On May 6, 2013, the SEC charged the City of Harrisburg, PA with securities fraud for its misleading public statements when its financial condition was deteriorating and financial information available
to municipal bond investors was either incomplete or outdated.  Specifically, an SEC investigation found that the misleading statements were made in the city’s budget report, annual and mid-year financial statements, and a State of the City address.  Further, the SEC found that Harrisburg failed to comply with requirements to provide certain ongoing financial information and audited financial statements for the benefit of investors holding hundreds of millions of dollars in bonds issued or guaranteed by the city. 

Unfortunately, as a result of Harrisburg’s non-compliance from 2009 to 2011, in order to obtain current information about Harrisburg’s finances, investors were required to search for city’s other public statements but very little information about the city’s fiscal situation was publicly available elsewhere.  As a result, the SEC separately issued a report on May 6^th addressing public official’s disclosure obligations and their potential liability under the federal securities laws for public statements made in the secondary market for municipal securities.

According to the SEC’s order, Harrisburg’s mid-year fiscal report for 2009 was designed to provide simply a snapshot of budget-to-actual figures at the middle of the year.  This mid-year point totaled $2.3 million but the report did not reference any of the guarantee payments the city had made on the municipal resource recovery facility debt.  The SEC order mandates Harrisburg to cease and desist from committing or causing Section 10(b) of the Securities Exchange Act of 1934 violations and Rule 10b-5.  Harrisburg neither admitted nor denied the findings in the SEC’s order and in the settlement.

Brokerage firms often offer financial advisers loans, which are payments to lure advisers, and thus their clients, to the firm and keep them there.  If the financial adviser meets various performance requirements and does not defect to a rival then the loans are typically forgiven. 

The SEC requires firms to hold a significant amount of capital.  Specifically, the SEC requires one dollar for each dollar lent to protect against loan losses.  Morgan Stanley, on the other hand, holds 8 cents for every dollar lent, which is far less than its rivals like Wells Fargo and Bank of America, by moving those loans outside of the firm.  However, some executives, with knowledge of the loan structures, suggested that some firms have not moved the loans outside of the broker-dealer because doing so might draw regulatory scrutiny and would require them to rewrite thousands of client contracts.

The SEC will be more aggressive in the next couple of years with efforts to bar securities law violators from financial firms.  In particular, the SEC will use its powers under The Dodd-Frank Wall Street Reform and Consumer Protection Act to bar advisors and other financial professionals that are “bad advisors” from investment advisory firms, broker-dealers, municipal securities dealers, municipal advisors, transfer agents and credit rating agencies, the unit’s co-chief George Canellos said on
April 26, 2013. 

Before Dodd-Frank was signed into law in 2010, the SEC could only prohibit securities law violators from working in the kind of entity where they worked at the time of the infraction.  Now, under Dodd-Frank, the SEC is able to impose “collateral bars,” which prohibit a violator from associating with firms in other parts of the financial industry.  The SEC enforcement division has already instituted many such bars.

Matt Degenhart (“Degenhart”) recently agreed to settle a FINRA enforcement action in which the offense oddly addresses the underlying facts.

According to the Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted, the facts are as follows.  In August 2012, one of Degenhart’s clients complained to him that she was not earning any interest on deposits in her checking account and needed money to cover upcoming legal
expenses.  The AWC asserts that in response Degenhart advised the customer against investing her checking funds in stocks.  On the other hand, Degenhart allegedly suggested that she give him the funds on deposit in her checking account, and he would “help her earn a little more interest on it than she currently was receiving.” 

LPL Financial (“LPL”), the nation’s fourth-largest brokerage firm and the largest in much of rural
America, is growing in size and, unfortunately, in its list of problems with regulators.

As LPL has expanded, state and federal authorities have censured the company and its brokers with unusual frequency, as demonstrated by recent New York Times article.  Among other complaints, regulators penalized LPL brokers for selling complex investments to unsophisticated investors, for speculative trading in customer accounts, and, in a few cases, for outright stealing from clients.  In the last year and a half, state regulators in Illinois, Massachusetts, Montana, Oregon and Pennsylvania have penalized LPL for failure to oversee its brokers properly.  Surprisingly, LPL’s brokers have faced the most common industry reprimands, and have done so more frequently than even its larger competitors (Wells Fargo, Morgan Stanley and Merrill Lynch).

FINRA last year reported filing 1,541 disciplinary actions, which is a 3.6% rise over the prior year.  This marks the fourth consecutive year of increased disciplinary actions by the brokerage industry
regulator and the second straight year of higher fine totals.  The top enforcement issues related to
suitability, due diligence, research report and research analysts cases, advertising and exchange-traded funds (“ETF”).

The increase in suitability cases is due mainly to the $7.5 million in fines assessed in four ETF cases, as well as cases involving complex products such as reverse convertible notes and unit investment trusts.  This is expected to be an area with increasing number of cases due to the complicated financial products on the market.

Eccleston Law Offices counsels, represents and defends financial advisers nationwide in regulatory, compliance, disciplinary and employment matters in arbitration and litigation, and before regulatory bodies such as the SEC, FINRA and state securities regulators.  We frequently defend forgivable loan collection actions, prosecute Form U-5 defamation actions, counsel advisers as to how to transition successfully from firm to firm and negotiate the best possible agreements with their new firm, and
provide succession planning, buy-sell agreements and other exit strategies and strategic consulting, practice transitions, mergers, acquisitions and divestitures.

A recent Letter of Acceptance, Waiver and Consent (“AWC”) illustrates why reps don’t want to make guarantees against customer losses, even “guarantees” that loosely are defined.

In 1999, the rep entered the securities industry. From January 2004 through October 2012 the rep was
registered with EKN Financial Services, Inc. (“EKN”).  The AWC alleges that between September 2010 until October 2010 the rep offered to customers a signed statement on firm letterhead, which essentially guaranteed (but did not explicitly guarantee) the immediate return of the original amount of the investment and represented that the investment would be maintained in cash, securities, or hard assets. 

Notably, this was not your typical guarantee, but, arguably instead, a misrepresentation / omission that FINRA construed as being a "guarantee."  FINRA thus found that the rep violated Rule 2010 and 2150(b), which prohibit stockbrokers from guaranteeing customers against losses and from sharing the profits in customers’ accounts.  As a result, FINRA imposed upon the rep a $5,000 fine due upon re-association with a member firm and a 10 business-day suspension from association with any FINRA member firm in any capacity. 

Strategic Return Notes (“SRNs”) sold by Bank of America apparently lost over 50% of their value in approximately one year.

Bank of America’s subsidiary, Merrill Lynch, sold these SRNs to hundreds of its clients nationally.  There are allegations that the clients were told there were no risks involved in this products or were promised that this product could be used as a hedge to reduce overall portfolio risk when that was not the case.  Unfortunately, Bank of America has no obligation to and will not make any interest payments throughout the duration of the SRNs, which go through 2016 if held until maturity.  Further, investors also have no guarantee of recouping the original purchase price of the SRN at maturity.  Rather, investors are paid back a variable amount that is based upon the performance of an underlying index, the Investable Volatility Index (“VOL").

The VOL measures the volatility of the S&P 500 and essentially attempts to calculate the stock market’s volatility is as a whole as well as predict how volatile it will be in the future.  As a result, the SRNs investors receive returns or sustain losses based upon how wildly the market was swinging.  Naturally, these products are extremely complicated and hence should only be sold to only a certain suitable investors.

If you are a financial adviser who has information related to SRNs, or if you are an investor that has suffered losses investing with these SRNs, please contact one of our attorneys at 312-332-0000.

The SEC has approved a FINRA rule giving reps a process to correct language on their Forms U-4 and U-5. The new process comes into play for reps who are not named in arbitration proceedings, between customers and firms.

Reps wishing to take advantage of the new role must be aware of several critical requirements. Reps are urged to retain securities counsel to navigate through the process.

We often defend reps who themselves or their sales assistants cut corners. Maybe they are rushed. But FINRA cuts them no slack for expedited client service.

Mr. Robert P. Gulan was a broker who registered with FINRA from 2002 to 2011. He cut-and-pasted client signatures on clients' IRA distribution requests and shredded the original IRA form. The fax didn't go through, Gulan cut signatures from another document that the clients had signed earlier and affixed the signature onto a new IRA form, resubmitting that form for processing. FINRA imposed a 30 day suspension and $5,000 fine.

Similarly, broker Arthur Apostol was sanctioned $5,000 and a three months suspension. He cut and pasted at least four customers' signatures after the customers authorized the opening of their LPL accounts. Mr. Apostol also asked customers to sign blank forms for future use.

All things considered, the three months downtime seems a bit too heavy but in both cases, the brokers chose to settle for those sanctions regardlessly.