Articles Posted in For Public Investors

Investors lost millions in UBS’s high-risk Yield Enhancement Strategy (“YES”).  Despite UBS’s claims that this was a low-risk strategy and that losses were protected by hedging put and call options, investors had substantial losses when the S&P dropped in 2018 and 2019.  Even with these losses, UBS brokers continued to push this strategy onto investors.  Because of market volatility in early 2020, losses ensued further, causing investors to lose millions.  RIK’s investment fraud lawyers represent several claimants in multimillion-dollar FINRA arbitrations against UBS on behalf of YES investors.

Investors who suffered losses from the YES strategy began to file claims against UBS as early as February 2019.  Due to the coronavirus, FINRA arbitrations were conducted by videoconference for most of 2020 and 2021 (read more about FINRA Arbitrations During the Covid-19 Pandemic here).  As a result, several YES investors had their arbitration hearings held remotely.  Holding a remote hearing presents a variety of challenges and hurdles for investors.  Three of the most significant difficulties for a claimant to overcome in a remote hearing are gaining credibility with the arbitrators, earning sympathy, and conducting an effective cross examination of respondent witnesses.

Credibility is based on the competence of the witness and determines whether their testimony is worthy of belief.  In many cases, once the panel decides which witnesses are credible and which are not, the question of right and wrong is easily reached.  Panels determine credibility, in part, by observing and examining how witnesses and attorneys react to a lawyer’s questioning.  When a hearing is conducted through a two-dimensional platform, like videoconferencing, the ability to effectively and fully observe witness and attorney reactions is lost.

Although some registered representatives and financial firms downplay the risks involved with options trading, in reality, options trading can be an aggressive strategy that may entail high risks.  Because of the risks associated with option trading, it is generally only suitable for investors with a high net worth, experience, and an appetite for risk.  Brokers, financial advisors, and financial firms sometimes ignore a customer’s tolerance for risk and improperly approve options trading in the customer’s account.  Unfortunately, this can lead to tremendous losses in their accounts.  RIK recently filed several multi-million-dollar cases on behalf of investors to recover for losses relating to improper options trading.

Options are contracts that grant an investor the right, but not obligation, to buy or sell an underlying asset at a set price on or before a specific date.  Options trading has become popular amongst investors in recent years.  To be successful, options trading requires research, discipline, and constant market monitoring.  This type of trading involves high risk and requires special approval from the financial firm.

From the outset, options trading often comes with excessive fees which incentivizes brokers and advisors to recommend options trading to their clients regardless of the clients’ investment objectives and willingness to take on risk.  In doing so, the broker or advisor sometimes downplays the risks associated with an options trading strategy by claiming that the only potential downside is the initial cost of the contract or that the advisor can hedge the position.  Both notions can be misleading.  First, the investor pays a premium for options in addition to paying high commission fees.  This means the investor is at a loss the moment an option is purchased.  Secondly, hedging options is highly dependent on market conditions and is an extremely risky strategy in the current volatile market.

In recent years, options trading has become more popular with investors.  Because of the high risks associated with options trading, FINRA imposes specific rules and guidelines relating to trading options and which accounts can be approved for options trading.  For example, firms are required to have an options principal oversee option trading in accounts.  Moreover, in April 2021, FINRA sent a notice to members reminding them that, “[r]egardless of whether the account is self-directed or options are being recommended, members must perform due diligence on the customer and collect information about the customer to support a determination that options trading is appropriate for the customer.”  See FINRA, Notice to Members 21-15 (2021).

FINRA’s recent investigations and sanctions against financial institutions, brokers, and advisors for options-related violations demonstrate how serious rules relating to options approval and option trading are.  For example, last month FINRA imposed its largest financial penalty ever against Robinhood Financial LLC, in part, for failing to exercise due diligence before approving investors for options trading in self-directed accounts.  Below are other recent examples of options-related sanctions FINRA imposed on firms and individuals:

  • Cambridge Research, Inc. was censured, fined $400,000, and ordered to pay over $3,000,000 in restitutions for improper conduct relating to the firms “risky strategies” that relied on purchasing uncovered options – options where the seller does not hold the underlying stock and is required to have an option margin to show the ability to purchase the stock when needed (FINRA Case No. 2018056443801);

Wall Street’s fastest growing trend is investing in Special Purpose Acquisitions Companies (“SPACs”).  SPACs are a way for private companies to go public without having to go through the traditional IPO process.  SPACs have been around for decades but have recently gained popularity in companies seeking to go public in this period of high market volatility.  Historically, SPACs were viewed as extremely risky investments.  The recent rise in SPACs does not change the high risks associated with them.  Some brokers and financial advisors ignore these risks and recommend customers invest in SPACs regardless of the customer’s investment profile and appetite for risk.  RIK’s investment fraud lawyers have extensive experience handling these types of cases and recovering losses for customers.

SPACs, also known as blank check companies, are companies created and publicly traded for the sole purpose of buying or merging with a private company in the future, known as the target company.  SPACs disclose criteria about the what kind of target company or companies it seeks.  Despite these disclosures, which are usually very limited and loosely defined, investors of the SPAC have no idea what the eventual acquisition company will be.  In other words, investors are going in blind.

In using SPACs to go public, private companies forego the process of registering an IPO with the SEC, meaning there is less oversight from the SEC.  The SPAC process also permits private companies to go public in a substantially shorter time period than a conventional IPO.  As one might suspect, the due diligence of the SPAC process is not as rigorous as a traditional IPO and no one is looking out for the best interests of investors.  Even worse, SPAC managers are not incentivized to obtain the best possible deal for investors – their job is to get a merger deal, not get the best deal.  Not surprisingly, this can lead to substantial harm to investors.  For example, the SPAC company may be overpaying for the target company – meaning investors are losing on the deal.

Yes, many investors have filed claims to recover losses sustained as a result of their investments in NYC REIT, a real estate investment trust that purports to own “a portfolio of high-quality” commercial real estate located within the five boroughs of New York City.  This REIT began as a non-traded REIT, meaning it was not traded on an open exchange, making it is highly illiquid.  Not only was it difficult for investors to get out of their positions, share prices have dropped substantially since its initial private stock offering.  Investors were led to believe returns on the investment would exceed 10% on an annualized basis, but in reality, NYC REIT turned out atrocious for investors.  The securities lawyers at Rich, Intelisano & Katz (RIK) have been highly successful in recovering losses for investors who had positions in non-traded REIT investments.

NYC REIT is not a high-quality investment with annual returns exceeding 10%.  On the contrary, this REIT, like all REITs, is high risk and only suitable for a limited pool of investors – savvy investors who are wealthy and sophisticated with a long-term investment horizon.  First, NYC REIT is a non-traded REIT, which means it is significantly less liquid than REITs that trade on an open exchange.  As such, when investors want to sell their position, they are forced to sell their shares at a heavily discounted price.  Thus, non-traded REITs are rarely a suitable investment for most investors.  Second, NYC REIT owns only 8 mixed-use office and retail condominium buildings (which is miniscule compared to other REITS).  The limited portfolio creates an inherent high risk, such as limited diversification, less exposure to potential tenants, and the lack of ability to spread costs over a larger portfolio.  Unfortunately, NYC REIT severely underperformed and the risk associated with it became realized for many investors.

The NYC REIT was disastrous from the beginning.  The initial private stock offering price of the REIT was $25 per share.  By 2018, the price per share plummeted over 50%.  The board then decided to suspend future distributions – hurting investor cash flow.  Then, the board authorized a reverse stock split, an action that consolidates the number of existing shares of stock into fewer, proportionally more valuable shares (generally, a move to boost the company’s image if the stock price has dropped dramatically).  Then, when the REIT went public in August 2020, it was a complete failure.  NYC REIT, now trading on the New York Stock Exchange (“NYSE”) under the symbol “NYC,” dropped in value approximately 40% on the first day.  This abrupt decrease in share price left investors with significant losses.

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.

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

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.

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