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.