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FINRA Interference with Estate Planning

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Financial exploitation of the elderly is rampant in the United States.  The elderly are routinely exploited by those close to them, such as family and friends, caregivers, financial advisors, as well as by scammers trying to sell them products they do not need.  These products include elaborate home security systems and other home improvements.

An example of a new type of elder abuse is that which will be the by-product of the Financial Industry Regulatory Authority’s (hereafter “FINRA”) well intended rules designed to curb financial exploitation.  Effective February 2018, FINRA Rule 4512 requires registered representatives to make reasonable efforts to obtain the name of and contact information for a “trusted contact person” (hereafter “TCP”) upon the opening of a retail account, or when updating account information for a retail account.  Pursuant to the Rule, “the member is authorized to contact the trusted contact person and disclose information about the customer’s account to address possible financial exploitation, to confirm the specifics of the customer’s current contact information, health status, or the identity of any legal guardian, executor, trustee or holder of a power of attorney….”  The TCP is intended to be a resource for the FINRA member in administering the customer’s account, protecting assets and responding to possible financial exploitation.  Unfortunately, this Rule will serve to alert nefarious third parties that Aunt Betty or Uncle Bernie had significantly more assets than relatives may have believed.  But for Rule 4512, certain people (the putative “villains”) will be alerted to assets they did not know existed.  Opportunity and motive to steal have been created by this new Rule.  The Rule may also interfere with pre-existing estate plans.

Because FINRA Rule 4512 does not require the customer to identify the TCP, how should we as lawyers advise our clients?  Do we tell them to refuse to identify TCP’s?  Do we encourage clients to identify TCP’s, and if so, do we do it in writing?  Should we explain to our clients the pros and cons of designating TCP’s?  Do we incorporate the TCP concept in estate planning documents?  Do we revise Durable Powers of Attorney to address issues that will arise from a potentially conflicting TCP?  Do we provide copies of Durable Powers of Attorney to financial advisors?  Do we routinely write to financial advisors to find out if our clients have already designated a TCP?  If our clients have designated a TCP, is the TCP consistent with the client’s choice of Estate Executor or trustee?  Do we want to put into place mechanisms that prevent financial advisors from changing TCP’s without attorney involvement?

 

SEC Charges New York-Based Firm and Supervisors for Failing to Supervise Brokers Who Defrauded Customers

On June 29, 2018, the Securities and Exchange Commission announced that it had charged New York-based broker-dealer Alexander Capital L.P. and two of its managers for failing to supervise three brokers who made unsuitable recommendations to investors, “churned” accounts, and made unauthorized trades that resulted in substantial losses to the firm’s customers while generating large commissions for the brokers.

Their report found that Alexander Capital failed to reasonably supervise William C. Gennity, Rocco Roveccio, and Laurence M. Torres, brokers who were previously charged with fraud in September 2017.  According to the order, Alexander Capital lacked reasonable supervisory policies and procedures and systems to implement them, and if these systems were in place, Alexander Capital likely would have prevented and detected the brokers’ wrongdoing.

In separate orders, the SEC found that supervisors Philip A. Noto II and Barry T. Eisenberg ignored red flags indicating excessive trading and failed to supervise brokers with a view to preventing and detecting their securities-law violations.  The SEC’s order against Noto found that he failed to supervise two brokers and its order against Eisenberg finds that he failed to supervise one broker.

Alexander Capital agreed to be censured and pay $193,775 of allegedly ill-gotten gains, $23,437 in interest, and a $193,775 penalty, which will be placed in a Fair Fund to be returned to harmed retail customers.  Alexander Capital also agreed to hire an independent consultant to review its policies and procedures and the systems to implement them.  Noto agreed to a permanent supervisory bar and to pay a $20,000 penalty and Eisenberg agreed to a five-year supervisory bar and to pay a $15,000 penalty.  These penalties will be paid to harmed retail customers.  Alexander Capital, Noto and Eisenberg agreed to settle today’s charges without admitting or denying the findings in the SEC’s orders. If you believe that you have suffered losses as a result of Alexander Capital L.P.’s misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

SEC Charges Morgan Stanley in Connection With Failure to Detect or Prevent Misappropriation of Client Funds

On June 29, 2018, the Securities and Exchange Commission announced that Morgan Stanley Smith Barney (MSSB) had agreed to pay a $3.6 million penalty and to accept certain undertakings for its failure to protect against its personnel misusing or misappropriating funds from client accounts.

The SEC’s order found that MSSB failed to have reasonably designed policies and procedures in place to prevent its advisory representatives from misusing or misappropriating funds from client accounts.  The order further found that although MSSB’s policies provided for certain reviews of disbursement requests, the reviews were not reasonably designed to detect or prevent such potential misconduct.

According to the SEC’s order, MSSB’s insufficient policies and procedures contributed to its failure to detect or prevent one of its advisory representatives, Barry F. Connell, from misusing or misappropriating approximately $7 million out of four advisory clients’ accounts in approximately 110 unauthorized transactions occurring over a period of nearly a year.

Without admitting or denying the findings, MSSB consented to the SEC’s order, which includes a $3.6 million penalty, a censure, a cease-and-desist order, and undertakings related to the firm’s policies and procedures.  Morgan Stanley previously repaid the four advisory clients in full plus interest. If you believe that you have suffered losses as a result of Barry Connell’s misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

FINRA Announces Initiative to Transform CRD, Other Registration Systems

On June 14, 2018,FINRA announced details of a multi-phased effort to overhaul its registration and disclosure programs, including the Central Registration Depository (CRD)—the central licensing and registration system that FINRA operates for the U.S. securities industry and its regulators and that provides the backbone of BrokerCheck. The first phase of the transformation—a new WebCRD interface that highlights important information or activities requiring immediate attention of firms, branches and individuals—goes into effect June 30.

The transformation aims to increase the utility and efficiency of the registration and disclosure process for firms, investors and regulators, as well as to reduce compliance costs for firms. FINRA’s Board of Governors has approved moving forward with the project, which FINRA expects to complete in 2021.

FINRA developed and operates several systems that support registration and disclosure requirements for the securities industry, and works closely with the SEC and NASAA on policy and program requirements for the systems. Securities firms use these systems to register and maintain the records of associated persons who operate within the securities industry, and investors use them—through BrokerCheck—to research the professional backgrounds of brokers and brokerage firms. These registration systems are essential to the operation of the securities industry, and experience consistently high usage volume.

The redeveloped registration systems will facilitate more efficient interaction for users and leverage information from other FINRA regulatory programs, resulting in a more accurate and complete set of information about registered individuals, branches and firms—enhancing firm compliance programs and reducing compliance costs. The transformation also allows FINRA to leverage the information security benefits of cloud-based technology, and architect systems that address dangers associated with current and anticipated cyber threats and risks.

The changes are being made in response to feedback FINRA has received through various channels during its ongoing organizational improvement initiative—FINRA360—including via recommendations from firms in response to FINRA’s 2017 Special Notice on Engagement. FINRA is working closely with member firms throughout the multi-year project, and will continue to solicit their input and feedback to ensure the enhanced systems are meeting the industry’s needs.

 

SEC Charges Long Island Investment Professional in $8 Million Scam Targeting Long-Standing Brokerage Customers

On May 30, 2018, the Securities and Exchange Commission charged a former registered representative with defrauding long-standing brokerage customers in an $8 million investment scam.

According to the SEC’s complaint, Steven Pagartanis, who was affiliated with a registered broker-dealer, told some investors – including retirees who had been Pagartanis’s customers for many years – that he would invest their funds in either a publicly-traded or private land development company.  He promised that the funds would be safe and also promised guaranteed monthly interest payments on the investments.  At Pagartanis’s direction, his investors wrote checks payable to a similarly-named entity that was secretly controlled by Pagartanis.  In all, the customers invested approximately $8 million, which Pagartanis used to pay personal expenses and make the guaranteed “interest” payments to his customers.  To conceal the scam, which unraveled earlier this year when Pagartanis stopped making the so-called interest payments to customers, Pagartanis created fictitious account statements reflecting ownership interests in the land development companies.

The Suffolk County District Attorney’s Office filed criminal charges on May 30, 2018 against Pagartanis.

The SEC’s complaint, filed in federal district court in Brooklyn, charged Pagartanis with violating the antifraud provisions of the federal securities laws.  The SEC is seeking a judgment ordering Pagartanis to disgorge his allegedly ill-gotten gains plus prejudgment interest, and to pay financial penalties. If you believe that you have suffered losses as a result of Steven Pagartanis’ misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

93.7577 or 800.718.1422.

FINRA Sanctions Fifth Third Securities, Inc., $6 Million for Cost and Fee Disclosure Failures and Unsuitable Recommendations Related to Variable Annuity Exchanges

On May 8, 2018, FINRA announced that it had fined Fifth Third Securities, Inc., $4 million and required the firm to pay approximately $2 million in restitution to customers for failing to appropriately consider and accurately describe the costs and benefits of variable annuity (VA) exchanges, and for recommending exchanges without a reasonable basis to believe the exchanges were suitable. This is the second significant FINRA enforcement action against Fifth Third involving the firm’s sale of variable annuities.

Variable annuities are complex investments commonly marketed and sold to retirees or people saving for retirement. Exchanging one VA with another involves a comparison of the complex features of each security. Accordingly, VA exchanges are subject to regulatory requirements to ensure that brokers have a reasonable basis to recommend them, and their supervisors have a reasonable basis to approve the sales.

FINRA found that Fifth Third failed to ensure that its registered representatives obtained and assessed accurate information concerning the recommended VA exchanges. It also found that the firm’s registered representatives and principals were not adequately trained on how to conduct a comparative analysis of the material features of the VAs. As a result, the firm misstated the costs and benefits of exchanges, making the exchange appear more beneficial to the customer. By reviewing a sample of VA exchanges that the firm approved from 2013 through 2015, FINRA found that Fifth Third misstated or omitted at least one material fact relating to the costs or benefits of the VA exchange in approximately 77 percent of the samples.  For example:

  • Fifth Third overstated the total fees of the existing VA or misstated fees associated with various additional optional benefits, known as riders.
  • Fifth Third failed to disclose that the existing VA had an accrued living benefit value, or understated the living benefit value, which the customer would forfeit upon executing the proposed exchange.
  • Fifth Third represented that a proposed VA had a living benefit rider even though the proposed VA did not, in fact, include a living benefit rider.

FINRA found that the firm’s principals ultimately approved approximately 92 percent of VA exchange applications submitted to them for review. However, in light of the firm’s supervisory deficiencies, the firm did not have a reasonable basis to recommend and approve many of these transactions.

In addition, FINRA found that Fifth Third failed to comply with the terms of its 2009 settlement with FINRA. In the 2009 action, FINRA found that, from 2004 to 2006, Fifth Third effected 250 unsuitable VA exchanges and transactions and had inadequate systems and procedures governing its VA exchange business. For more than four years following the settlement, the firm failed to fully implement an independent consultant’s recommendation that it develop certain surveillance procedures to monitor VA exchanges by individual registered representatives.

In settling this matter, Fifth Third neither admitted nor denied the charges, but consented to the entry of FINRA’s findings. If you believe that you have suffered losses as a result of Fifth Third Securities Inc.’s misconduct, you may contact David A. Weintraub, P.A., 7805 SW 6th Court, Plantation, FL 33324.  By phone:  954.693.7577 or 800.718.1422.

SEC Shuts Down $85 Million Ponzi Scheme and Obtains Asset Freeze

On May 1, 2018, the Securities and Exchange Commission announced the unsealing of fraud charges against a Mississippi company and its principal who allegedly bilked at least 150 investors in an $85 million Ponzi scheme.  The defendants agreed to permanent injunctions, an asset freeze, and expedited discovery.

The SEC’s complaint alleges that Arthur Lamar Adams lied to investors by telling them that their money would be used by his company, Madison Timber Properties, LLC, to secure and harvest timber from various land owners located in Alabama, Florida, and Mississippi, and promised annual returns of 12-15%.  But Madison Timber never obtained any harvesting rights.  Instead, Adams allegedly forged deeds and cutting agreements as well as documents purportedly reflecting the value of the timber on the land.  Adams also allegedly paid early investors with later investors’ funds and convinced investors to roll over their investments.  According to the complaint, Adams used investors’ money for personal expenses and to develop an unrelated real estate project.

The SEC’s complaint, filed under seal in federal court in Jackson, Mississippi on April 20, 2018, charges Adams and Madison Timber Properties with violating the antifraud provisions of the federal securities laws.  The court granted the SEC’s request for an asset freeze and permanently enjoined Madison Timber and Adams from violating the antifraud provisions of the federal securities laws and ordered Adams to surrender his passport.  Adams and Madison Timber consented to the entry of the court order.

 

SEC Announces its Largest-Ever Whistleblower Awards

On March 19, 2018, the SEC announced its highest-ever Dodd-Frank whistleblower awards, with two whistleblowers sharing a nearly $50 million award and a third whistleblower receiving more than $33 million.  The previous high was a $30 million award in 2014.

The SEC has awarded more than $262 million to 53 whistleblowers since issuing its first award in 2012.  All payments are made out of an investor protection fund established by Congress that is financed entirely through monetary sanctions paid to the SEC by securities law violators.  No money has been taken or withheld from harmed investors to pay whistleblower awards.

Whistleblowers may be eligible for an award when they voluntarily provide the SEC with original, timely, and credible information that leads to a successful enforcement action.

Whistleblower awards can range from 10 percent to 30 percent of the money collected when the monetary sanctions exceed $1 million. As with this case, whistleblowers can report jointly under the program and share an award.

By law, the SEC protects the confidentiality of whistleblowers and does not disclose information that might directly or indirectly reveal a whistleblower’s identity.

If you believe you have information evidencing violations of the federal securities laws, please contact David A. Weintraub, P.A., 800.718.1422.

Merrill Lynch Charged With Gatekeeping Failures in the Unregistered Sales of Securities

On March 8, 2018, the SEC announced that it had settled charges against Merrill Lynch, Pierce, Fenner & Smith Inc. for its failure to perform required gatekeeping functions in the unregistered sales of securities on behalf of a China-based issuer and its affiliates.

The SEC’s order found that Merrill Lynch sold almost three million shares of Longtop Financial Technological Limited’s securities into the market despite red flags indicating that the sales could be part of an unlawful unregistered distribution.  Ultimately, the distribution generated almost $38 million in proceeds for the overseas issuer and its affiliates.

It was determined that Merrill Lynch violated Sections 5(a) and 5(c) of the Securities Act of 1933.  In settlement, without admitting or denying the SEC’s findings, the firm agreed to be censured and consented to the order requiring it to cease and desist from committing or causing any future violations of the registration provisions of the Securities Act.  The order also requires Merrill Lynch to pay a penalty of $1.25 million and more than $154,000 in disgorgement and prejudgment interest from commissions and fees earned on the improper sales.  The SEC has revoked the registration of Longtop’s securities.

Massachusetts Leads the Path for Enforcement of Fiduciary Rule

In court papers filed February 23, 2018, the Office of the Secretary of the Commonwealth alleged Scottrade violated Massachusetts’ securities laws by failing to comply with the impartial conduct standards of the Labor Department’s fiduciary rule.

According to the complaint, the discount broker-dealer knowingly violated the fiduciary rule by running sales contests targeting retail investors’ assets in qualified retirement accounts. The contests also violated the internal compliance policies the company put in place after the impartial conduct standard went into affect in June of 2017, the complaint says.

Broker-dealer Scottrade has been charged with violating the impartial conduct standards of the DOL fiduciary rule. Under the fiduciary rule’s impartial conduct standards, any recommendation to buy a security with assets in IRAs or 401(k) plans must be made in investors’ best interests.

Scottrade ran two sales contests; one launched days before implementation of the impartial conduct standards, and one launched in September of 2017. Those contests, which were common in what the claim says was Scottrade’s “aggressive sales practices” prior to the implementation of the impartial conduct standards, incentivized brokers to bring in new assets from customers, including through rollovers from qualified retirement accounts.

In the first contest, Scottrade offered $285,000 in cash prizes to brokers that satisfied high cold-calling penetration benchmarks. In the second, brokers were awarded weekly cash prizes of $500 and $2,500 for recommending investors move to the firm’s advisory program.

Under the fiduciary standard established by the impartial conduct standards, any compensation arrangement that creates a potential conflict of interest must be disclosed to investors. Massachusetts’ complaint says Scottrade failed to inform clients of the conflicts arising from the incentives in the sales contests.

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