Competition among brokerage firms for high-revenue-generating brokers is surging, and that is driving up the financial incentives being offered to those brokers (“Brokers Face Pay Disclosures,” Julie Steinberg, Wall Street Journal).  The brokers that have a track record of generating the most revenue receive the most generous compensation packages.  The enhanced pay packages usually take the form of a cash bonus plus a big-dollar loan, the pay-back of which is forgiven in annual installments (if the broker leaves the firm during the term of the loan, he must repay a portion of the loan that has not been thus forgiven).

Of course, what is being rewarded is not how successfully the broker makes money for the clients, but how successfully he makes money for the firm (and himself).  The clients that generate the revenue for top-producing brokers are as much of an asset as the broker to the acquiring firm.  Therefore, firm-jumping brokers try very hard to persuade clients to follow them, and the former firm tries just as hard to persuade them to stay put.

Clients usually have no idea when their broker stands to receive millions of dollars to switch firms.  For example, Credit Suisse is thought to have paid $20 million to obtain a star broker in 2008.  FINRA’s proposed rule would require a broker to disclose his compensation arrangement to the clients he is asking to move with him to another firm if the “enhanced compensation” is worth at least $50,000.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

The brokers in that case not only denied they owed UBS anything on the promissory notes, but also counterclaimed for damages against UBS.  One of Mr. Kirwin’s counterclaims sought “$1,000,000.00 for reputation damage and personal suffering from the three years of constant stress for [sic] working at an allegedly immoral, unethical company.”  Mr. Kirwin also sought “$300,000.00 for introductory letters not going out” and “$720,000.00 for the sum of UBS’ alleged illegal malfeasance….”  For her part, Ms. Meninger counterclaimed for $90,000 in unpaid compensation, but apparently said nothing about UBS being immoral or unethical.

The Financial Industry Regulatory Authority (FINRA) arbitration panel that heard the case denied UBS’s claims on the notes as to both brokers, and further stated: “UBS is liable for and shall pay to Kirwin and Meninger compensatory damages in the amount of $250,000.00.”

The FINRA award did not specify how the award was to be split between the two brokers, and, as usual, did not provide any details concerning the panel’s reasons for the decision in the case.  However, while there was no finding by the arbitrators that UBS was immoral or unethical, and we have no way of knowing whether part of the award was for the claim having to do with UBS being immoral and unethical, it was not specifically denied by the arbitration panel either.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

In light of the foregoing, investors should adopt alternative investment strategies according to many such investment advisors (“In praise of alternatives,” InvestmentNews). The author says his firm “offers the nation’s largest lineup of alternative ETFs,” and he advocates asset classes and strategies such as “real estate, commodities, precious metals, currencies, volatility, and private equity; and strategies that are dynamic and focused on absolute returns, such as equity long/short, relative value, and merger arbitrage.” He claims that investors need them “to build modern portfolios capable of weathering [future] market storms.”

Yet, almost in the same breath, he admits that investing, especially using his brand of alternative investing, involves risk, including the risk of not weathering market storms and possible loss of principal.  He further admits that the alternative investment products he advocates and sells are non-diversified and entail substantial risks associated with the use of derivatives (swap agreements, futures contracts and similar instruments), imperfect benchmark correlation, leverage and market price variance, and that the materialization of these risks should be expected to increase volatility and decrease performance.

The truth is that alternative investments are not a panacea for conditions of market volatility and corrections.  For the reasons the author identified (lack of diversification, over-concentration, use of derivatives and leverage, lack of appropriate benchmarks to analyze performance), most individual investors would be well advised to be skeptical when receiving sales pitches involving substantial investments in alternative investments.   Some other reasons for wariness include the following risks and problems associated with alternative investments:

•    Illiquidity (Although ETFs are market traded, niche, leveraged and inverse leveraged ETFs may have significant liquidity problems. Non-traded alternative investment products, such as non-traded REITs, are illiquid.)

•    These complex, non-conventional products lack transparency in pricing and operation, and are often not fully understood by the investor or the seller, as evidenced by the seller’s inability to explain how the investment works to an arbitration panel.

•    Valuation problems (Traded ETFs often trade at significant premiums or discounts.  Non-traded alternative investments are valued using models and guesswork, and sometimes are fraudulently valued.)

•    Expensive fee structures decrease returns on investments.

Alternative investments remain on regulators’ radar screens because of these inherent problems and because of sales practice violations. The Financial Industry Regulatory Authority (FINRA) has long been concerned with sales practices relating to alternative investments (see e.g., Regulatory Notice 03-71 Non-Conventional Investments), and has found it necessary to regularly remind members of their obligations when selling them.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

In his remarks to the association of state securities regulators known as NASAA, Mr. Aguilar was quoted as saying: “By providing investors with the ability to choose the forum in which to bring their legal claims and protect their legal rights, we enhance investor protection and add more teeth to our federal securities laws. … I believe the commission needs to be proactive in this important area. We need to support investor choice. (“U.S. SEC’s Aguilar urges end to mandatory arbitration agreements,” by Sarah N. Lynch, Reuters).

The SEC is authorized to prohibit or restrict the use of pre-dispute arbitration agreements under the 2010 Dodd-Frank Wall Street reform law.   Commissioner Aguilar’s statements may prod his fellow Commissioners at the SEC to use that authority.

According to the article, at least one of Mr. Aguilar’s fellow Commissioners has expressed doubts that banning pre-dispute arbitration agreements would provide “significant advantages” over court litigation.  Meanwhile, the new SEC Chairman, Mary Jo White, has apparently not disclosed her views on the subject.

Mr. Aguilar is also concerned that pre-dispute arbitration agreements may be expanded into other investment agreements.  For example, many investment advisory firms do require customers to sign similar arbitration agreements binding disputes to be determined before other forums.

In addition, state regulators remain concerned about the crowdfunding provision in the 2010 Jumpstart Our Business Startups (“JOBS”) Act. That law requires the SEC to create new rules permitting crowdfunding, which would enable startup companies to raise seed capital via unregistered securities offerings over the Internet.  Most investors would be limited to investing $2,000 in a particular offering.   Regulators are concerned, however, because any scam artist with a computer could take advantage of unsophisticated investors through this largely unregulated new marketing channel.

Since it is often not economically feasible to file individual arbitrations and court actions to recover relatively small sums, class actions, which aggregate numerous small claims, provide the only practical means of loss recovery for these investors.  However, some customer agreements also contain class action waivers.  If securities brokerage agreements are allowed to rely on class action waivers, defrauded investors could be left with no available legal remedy.

In 2012, Charles Schwab & Co., Inc. compelled 8.8 million customers to waive their class action rights in their customer agreements. FINRA sued Schwab to overturn the waivers, but a disciplinary hearing panel found that Schwab was permitted to require its customers’ to sign them. FINRA has since appealed that decision.

NASAA members reportedly intend to ask Congressmen to sign a letter asking the SEC to prohibit all such pre-dispute arbitration agreements and class action waivers.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

DLG was a fraudulent ponzi scheme and its notes were not an “approved product” sold by MML.  The MML broker, Steven Corzan, sold them to the claimant in a private transaction, presumably with apparent authority, but not actual authority, from MML (“MML Investors Services Ordered to Pay Investor $1.1 Million,” by Caitlin Nish, Wall Street Journal).

Apparent authority essentially means that the circumstances surrounding the sale were such that the customer claimant reasonably believed that MML knew about and approved the sale of the security, even though it actually did not.  One way that could come about would be if Corzan’s dealings with the claimant took place in his MML office.  FINRA barred Corzan from the industry for engaging in this prohibited practice known as “selling away” (i.e., away from the firm and its oversight).

Broker-dealer firms are required by law and FINRA rules to have a system of supervision that is reasonably designed to assure compliance with the securities laws and FINRA rules, and to implement that system appropriately.  Broker dealer firms are also vicariously liable for the acts and omissions of their agents (brokers) committed in connection with their employment with the firm under common agency law.

Brokers are required by FINRA rules to disclose to the firm any outside business activities in which they are involved.  Selling private securities away from the firm is an outside business activity.  It is not clear from the article whether Corzan disclosed his outside business activity to MML.

MML reportedly said it would file a motion to vacate (“throw out”) the award.  Motions to vacate are filed in court and are rarely granted (only in very limited circumstances that basically rise to the level of a fraud in the process of the arbitration).  Groundless motions to vacate can be punished by the assessment of a monetary penalty against the movant.

Although the article did not say so, MML may be taking the position that Corzan’s sale of the DLG notes was done without the actual knowledge and authority of MML, that he was off on a personal mission that was not in connection with his employment, that he concealed the private sales of DLG notes from MML, and, therefore, MML should not be held responsible for his actions.

However, although the FINRA arbitration panel did not give its reasons, one may assume that it found sufficient evidence that MML should have known what Corzan was up to, and should, therefore, have taken steps to prevent the damage that occurred.  It will be interesting to see how the court handles the motion to vacate, if one is actually filed.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

Stockton, like most California cities, pays into the California Public Employees’ Retirement System (“CalPERS”).  Stockton reportedly pays CalPERS about $30 million per year.  Approximately 40% of Stockton’s outstanding liabilities are to CalPERS, making CalPERS the Stockton’s largest creditor, according to an InvestmentNews article by Jeff Benjamin entitled “Stockton ‘cram-down’ would severely test muni market.”

The municipal bond market sees overly generous pay and benefits as a contributing factor in Stockton’s financial disaster, and is insisting that CalPERS (and Stockton pensioners) not be made whole at their expense. Yet, according to Stockton officials, spreading the pain to CalPERS is “off the table.”  Apparently, Stockton did not even list CalPERS as a creditor in its bankruptcy filing.

Municipal bonds are supposed to be senior to other debt obligations in the event of a default.  If CalPERS pensioners are given priority over municipal bondholders, that is likely to lead to repercussions not only for Stockton, in terms of its ability to issue debt in the future, and its ultimate survival, but the entire $4 trillion municipal bond market as well.

So far, however, Stockton has shown no interest in renegotiating its obligation to CalPERS, and that does not bode well for the municipal bondholders (“Stockton bankruptcy sends chilly message to muni bondholders,” by Jeff Benjamin, InvestmentNews).  As the article notes, it is a time for municipal bond investors to pay attention.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

Mr. Roth’s article on the subject, “Beware the Muni-Bond Illusion,” uses a particular municipal bond to expose the illusion.  The bond he picked out matures in 4 years and the coupon rate is 4.5% – not bad, he says.  The client’s bond manager bought it a $112 – $12 over par, however, which reduces the interest rate down to 4.0% – still not bad at all, though, especially compared to the Vanguard Intermediate-Term Tax-Exempt Fund (Admiral Shares) return of 1.64%. Right?  Wrong.

The actual return netted by the investor is very different.  First, the $12 premium pulls the 4% yield down to 1.3%, because at maturity the bond pays $100, not the $112 that was invested, and the $12 that is lost in this way at the rate of $3.00 per year over 4 years equals 2.7%.

Peeling back another layer of illusion, Mr. Roth points out that the muni bond manager charges a management fee of 1% per year, which reduces the 1.3% annual return down to 0.3%.  Now the stodgy 1.64% return of the Vanguard fund looks much better.

Mr. Roth’s article is reminiscent of an entertaining book written by a magician named The Amazing Randi.  He followed a self-proclaimed supernatural showman named Uri Geller around like a one-man truth squad, exposing the slight of hand tricks Geller used to bamboozle audiences by supposedly bending spoons and things by his powers of concentration, and probably making Geller very angry.  It is a book that could be applied appropriately to the world of investments.

In today’s low interest rate environment, it is frustrating for income-oriented investors to learn how various investment strategies may be flawed. But it is clearly better to find out this way than after the fact.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

According to the SEC, Oppenheimer used total return swaps (a type of derivative) and commercial mortgage-backed securities (CMBS) to add significant leverage exposure to two of its bond funds without purchasing actual bonds.  The funds involved were the Oppenheimer Champion Income Fund (a high-yield bond fund) and the Oppenheimer Core Bond Fund (an intermediate-term, investment-grade fund).

As a result, staggeringly large payment obligations arose out of the swap contracts.  Oppenheimer was forced to sell portfolio securities into the collapsing market to raise cash to make those payments and reduce the funds’ CMBS exposure, according to the SEC. OppenheimerFunds reportedly sought to mislead investors into believing that the funds were maintaining their positions, that the funds had only suffered paper losses, that their holdings and strategies remained intact, and that the losses could be recovered.

The SEC alleged that prospectus for the Champion fund failed to adequately disclose the substantial leverage that resulted from the transactions according to the SEC.  Instead, it provided an example of how boilerplate disclosures can be legally inadequate.

The prospectus disclosed that the fund “invested” in “swaps” and other derivatives “to try to enhance income or to try to manage investment risk,” but it did not adequately disclose the magnitude of the derivatives exposure.  For example, the prospectus did not disclose that the fund’s total investment exposure could far exceed the value of its portfolio securities, or that its investment returns could be tied to the performance of bonds that it did not own.

The SEC also accused OppenheimerFunds of over-valuing one of the funds.  Marketing materials reportedly stated that the fund’s holdings of private equity funds were valued based on the manager’s estimates, when they were actually valued at a substantial mark-up of the estimates (“Oppenheimer & Co. to Pay Fine Over Fund,” by Gregory Zuckerman and Jean Eaglesham, Wall Street Journal).

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.

For decades, bond investors were able to pursue income, appreciation and preservation of capital all at once, but that is not possible any more, according to BlackRock’s chief investment strategist, Jeff Rosenberg. He says that investors must now choose which of the three is most important to them (“The Bond bomb survival guide,” by Jeff Benjamin, InvestmentNews).

“The bond market offers you different mixes of liquidity, term, credit, currency and interest rate exposure, and the key for any investor is to understand where they stand in this mix and how it is likely to behave under different market conditions.  The important reality to remember is that the global bond market is far from homogeneous,” PIMCO co-manager Mohamed El-Erian was quoted as saying.
In general, alternative bond funds are holding fewer Treasury securities, more corporate and mortgage bonds, and shorter-duration bonds.

One alternative strategy is “go anywhere” bond funds.  There are $66 billion of such funds that bear no restrictions on credit quality, geography and duration.  But there is not much of a track record. Almost 63% of the “go anywhere” bond funds followed by Morningstar are relatively new, having been launched since 2009.

Still another alternative strategy is an updated variation on the traditional bond ladder.  Yesterday, investors built bond ladders – bond portfolios with staggered maturity dates – out of individual bonds.  Today, ETFs may hold a basket of corporate bonds that mature on a specific date, so investors can use them instead of individual bonds for their ladders.  In theory, investors can reduce both interest rate risk and credit risk in this way.

Regardless of what alternative strategy is recommended, investors should be wary and ask lots of questions.

Page Perry, LLC is an Atlanta-based law firm with over 150 years of collective experience maintaining integrity in the investment markets and protecting investor rights.