Articles Posted in Securities Arbitration

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.

Annuities are insurance contracts that make routine payments to customers either immediately or at some point in the future.  This insurance contract allows investors to protect and grow their retirement savings while providing them with guaranteed income.  Some brokers and financial advisors recommend selling or exchanging annuities for “better” investment opportunities.  However, liquidating or exchanging an annuity comes with a high price– commissions, tax implications, and the loss of benefits associated with the original annuity.  For these reasons, liquidating or exchanging an annuity without very clear financial reasons may be  unsuitable for customers.  The securities fraud lawyers at Rich, Intelisano & Katz, LLP (RIK) have recovered millions for investors who suffered from annuity-related losses.

When investors sell or exchange their annuities, it comes with a heavy price.  First, when customers sell their annuity, they are subjected to costly fees and penalties.  For example, the customer may incur surrender charges and high cancellation fees.  Second, customers will lose all benefits associated with the annuity, such as legacy protection which is a death benefit to help provide a legacy for your loved ones.  Third, the customer forfeits expected benefits from the annuity– the customer will no longer have guaranteed income.  Fourth, taxes may become immediately due on the proceeds.  Lastly, there are often high commissions associated with the sale of annuities.

Regardless of the costs and losses associated with selling or exchanging annuities, brokers and financial advisors sometimes recommend such actions to customers in order to generate commissions for themselves.  Essentially, liquidating or exchanging annuities could potentially be a scheme for your broker or advisor to take money out of your savings and put it into their pocket.  What’s worse is that the broker or advisor will use your money from the sale of the annuity to purchase another annuity or other investment products further increasing commissions and fees.  Just like with any scheme to take advantage of customers, this is ill-suited and exceedingly improper.

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.

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

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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