Suitability

RIK Files $3 Million Claim Related to the UBS Yield Enhancement Strategy (“YES”)

September 29, 2020 | By Christopher Keogh

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.

Beware of Indirection at “Self Directed” Investment Firms

April 15, 2020 | By John G. Rich

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

Beware of Investment Advisor “Recommendations” from Securities Firms that Specialize in “Self Directed” Trading Accounts.

January 29, 2020 | By John G. Rich

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).

FINRA’s Regulatory Arm Announces Strengthening of Sanction Guidelines for Fraudulent Conduct by Brokers

May 22, 2015 | By Diane Mall Sammarco

In a move intended to emphasize that FINRA’s ultimate mandate is to protect investors, the SRO’s National Adjudicatory Council last week issued newly-revised Sanction Guidelines including tougher ranges of recommended punishments to be meted out against member firms or brokers who commit fraud or make unsuitable recommendations to customers.

Since 1993, FINRA has maintained and published “Sanction Guidelines” setting forth common securities rule violations and the range of disciplinary actions FINRA can issue for such violations, including monetary fines as well as suspensions, bars from the industry and other sanctions.

Specifically, the revised Guidelines, announced in Regulatory Notice 15-15 available on FINRA’s website at www.finra.org, contain revisions to the Sanctions relating to two specific areas: (i) fraud, misrepresentations or material omissions of fact; and (ii) suitability and the making of unsuitable recommendations to investing customers. According to the Notice, the ramped-up sanctions are meant to reinforce that fraudulent conduct is unacceptable, and that FINRA adjudicators on the Regulatory side should consider strong sanctions for such conduct, including barring or expelling repeat offenders, particularly where aggravating factors outweigh mitigating ones. With regard to unsuitability, the heightened punishments include an increase in the high-end range of suspensions from one year to two, as well as recommending bars, suspensions or expulsions for the most egregious recidivists.

Labor Department Proposes New Rule Imposing Fiduciary Duty on Brokers

April 15, 2015 | By Jessica A. Murzyn

In what has become a hot issue this Spring, the Labor Department yesterday proposed a new set of standards for brokers who offer advice in connection with 401(k)’s and other retirement accounts. Currently, brokers are required only to recommend products that are “suitable” for investors, which permits the sale of products that earn the broker high fees. Reuters reports that the new standards will require brokers to put their clients’ best interests first ahead of any personal financial gain. The Labor Department proposal will require “best interest” contracts between brokers and investors.

Rich Intelisano and Katz LLP represents investors in FINRA arbitrations and other litigations against broker-dealers and other financial firms.

Concern Mounts Over the Lack of a Rule Imposing a Fiduciary Duty on Brokers

April 10, 2015 | By Jessica A. Murzyn

I noted in my March 20 post that the Chair of the SEC had just come out in favor of a rule requiring brokers to act in their clients best interests. While investors wait for the SEC to move forward on the issue, the New York City Comptroller, Scott Stringer, is proposing that New York State require brokers to disclose the present state of their relationship to clients – “I am not a fiduciary” and “I am not required to act in your best interests, and am allowed to recommend investments that may earn higher fees for me or my firm, even if those investments may not have the best combination of fees, risks and expected returns for you.” The Wall Street Journal posited that New York’s adoption of such a requirement could spur other states to impose similar regulations.

A recent report by the Public Investors Arbitration Bar Association (“PIABA”) shows why Stringer’s proposal is critical. U.S. News describes the PIABA report which contrasted brokers’ advertising campaigns with the legal positions taken by those brokers in litigation against their clients. For example:

• Ad: “It’s time for a financial strategy that puts your needs and priorities front and center.”

SEC Chair Hints that the Commission Is Considering Rule on Fiduciary Duty for Brokers

March 20, 2015 | By Jessica A. Murzyn

Reuters reported that Mary Jo White, Chair of the U.S. Securities and Exchange Commission, came out in favor of creating of new rules to harmonize standards of care between investment advisers and brokers. Currently, investment advisers must act in a client’s best interest, while brokers may continue to sell products that primarily benefit their or their firm’s financial interests – so long as such products are “suitable” for the clients.

Wall Street has opposed efforts by the Department of Labor to craft rules governing such broker conduct and requiring them to put client’s interest first. White’s comments this week suggest that the SEC may be preparing to weigh in on the issue.

Rich Intelisano and Katz LLP represents investors in FINRA arbitrations and other proceedings against both investment advisers and brokers.

Master Limited Partnerships: Unsuitable for Some Investors?

March 3, 2015 | By Ross B. Intelisano

Are master limited partners unsuitable for some investors? The term master limited partnership sounds like a complicated legal transaction. In fact, master limited partnerships or MLPs are complex investments that have become hugely popular in the last few years in this low interest rate environment. MLPs are tax exempt publicly traded companies that often own infrastructure in the energy field (pipelines, tanks, etc.). Individual and small institutional investors having be loading up on MLPs because they pay a large percentage of their income out to shareholders as distributions. According to Morningstar, investors added almost $12 billion in 2014 into mutual and exchange-traded funds which invest in MLPs. That’s a huge amount of hard earned money looking for higher yields. The question is, do investors understand the real risks? We doubt it.

Brokers commonly market MLPs as low risk, higher yield securities. But that’s not the case. An MLP is a publicly traded limited partnership with two types of partners: the general partner (or GP) who is responsible for managing the MLP and is compensated for performance; and the limited partner (or LP) who is the investor who provides the capital to the MLP and receives periodic income distributions. Unlike most partnerships, shares of MLPs can be bought or sold on a stock exchange. Just like any partnership, the problem with being a limited partner is that an LP has no role in the management of MLP. That’s risk number one.

Risk number two is that most MLPs invest in the natural resources infrastructure. This is normally a risky space, especially with the swings on energy and commodity prices.

Securities Arbitration Award Against Merrill Lynch Upheld

February 19, 2015 | By Ross B. Intelisano

This week, the New Jersey Supreme Court denied the appeal of an arbitration award against Merrill Lynch by the Associated Humane Societies Inc. of Tinton Falls, N.J. In the original FINRA arbitration, the society alleged that certain of its investments were improper, it improperly sustained penalties and other charges when the investments were liquidated, its accounts were improperly managed and churned, and it was overcharged for management of its accounts. The society sought $10 million in punitive damages, $872,171 in compensatory damages and $544,299 in attorneys’ fees. After an 18-day hearing, the FINRA panel found in favor of the society, but awarded it only $168,103 in compensatory damages and $126,077 in punitives.

The society appealed. A 3-judge appellate division panel upheld the award in October, finding that the FINRA panel did not abuse its discretion. Associated Humane Societies, Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. L-4376-13 (Oct. 29, 2014). The New Jersey Supreme Court denied any further appeal on Feb. 17, 2015.

Though the society was ultimately disappointed with the size of the award, the decision shows the reluctance of courts to disturb FINRA arbitration awards.

Brokers Must Consider New Market Realities When Determining the Suitability of Asset Allocation for Young Investors

February 19, 2015 | By Ross B. Intelisano

Does the conventional wisdom regarding asset allocation hold up in today’s economy? The New York Times recently featured an article suggesting that a portfolio teeming with risky stocks, derivatives, and other exotic investments may, in fact, not be suitable for even young investors. The Times points out that these young investors experience higher rates of unemployment and are more likely to cash out their 401(k)’s and other investments when they switch jobs. An appropriate suitability analysis under FINRA Rule 2111 would take these factors into account. It is highly likely that many brokers are still using a one-size-fits-all asset allocation formula for their young customers.

Investors may have a variety of claims against such brokers who fail to take into account current market conditions, including unsuitable investment advice, fraudulent misrepresentations and omissions, and failure to supervise.