Brokers often pitch alternative investments when the stock market is declining and returns on traditionally safe investments are too low. A few alternative investments may have some merit. Many more are flawed, bad and ugly in that they provide investors little more than uncompensated high risk. Then there are those that cross the line into the realm of the outright fraudulent. Unless the brokerage firm is itself a criminal enterprise, brokers often try sell fraudulent investments away from the firm to avoid detection by the firm. The practice is known as “selling away.”
The North American Securities Administrators Association (NASAA), an association of state securities regulators, has put selling away as number 8 on its list of the top ten industry violations. State securities regulators have seen an increase in selling away, and have initiated 54 enforcement actions involving selling away.
“When the financial crisis hit, brokers and agents were left with clients who weren’t happy with the investment options they were offered. Some brokers, also looking to supplement their income, went outside the traditional market, trying to find other products to push,” said Matt Kitzi, Missouri securities commissioners and head of NASAA.
Brokerage firms have a legal obligation to take reasonable steps to supervise their brokers. A frequent issue in selling away cases is whether the firm should have detected the selling away and taken action.
The Financial Industry Regulatory Authority (FINRA), the securities industry’s self-regulatory organization, has rules requiring brokers to disclose any outside business activities to the firm. Unfortunately, those rules are there to protect the firm, not customer, as the firm often tries to avoid liability for failure to supervise by arguing that the broker failed to disclose the outside business activity.
Brokers at some leading independent broker dealers have been investigated this year for selling away schemes. They are often one or two person shops without any day-to-day supervision from the home office, which may not even be located in the same region of the country.
Brokerage firms cannot avoid their supervisory responsibilities by arguing that a branch office where misconduct occurred is too far away to supervise effectively. It is, in fact, often the case that distance makes supervision all but impossible, but firms are still legally responsible to have and implement a reasonable supervisory system.
When a broker recommends an investment, the customer typically believes that the broker is acting in his capacity as a registered representatives of the brokerage firm. Even if the broker is selling away, cues like discussing the investment with the broker at his brokerage firm office, and receiving emails or letters bearing the firm letterhead regarding the investment, lead the customer to believe that the firm is involved.
The relationship of trust and confidence that typically exists between broker and client (at least initially), along with the apparent involvement of the firm, can lead to some pretty unusual investments. They may involve ponzi schemes or even more bizarre schemes. In one such case, a broker with a national firm sold his elderly client a purported interest in a used car dealership. In all probability, the investment money was simply stolen by the broker, but proving that can be difficult and expensive for the client.
Investors should be wary of all alternative investments, and consider the possibility that the broker may be selling away.
Page Perry is an Atlanta-based law firm with over 150 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. For further information, please contact us.