FINRA Dispute Resolution Statistics

I'm sharing a few observations on FINRA's dispute resolution statistics (through October, 2015), which are worth a look here: 

• 80% of cases mediated through FINRA in recent years are settled;
• 15% fewer customer cases were filed in 2015 as compared to 2014;
• the average time to hearing is 17.6 months, but about half that time in simplified decisions (for smaller cases);
• breach of fiduciary duty is the #1 type of controversy in each year form 2011-2015;
• municipal bond funds have been the #1 security in customer disputes (thanks in large part, no doubt to Puerto Rican bonds) in 2014-2015, but prior to that time municipal bond funds were nowhere close to the top of the list;
• a steady 18-19% of cases have been decided by hearing from 2011-2015;
• recent statistics (2015) show that customers win about half the time, but FINRA does not report more information that might shed light on why some customers win and others do not (such, as, whether the customer appeared with or without an attorney -- presumably the win rate is much lower for customers representing themselves).

New Hampshire Adopts Uniform Securities Act - Effective January 1, 2016

On July 27, 2014 New Hampshire’s Governor signed into law a new Uniform Securities Act. The new Act repeals and replaces New Hampshire’s current Uniform Securities Act which is based on the 1956 model securities act. The new Act is based on the Uniform Securities Act of 2002, drafted by the Uniform Law Commission of the American Bar Association, which is a model statute designed to guide each state in drafting its state securities law.

The new Act goes into effect on January 1, 2016 and is intended to simplify and facilitate capital-raising by small-and medium-sized companies, better align securities offering rules with regulatory interests, update and clarify securities compliance requirements, and preserve and enhance investor protections. It is also expected to eliminate any disincentives for companies to operate in New Hampshire and bring consistency between New Hampshire securities law and the securities law of many other states.

A link to the new Securities Act is here.

FINRA Proposes Update to Temper Expungement and Elder Abuse

FINRA’s Board of Governors recently voted to move ahead with two key initiatives for broker-dealers. One initiative would amend codes of arbitration to make it tougher for brokers to erase black marks from their public record. The proposal, which will be submitted to the SEC for approval, would incorporate existing guidance and best practices into the rules. The guidance reminds arbitrators that expungement is “an extraordinary remedy that should be recommended only under appropriate circumstances” and that “customer dispute information should be expunged only when it has no meaningful investor protection or regulatory value.” Ultimately, FINRA is trying to strike the right balance between transparency and eliminating information in a report about a broker that is either unfair or false.

The other initiative is meant to enhance protection for senior investors. The rule would require firms to obtain the name and contact information of a trusted person for the customer's account and allow firms to freeze funds in accounts of investors 65 and older when there is “reasonable belief” of financial exploitation. The proposal does not indicate precisely what constitutes a “reasonable belief” of exploitation.

Non-Traded Real Estate Investment Trusts (REITS): Danger for Retail Investors!

Are some investments so risky that they are virtually always unsuitable -- they should never be recommended -- to typical retail investors, regardless of risk tolerance?   Yes.  The purpose of this post is not to generate a list, but to focus on one particular investment that seems to fall into this category: non-traded real estate investment trusts (REITS).

According to a recent article, Fiduciary Duty and Non-Traded REITS by Craig McCann, non-traded REITS performed about as well over the past 25 years as "investing in short and intermediate term U.S. Treasury securities"  but, unlike U.S. Treasury securities non-traded REITS are illiquid and much more risky.  Not only that, non-traded REITS underperformed their traded REIT cousins.  McCann writes, "Investors in the 41 non-traded REITs that became traded REITS or were cashed out suffered $24.25 billion in underperformance."  "Non-traded REITS underperform traded REITS by approximately 6.8 percent annually."

What else is of concern about non-traded REITS? Investors pay a substantial up front fee, averaging 13.2%  This compares with mutual funds, which charge fees topping out at about 5%. 

McCann found that institutional investors tend to stay away from non-traded REITS.  He writes, "institutional investors almost never own material stakes in non-traded REITS." For retail (and institutional) investors interested in real estate there are ready alternatives, including a wide variety of mutual funds.

Non-traded REITS face the triple-whammy of being illiquid, expensive and performing poorly.  According to McCann, "Brokers and investment advisors may have a good-faith basis for recommending that a client make a focused real estate investment, but they cannot justify a recommendation to purchase a non-traded REIT."

Tips from the Guide for Legal Professionals: Elder Investment Fraud & Financial Exploitation

I offer helpful information from the "Pocket Guide for Legal Professionals, Elder Investment Fraud & Financial Exploitation" published and distributed by the Maine Office of Securities.

Asking About Financial Capacity -- Conservation Starters:

• Do you feel confident making financial decisions on your own?
• Who manages y our money day to day?  How is that going?
• Are you having any trouble paying your bills?
• Is anyone pressuring you to give them money?
• Do you receive a lot of solicitations by phone or mail?

Red Flags for Financial Exploitation:

• Senior moves away from existing relations and toward new associations with other "friends" or strangers
• Sudden appearance of previously uninvolved relatives claiming their rights to senior's affairs and possessions
• Abrupt changes to financial documents, such as POA, account beneficiaries, wills and trusts, or deeds
• Senior is accompanied by an overly protective caregiver who dominates the client
• Changes in the senior's behavior; suspicious, fearful, emotionally labile, or secretive
• Senior displays unexplained or unusual excitement over a financial windfall or prize check; may be reluctant to discuss details
• Noticeable neglect or decline in appearance or hygiene or the senior's basic needs are not being met

Vulnerability/ Risk Factors:

• Social isolation
• Bereavement
• Dependence on another to provide care
• Financial responsibility for an adult child or spouse
• Alcohol or drug abuse
• Depression or mental illness

SEC Issues Risk Alert Regarding Suitability of Structured Products in Retailed Sales

The SEC’s Office of Compliance Inspections and Examinations (“OCIE”) recently issued a “Risk Alert” highlighting deficiencies in broker-dealer supervision and compliance controls over retail Structured Securities Products (“SSP”) sales. SSPs are securities, often issued as corporate obligations of an affiliate of an underwriting broker-dealer. They derive their value from, and provide exposure to, a variety of underlying asset classes such as a single security, baskets of securities, indices, options, commodities, and/or foreign currencies. SSPs, which may or may not be listed on an exchange, typically have some form of embedded derivatives and may supply, among other things, principal protection, interest payments, or leveraged exposure to the referenced assets.

The Alert references deficiencies in the areas of suitability and supervision. In particular, OCIE found that all of the various examined firms failed to maintain or enforce adequate controls relating to determining the suitability of SSP recommendations and failed to conduct compliance and supervisory reviews of determinations by registered representatives of customer suitability in the SSPs, as required by internal controls.

Ultimately, the Alert offers some pointers for compliance by broker-dealers. It notes that broker-dealers should use the Alert as a chance to double-check supervisory and compliance procedures for general suitability criteria and especially for complex or structured products sold to retail customers. It also suggests that broker-dealers perform random internal audits to ensure compliance with its own rules.

FINRA Arbitration and Confidentiality: the Exception Not the Rule

Arbitration is typically "private" in the sense that there is no First Amendment right of the public to access to arbitration hearings or arbitration documents, but that doesn't mean that arbitration is strictly confidential either.  Just the opposite, confidentiality in arbitration is the exception not the rule, according to guidance available from FINRA here.

While arbitrators and FINRA staff have an obligation to "respect the privacy of the parties before whom they serve" and not to "personally disclose the details of arbitration proceedings" -- much the same obligation applicable to Judges and clerk's offices in civil litigation in court -- the parties themselves "are generally free to disclose details of their own proceeding as they see fit."  Arbitrators should rarely, if ever, grant orders requiring that everything pertaining to a dispute be kept confidential by the parties to the dispute.  So-called "blanket orders of confidentiality" may be entered only upon a showing of truly exceptional circumstances.

Although discovery in arbitration is often conducted according under agreed-to confidentiality orders, the parties may not always agree on what documents or information deserves to be treated as confidential.  When the arbitrators are called upon to decide whether particular information should be treated as confidential, they must engage in "a serious and case-by-case consideration of the issues."

Why? Unnecessary secrecy is burdensome and contrary to important public interests.  According to FINRA, "A ruling that documents are confidential may impose burdens and limitations on the receiving party, such as requiring special handling or limiting the ability of the party to discuss the documents with witnesses and others who may assist in developing the case. Likewise, such a ruling may keep regulatory officials from learning of conduct in violations of statutes and rules."

What factors should be considered?  According to FINRA, in considering questions about confidentiality, the arbitrator should consider such factors as:

1. Is the information so personal that disclosure would constitute an unwarranted invasion of personal privacy (e.g., an individual's social security number, tax return, or medical information)?
2. Is there a real threat of injury attendant to disclosure of the information?
3. Is the information proprietary containing confidential business plans and procedures or a trade secret?
4. Are there essential competing interests at stake that require confidential treatment of certain portions of the proceedings?
5. Is the information already public (e.g., has it previously been published or produced without confidentiality) or is it already in the public domain?
6. Would an excessively broad confidentiality order be against the public interest in disclosure? Keep in mind that securities arbitration is highly regulated by the Securities and Exchange Commission. The former SEC Director of Enforcement, William R. McLucas, has stated: "[P]rivate [securities] actions will continue to be essential to the maintenance of proper investor protection."
7. Are there first amendment or other issues which might be raised by excessive restrictions on the ability of parties to comment freely upon matters in which they are involved?
8. Would an unduly extensive confidentiality order impair the ability of counsel to represent other clients?

"Arbitrators should not routinely designate all discovery as confidential. Where confidentiality is appropriate, bear in mind that it should generally be accomplished in the least restrictive manner."

CFPB and SEC Jointly Issue a Consumer Advisory and Investor Bulletin on Diminished Capacity

The Consumer Financial Protection Bureau’s Office for Older Americans and the Securities and Exchange Commission’s Office of Investor Education recently issued a bulletin to help investors and consumers understand the potential impact of diminished capacity on their ability to make financial decisions and to encourage investors and consumers to plan for possible diminished financial capacity well before it happens.

The advisory bulletin makes the following recommendations to help avoid or minimize problems: (1) organize your important documents (this includes bank and brokerage statements and account information, mortgage and credit information, insurance policies, pension and other retirement benefit summaries, Social Security payment information and contact information for financial and medical professionals); (2) provide your financial professionals with trusted emergency contacts; (3) consider creating a durable financial power of attorney; (4) think about involving a trusted relative, friend, or professional; (5) keep things up to date; and (6) speak up if something goes wrong (i.e. if you ever think someone is taking advantage of you, or that you’ve been the victim of a fraud)

With regard to helping others who may have diminished capacity, the CFPB and SEC make the following recommendations: (1) have an open conversation about investments and other financial matters sooner rather than later; (2) help your relative or friend with managing finances; (3) if your family member or friend has named you to manage money or property, understand your responsibilities and how you can protect your loved one from financial exploitation. 

Finally, if you are someone who has been asked by a loved one or friend to help out with his or her finances, the CFBP and SEC notes you can do the following to help: (1) help with ongoing financial responsibilities (you may need to take on immediate tasks, such as helping to pay bills, arranging for benefit claims, preparing tax returns, or helping with investment decisions); (2) review their investment portfolio; (3) assess the riskiness of their investment portfolio; (4) contact their investment professional.

How Do I Find a Lawyer for a Securities Litigation or Arbitration?

According to the Financial Industry Regulatory Authority (FINRA), "You should consider hiring an attorney to represent you during the arbitration or mediation proceedings to provide direction and advice. Even if you do not choose to hire an attorney, brokerage firms are generally represented by an attorney. If you cannot afford an attorney, some law schools provide legal representation through securities arbitration clinics."

I agree.  At the very least "consider" hiring a lawyer if you have a securities or brokerage firm, insurance, or similar dispute!

How do you find a suitable lawyer?  For customers and brokerage firm employees, a great place to start is the Public Investors Arbitration Bar Association (PIABA).  PIABA's website includes a "FIND AN ATTORNEY" search tool that allows searches by state or zip code. 

Other options, suggested by FINRA on its website include:

• Consult with your lawyer, if you have one, about your options and whether you need a lawyer who specializes in securities arbitration or litigation.
• Call several bar associations to obtain a varied listing of lawyers in your area. Many lawyers will offer to consult with you initially for free or for a minimal fee.
• Broaden your list of potential securities lawyers by consulting directories of attorneys. The Martindale-Hubbell^® Law Directory can be found at many libraries or at at its website. It lists lawyers by state and jurisdictions. Some state and local bar associations also compile directories and may list attorneys according to specialty.

Other selective law directories include Chambers USA, Super Lawyers, Best Lawyers, and Avvo.  Attorneys are listed by location and practice area.

For customers with small claims and who are unable to afford a lawyer a number of law schools host securities law clinics.  Many of the law school clinics will only accept claims demanding less than $100,000 for claimants with a household income below $100,000, or where the customer has been unable to find counsel.  It never hurts to ask, however, since clinics offer pro bono (free) representation -- customers who may qualify and have a claim should consider representation through a clinic.  FINRA lists all the law school clinics here.

Obama Administration Proposes Rules to Tighten Broker Standards for Retirement

One source notes that the Department of Labor is moving full steam ahead with a proposed fiduciary standard for anyone giving retirement investment advice. As the Wall Street Journal notes, at present, brokers’ recommendations only have to be “suitable.”

The proposed rule would require financial advisers dealing with retirement savings to do so in their clients' best interests and disclose any potential conflicts of interest. It also calls for several prohibited transaction exemptions that would allow retirement advisers and service providers to continue arrangements like revenue sharing and fees.

The rules come as individuals have become increasingly responsible for their own retirement security as traditional pensions have mostly disappeared in favor of IRAs and 401(k)s. Such products either didn’t exist or were brand new when the department wrote its rules for retirement advice 40 years ago but now contain about $11 trillion in assets.

Labor Secretary Tom Perez notes that the rule is “intended to provide guardrails but not straitjackets, so we know consumers are getting advice that is in their best interest.

The DOL sent its proposed rule to the Office of Management and Budget for regulatory review on Feb. 23, which typically can take up to 90 days. The proposed rule is now being released for a 75-day public comment period, followed by a public hearing and further public commentary.

 

 

Former Old Town, Maine Mill Owner Faces SEC Fraud Charges

As the Bangor Daily News and other media outlets reported recently, Lynn Tilton -- the force of nature behind a brief ray of hope for Maine's Old Town paper mill -- is now facing Securities Exchange Commission fraud charges.   Tilton's firm had tried but failed to breath new life into the Old Town mill and, ultimately, sold the facility as reported here.

The SEC's press release says, "The Securities and Exchange Commission today announced fraud charges against an investment adviser and her New York-based firms accused of hiding the poor performance of loan assets in three collateralized loan obligation (CLO) funds they manage." 

Tilton has responded, as Reuters reports, by suing the SEC over alleged constitutional defects in that agency's administrative justice system.

White House: "conflicted advice leads to large and economically meaningful costs for Americans’ retirement savings."

In a report issued in February 2015 the White House concluded that conflicted investment advice harms investors to the tune of billions of dollars.  The White House estimates losses at between $8 billion and $17 billion or between 1 percent and 0.5 percent of the $1.7 trillion dollars of IRA assets under management.


The report suggests that mandated disclosures are not a solution. They may actually backfire by providing a false sense that advice is unbiased.  Disclosures are not read by investors.  They are often are not understood.  They are in fine print or in legalese and may not be understood.   


The report also suggests that the American public receives much less protection against conflicts of interest than our neighbors in Canada, Europe, and India.


This report supports a push by the White House, as widely reported, to have the Department of Labor move forward with rules that will impose a fiduciary standard on all stock brokers handling retirement accounts.  

Maine Securities Regulator Testifies Before U.S. Senate Committee on Aging; Touts Success of Maine Program to Combat Senior Financial Exploitation

As the North American Securities Administrators Association (NASAA) reports, on February 4, 2015 Maine Securities Administrator Judith Shaw testified before the U.S. Special Committee on Aging. Shaw emphasized the difficulty in addressing senior financial exploitation, noting that many elderly individuals are vulnerable, socially isolated and distant from family and other supportive networks. According to Shaw, financial exploitation is one of the most serious issues facing seniors.

Of note, Shaw discussed the approach Maine is taking to address this growing issue. In particular, Shaw noted the success of Maine’s “Senior$afe” program (a partnership between the Maine Department of Health and Human Services’ Office of Aging and Disability Services, the Maine Department of Professional and Financial Regulation, the Maine Bankers Association, the Maine Credit Union League, Maine’s Legal Services for the Elderly, and Maine’s five Area Agencies on Aging). The “Senior$afe” program is a training and outreach effort intended to increase identification and reporting of elder financial exploitation by financial institutions. It provides training for tellers, other front-line staff and managers on the red flags of elder abuse and financial exploitation.

According to Shaw, over 200 bank and credit union employees in Maine have received Senior$afe training. The program has been so successful that Senior$afe program materials have been shared with NASAA for revision and co-branding so that it can be made available to NASAA members in the United States, Canada and Mexico. According to one source, Shaw “strongly believe[s]” the program could be a model for other states.

According to U.S. Senator Susan Collins, “Maine is on the cutting edge of helping to combat financial abuse of seniors though programs like the innovative Senior$afe program, which is the first of its kind in the nation.”

Shaw’s testimony can be viewed by video by clicking here.

Arbitration versus Litigation: Factors to Consider

 ARBITRATION v. LITIGATION: Pros & Cons
How do they compare?   What factors might you consider if you have a choice whether to go to U.S. state or federal court or pursue arbitration? 

	Litigation	Arbitration
Cost	High.  Litigation is the most expensive dispute resolution process as a result of extensive pre-trial discovery, motion practice, and formal process.	Moderate.  Arbitration is generally less expensive than litigation, although unlike litigation, the arbitrator’s fees are paid by the parties (Judges are paid by taxpayers).
Discovery	Expansive. Ability to uncover vast amounts of information.	Limited.  Most arbitration rules favor limited discovery, so opportunities for depositions and subpoenas to third-parties are limited.
Dispositive Motions	Allowed.  Courts often dismiss claims prior to trial.	Limited.  Many arbitration rules limit or disfavor dispositive motions.
Speed	Slow.  Timing of resolution based on court’s schedule, cases may be set for hearing on short notice.	Faster.  Arbitration is usually faster, and a date certain for hearing is standard; greater  scheduling flexibility.
Predictability	Unpredictable.  Juries can be unpredictable.   The parties cannot select the judge and have limited ability to select the jury.	More predictable. Arbitrator is agreed upon by both parties and can be an expert in the subject matter.
Appeal Rights	Yes.  Full rights of appeal. Decisions by judges are explained.	Very limited.  Arbitration awards are subject to appeal only on very narrow grounds.  Decisions may not be explained, making it even more difficult to appeal.
Evidence	Formal.  Rules of evidence apply.	Informal.  Rules of evidence do not apply.  Evidence can be introduced in arbitration that would be prohibited by a court.
Privacy	Public.  The Courts are public; information obtained through litigation is often public too.	Private.  Information disclosed and outcome can be confidential if agreed upon by both parties.
Forum Selection	Limited.  Limited by the events giving rise to the dispute and where the parties are located.	Flexible.  Parties can select where to hold the arbitration regardless of where they live or where the events giving rise to the action took place.

Largest One-Time Settlement in Maine History Involving Alleged Unfair Credit Rating Practices

The Maine Attorney General announced earlier this week that its $21.5 million share of the multi-state settlement with Standard & Poor's over credit rating practices is the "largest ever one-time settlement in Maine history."  The settlement received substantial press attention nationwide following Attorney General Eric Holder's press conference and in Maine following the Attorney General Janet Mills' February 4 press conference at the Kennebec County Courthouse.

According to the Maine Attorney General's press release, "Attorney General Mills said her office has aggressively litigated and negotiated the case for two years. Initially S&P removed the case from Kennebec County to federal court in Maine. The case was then consolidated with cases in other states and transferred to the United States District Court for the Southern District of New York. The Attorneys General then litigated the case in New York for eight months until the federal court remanded Maine’s lawsuit back to Kennebec County, where S&P then tried unsuccessfully to have the case dismissed on jurisdictional grounds."

Attorney General Mills singled out Assistant Attorney General Linda Conti, head of the Consumer Protection Division, for praise.  AAG Conti "traveled to New York City a number of times and . . . spent hundreds of hours litigating the case in state and federal courts on behalf of the State of Maine."

Crowdfunding -- Less Useful and More Risky?

It's great that Maine and about fifteen other States are making it easier for startups to raise money by authorizing crowdfunding -- a money-raising strategy that may be a way of assisting small businesses and start-ups looking for investment capital to get their ventures off the ground. 

Crowdfunding is an option for some entrepreneurs .  But there are plenty of ifs, ands, and buts that go along with crowdfunding.  What about complying with federal law?  Required.  Complying with the law of any other state in which investors reside?  Required.  Substantial legal oversight and advice and financial reporting capabilities?  Required. 

What about investors?  Investors should be extremely cautious about crowdfunding.  The companies involved may be new and inexperienced, information about the investment may be limited, regulatory oversight may be limited, the investments may not be liquid (it may be impossible or very difficult to cash-out), and the risk of loosing money may be off the charts.

Information from the Maine Office of Securities can be found here.

As reported in recent press, entrepreneurs can now lawfully raise capital by crowdfunding in several states.  But the utility of this tool for most entrepreneurs is limited and, as is the case with many other forms of private offerings,  the risk to investors can be substantial.

Less Secrecy, More Transparency in Securities Arbitration!

Every now and then federal regulators exercise their authority to oversee securities arbitration practices and procedures, but does the public have access to reports, examinations, and other documents related to that oversight?  No. 


The federal court of appeals in the District of Columbia determined that four examinations by federal regulators (the Securities and Exchange Commission) and other records concerning securities arbitration are secret.  In an opinion issued in November of law year, Public Investors Arbitration Bar Association v. Securities & Exchange Commission, 771 F.3d 1 (D.C.Cir. 2014) the court reached this conclusion even though the records are not core “financial” data that federal secrecy laws originally were meant to protect.

One of the three Judges on the federal court of appeals wrote separately to urge Congress to change federal law to enhance transparency.  Circuit Judge Janice Rogers Brown  wrote, “Congress should revisit this ill-conceived amendment and make sure an apparent miscue does not morph into a serious misadventure.”

She explained, “The financial world has changed since the genesis of our . . . case law. So has the world in which our financial system operates. Financial institutions and their regulators now frequently operate under a haze of public distrust fueled by repeated regulatory failures and massive, opaque, and unaccountable bailouts. The public now has good reason to doubt the rigor of our financial systems’ reliability and oversight.”

“The ramifications of . . . all-encompassing secrecy therefore reach far beyond [investors'] (legitimate) concern for the adequacy and fairness of FINRA’s regime of arbitration. It bodes ill for rebuilding civic trust that [federal law] could be employed to permanently shroud both the possible reckless conduct by regulated financial institutions and the particulars of sweeping agency intrusions into the sphere of the financial marketplace.”

Judge Brown cautioned that secrecy in the interest of “vague principles of regulatory cooperation” between regulated entities and their regulators ought not “inevitably trump the public’s interest in transparency.”


Amen.

Beware of Misleading Financial Advisor Credentials

What is an investor to make of the alphabet soup list of privately run credentialing organizations issuing credentials to financial advisors?  One of the most reputable ones, the Certified Financial Planner (CFP) Board, cautions that "accredited," "chartered," "registered" and similar designations often should be taken with a grain of salt. Investors may use a FINRA tool to look up designations to see what it actually takes to earn the designation.

The CFP Board writes, "A financial advisor hands you his business card with all sorts of letters after his name.  You ask him what they mean, and when you hear the words "Accredited" or "Chartered" or "Registered," you assume you are in the right hands.  After all, don't those terms mean that the advisor is regulated, just like a doctor or attorney."

Actually, no.  Many of these designations are mere marketing tools, with little or no education needed, no disciplinary process to police membership, and no rigorous or enforceable standards of ethics or practice.  The punch line, according to the CFP Board, "LOOK BEYOND THE LETTERS."

The American Association for the Advancement of Retired Persons (AARP) has made much the same point -- drawing on a report to Congress by the Consumer Financial Protection Bureau.  "[S]ome of these designations don't require ... rigorous training or expertise, or even the ethics to put investors' interests first, that they imply . . . ."

The take away, according to the Consumer Financial Protection Bureau is that "[m]ost financial advisers are well trained, reputable professionals. But credentials alone don’t guarantee expertise or the quality of someone’s training."  Even worse some credentials confuse and mislead investors, particularly vulnerable investors who may be more trusting.   And vulnerable investors are "too often targeted by financial services professionals with senior designations who are selling products that may not be appropriate."

Many states have banned the use senior designations that misleadingly imply expertise in senior investor issues, including  Maine, which adopted a regulation Chapter 512 of the Rules issued by the Office of Securities prohibiting such designations.

Investors Should be Wary of "Happiness Letters"

As the Wall Street Journal's Jason Zweig recently cautioned, "If you get a 'happiness letter' from your brokerage firm . . . be worried." 

What is a happiness letter?  A letter from a broker-dealer intended to elicit an acknowledgement from an investor that all is well with account activity and related transactions.  Also called "CYA" letters these letters are a risk-mitigation tactic employed by the industry to inoculate themselves against legal claims by investors.   Of course, they are also an opportunity for investors to take stock of their account positions and raise their hands if things are out of order.  And it is not unreasonable for broker-dealers to want investors to tell them if something is amiss earlier rather than later.

What should you do if you receive such a letter?  The following makes sense for starters:

• Read It:  "If you're one of those people who immediately throws away notices from your brokerage firm, you might want to think twice around this time of year." 
• Review Your Account Statements: "If you receive such a letter, immediately search your account for signs of activity that seems inappropriate or not in keeping with your instructions to your broker."
• Do Not Sign:  "Never sign and return a happiness letter. Nor should you speak to your broker about it. "
• Get More Information. "Call the compliance officer or branch manager who sent the letter and politely insist on seeing the internal data that prompted it. Don’t discuss anything else or answer any questions seeking to establish how satisfied you are with your account’s performance."
• Get a Second Opinion.  "Then bring the happiness letter, your account statements and the internal data (if you can get it) to someone who can give you an objective second opinion: an accountant, a registered investment adviser, a securities attorney, even a trusted family member or friend."

There is nothing in applicable rules or regulations giving such letters legal effect and they in fact do not have any binding legal effect -- and certainly do not absolve broker-dealers of applicable requirements, including suitability.  But investors who ignore such letters and complain later about  will have a bit of explaining to do, just as investors who jump on any disclosures contained in such letters will be in good position to get their account in order and pursue appropriate remedies.

Private Placements: Retail Broker-Dealers Shape Terms of Placements to Sell More of Them

A recent Reuters special report shines light on an "increasingly common" practice among broker-dealers of changing -- and shaping -- the terms of private placements they sell.  The report highlights several points:

• Broker-dealers have an incentive to sell private placements because they generate higher commissions as compared, for example, to even the most expensive mutual funds.  Investors are drawn to private placements because of the promise of higher returns without necessarily appreciating the substantial additional risk involved in private placements.
• Private placements are relatively lightly regulated -- disclosures are often less robust and less comprehensive.
• Brokers are working with issuers of private placements to "change the structure" of the deals to sell more private placements.  This is not illegal and may provide useful feedback to the issuer looking to understand what investors want.  
• A material change in the terms of private placements may impact the risk profile of the investment, such as, for example a change in interest rates or shortening the term of the investment. 

The involvement of brokers in shaping the terms of the investment raises questions about conflicts of interest (who is looking out for whom) and concerns about the independence and objectivity of the broker's due diligence process in vetting the private placement before offering securities to investors.