Securities Lawyer Blog

Remember February of 2008? It was a cold winter for investors holding Auction Rate Securities (ARS) when the auctions went into a deep freeze and never thawed.

The Securities Lawyer Blog has previously posted on the many issues with ARS and related auction failures. Now ARS have resurfaced as the Financial Industry Regulatory Authority (FINRA) announced two more settlements with major firms.

FINRA says it has completed ARS settlements amounting to fines of almost $5 million with 14 firms and that those firms have returned over $2 billion to impacted investors. The two recent settlements are with HSBC Securities (USA), fined $1.5 million and US Bancorp Investments, Inc. fined $275,000.

In the HSBC matter, FINRA revealed that the firm had returned over 90 percent to ARS investors. However, there were additional investors who had for various reasons not received the repurchase of their ARS holdings. The settlement includes a repurchase offer to those customers who did not previously receive a repurchase of their holdings.

In the US Bancorp Investments matter, the firm had previously repurchased customer ARS holdings.

Reiterating the failure of these firms "to adequately disclose the risks associated with auction rate securities," James S. Shorris, FINRA Executive Vice President and Executive Director of Enforcement stated that ... "FINRA's first priority has been to ensure investor access to the money frozen in their ARS investments. We are pleased that these firms have completed or agreed to complete offers to buy back frozen ARS from their customers."

FINRA found that each of these firms had engaged in the sale of ARS with representations to their customers that these were safe and liquid. In HSBC's case, FINRA found that marketing materials were not fair and balanced.

These securities were recommended as safe and liquid even after the credit crisis began and failure of the auctions became a possibility. FINRA found that one broker suggested that the firm email a warning to customers that the auctions could fail. The suggested email to customers was not permitted by management and retail brokers continued to recommend ARS.

The situation with US Bancorp also involved marketing materials (provided by other securities firms) that did not adequately disclose ARS risks, were not balanced and did not disclose material differences between money market securities and ARS while comparing the yields of the two types of securities. Additional problems included failure of due diligence prior to including ARS on the firm's approved products list.

As part of the settlement, both firms have agreed to participate in the FINRA-administered arbitration program that allows resolution of claims of consequential damages for those customers that suffered such damages when their ARS funds were not available to them.

Apparently, there are more investigations on ARS ongoing and future FINRA settlements are likely.

Related Web Resources

For more information on the special arbitration program for ARS, go to FINRA.

Continue reading "The Big Freeze Still Thawing as ARS Settlements Continue" »

Private placements have been a significant source of capital in recent years, but with these offerings have also come more investigations and enforcements. For example, last month the Securities Lawyer Blog posted on the Financial Industry Regulatory Authority's (FINRA) expulsion of Dallas broker-dealer Provident Asset Management for marketing allegedly fraudulent private placements.

FINRA has taken steps to help broker-dealers understand their obligations with regard to these offerings and has recently provided some guidance on avoiding problems with them.

According to FINRA's Regulatory Notice 10-22 and related news release, there is a "significant lack of regulatory compliance" which is evidenced by investigations and enforcements. Regulatory Notice 10-22 is intended to help firms comply with requirements and ensure proper investigation before recommending and selling private placements.

The Regulation D offerings are significant. Recently, the Securities and Exchange Commission estimated that these offerings were about $609 billion in 2008. FINRA says that's a large source of capital for small businesses in particular.

Specifically, Notice 10-22 seeks to ensure that when offering and recommending private placements under Regulation D of the Securities Act of 1933, broker-dealers perform a reasonable investigation of issuers and securities offered. It also emphasizes supervisory requirements for these offerings as well as suitability and risk for the investor and accuracy in sales materials for investors to make investment decisions.

As noted by FINRA's Chairman and CEO Rick Ketchum, " '[a]n increase in investor complaints regarding private placements, as well as SEC actions halting sales of certain private placement offerings, led FINRA to launch a nationwide initiative that involves active examinations and investigations of broker-dealers engaged in retail sales of private placement interests. That initiative has uncovered misconduct, including fraud and sales practice abuses ... FINRA is taking this opportunity to remind firms of their substantial duties when engaging in the sale of private placement offerings.' "

Related Web Resources

The SEC has a website devoted to educating investors on how to avoid fraudulent investments and such things as Ponzi schemes which can be found at investor.gov.

Continue reading "FINRA Issues New Notice -- $609 Billion in Private Placements Compels Guidance " »

Citigroup Global Markets, Inc. has the dubious distinction of being the subject of the first enforcement action by the Financial Industry Regulatory Authority (FINRA) involving a broker-dealer stock borrow program.

Citigroup was fined $650,000 for what FINRA alleged were issues with both disclosure and supervisory violations in its Direct Borrow Program or DBP. According to the investigation, which covered nearly a three-year period from early 2003 through late 2005, the Citigroup DBP borrowed securities that were then placed in a pool of securities. This was used to support the firm's client's short-selling strategies. The loans averaged $301 million a year and were borrowed from over 2,000 customers.

FINRA alleged that Citigroup did not supervise its DBP staff or establish procedures to do so. Moreover, brokers did not adequately monitor the accounts of customer involved in the DBP.

The allegations, which were neither admitted nor denied by the firm, center around what FINRA claimed to be failures to disclose or to adequately disclose material information to customers in the DBP. FINRA found that Citigroup did not inform customers of many critical facts that could impact this activity including such things as the fact that the firm could reduce interest rates, that the loans could be sold by customers, that brokers received commissions throughout the loan period, and that higher tax rates could apply to these dividends.

Other issues FINRA found in this case involved the branches and what they knew and did not know. For example, many branch managers and supervisors were not aware that Citigroup had a DBP or that brokers they were supervising had customers involved in it. Further, customer accounts that had securities in the DBP could not be monitored with tools generally used internally. These accounts could not be monitored to accurately reflect customer's positions or to monitor the ongoing appropriateness of the activity for specific customers.

As has been determined in other cases, the marketing materials regarding the DPB were found to be misleading regarding risk and other issues.

At the time of settlement all loaned shares had been returned to Citigroup customers who were involved in the DBP.

Continue reading "Sometimes It's Not Good to Be First -- Citigroup Fined $650,000" »

Late last year, the Securities Lawyer Blog posted on $600,000 in fines imposed by the Financial Industry Regulatory Authority (FINRA) on Scottrade, Inc. for what FINRA found to be an inadequate money-laundering program.

On April 1, 2010, FINRA announced that it has "fined Scottrade, Inc. $200,000 for violating pattern day trading margin rules and for extending credit to customers in violation of federal securities laws and banking regulations."

This time, FINRA found that the firm had permitted some margin account customers to trade even after their account values had fallen below the minimum equity required to continue. The problem centered around high volume traders whose minimum equity fell below the $25,000 required to continue trading. FINRA noted that the minimum is intended to limit risks that day-traders can present to both the market and to clearing firms as they leverage their positions throughout the day.

According to FINRA, the problem for Scottrade was that from February 2006 through October 2007, the firm failed to ensure that pattern day traders were restricted from trading when their account values fell below the required minimum. Rather, the firm provided those traders a written notice telling them to bring their account value to the $25,000 minimum prior to further trading.

Those pattern day traders who did not bring their account values up, were permitted to continue trading and received a second written warning from Scottrade. It was only after a failure to bring accounts up to the minimum that Scottrade restricted these traders from continuing to day trade. Over 11,000 day traders, trading nearly 172,000 day trades were allowed to continue trading in violation of the rules.

Pattern day traders are customers who day trade four or more times within five business days. These traders are required by FINRA rules to maintain at least $25,000 in their margin accounts.

Compounding this problem, Scottrade was also found by FINRA to have improperly extended credit to some cash account customers. These credit extensions were permitted to go beyond the time frame established under Federal Reserve Regulation T. Customers who did not have funds to cover stock purchases were sent a "sellout" letter when the funds were due. According to FINRA, this improperly permitted the customer to have additional days to pay for the transactions beyond the time frames allowed under Regulation T.

Related Web Resources

More information on margin accounts and Regulation T can be found on the SEC's website.

Continue reading "Not Another Fine Day for Scottrade -- $200,000 for Securities and Banking Issues." »