BD Law Blog - by Georgia Securities Lawyer Joel Beck

Massachusetts Charges UBS with Fraud in Auction-Rate Securities Case

Last week, on June 26, 2008, William Galvin, the Securities Commissioner of Massachusetts, filed charges against UBS Financial, alleging that they defrauded investors in connection with sale of auction-rate securities.  According to the Complaint, UBS sold auction-rate securities to clients "[w]ith express representation that they were liquid, safe, money-market instruments, that their interest rates would reset at periodic auctions based on the bids submitted by market participants, and that they could be sold at the next auction."  In reality, according to the Complaint, no auctions existed for many of the securities and UBS did not disclose its conflicts of interests in its dual role as the underwriter of the securities and its selling the securities to clients. 

The Complaint seeks an order requiring UBS to cease and desist from continuing to violate state law, to offer rescission to investors (or restitution to those who sold at a loss), a censure, a fine, and any other appropriate relief. 

SEC Proposes New Rule for Indexed Annuities

Today, the SEC announced a proposed rule relating to indexed annuities.  Indexed annuities are investment products that have been classified (or sought to be classified) as either a security or an insurance product, depending on who you speak with and where you're located.  The proposal seeks to clarify the status of indexed annuities under federal securities laws, and to provide investors with all protections of federal securities laws, "including full and fair disclosure and sales practice protections." 

The proposal would exempt insurance companies from filing reports under the Securities Exchange Act, provided that the indexed annuities are regulated under state insurance laws, the issuer and its financial condition are subject to supervision and inspection by a state insurance regulator, and the annuities are not publicly traded.  It would define certain indexed annuities as not being annuity contracts or optional annuity contracts if the amounts payable by the insurer "are more likely than not to exceed the amounts guaranteed under the contract." 

The rule proposal, which includes the basis and overview of the proposed new regulations is about 96 pages.  I'll admit I have not gotten through it all yet, and can't really comment yet on all potential ramifications, but wanted to go ahead and post this information for readers of BDLawBlog.com.  The SEC is seeking comments on the proposal - comments due by September 10, 2008.

SEC Chairman Sets Goals for Summer

In a speech June 12th in Washington DC to the Chartered Financial Analyst Institute Conference on Next Generation Asset Management, SEC Chairman Christopher Cox informed audience members  on upcoming issues and items to be addressed by the SEC this summer.  He stated that he expected the commission to soon consider rules on equity-indexed annuities and when those are traded as securities.  The SEC is working closely with NASAA (the North American Securities Administrators Association) and their state securities counterparts on this issue, he said.  Further, Chairman Cox noted that we can expect quick action on a proposal for new interpretive guidance on soft dollars, and to expect the SEC to consider, this summer, among other things:  a final principal trading rule for both broker-dealers and investment advisers, new interpretive guidance for both broker-dealers and investment advisers, as well as the adoption of amendments to Regulation S-P relating to account intrusions.   

Initial Decision issued in NEXT Financial SEC Case

Earlier this week, the initial decision of Judge James T. Kelly, an administrative law judge with the SEC, was issued in the NEXT Financial Group, Inc. case.   The SEC's Division of Enforcement had brought this action against the firm alleging violations of Regulation S-P.  According to the initial decision, NEXT would "pre-populate" certain customer account documents and transfer forms to assist recruits in transferring client accounts to NEXT from their former firm.  They did this by receiving personally identifiable financial information from recruits before they joined NEXT, and while they were still at their other firm, without determining whether the customers had consented to the transfer of the personal information. 

The Division of Enforcement sought a cease and desist order and a civil penalty (fine) of $325,000.  The judge found that the issuance of a cease and desist order, relating to violations of Regulation S-P, was appropriate, as was a civil penalty in the amount of $125,000.  The decision is only an initial decision and is not yet final, and may be modified before it becomes final. 

SROP and CROP Designations Coming to an End

Effective June 23, 2008, FINRA will eliminate the requirements that firms that engage in options business, designate a senior registered options principal (SROP) and a compliance registered options principal (CROP) charged with the responsibilities of supervising the firm's options business and compliance programs.  Under the amended rules, firms can integrate the supervision and compliance of their options business into their overall supervisory and compliance programs.  See FINRA's Regulatory Notice 08-28 announcing these changes.  And, as a reminder, these affected firms should also review their Form BD, Schedule A to determine if any changes need to be made there as a result of the elimination of the SROP and CROP titles.  

SEC Seeks Comments on Revisions to FINRA Rule 2821 Regarding Variable Annuities

FINRA has filed proposed changes to its new Rule 2821 dealing with supervisory requirements for sales of deferred variable annuities.  On June 4, 2008, the SEC requested comments on these proposed changes to Rule 2821. 

The proposed changes primarily deal with the timing and scope of principal review of transactions.  Importantly, the proposal also seeks to apply Rule 2821 only to recommended transactions, taking an approach more akin to the suitability rule (Rule 2310).  The changes also would add supplementary information to the rule to clarify issues for firms, including whether a firm could forward funds to an insurance company for deposit into its suspense account pending a principal approving the transaction. 

FINRA did not seek comments from members prior to making this filing to the SEC, so firms engaging in sales of deferred variable annuities should review this proposal and consider offering comments to the SEC. 

FINRA Enforcement Chief Addresses Variable Annuity Crowd

Last week, Susan Merrill, the Exec. VP and Chief of Enforcement for FINRA, addressed the NAVA (National Association for Variable Annuities) conference in Washington, DC.  The text of Merrill's speech can be found online at FINRA's website. After providing a brief update on the efforts to consolidate the NASD and NYSE Regulation operations, including work on a consolidated rulebook, Merrill turned to the subject of variable annuities.  Merrill noted that she believes that VAs have a place in the market, but that they are not for everyone.  She stated that studies show that 48% of all cases of "senior investment exploitation" in 2005-2006 involved either variable or equity-indexed annuities.  This was up from 34% in 2004, she said.

Merrill noted that the VA products typically come with high commissions and that supervision of sales needs to be a priority at firms, including reviewing for suitability and for switches.  She cited FINRA's recent enforcement action against Banc One of Chicago for making unsuitable sales of variable annuities to 23 customers, nearly all of which were older than 70.  FINRA found that brokers recommended that these customers sell their fixes annuities, paying a minimum of 3%, and purchase variable annuities.  But, the customers were advised to place all of their funds into a fixed rate feature that paid a maximum of 3%.  Moreover, the customers were subjected to new surrender periods.  FINRA found that the firm failed to supervise adequately these sales. 

Finally, Merrill addressed new FINRA rule 2821 that covers supervision of VA sales.  She noted that certain portions of the rule have not become effective, as they work on revisions to it that the regulator believes are necessary.  More information on those changes will come later, she said.

Undercover NFA Examiners Find Violations

The National Futures Association barred Los Angeles based member Jaguar Trading from NFA membership and suspended its sole principal, Jonathan Berman, from NFA membership for 1 year based upon allegations of misleading sales solicitations. 

According to the NFA's press release, the NFA filed a Complaint against Jaguar and Berman in December 2007, and following the submission of an offer of settlement by the firm and Berman, a hearing panel issued a decision.  The Decision states that the "complaint alleged that Jaguar and Berman made misleading sales solicitations to NFA Compliance staff members, posing as a (sic) prospective customers, which exaggerated the profit potential of trading options, downplayed the risk of loss, failed to disclose that the vast majority of jaguar and Berman's customers lost money, contrary to Berman's rosy profit claims, and suggested that well-known current events and weather trends would move the markets higher, without disclosing that such information has already been factored into the markets." 

Pursuant to the terms of the settlement, if Berman becomes an NFA member or associate following the suspension, he will pay a $5,000 fine, as well as be required to tape-record all conversations between him and existing or potential clients for 6 months, retain the tapes for 1 year, and make them available to the NFA upon request.  Further, if he becomes a principal of an NFA member, then the tape-recording requirement shall apply to the entire firm, including all other associated persons, though in any event, all tape recording requirements will expire at the end of 2011.

I can't recall of other cases where SRO examiners posed undercover in an examination of this type, can you?

SEC Shuts Down North American Clearing

Last week, on May 27th, the SEC obtained an asset freeze and temporary restraining order against North American Clearing, and had a court appoint a receiver over the firm.  The SEC's alleged, in a complaint filed against the firm, its founder and director Richard Goble, the firm's president Bruce Blatman, and its former FINOP Timothy Ward, that the firm, in March and April 2008, improperly sold customer money market funds to free up funds that it could then use for daily operations expenses.  The SEC also charged the firm with a host of other violations.  According to the SEC, North American Clearing cleared for about 40 introducing broker-dealers, and held over 10,000 customer accounts.  Peter Anderson, the receiver for the firm, has posted a few updates to the North American Clearing website.

This action by the SEC comes many months after the NASD (now known as FINRA), charged North American Clearing with many rule violations in August 2007.  In the release announcing NASD's complaint, the regulator charged that from March 2004 to March 2005 the firm improperly liquidated customer money moarket positions to create cash flow to meet the firm's daily settlement obligations, among other violations (See NASD Case E072005017201).  That case has not gone to hearing, and, due to the appointment of a receiver over the firm, its status may be somewhat uncertain.