COVID-19 Update: How We Are Serving and Protecting Our Clients.

Over the past several years, there has be an increasing number of registered investment advisors and financial advisors using omnibus accounts.  In short, an omnibus account allows an advisor to trade the same securities on behalf of multiple clients, while typically identifying in advance which trades are intended for which client accounts.  However, in some cases, trades are allocated after they are made.  This creates an increased risk of fraud since some firms’ supervisory failures have allowed advisors to “cherry-pick” which accounts get the winning trades, and which accounts suffer losses.  The securities fraud lawyers at Rich, Intelisano & Katz, LLP (RIK) won multiple claims against broker-dealers for allowing third parties to engage in this misconduct.

An omnibus account is intended to facilitate large purchase blocks of securities for multiple client accounts.  The idea of aggregating or bunching purchases in a single transaction is to obtain more favorable prices, lower brokerage commissions, and create more efficient execution.  After the trades are made, the advisor is supposed to allocate the trades to client accounts in accordance with the previously approved allocations.  The allocations of trades then should be reviewed by compliance and/or risk management periodically to ensure that accounts are not systematically disadvantaged by this policy.

Unfortunately, some advisors use this policy to scam their clients.  Sometimes allocation instructions are submitted after trades are executed, when the adviser has had the opportunity to view the performance of the trade over the course of the day.  By reviewing trade performance first, the advisor knows which trades are profitable and which are unprofitable, then can “cherry-pick” – that is to allocate the profitable trades to favored accounts and allocate losing trades to other disfavored accounts.

Rich, Intelisano & Katz, LLP (RIK) filed a $3 million FINRA arbitration this month on behalf of clients that invested in UBS Financial Services, Inc.’s Yield Enhancement Strategy (YES).  UBS claimed the YES Program had minimal risk, but unbeknownst to its customers, the risks of this options trading strategy significantly outweighed any potential gain.  Unfortunately, investors around the world lost hundreds of millions of dollars investing in YES.

Although UBS and its brokers claimed the YES Program had limited risk of loss, in actuality, this was a high-risk strategy.  UBS implemented the YES Program beginning in 2016 after it recruited a high-profile team of brokers from Credit Suisse with massive up front bonuses.   To entice customers to invest, UBS represented that the YES Program was a low-risk way to generate incremental income of 3% to 6% annually (before the deduction of fees).  UBS further stated that the Program used protective options trading combinations to create a market-neutral strategy, meaning the Program’s performance would have little correlation to the markets, thereby protecting investors from significant losses.  These low-risk and loss protection statements made by UBS contradict the actual risks associated with the Program.

The fact is that the YES Program was a high-risk, complex options strategy that subjected UBS customers to significant market exposure and risk of loss.  This complex options strategy involved hundreds of combinations of puts and calls.  The complexity of the program and the lack of adequate risk controls exposed YES investors to significant risk of loss – loss that was far beyond the alleged risk protection.  Specifically, YES investors were exposed to 15% to 40% of losses depending on their holding period, even though their expected annual income was only 3% to 6%.  In sum, YES was not the low-risk, market neutral, downside protection strategy that UBS had stressed to its customers.

Arbitration at FINRA has long been known as a quicker, more efficient alternative to court litigation of disputes eligible for submission to FINRA’s Dispute Resolution forum.  This continues to be true, to an even greater extent, during the COVID-19 pandemic.

Many courts at the federal and state levels, both in New York and across the US, have indefinitely suspended the filing of new nonessential cases during this time. Courts have also frozen the commencement of trials and the perfection of appeals in pending cases. And conferences, depositions and other in-person court appearances cannot take place where social distancing and large-group gathering guidelines are in effect. Thus, both new and pending court cases are in large part on hold until further notice, to protect the safety of parties, court personnel and the public.

At FINRA, however, the processing and handling of arbitration cases is primarily done electronically, with very little need for in-person contact until the final hearings on the merits. Even during the current unprecedented situation, parties can still file new cases at FINRA using the Dispute Resolution Portal, and can choose arbitrators and engage in discovery. Because FINRA arbitration does not allow for depositions except in extraordinary circumstances, the discovery process and exchange of documents and information can be done completely remotely and electronically, and without delay.  Parties or potential parties should be reassured that their new or already-pending cases will continue to be administered as they were before the current pandemic.

Cantor Fitzgerald has a practice of awarding its FINRA registered employees compensation in the form of partnership units in an associated entity called Cantor Fitzgerald, L.P. (CFLP), which is not a member of FINRA.  The employees are often employed by or registered with Cantor Fitzgerald & Co. (CF&Co.), the main Cantor FINRA-registered broker dealer.  Many Cantor employees have employment agreements with CF&Co. which provide for payment in CFLP partnership units.  The compensation in the form of CFLP partnership units can only be for the employees’ work as FINRA-registered representatives for CF&Co since the employees don’t work for CFLP.

As Bloomberg reported. Cantor recently announced layoffs.  https://www.bloomberg.com/news/articles/2020-04-16/cantor-to-cut-hundreds-of-jobs-in-break-from-wall-street-pledge

Many employees who are laid off may own significant amounts of CFLP partnership units.  If an employee believes he or she is not being compensated fairly with respect to the partnership units, what can an employee do?  Our firm has handled this issue with Cantor before.  The answer, if the employee is a FINRA registered representative, is he or she can bring a FINRA arbitration against CF&Co. to recover the value of the partnership units.

We are increasingly hearing from investors who say that their investment representative at their “self directed” broker dealer—such as T.D. Ameritrade—recommended an outside investment advisor who was not formally affiliated with the firm and incurred investment losses as a result.

There could be many reasons why this may happen: the investment representative may have a financial arrangement with the advisor, or a personal relationship, or even just trying to be helpful. However, this is a problem that is obviously foreseeable for such firms, and sometimes lands an unwitting investor with a fraudster.  In fact, such firms discourage their investment representatives from giving any investment advice because that can expose them bring to potential liability if the advisor or advice is unsuitable or fraudulent. Nevertheless, investment representatives sometimes make recommendations of outside unaffiliated advisors to their customers.  The question is can the firm be legally responsible if the recommended advisor’s strategy is not suitable or fraudulent. The general rule is that if an investment representative recommends that a customer use an outside advisor, or even brings such an advisor or her strategy to the attention of the customer, the firm may be liable in FINRA arbitration to the customer if the advisor/strategy is unsuitable or fraudulent and losses are incurred as a result.

Brokerage firms that use the self directed business model try to protect themselves by inserting language in their client agreements that purports to absolve them of such liability. However, FINRA frowns on brokerage firm attempts to insulate themselves contractually for liability resulting from breach by their registered representatives of industry rules, such as the suitability rule. In addition, at least one FINRA panel has awarded damages against T.D. Ameritrade in just such a case. https://www.finra.org/sites/default/files/aao_documents/18-01404.pdf

The market for financial advisors to transition from one firm to another is thriving despite less broker dealers being part of the Broker Protocol, the global economy being at a near standstill, and millions of Americans applying for unemployment on a weekly basis. The wire houses are actively recruiting and Fidelity recently announced its hiring efforts: https://jobs.fidelity.com/ With a volatile stock market causing extreme angst among investors, advisors are in high demand as they calm unsteady nerves and identify investment opportunities for weary clients. Given these realities, it would seem an unlikely time for advisors to make the jump from one firm to another. But many advisors – and the firms who have stepped up their recruiting efforts during the pandemic – feel otherwise.

Attempting to move an entire book of business during unprecedented market volatility can certainly be a risky endeavor, but there are good reasons to consider taking the leap at this particular time. Having experienced counsel will help too.

First, in light of the stock market roller coaster of the past several weeks, investors are more inclined to remain with the advisor upon whom they’ve come to rely, regardless of which firm he or she works.

Mortgage REITs have often been recommended by brokerage firms as safe investments that generate consistent income.  However, during the recent market turmoil the bottom has fallen out for many Mortgage REITs.  For example, AGNC Investment and Annaly Capital are down over 50% in the last month or so, a way larger drop than the general equities markets.  Another Mortgage REIT, AG Mortgage, is down 75%.  Many of these mortgage REITs do not expect to be able to meet upcoming margin calls.

How did these mortgage REITs end up here?  Well, first of all, a REIT is a real estate investment trust which is a security that invests in real estate directly either through properties or in this case, mortgages or mortgage-related bonds.  The mortgage REITs listed above are publicly held and sold on exchanges. There are also what are called non-traded REITs which are often sold through broker-dealers and are not traded publicly.  Mortgage REITs invest and own property mortgages. They also loan money for mortgages to real estate owners, buy existing mortgages and purchase complicated MBS (mortgage-backed securities). Mortgage REITs generate revenue by collecting interest on the mortgage-related products.

As reported widely this week, the Mortgage REITs often fund themselves by pledging bonds in return for cash in the repo markets.  They are highly leveraged which in good times allowed them to pay dividends at higher yields than most bonds.  Brokers often recommend to investors to reach for yield in low yielding time periods and many brokers sold Mortgage REITs to investors without fully disclosing the risks associated with them.  In recent weeks, many Mortgage REITs found that the mortgage bonds they held dropped in value which triggered margin calls which then forced the Mortgage REITs to sell bonds into a falling market.

Margin call disputes often arise during times of market turmoil such as now.  Knowing what to do and whom to speak to when a margin call is issued is vitally important to an investor’s financial well-being.  Here is a little primer on what to do.

A margin call often occurs when the value of an investor’s margin account falls below the broker dealer’s required amount. A margin call is the broker dealer’s demand that an investor deposit additional money or securities so that the value of the account is brought up to the minimum value, which is known as the maintenance margin.  Some margin calls are small and an investor simply has to move securities in from another account or write a check to the broker.  However, in other situations, the acts by the broker dealer prior to the margin call being issued may have played a role in the margin call itself.

For example, a conservative investor often should not be holding any securities on margin at a brokerage firm.  If the firm recommended an unsuitable investment strategy that contained a significant amount of margin, and the market turned bad, and the investor sustained losses, said investor may have a potential FINRA arbitration claim against the broker.  In these situations, when a margin call is issued on the account, we highly recommend that the investor call a law firm such as ours who regularly represents investors in disputes with the financial industry.  It is paramount that the investor receives legal advice as soon as possible.  Most broker dealers have very broad powers in how to handle margin calls pursuant to onerous margin agreements.  The brokers sometimes even blow out investors’ portfolios without providing any notice (though they are supposed to exercise good faith in any decision they implement).  Time is usually of the essence.  It is important to have counsel engage with the broker dealer as soon as possible to potentially work out any issues.

Many firms, such as TD Ameritrade, Charles Schwab and Fidelity, whose business model includes or is tailored primarily to investors who want the benefits of a self-directed account also offer to introduce investors who wish independent investment advice to professional investment advisors who are technically “unaffiliated” with the firm.  Such investment advisors are often small SEC Registered Investment Advisors (“RIA”s) who are thinly capitalized and have supervisory systems that are well below FINRA broker dealer standards. The brokerage firms contract with such RIAs to be on their platforms and available to provide advice to customers that the firm introduces them to.   Those contracts are often designed to, among other things, insulate the brokerage firm from liability for investment advice given to the investor. This is so even though the brokerage firms vet such advisors, who become part of a “platform” they market to investors. Investors who are “introduced” by their firm to an RIA who will provide them investment advice may not realize that the firm’s position is that if the advice is inappropriate the RIA and not the firm is legally responsible.  Indeed, the firms structure their contracts with the customer as well as the RIA to give them this protection. Customers can be easily misled by such “introductions” into believing that the firm stands behind the RIA. Although the legal documents, couched in legalese, may so specify, the customer, who often does not read all the legalese in these documents, can be forgiven for believing that the firm that recommended the advisor and investment plan should have some responsibility if that advisor acts improperly. Investors at such firms need to know that they are taking a risk that if their firm recommended RIA gives them unsuitable advice they may be stuck suing a potentially judgment proof RIA in court (rather than the more cost effective FINRA arbitration).

Rich, Intelisano & Katz, LLP (RIK) continues its investigation into UBS’ sale of its Yield Enhancement Strategy or the “YES” options program. Many investors around the country have filed arbitrations against UBS alleging that UBS misrepresented the risks of the options program, failed to implement appropriate risk controls, and failed to supervise the YES options program.

The Yield Enhancement Strategy is run by two UBS registered representatives, Matthew Buchsbaum and Scott Rosenberg. UBS recruited both gentlemen from Credit Suisse in 2015 when Credit Suisse closed its private wealth management business. Messrs. Buchsbaum and Rosenberg ran the YES options program at Credit Suisse for many years.

UBS allowed its financial advisors other than Messrs. Buchsbaum and Rosenberg to market and sell the YES options program to their own clients. Cases filed by aggrieved investors allege that UBS represented that its YES options program was a low-risk strategy to generate modest income. However, the program is actually a complex investment strategy that carried significant risk and caused substantial investor losses.

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