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Merrill Lynch to pay $1 Million for Failure to Arbitrate Disputes with Employees

The Financial Industry Regulatory Authority (FINRA) announced today that it has fined Merrill Lynch, Pierce, Fenner & Smith $1 million for failing to arbitrate disputes with employees relating to retention bonuses.

FINRA’s investigation found that on January 2009, when Merrill Lynch merged with Bank of America, an Advisor Transition Program (ATP) was implemented.  Under the ATP, Merrill Lynch would pay a lump sum retention payment to certain high producing registered representatives.  The ATP was structured as an up-front forgivable loan to entice Merrill Lynch’s high producing brokers to stay with the firm after the merger.

In January 2009, Merrill Lynch paid $2.8 billion in retention bonuses structured as loans to over 5,000 registered representatives.  In most cases, the loans were set up to be forgiven by Merrill Lynch on an annual basis.  If the financial advisor stayed with the firm through the duration of the forgiveness period of the loan, the broker would not have to repay the loan.  If, however, the financial advisor resigned from the brokerage firm, or was terminated, before the loan was forgiven, the broker was contractually obligated to repay the outstanding amounts owed on the loan and the Merrill Lynch could move to collect the outstanding amount still owed.

According to FINRA, Merrill Lynch designed the ATP programs so it could avoid arbitration proceedings when seeking to collect amounts due under the ATP loans.  Merrill Lynch achieved this by stating that the loans were being made to the registered representatives by a non-registered affiliate of Merrill Lynch, when in fact, the funding for the ATP loans came from Merrill Lynch.  The program was structured to allow Merrill Lynch to pursue collection of the amounts under the loans in expedited proceedings in New York state court.  FINRA rules require that disputes between firms and associated persons be arbitrated if they arise out of the business activities of the firm or associated person.  Between January and November 2009, Merrill Lynch filed over 90 of these actions in New York state court, violating FINRA Rule 2010.

Brad Bennett, FINRA Executive Vice President and Chief of Enforcement, said, “Merrill Lynch specifically designed this bonus program to bypass FINRA’s rule requiring firms to arbitrate disputes with employees, and purposefully filed expedited collection actions in New York State courts and denied those registered representatives a forum to assert counterclaims.”

SEC Charged a “Criminal Club” with Insider-Trading in Dell, Inc. Shares

On January 18, 2012, the Securities and Exchange Commission (SEC) charged two multi-billion dollar hedge fund advisory firms as well as seven fund managers and analysts involved in a $78 million insider trading scheme based on nonpublic information about Dell’s quarterly earnings.

Insider-trading is an illegal activity when a corporation’s stock or other securities are traded by individuals with special knowledge or access to non-public information about the company, giving them an unfair advantage over regular investors.  The SEC states that this case involves insider trading by members of a network closely associated hedge fund trades who illegally obtained material nonpublic information concerning public companies Dell, Inc and/or Nvidia Corporation, exchanged that information with others, and reaped massive profits from trading on that information.

Manhattan U.S Attorney, Preet Bharara, described the group of individuals involved as “a circle of friends who essentially formed a criminal club, whose purpose was profit and whose members regularly bartered lucrative inside information. It was a club where everyone scratched everyone else’s back.”  The Director of the SEC’s Division of Enforcement said in a statement that “These are not low-level employees succumbing to temptation by seizing a chance opportunity. These are sophisticated players who built a corrupt network to systematically and methodically obtain and exploit illegal inside information again and again at the expense of law-abiding investors and the integrity of the markets.”

The SEC alleges that during at least 2008, investment analyst Sandeep “Sandy” Goyal illegally obtained Dell quarterly earnings information and other performance data from an insider at Dell.  Goyal then tipped Diamondback Capital Management, LLC analyst Jesse Tortora with the inside information in advance of Dell’s first and second quarter earnings announcements in 2008, Tortora then tipped his portfolio manager at Diamondback, Todd Newman, then he traded on the information on behalf of the Diamondback hedge funds he controlled.  Tortora also tipped Spyridon “Sam” Adondakis, an analyst at Level Global Investors, L.P.  Adondakis tipped his manager Anthony Chiasson, who then traded on the inside information on behalf of Level Global hedge funds.  According to the SEC’s complaint, Tortora also tipped two others at firms other than Diamondback or Level Global with the Dell inside information: Jon Horvath of New York City and Danny Kuo of San Marino, Calif.  The SEC complaint further alleges that in addition to engaging in insider trading in Dell securities, at least five of the seven individual defendants and both investment adviser firm defendants obtained material nonpublic information concerning Nvidia, and traded on the basis of that information and/or passed the information on to other who traded.

The SEC’s investigation and complaint filed in federal court in Manhattan is part of an ongoing four-year old insider-trading probe named “Operation Perfect Hedge”, which so far has resulted in 63 arrests and 56 convictions.

UBS Global Asset Management Charged by SEC for Fund Overvaluation

The Securities and Exchange Commission (SEC) charged an investment advisory arm of UBS with failing to properly price securities in three mutual funds that it managed.  In the complaint, the Commission states that this proceeding concerns the misstatement of the Net Asset Values (“NAV’s”) of certain registered investment companies (the “Funds”) managed by UBSGAM. UBSGAM failed to cause certain fixed-income securities in the portfolios of the Funds to be valued in accordance with the Funds’ fair valuation procedures. UBSGAM’s failure to properly fair value these securities resulted in a misstatement of the NAVs of the Funds.

Netassetvalue (NAV) represents a fund’s per share marketvalue. This is the price at which investors buy (“bid price”) fund shares from a fund company and sell them (“redemption price”) to a fund company. It is derived by dividing the total value of all the cash and securities in a fund’s portfolio, less any liabilities, by the number of shares outstanding. A NAV computation is undertaken once at the end of each trading day based on the closing market prices of the portfolio’s securities.  This number is important to investors, because it is from NAV that the price per unit of a fund is calculated.

The SEC found that in June 2008, UBSGAM bought 54 fixed income securities; most of them were purchases of non-agency mortgage-backed securities.  Forty eight of these securities were then valued at prices substantially in excess of the transaction prices, including many at least 100% higher.  The valuations used by UBS were provided by pricing sources that did not appear to take into account the prices at which the mutual funds had purchased the securities, the SEC said.  Because the Funds did not properly or timely fair value the Securities, the NAV’s of the funds were misstated between one cent and 10 cents per share for several days in June 2008, violating rule 22c-1 adopted pursuant to Section 22c of the Investment Company Act.  Merri Jo Gillette, Regional Director of the SEC’s Chicago Regional Office said “Fortunately this misconduct was brought to light quickly, so the duration was short and the harm to investors minimal.”

UBSGAM agreed to pay $300,000 to settle the SEC’s charges.

SEC Charges Life Partners Holdings for Fraudulent Activities Involving Life Settlements

The Securities and Exchange Commission (SEC) has charged Life Partners Holdings, a publicly traded, Texas based financial services firm, and three of its senior executives: Chairman and CEO – Brian Pardo, President and General Counsel – Scott Peden, and its CFO – David Martin with disclosure and accounting fraud.

Life Partners buys and sells interests in life insurance policies on the secondary market. In these deals, life insurance owners sell their policies to investors in exchange for a smaller lump-sum payment.

A life settlement is a financial transaction in which the owner of a life insurance policy sells an unneeded policy to a third party for more than its cash value and less than its face value. A life settlement is an alternative to the surrender or lapse of a policy, or when the owner of a life insurance policy no longer needs or wants the policy, the policy is underperforming or can no longer afford to pay the premiums.

The SEC alleges that Life Partners executives misled shareholders by failing to disclose a significant risk to Life Partners’ business.  The company was underestimating the life expectancy rate used to price its transactions.  This estimate is an important and critical factor used to calculate the company’s revenue and profit margins.   Additionally, the accounting method used by Life Partners, overvalued the company’s assets creating the appearance of a steady stream of earnings from brokering the life settlement transactions.    As a result, the SEC says, Life Partners materially misstated net income from fiscal year 2007 through the third quarter of fiscal year 2011.

“Life Partners duped its shareholders by employing an unqualified medical doctor to assign baseless life-expectancy estimates to the underlying insurance policies,” said Robert Khuzami, head of the SEC’s enforcement division. “This deception misled shareholders into thinking that the company’s revenue model was sustainable when in fact it was illusory.”

Additionally, the SEC charged Pardo and Peden with insider trading, for allegedly selling shares of the company while having knowledge and in possession of material, non-public information showing that Life Partners, Inc. underestimated life expectancy estimates.   During this period of time, Pardo and Peden sold about $11.5 million and $300,000, respectively, of Life Partners stock at inflated prices, while knowing the revenue estimates were not accurate.

SEC Files Charges against Three Individuals in Connection with a $16 Million Ponzi Scheme

On December 29, 2011, the Securities and Exchange Commission (SEC) filed a civil fraud action against Kevin J. Wilcox, Jennifer E. Thoennes, and Eric R. Nelson for their role in a $16 million Ponzi scheme operated by Joseph Nelson. The SEC filed a separate lawsuit against Joseph Nelson and others involved in the scheme.

A Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors. Ponzi scheme organizers often solicit new investors by promising to invest funds in opportunities claimed to generate high returns with little or no risk. In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.

The SEC’s complaint alleges that from January 2007 to June 2010, Joseph Nelson and his associates, including Wilcox and Thoennes, solicited at least $16 million from more than 100 persons to invest in promissory notes offered by Joseph Nelson’s companies.  Most of the people the three targeted were members of the Church of Jesus Christ of Latter-day Saints. They met them at church functions and through church connections.  The investors were lured by promises of extraordinary rates of return. Most investors were given promissory notes promising returns of 14% to 60% on an annualized basis and additional premium of 20% to 60% at maturity. Some investors were simply told that they would double their money.

The SEC alleges that Nelson and his companies never purchased or sold a single merchant credit card portfolio. The money invested with Nelson and his companies was instead used by Nelson to make incremental payments to investors in a Ponzi-scheme fashion, to pay his associates, including Wilcox and Thoennes, and to pay his own lavish personal expenses, as well as those of other family members.

The SEC’s complaint also alleges that Eric Nelson, Joseph Nelson’s brother, created fictitious documents including bank account statements to lure and deceived investors into believing that Joseph Nelson and his companies were engaged in the business of buying and selling merchant credit card portfolios and that these were viable investments.

In the complaint, Wilcox, Thoennes, and Eric Nelson were each charged with violating the antifraud provisions of the federal securities laws.  The complaint also alleges that Wilcox and Thoennes violated the broker-dealer and securities registration provisions of the securities laws.

Credit Suisse Securities Fined $1.75 Million

On December 27, 2011, the Financial Industry Regulatory Authority (FINRA) fined Credit Suisse Securities, LLC, $1.75 million for violating Regulation SHO and failing to properly supervise short sales of securities and marking of sale orders.

By definition, a short sale is the selling of a security that the seller does not own, or any sale that is completed by the delivery of a security borrowed by the seller.  Short sellers assume that they will be able to buy the stock at a lower amount than the price at which they sold short.  Regulation SHO requires a broker or dealer to have reasonable grounds to believe that the security could be borrowed and available for delivery before accepting or effecting a short sale order. Requiring firms to obtain and document this “locate” information before the short sale is entered reduces the number of potential failures to deliver in equity securities. In addition, Reg SHO requires a broker or dealer to mark sales of equity securities as long or short.

FINRA found that for at least the period from June 2006 through December 2010, Credit Suisse released millions of short sale orders to the market without reasonable grounds to believe that the securities could be borrowed and delivered.  In addition, Credit Suisse mismarked tens of thousands of sale orders in its trading systems. The mismarked orders included short sales that were mismarked as “long,” resulting in additional violations of Reg SHO’s locate requirement.

FINRA found that Credit Suisse’s supervisory framework over its equities trading business was not reasonably designed to achieve compliance with the requirements of Reg SHO and other securities laws, rules and regulations.  Due to the company’s supervisory failures, many violations were not detected or corrected until after FINRA’s investigation.

Brookstone Securities, Inc., fined for making misrepresentations, omissions, unsuitable investments

FINRA has taken disciplinary action against Brookstone Securities, Inc and five of its agents for making misrepresentations or omissions of material fact.  Additionally, FINRA found that registered representatives recommended and effected the sale of securities without having a reasonable basis to believe that the transactions were suitable given the customers’ financial circumstances and conditions, and their investment objectives.

FINRA’s investigation found that Richard J. Buswell and Herbert S. Fouke, while registered with Brookstone, made misrepresentations and omissions of material fact in connection with the sale of investments in Advanced Blast Protection, Inc.  The registered representatives guaranteed customers that they would receive back their principal investment plus returns.  Additionally, they failed to inform investors of risks associated with the investments and did not discuss the risks outlined in the private placement memorandum (PPM).  The PPM stated that the investment was speculative, involved a high degree of risk and was only suitable for investors who could risk losing their entire investment.  In addition, Buswell exercised discretion in the accounts of customers without prior written authorization, made unsuitable recommendations to customers with conservative investment objectives, and made excessive use of margin.

FINRA found that Anthony L. Turbeville, acting as Chief Operating Officer (COO), and David W. Locy, as President, failed to reasonably supervise Buswell and failed to follow up on “red flags”.  FINRA stated that Brookstone failed to establish, maintain and enforce reasonable supervisory procedures in four areas: (1) due diligence; (2) prevention and detention of unsuitable recommendations resulting from excessive trading, excessive use of margin and over concentration; (3) the new account application process; and (4) the reviews of customer accounts required by the procedures.  Despite numerous violations and red flags, the firm took no steps to contact customers or place the representative on heightened supervision, although it later placed limits only on the representative’s use of margin.

FINRA stated that Mark Mercier was the Chief Compliance Officer and was responsible for ensuring that the offering of Advanced Blast Protection, Inc. complied with due diligence requirements, but performed only a superficial review and failed to complete the steps required by the firm’s Written Supervisory Manuals.  The findings also stated that the firm failed to establish, maintain and enforce supervisory procedures reasonably designed to prevent violations of NASD Rule 2310 regarding suitability.

FINRA accepted an offer of settlement, in which the firm will pay a fine of $200,000.00.  David W. Locy, Mark M. Mercier and Anthony L. Turbeville were sanctioned with suspensions and additional fines.

Wells Fargo to Pay Restitution to Affected Customers

On December 15, 2011 the Financial Industry Regulatory Authority (FINRA) announced that it fined Wells Fargo Investments, LLC, $2 million for unsuitable sales of reverse convertible securities to elderly customers.  In addition, the firm is required to pay restitution to customers who did not receive UIT sales charge discounts and to provide restitution to certain customers found to have unsuitable reverse convertible transactions.

Also known as “revertible notes” or “reverse exchangeable securities”, reverse convertibles are interest-bearing notes in which repayment of principal is tied to the performance of an underlying asset, such as a stock or a basket of stocks. Depending upon the reverse convertible’s specific terms, an investor risks sustaining a loss if the value of the underlying asset falls below a certain level at maturity, or during the term of the reverse convertible.

In addition to the reprimand, FINRA filed a complaint against Alfred Chi Chen, the former Wells Fargo registered representative responsible for recommending and selling the unsuitable reverse convertibles, and making unauthorized trades in several customer accounts, including accounts of deceased customers.  Chen recommended hundreds of unsuitable reverse convertible investments to 21 clients, fifteen of whom were over 80 years old.  These transactions exposed investors to risk inconsistent with their investment profiles, and resulted in overly concentrated reverse convertible positions in their accounts.

FINRA also found that Wells Fargo had insufficient systems and procedures to monitor for unsuitable reverse convertibles sales.  As a result of these deficiencies, the firm failed to provide certain eligible customers with breakpoint and rollover and exchange discounts in their sales of UIT’s.  UIT’s offer sales charge discounts on purchases that exceed certain thresholds (“breakpoints”) or involve redemption or termination proceeds from another UIT during the initial offering period. Between January 2006 and July 2008, Wells Fargo failed to provide certain eligible customers with these “breakpoint” and “rollover and exchange” discounts.

Former Securities America Representative Sanctioned for Not Disclosing Outside Businesses

FINRA sanctioned a former Securities America representative, Frank A. Gutta, for failing to disclose that he owned and operated a Florida corporation, Business Investors, Inc. (BII).  Mr. Gutta participated in numerous private securities transactions without notice or approval from Securities America, his employer at the time.

FINRA’s investigation found that during the period from September 2003 through at least January 2008 he operated Business Investors, Inc., without any notice to SAI.  He offered and sold BII promissory notes to 19 individuals, nine of which were SAI customers, for proceeds of approximately $2.9 million.  The proceeds were used to finance the creation and/or operation of various small businesses, including gas stations and a dollar store.  The BII promissory notes were not sponsored or approved by SAI.   Additionally, Mr. Gutta recommended BII Promissory notes to at least one of his SAI customer without having a reasonable basis to believe that the investment was suitable for her.

FINRA imposed a two-year suspension from association with any FINRA member in any capacity upon Mr. Gutta.  Since Mr. Gutta was granted a discharge in bankruptcy on June 11, 2010, no monetary sanctioned was placed.