of customer information.  Let's examine what went wrong and how customers at the firm, Commonwealth Equity Services, LLP d/b/a Commonwealth Financial Network ("Commonwealth"), were exposed to an Internet pirate.

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Although financial advisers think that succession planning is important, many also believe that they aren't getting enough help preparing for that transition, according to a new survey conducted by Mathew Greenwald & Associates for John Hancock Financial group.

The research company performed a blind poll of 516 advisers from a variety of firms for its 2009 John Hancock Financial Network Equity and Succession Survey.  Fully 63% said that succession planning is a concern for them, while 55% of the surveyed representatives said that the financial services industry hasn't done a good job of helping them with succession planning.

Less than one-third (31%) of those surveyed have worked on a succession plan.  Another 34% of the respondents said that they have thought about succession but haven't done anything yet, while 35% haven't even thought of how they will transition their practices.

Source:  InvestmentNews

Recently, the Securities and Exchange Commission (SEC) filed a federal lawsuit against Morgan Keegan & Company, Inc., alleging widespread sales practices violations in connection with its underwriting, marketing and sale of auction rate securities ("ARS").

The SEC's complaint (available on the SEC's website) contains a treasure trove of alleged facts against Morgan Keegan, which investors, and their lawyers, should find to be fascinating reading.  As background, ARS are bonds (issued primarily by municipalities and student loan entities) or preferred stock (issued by closed-end funds), each of which provide for interest rates or dividend yields that are periodically reset through auctions.  Auctions fail when there are not enough bids at the auction to cover the securities for sale.  If an auction fails, then the issuer (the municipality, student loan entity or closed end fund) must pay a pre-determined maximum rate or yield, but, importantly, the ARS is illiquid at that point in time and until the next, successful auction.

Let's highlight the key allegations of the SEC's complaint.

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