Maine Supreme Court Upholds Order Requiring Insurer to Pay Restitution and Civil Penalty Stemming From Deceptive Practices by its Agent

The pertinent facts are as follows. In 2007, a Bankers Life insurance agent met with a 75 year-old woman who had recently been treated for cancer to discuss issues related to Medicare, health and prescription insurance. These meetings resulted in the elderly woman purchasing three Bankers Life annuities. To purchase these annuities, the woman liquidated three certificates of deposit, sold General Electric stock and rolled over an IRA. The sales contained several irregularities: (1) a required summary of the woman’s financial situation failed to quantify many items, including debts; (2) the suitability of the IRA annuity rollover was questionable for several reasons (not the least of which was that the annuity would not mature until a time period after the woman’s life expectancy terminated); (3) mathematical considerations used to justify the recommendations were improperly compared, and omitted in part; (4) the timing of the stock sale was questionable given the substantial capital gains tax and the negative tax liability; and (5) the woman’s access to funds was diminished and delayed.

The Maine Superintendent of Insurance (which has oversight over insurance companies and agents that sell insurance and annuity products to the public) found the Bankers Life agent failed to evaluate the suitability of his recommendations, was incompetent, untrustworthy and financially irresponsible in his annuity sales, and made misleading comparisons between the woman’s existing investments and those offered by Bankers Life.  The Superintendent ordered Bankers Life to pay restitution and a $100,000 civil penalty stemming from these deceptive practices.

Bankers Life appealed to the Superior Court. The Superior Court affirmed the decision of the Superintendent. Bankers Life appealed to the Maine Supreme Court.

In Bankers Life and Casualty Company v Superintendent of Insurance, 2013 ME 17 (January 10, 2013), the Maine Supreme Court affirmed the Superintendent’s decision, finding the Superintendent did not abuse her discretion in imposing restitution and a civil penalty against Bankers Life.

The Bankers Life decision is significant in at least two respects. First, it seems that the Maine Bureau of Insurance has taken a keen interest in pursuing actions against insurers for unsuitable sales of annuities to the elderly. In all likelihood, this will be an ongoing trend, particularly given Maine's aging populations. Second, the decision highlights the challenge in overturning agency decisions. Under the applicable standard a court will reverse administrative fact findings by a state agency only if the decision "plainly compels a contrary result." That means that focus in defending such matters should be at the administrative level.

New York Times Shines Spotlight on “Mini-Madoffs”

by Michael S. Smith
On January 6, the New York Times ran a story on Philip Horn, a Wells Fargo financial adviser in the Los Angeles area who recently pleaded guilty to defrauding Wells Fargo and more than a dozen of his clients out of at least $732,000. 

Horn, described by clients as charismatic and outgoing, “a great guy and a straight shooter,” spent a good deal of his time at the upscale Braemar Country Club.  The club was a lucrative source of clients for Horn, as well as the scene of a tense, public confrontation with one of his defrauded investors.  It appears that Horn bilked numerous of his fellow club members out of sums rising into the six figures and perhaps beyond.

Though the Horn affair provides the article’s narrative hook, its true focus is on a much bigger issue: 

While Mr. Horn is a relatively minor player in the pantheon of financial fraud, his actions highlight the persistent problems with policing the industry, even after the wave of rules enacted since the collapse of Bernard L. Madoff’s giant Ponzi scheme in 2008 ... Every month, the Financial Industry Regulatory Authority, a Wall Street watchdog, penalizes more than 100 brokers for various actions, including unauthorized trading and fraudulent activities ….

Unfortunately, the Horn case and others like it show that financial fraud is alive and well in the post-Madoff era.  The SEC and other federal and state regulators have more than enough large-scale investigations to keep them busy.  As a result, relatively small-scale financial advisers like Horn who defraud their clients are often able to slip under the enforcement authorities’ radar for years.  

For more information, contact Preti Flaherty Attorney Michael S. Smith or visit Preti's Financial Services Practice Group page to learn more.

Massachusetts Quick to Crack Down on Crowdfunding

Crowdfunding, which allows smaller private companies to sell directly to investors, has recently come under fire in Massachusetts. Secretary of State William Galvin has filed fraud charges against two out-of-state oil and gas operations relative to their sale of unregistered securities to investors in Massachusetts.

In the first instance, Prodigy Oil and Gas LLC allegedly employed a cold-caller who had been found gulty of theft. Prodigy sold at least $464,000 in unregistered securities to one Massachusetts investor. In the second case, Synergy Oil LLC of Oklahoma allegedly sold $35,000 of unregistered securities to two investors.

Through the JOBS Act, signed into law April 5, 2012, small business and entrepreneurs will be able to sell equity (up to $1,000,000 annually) directly to investors to finance their business venture. Crowdfunding is technically not legal yet. Once it is allowed, it must occur on SEC- registered websites. The SEC has until 2014 to adopt rules relative to crowdfunding.

Would-be investors should heed the warning that Crowdfunding is not yet legal or regulated. Proceed at your peril.

 

Crowdfunding Isn't Legal Yet, Regulators Say

 

Crowdfunding Takes Early Hit in Massachusetts

 

Are Massachusetts Crowdfunding Actions a Sign of Things to Come?

 

Top Investor Threats of 2012

What were the top investor threats of 2012?  According to a speaker during the NASAA roundtable session at the November, 2012 annual meeting of the Public Investors Arbitration Bar Association, the top four new threats were:

1. Crowd funding / internet securities offerings
2. Inappropriate advice or practices by investment advisors
3. Scams involving self-directed IRAs to mask fraud
4. EB-5 investment for visa scams

The top six persistent threats were:

1. Gold / precious metals
2. Risky oil / gas drilling schemes
3. Promissory notes
4. Real estate investment schemes
5. Reg. D / Rule 506 private offerings
6. Unlicensed salespersons giving liquidation recommendations (for example, recommendations to sell stocks to buy a variable annuity by an insurance agent not licensed as an investment advisor or stockbroker)

FINRA Issues Guidance on Suitability Rule Concerning Definition of "Customer" and "Investment Strategy"

By way of background, FINRA Rule 2111 requires that a broker-dealer or registered representative “have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer based on the customer’s investment profile.”

Recently-issued FINRA Regulatory Notice 12-55 provides additional guidance related to FINRA Rule 2111. Specifically, Notice 12-55 addresses the scope of the terms  “customer” and “investment strategy.”

According to Notice 12-55, “the term customer includes a person who is not a broker or dealer who either opens a brokerage account at a broker-dealer or purchases a security for which the broker-dealer receives or will receive, directly or indirectly, compensation even though the security is held at an issuer, the issuer’s affiliate or a custodial agent . . . or using another similar arrangement” (i.e. even though the security is not held by the broker-dealer).

Notice 12-55 also addresses the application of the suitability rule in the context of a recommendation made by a broker-dealer or registered representative to a potential investor. In such a case, suitability obligations do not apply unless the potential investor executes the transaction through the broker-dealer or if the broker-dealer receives compensation. If and when a transaction occurs, suitability obligations immediately commence. However, the suitability of the recommendation is evaluated based on circumstances at the time of the recommendation.

Notice 12-55 also addresses the term “investment strategy.” Under 12-55, the term “investment strategy” is to be broadly construed, focusing on whether the recommendation was suitable when made. The “investment strategy” language would  “apply to recommendations to customers to invest in more specific types of securities, such as high dividend companies or the ‘Dogs of the Dow,’ or in a market sector, regardless of whether the recommendations identify particular securities.” This language would also apply to general recommendations to customers to use a bond ladder, day trading, “liquefied home equity,” or margin strategy involving securities even if the recommendations do not reference particular securities. In addition, “the term would capture an explicit recommendation to hold a security or securities or to continue to use an investment strategy involving a security or securities.”

It is worth emphasizing that, under Notice 12-55, the suitability rule encompasses a broker-dealers’ recommendation of an investment strategy involving both security and non-security components.

Although Notice 12-55 appears to offer some helpful clarifications, it is interesting to note the inconsistent treatment between customers and potential customers. Moreover, despite various illustrations, the limit of Notice 12-55’s broad reach with regard to investment strategy is far from clear. Outside of the specific illustrations in Notice 12-55, it seems that it would be safe to assume that most investment advice would constitute “investment strategy,” particularly given that this term is to be broadly construed. Time will tell how Notice 12-55 will play out in practice.

Regulatory Notice 12-55, Guidance on FINRA's Suitability Rule

Davis Polk. Guidance on FINRA's Suitability Rule

FINRA Clarifies Customer and Investment Strategy Terms Under the Suitability Rule

FINRA Suitability Overview

 

 

Former New Hampshire Stockbroker Convicted in Maine Theft and Securities Fraud Case

On November 2, 2012, Maine Securities Administrator Judith M. Shaw and Attorney General William J. Schneider that former New Hampshire stockbroker James A. Philbrook was found guilty by an Aroostook County jury of two felony charges stemming from an investment scheme that duped a St. Agatha couple out of $195,000.

Philbrook initially convinced the couple to invest $145,000 in developing a pay-per-view cable television production featuring Carmen Electra. The couple relied on Philbrook’s assurances that the production would net a substantial return. Unbeknownst to the couple, Philbrook used a substantial portion of the money for his personal gain.

Following that incident, Philbrook obtained another $50,000 investment from the couple which he used for his personal benefit.  

The jury rejected Philbrook’s claim that the funds provided by the couple were personal loans to be used at his discretion.

Philbrook is expected to be sentenced in October. The New Hampshire Bureau of Securities Regulation took administrative action against Philbrook on September 7, 2012, for the same conduct.

http://www.mainebiz.biz/apps/pbcs.dll/article?AID=/20121106/NEWS0101/121109984/1092&utm_source=enews&utm_medium=Daily%2BReport&utm_campaign=Tuesday

http://www.unionleader.com/article/20120919/NEWS02/709199979/0/News07

SEC Shows Much Progress to Be Made in Educating the Average Retail Investor

On August 30, 2012, The Securities and Exchange Commission (SEC) released a “Study Regarding Financial Literacy Among Investors.” The Study is mandated by the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.  The results of the Study are based upon multiple sources, including online surveys, focus group research, public comments to the SEC and a Library of Congress review of studies of financial literacy among U.S. retail investors. 

The SEC concludes that “U.S. retail investors lack basic financial literacy . . . have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud.” According to the Study: "[I]nvestors do not understand the most elementary financial concepts, such as compound interest and inflation,” nor do they understanding “the differences between stocks and bonds, and are not fully aware of investment costs and the impact on investment returns." 

Aside from shedding light on the general lack of knowledge in the retail investment population, a primary goal of the Study was to provide solutions. Most of these solutions centered on providing more transparency as well as more relevant and understandable information to the average investor.

The Study lists some common traits of retail investors. The Study found investors prefer to receive investment disclosures before investing (rather than afterwards, which often occurs). In reviewing disclosures, most investors preferred a visual format, using charts, bullets and graphs. The Study also identified information that most investors find useful and relevant in helping them make informed investment decisions. This includes information on fees, investment objective, performance strategy, and risks of an investment product. The Study also found that with regard to financial professionals, most investors care about professional background, disciplinary history and conflicts of interest.

It is anticipated that the SEC will act on this information to at least implement steps to give retail investors the tools they need to invest safely and successfully.
 
Click here for a link to the study.

Sources:http://www.sec.gov/news/press/2012/2012-172.htm
http://nymag.com/daily/intel/2012/08/sec-study-nobody-knows-anything.html?mid=googlehttp://www.minyanville.com/business-news/markets/articles/retail-retail-investors-how-to-invest/8/31/2012/id/43648