State Regulators Focus on Precious Metals and Self-Directed IRA’s

The organization of North American securities regulators recently had their annual conference. The organization is known as NASAA.

During the conference presentation and panel discussion, it was reported that much attention was paid to self-directed IRA’s. The regulators believe that SDIRA’s are being used in conjunction with investment “scams.” It was reported that the regulators are anxious to work with federal legislators, but it was unclear as to what the proposed legislative solution to the alleged problem would be.

In conjunction with the discussions, the regulators referenced the precious metals industry. Our firm has worked with stakeholders in the precious metals industry for over a decade. Many of those industry players take compliance and ethical business practices very seriously. We also represent precious metals industry stakeholders when they are contacted by or receive a subpoena from a regulator. It was reported that state regulators opened more than 80 investigations of offerings related to SDRIA’s last year and brought 53 enforcement actions as well. The results of these investigations and actions were not, however, reported.

Proposed FINRA Rule 3241 (Registered Person Being Named a Customer’s Beneficiary or Holding a Position of Trust for a Customer)

            On July 2, 2020, the U.S. Securities and Exchange Commission (the “SEC”) published its notice to solicit comments on Proposed FINRA Rule 3241 (the “Notice”).[1] This proposed rule change would allow registered persons[2] to be named as beneficiaries or appointed to positions of trust,[3] and states as follows: 

            “Proposed FINRA Rule 3241 would provide that a registered person must decline: 

(1)    Being named a beneficiary of a customer’s estate or receiving a bequest from a customer’s estate upon learning of such status unless the registered person provides written notice upon learning of such status and receives written approval from the member firm prior to being named a beneficiary of a customer’s estate or receiving a bequest from the customer’s estate; and

(2)   Being named as an executor or trustee or holding a power of attorney or similar position for or on behalf of the customer unless:

a.       Upon learning of such status, the registered person provides written notice and receives written approval from the member firm prior to acting in such capacity or receiving any fees, assets, or other benefit in relation acting in such capacity; and

b.      The registered person does not derive financial gain from acting in such capacity other than from fees or other charges that are reasonable and customary for acting in such capacity.[4]” 

            Being designated a customer’s beneficiary, trustee or executor and/or holding a customer’s power of attorney raises actual or potential conflicts of interest, and registered person’s had been known to circumvent these conflicts in form rather than substance. FINRA proposed this rule change “to create a uniform, national standard to govern registered persons holding positions of trust” in order to ostensibly “better protect investors and provide consistency across member firms’ policies and procedures.”[5]    

A close examination of the rule change reveals that it would do little regarding a registered person’s actual or potential conflict of interest, which FINRA proposes to assess “to determine the effectiveness of the rule addressing potential conflicts of interest and evaluate whether additional rule making or other action is appropriate”[6] if the rule change passes. This further assessment may be why the NASAA[7] opposes the rule change as written, and instead proposes to limit its application to registered persons who are immediate family members, and even in that case require the member to implement heightened supervision standards regarding that registered person.[8] 

If passed, the proposed rule change would become effective either (a) within 45 days of the date of the publication of the Notice, or (b) within such longer period not to exceed 90 days of such date if the SEC finds it appropriate.   

 Author: Brian St. James

Please follow us on Twitter @CosLawGroup, on LinkedIn at Cosgrove Law Group, LLC, and on Facebook at Cosgrove Law Group, LLC. 

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[1] SECURITIES AND EXCHANGE COMMISSION (“Release No. 34-89218; File No. SR-FINRA-2020-020").

[2] “Registered person” means an “associated person of a member” as set forth in FINRA By-Law Article I (rr).

[3] The text of the proposed rule is available at http://www.finra.org.

[4] The proposed rule change would not apply where the customer is a member of the registered person’s immediate family.

[5] SECURITIES AND EXCHANGE COMMISSION (“Release No. 34-89218; File No. SR-FINRA-2020-020.

[6] Id.

[7] North American Securities Administrators Association, Inc.

[8] NASAA comments to Proposed FINRA Rule 3241 (Registered Person Being Names a Customer’s Beneficiary or Holding a Position of Trust for a Customer), dated July 30, 2020.

NASAA Releases Its 2016 Enforcement Report

The North American Securities Administrators Association (NASAA) recently released its Enforcement Report for 2016, an annual publication providing a general overview of the activities of the state securities agencies responsible for the protection of investors who purchase investment advice or securities. Admittedly, the information undercounts many statistics due to differences in fiscal year reporting and a lack of response or underreporting for each survey question posed. However, trends in the 52 U.S. jurisdictions are still apparent in the report.[i]

For the first time since NASAA began tracking enforcement statistics, more registered than unregistered individuals and firms were subject to respondent status.[ii] During 2015, state securities regulators conducted 5,000 investigations and brought 2,000 enforcement actions against 2,700 respondents, which often involved more than one individual or company.[iii]

Sanctions imposed upon those who were found in violation of securities law ranged from incarceration to monetary relief and bans on trading. The year witnessed a combined 849 years of imprisonment, 410 years of probation, and 23 years of deferred prosecution, as well as $538m paid in restitution and $238m in fines/penalties.[iv] In addition to criminal and monetary repercussions, revocation and disbarment from the industry occurred for more than 250 individuals, while another 475 licenses/registrations were denied, suspended or conditioned.[v]   

The five most common violations prompting these actions were, in order of frequency: Ponzi Schemes, Real Estate Investment Program Fraud, Oil & Gas Investment Program Fraud, Internet Fraud, and Affinity Fraud.[vi]

The NASAA report found that Ponzi scheme victims were often targeted through the internet or for identifiable attributes, such as race or religion. The report also found that vulnerable seniors were disproportionately victims; jurisdictions that reported on seniors found one-third of all investigations related to their victimization.[vii]

Prison terms have become more common for those conducting such schemes, such as Derek Nelson, found guilty of selling about $37m in promissory notes for property purchases that never took place. As a consequence, Mr. Nelson received 19 years in prison.[viii]

Real estate and oil and gas investment fraud was also a major concern for reporting NASAA members. Some states, such as Colorado, have sought judicial remedy and have secured investor protection by winning the right to have oil and gas interests subject to securities law.[ix]

The report clearly states that all fraud has been made easier to accomplish due to the internet, where only basic computer skills allow an individual from anywhere in the world to “enter” the homes of investors. Scott Campbell was sentenced to 20 years in prison for conducting a Ponzi scheme over the internet from Florida. Alabama garnered 18 convictions in an international bank scheme conducted through Craigslist.[x] Affinity frauds, in which an individual purports to be a member of a certain group, are much easier to accomplish given the anonymity of the internet.

The industry’s heightened attention to elder abuse has not shielded those responsible for supervision or oversight. Wells Fargo Advisors, LLC and Fulcrum Securities, LLC were ordered to pay $470,000 to investors for their failure to oversee Christopher Cunningham of Virginia, who defrauded elderly clients in a Ponzi scheme. For his part, Cunningham was disbarred and sentenced to 57 months in federal prison.[xi]

Attorneys are not immune to abusing their positions in order to perpetrate fraud. According to the report, Michael Kwasnik, an estate planning attorney, used his position of trust to perpetrate a $10m Ponzi scheme against elderly victims in New Jersey. The Court found that he had taken advantage of the attorney-client trust. Earlier in the year, Kwasnik also pled guilty to securities fraud in Delaware, utilizing the client trust account of his law firm to commingle monies from both frauds. Though Mr. Kwasnik received no jail time, he was ordered to repay millions in lost monies, amongst other judgments.[xii]

What may be the single worst case of elder victimization presented in NASAA’s annual report was perpetrated by Sean Meadows, owner of a financial planning and asset management firm, Meadows Financial Group LLC (MFG). Meadows perpetrated a $13m Ponzi scheme against 100 individuals, some disabled, poor, or terminally ill. He took the life savings of most, luring them into draining their retirement accounts. Many lost their homes, ability to care for their families, and even pay for cancer treatments.[xiii]

Meadows convinced his victims to pull money out of tax-deferred accounts to invest with MFG, promising these transactions would be tax-free rollovers. He then convinced these same individuals to allow him to do their taxes, in order to cover up the scheme. He either filed fraudulent tax returns or filed nothing at all. As a result, in addition to losing retirement savings, many incurred significant tax liabilities. For his crimes, Meadows received 25 years in prison.[xiv]

As the NASAA report makes clear, positive steps are being taken by its members to address the fraudulent and criminal activities of some individuals and firms. Laura Posner, NASAA Enforcement Section Chair, believes enhanced regulatory scrutiny is responsible for the increase in action documented by the report.[xv] However, it is still necessary to be on alert for promises that seem too good to be true. If you feel you may have fallen victim, please seek consultation from an attorney immediately.   

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[i] North American Securities Administrators Association (2016) NASAA 2016 Enforcement Report (Based on 2015 Data) [Electronic Format]. Retrieved from: http://nasaa.cdn.s3.amazonaws.com/wp-content/uploads/2016/09/2016-Enforcement-Report-Based-on-2015-Data_online.pdf. (pp. 11)

[ii] Ibid. pp. 5

[iii] Ibid. pp. 2

[iv] Ibid. pp. 3

[v] Ibid. pp. 4

[vi] Ibid. pp. 4

[vii] Ibid. pp. 5

[viii] Ibid. pp. 6-7

[ix] Ibid. pp. 4-5

[x] Ibid. pp. 7

[xi] Ibid. pp. 7

[xii] Ibid. pp. 9

[xiii] Ibid. pp. 9-10

[xiv]Ibid. pp.  9-10

[xv] NASAA Releases Annual Enforcement Report (9.13.2006) [Electronic Format]. Retrieved from: http:nasaa.org/40256/nasaa-releases-annual-enforcement-report-2

David Cosgrove Interviews the Chair of NASAA'a Investment Adviser Section

Earlier this month, David Cosgrove of Cosgrove Law Group and The Investment Adviser Rep Syndicate interviewed Ms. Patricia Struck, Chair-Person of the Investment Advisor Section for the North American Securities Administrators Association (NASAA) and the Administrator of the Division of Securities of the Wisconsin Department of Financial Institutions.  The interview, relevant to state and SEC registered Investment Adviser Representatives and Registered Investment Advisers is posted below. 

David Cosgrove:    Let's start with the basics - What is NASAA?

Patricia Struck:   The North American Securities Administrators Association is oldest international organization devoted to investor protection. It’s a voluntary association whose membership consists of 67 state, provincial, and territorial securities administrators in the 50 states, the District of Columbia, Puerto Rico, the U.S. Virgin Islands, Canada, and Mexico.

DC:                 For how long have you been the administrator of the Wisconsin Division of Securities?

PS:                   I’ve been the administrator since 1995.

DC:                 What advisers do the states regulate as opposed to the SEC?

PS:                   Generally, the states regulate “small” (with assets up to $25 million) and “mid-sized” (with assets up to $100 million) advisers.  Of the 28,366 advisers currently on IARD, more than 17,000 are state advisers. The rest of the universe – nearly 11,000 advisers – are SEC advisers.

DC:                 It is my understanding that NASAA has different "working groups". Is there a working group focused on the advisory as opposed to the broker industry?

PS:                   NASAA has “sections” divided into 5 subject matter areas; one of the five is the investment adviser section and another is the broker-dealer section. But while the sections are separate on paper, they work very closely together – especially the investment adviser and broker-dealer section.

DC:                 For how long have you been the head of NASAA's Investment Advisor Section?
           

PS:                   I just became chair of the section in October of 2013. This is my third term as chair.

DC:                 Can you give me some examples of some of the positions held by the folks in this section?  What exactly does this section seek to accomplish and how does it go about meeting those goals?

PS:             The section includes nearly 50 volunteers from across the US and Canada with vast expertise in the whole range of regulatory issues relating to investment advisers. Some are the administrators in their jurisdictions. Some are registration chiefs or lead examiners in their states. Many are examiners who perform exams in advisers’ offices. All have specific subject matter expertise in issues 

DC:                       As you know, the Investment Adviser Rep. Syndicate focuses on the training, compliance, and business goals of the representative rather than the RIA. What observations did you make in 2013 that would be of interest to advisory representatives? 

PS:             In 2013, as state securities regulators assumed the increased regulatory oversight of investment advisers managing under $100 million in assets, NASAA released an updated series of recommended best practices that investment advisers should consider to minimize the risk of regulatory violations. These recommendations were based on the sample data reported by examiners in 44 state and provincial securities agencies between January and June 2013. The 1,130 reported examinations uncovered 6,482 deficiencies in 20 compliance areas, compared to 3,543 deficiencies in 13 compliance areas identified in a similar 2011 examination of 825 investment advisers.

As regulators, we are concerned about investor confusion stemming from the blurred lines between traditional brokerage, investment advisory, and financial planning services; partially because of the expectations the brokerage industry has set, and partially because of the marketing approach the industry uses – the proverbial ‘financial adviser’ who is your partner in retirement every step of the way. As long as the broker-dealer industry continues to engage in advice driven marketing the confusion will persist. That’s one reason why state securities regulators have long advocated that broker-dealers must be held to the fiduciary duty standard of care currently applicable to investment advisers and be required to place retail investor interests ahead of their own.

DC:                       What are the section's goals for 2014? 

PS:             The section always strives to look for ways to enhance uniformity in investment adviser firm and investment adviser representative registration practices. We also will continue our ongoing efforts to support states in conducting investment adviser exams. And of course, we will review our existing “best practices” for IA firms to consider while developing their own compliance programs and evaluate whether additional practice areas are necessary.

DC:                       How is the migration of RIA's pursuant to the Dodd-Frank Act going? 

PS:             The IA Switch, involving the transfer of more than 2,100 investment advisers from federal to state oversight, was one of the most significant achievements in the history of the North American Securities Administrators Association (NASAA).

The Switch stemmed from Section 410 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the Dodd-Frank Act), which raised the assets under management (AUM) threshold for state regulation of investment advisers from $25 million to $100 million. 

This report documents the work that went into the successful completion of the Switch.

http://www.nasaa.org/?s=switch+report

DC:                       If there were three things you would like to see the Syndicate accomplish what would they be?  

PS:             1. Helping IARs have a better understanding of the role of their state regulator

2. Helping to create an ongoing dialogue between the IAR and regulatory communities

3. Helping IARs appreciate investor confusion stemming from the blurred lines between traditional brokerage, investment advisory, and financial planning services – and work to cut through that confusion

DC:                       What is the one thing you would be grateful to see investment adviser representatives take away from this interview?

PS:                   I would like them to appreciate that we are their partners in putting investors first. State       securities regulators are accessible, both to investors and to the people we regulate. We work closely with     the IAR communities in our states and appreciate the value and importance of communication. We share       the same goal of providing the best level of service to investors. We’re in this together. 

SECURITIES REGULATORS DISCUSS ENFORCEMENT STATS AND TRENDS

State securities regulators' enforcement efforts were robust in 2010, according to a panel of regulators at NASAA's annual conference last week. Cosgrove Law, LLC provides both civil and criminal representation in the securities and white-collar arena, so it was interested to learn that there was a substantial increase in criminal prosecutions filed by securities regulators in 2010. For “non-fraud” cases, the regulators scored themselves a 32% increase in “failure to supervise” actions, but filed fewer “suitability” actions.

Other interesting statistics: almost half of the state regulators' enforcement actions were brought against non-registered persons in 2010. As for registered individuals, 12% of those actions were brought against investment adviser representatives (IAR's) and 23% were filed against broker-dealer agents. 5% were brought against registered solicitors, and the balance fell upon insurance industry members. The regulators continued to express ire over insurance industry members dually licensed as investment advisers with what they perceive to be an excess concentration or focus upon annuity sales.

Notably, today's Wall Street Journal has an interesting Adviser Alert that shares an important observation: investment advisers are “among regulators' best tipsters.” In our experience, reputable advisers are also likely to recommend legal counsel to new clients whom they observe to have been victimized by their prior broker or adviser or insurance agent. Food for thought.

STATE SECURITIES REGULATORS AT ANNUAL CONFERENCE LIST PRECIOUS METALS SALES AS ENFORCEMENT PRIORITY

Members of this firm, financial industry members, and SEC and FINRA staff joined state securities and commodities regulators at their annual conference this week. As always, the conference agenda was relentless—filled with impressive panels discussing trends and developments on the broker-dealer and investment advisory side, State, Federal and SRO enforcement actions and compliance audits, as well as commodities regulation and international financial market policy. When NASAA's Enforcement Section met during the conference, its leaders listed precious metals retail sales as one of their primary concerns and enforcement priorities. The discussion, however, focused on margin sales, with an additional dose of skepticism about precious metals depository services. Notably, many interpret language in the Dood-Frank Act to preclude most transactions that combine the use of margin and storage, although the precious metals industry still awaits belated CFTC rule-making in this area.

In the interest of full disclosure, Cosgrove Law, LLC is a member of the ICTA and provides compliance services to members of the precious metals industry. Is also, however, represents investors defrauded by the less reputable members of an industry arguably vindicated by years of market appreciation. Indeed, today's Wall Street Journal published one of dozens of articles regarding the role of gold and other metals in the personal finances and portfolios of Americans struggling through another year of economic malaise and equity market volatility. To read this full article, please click here.

Federal Judge Denies Preliminary Class Action Settlement, State Securities Regulators Give Sigh of Relief

On March 18, the Federal District Court for the Northern District of Texas, refused to a $21 million partial class action settlement with Securities America, a division of Ameriprise Financial.

The case stems from the sale of hundreds of millions of dollars of private placement notes in Medical Capital Holdings, which the SEC deemed to be a fraud in 2009. After the fraud was discovered, many investors filed arbitration claims against Securities of America, others joined together in multiple class actions, and others proceeded individually. The Massachusetts and Montana securities regulators also filed enforcement actions in 2010 against the defendants, which are now in the late-stages of litigation. On February 18, Senior District Judge W. Royal Furgeson, Jr. temporarily stayed several of the arbitration actions proceeding through FINRA while the motion was pending, but refused to halt the state enforcement actions.

The settlement was proposed by representative plaintiffs in three related class actions: Billitteri et al v. Securities America et al, Toomey et al v. Hofhines et al, and McCoy et al v. Cullum & Burks Securities Inc. et al. The representative plaintiffs’ motion sought approval of a 23(b)(1)(B) limited fund settlement with two of the defendant broker-dealers, Securities America, Inc. and Securities America Financial Corporation.

The proposed settlement would have affected all investors, regardless of how they decided to make their legal claim. If granted, the settlement also could have enjoined the state enforcement proceedings. According to the North American Securities Administrators Association, “enjoining state securities regulators [could] have a far-reaching impact by undermining investor protection not only in Massachusetts and Montana, but in other jurisdictions as well.” NASAA further stated that such an effect would make citizens “more vulnerable to fraud and abuse in the offer and sale of securities.” On March 14, NASAA filed a Brief in Opposition to Plaintiff’s Motion for Preliminary Approval of Partial Class Settlement, arguing how approval of the settlement would undercut state regulators’ enforcement ability. The organization was one of many that filed briefs and memoranda with the court regarding this motion.

In his Order, Judge Furgeson, notes the large number of outside parties interested in the outcome of the proposed settlement. He also makes specific mention of the enforcement actions proceeding in the two states, which likely weighed on his decision. However, Judge Furgeson’s order explaining the reasoning behind his decision has not yet been filed.