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Articles Posted in Broker Dealer Law

Northridge Holdings and Glenn Mueller recently released a letter to investors acknowledging the complaints and the cease and desist orders from four states as well as an investigation from the Securities Exchange Commission (“SEC”). The letter states that while the complaints and orders from state securities agencies are pending, Northridge can no longer make interest payments or distributions to investors.

As expressed in a previous article posted by the securities attorneys of Lubiner, Schmidt & Palumbo, Northridge has received complaints, as well as cease and desist orders from the four aforementioned state securities agencies as well as the SEC. The complaints charge Northridge with selling unregistered securities in addition to acting as an unregistered broker dealer. Northridge presented itself in marketing material as being exempt from federal registration requirements for securities, however they never filed any of the necessary forms for exemption with any state securities agency or the SEC.

The recent announcement of a stop to distributions and interest payments will have a devasting impact on retired investors relying on the interest payments from Northridge to cover living expenses. In addition, investors who were set to have their principal or total investment returned to them on the maturity date listed on their promissory notes will have to wait now for an indefinite period of time.

The New Jersey State Attorney Generals recent press release pertaining to Northridge made one thing absolutely clear. New Jersey was taking the sale of unregistered securities to investors or acting and an unregistered agent marketing the sale of securities as a top priority. The securities law firm of Lubiner, Schmidt & Palumbo has been tracking on the actions of Northridge securities for some time in connection with an unrelated matter with similar allegations, such as sale of unregistered securities. As stated in our post on Northridge, New Jersey along with the states of Illinois, Massachusetts, and New Hampshire are filing complaints in connection with Northridge and its sale of unregistered securities.
The state actions against Northridge of course leads to the obvious question of what qualifies as a “security” under the New Jersey uniform securities laws. Do all real estate deals have to be registered as securities or can exemptions to registration be used? First to define a security, pursuant to Title 49 Chapter 3 subsection 49(m) – N.J.S.A. 49:3-49(m) for short, security means any note; stock; treasury stock; bond; debenture; evidence of indebtedness; certificate of interest or participation in any profit-sharing agreement, including, but not limited to, certificates of interest or participation in real or personal property. There is no bright line rule for determining whether an instrument is a security under the New Jersey Uniform Securities Law. Whether a particular investment constitutes a security depends upon the facts and circumstances of each case. The term “security” has been interpreted broadly, encompassing unusual financial instruments as well as these commonly considered to be securities. Federal and state definitions of “securities” include the term “investment contract.” The definition of an investment contract is “an investment of money in a common enterprise, with an expectation of profits based solely on the efforts of the promoter” (Securities and Exchange Commission v. W.J. Howey Co., 328 U.S. 293—1946). Under the Howey Test as it is known, State examiners look to whether investors are investing money in a common venture with the expectation of profits based solely on promoters’ efforts. A major factor is the degree of control and authority retained by the investors over the joint venture. A review of the joint venture agreement indicating that substantial authority was retained by the investors may lead to the offering as being considered exempt from registration. General Partnerships are a prime example of this and are usually held not covered under the securities laws. This is because general partnerships usually consist of entrepreneurs, not investors, who have the ability to take care of their own interests because of the inherent powers available to them. General partners may act on behalf of the partnership, can bind their partners by their actions, may dissolve the partnership and are personally liable for all liabilities of the partnership. There are, however, instances in which even a general partnership interest may be considered a security. Whether a general partner’s or joint venture’s interest may be considered a security is a fact sensitive inquiry.
With the determination that Northridge was marketing unregistered securities the state of New Jersey in its complaint is seeking civil monetary penalties and other remedies against the firm. Imposition of civil monetary penalties against Northridge pursuant to NJSA 49:3-70.1 has been brought. As stated in the Northridge complaint, each sale of Northridge Securities to investors constitutes a cause for the imposition of civil monetary penalties for each separate violation. As stated in paragraph 1, of the complaint Northridge is looking at 62 separate violations for the sale of $10.46 million of Northridge to 62 individual New Jersey Investors. In addition to the penalities New Jersey is seeking restitution to each New Jersey Investor who purchased Northridge. New Jersey Bureau of Securities has also issued a cease and desist order against Northridge pursuant to its authority un N.J.S.A. 49:3—69(a). If you’re an investor who has purchased Northridge the securities lawfirm of Lubiner, Schmidt & Palumbo please contact the lawfirm of Lubiner, Schmidt and Palumbo for a consultation.

On January 29, 2019, the New Jersey State Attorney, Securities Fraud Prosecution Section filed a complaint for a civil action on behalf of the New Jersey Bureau of Securities in Mercer County Chancery Court alleging that Ford Graham, his wife Katherine Graham and several entities Ford Graham controlled participated in securities fraud relating to the sale of unregistered securities in purported oil and gas ventures. Media reports state that Graham, “with the active participation of his wife,” induced individuals in five states to invest close to $5 million with Graham’s LLCs in an alleged Ponzi Scheme.

The complaint alleges New Jersey natives invested $1.9 million with the LLCs in the Ponzi scheme. In connection with the fraudulent Ponzi scheme the New Jersey State Attorney General charged the Grahams with a the violation of the following under Title 49, Chapter 3 of the New Jersey Uniform Securities Laws:

1) N.J.S.A. 49:3-60 (offer and sale of unregistered securities)

The New Jersey Bureau of Securities recently entered into a Consent Order with LPL Financial. The broker dealer was found to have had poorly run supervisory procedures in place. Every broker dealer and securities firm in New Jersey has an obligation to establish reasonable policies and procedures to supervise and monitor the actions of the securities firm’s brokers and investment advisors. This lapse in adequate systems to supervise by the securities firm LPL, resulted in the sale of unregistered, non-exempt securities to LPL investors. According to the consent order the New Jersey Securities Bureau concluded that from October 1, 2006 to May 1, 2018 investment advisors marketed and sold unregistered securities to New Jersey Investors. The law firm of Lubiner Schmidt & Palumbo has written in the past on instances of securities fraud in connection with the sale of unregistered securities. One primary example of an unregistered security marketed to investors that turned out to be a securities fraud were Woodbridge Promissory Notes. These notes were marketed to investors as safe and secure investments that offered income and safety of the principal invested. In reality Woodbridge was a massive securities fraud operating as a Ponzi scheme.

The Attorney General and the NJ Bureau of Securities announced that LPL Financial had agreed per the terms of the Consent Order to a $499,000 civil penalty as well as a pledge to buy back any unregistered and non-exempt stock, bond or any other securities sold in New Jersey during the relevant time period by LPL investment advisors.

LPL also agreed to implement new supervisory procedures and compliance checks to prevent future sales and marketing of unregistered securities by investment advisors to New Jersey Investors. According to the consent order there were major deficiencies in the investment advisors compliance department.

On April 17, 2019 the New Jersey Bureau of Securities issued a proposal to require that retail broker dealers use the “fiduciary rule” in their dealings with customers. The rule proposal will also codify the fact that investment advisors already operate under the fiduciary rule. This will mean that in New Jersey brokers will have to put the interests of their clients first and not their commissions.

Imposition of the fiduciary standard on retail broker dealers has been a controversial topic nationwide for the past several years. The SEC staff has recommended to the Commission that the fiduciary rule be incorporated in federal securities laws. They have not been successful. Several years ago the Department of Labor passed regulations requiring that the fiduciary standard be applied to individual IRAs and 401(k) plans. However, a federal appeals court overturned those regulations in September 2018.

The SEC staff has now proposed to issue Regulation Best Interest in an effort to further enhance customer protection. However, in announcing its rule proposal, the Bureau of Securities stated that Regulation Best Interest does not go far enough in protecting investors.

The New Jersey Bureau of Securities announced that it has resolved its investigation of the online broker dealer Interactive Brokers LLC of Greenwich, CT (“Interactive”) relating to fraudulent trading activity and securities fraud Interactive permitted on its online trading platform. Interactive has agreed to pay a $100,000 penalty to the Bureau of Securities and reform its opening account procedures for investors looking to sign up with the broker dealer in the future.

The New Jersey Bureau of Securities investigation of the broker dealer Interactive arose from the fraudulent trading activity conducted by a former investment advisor Peter Zuck of Middletown, NJ, through his hedge fund, Osiris Fund LP of Jersey City, NJ. The former investment advisor Zuck operated the hedge fund from April 2009 through December 2011. According to the New Jersey Bureau of Securities, while Zuck promoted his hedge fund as a conservative trading fund, in reality his team conducted the investment fund’s trading in a “wildly speculative” and aggressive manner. Zuck opened 16 investment advisory accounts at Interactive. Two of the investment accounts were in his own name, and one for the hedge fund. The New Jersey Bureau of Securities investigation revealed that, after initially seeing trading profits, the hedge fund lost $4.5 million in April – May 2010. Zuck and his cohorts concealed trading losses from fund investors by fabricating monthly account statements showing investors their holdings and a breakdown of the securities and trading activity in the account. These monthly account statements falsely hid trading losses and inflated the accounts’ values. Zuck was also accused of charging investors $3.9 million in management fees to which the fund was not entitled. There were approximately 76 investors in the Osiris Fund.

As a result of Zuck’s illegal conduct managing the Osiris Fund, the New Jersey Bureau of Securities sued Zuck and others in 2014 and obtained a judgment of $7.5 million. In 2017, Zuck pled guilty in federal court to charges of conspiracy to commit fraud and tax evasion. He was sentenced to a three-year prison term in connection with the securities fraud.

Hector May, a registered investment advisor and 40 years securities industry veteran, pled guilty in federal court in New York in December 2018 to two counts of securities fraud. These securities fraud charges included conspiracy to commit wire fraud and investment advisor fraud. The former investment advisor faces up to 25 years in prison for securities fraud.

May was president of Executive Compensation Planning, Inc. (“ECP”) in New City, NY. ECP was affiliated with Securities America, Inc., and investment advisory headquartered in La Vista, NE. The SEC has also barred May from serving as an investment advisor, who is from Orangeburg, NY, and from any affiliation with the securities industry.

The federal prosecutor alleged that May and his daughter, Vania Bell May, who also worked at ECP, operated a classic Ponzi scheme from the 1990’s until March 2018. May convinced 15 of his clients that they should transfer funds from their existing Securities America accounts to new accounts from which May would purchase bonds and other investments on their behalf. In reality, the funds were delivered into a consolidated ECP brokerage account controlled by May and his daughter. They used the funds deposited in the fake investment account for personal and business expenses including cars, jewelry, country club dues, etc. The government alleged that May and his daughter stole $11.5 million from their clients.

            The Securities Exchange Commission (“SEC”) recently filed a complaint for fraud in connection with risky securities sold by a Registered Investment Advisor. The SEC complaint states that Tamara Steele and her investment advisory, defrauded retail investors by recommending high risk technology stocks with massive commission markups that were not disclosed to the clients. According the to the SEC complaint, from December 2012 through to October 2016 Steele and her wholly owned investment advisory Steele Financial marketed over $13 million of securities issued by a private company and was acting as a broker for the company.

The SEC complaint states that the high-risk securities were connected to a private issuer who the investment advisor had a relationship with. The registered investment advisor was receiving high commissions on these private securities in the range of 8 to 18% – a material piece of information that was not disclosed to investors in violation of the duty of care and duty of loyalty and breach of the investment advisors’ fiduciary duty. The SEC complaint goes on to state that Steele and Steele Financial marketed and sold these high-risk securities to clients even though neither entity was registered as a broker.

The clients who were marketed this product were not accredited investors. Rather most of the investors were employees of a school system. Steele was marketing these risky private securities while working for a broker dealer known as Comprehensive Asset Management. Steele was fired after disclosing to the broker dealer that she had been marketing the private securities without the firms approval or knowledge – a practice known as selling away. As stated in our post on Selling/Trading away FINRA rules mandate that an investor advisor provide prior notice to the broker dealer and receive approval for all private securities marketed. Brokers are required to report in writing.

Stockbrokers in the market do not all owe a fiduciary duty to their clients. A fiduciary duty, as listed in the Investment Advisors Act of 1940 calls upon investment advisors to act with the highest standard of care. It’s difficult for investors to tell when their stock broker owes them a fiduciary duty and even what having a duty owed to them would translate to. Investing with a financial professional who can be trusted to offer sage investment advice while also placing clients interests above their own is what any investor would want. But generally, what most investors discover if they ever consider filing a lawsuit or securities arbitration claim against their stockbroker for a stock market fraud claim of any kind, is that many investment professionals do not technically owe a fiduciary duty to their clients. What the stock brokers title is, which would seem like a small consideration when deciding who to invest with and use for professional wealth management is of critical importance.

Different Stockbroker Titles

When investors start looking to place money into the markets they are generally confronted with a barrage of titles stock brokers carry. Broker, Stockbroker, Investment Advisor, registered representative, account executive, financial advisor, portfolio management specialist, and on and on. What is important to understand and what few investors know before plunging into the world of professional wealth management, is that whether a broker truly owes a fiduciary duty of placing a clients interests before their own depends on a number of factors. Stock brokers making recommendations for a certain stock or bond alone, is not generally enough for a stock broker to be considered a customers fiduciary.

With the advent of new technology being employed at almost all broker dealers, the potential for a financial advisor to engage in excessive or unauthorized trading or “churning” has been substantially reduced. Churning is simply excessive trading in a brokerage account in order for the broker or financial management team managing the investment account to generate greater commissions.

In brokerage customer accounts, or trading accounts in which the broker is paid only when trades are generated, churning or excessive fees has always been a concern. If a broker is only compensated when selling or purchasing securities, the potential for the broker to engage in fraud is compelling. The logic of a brokerage account, as opposed to a fee based account, is that the model is suitable for investors who have a set asset allocation with very little trading activity. As opposed to a monthly or yearly fee for managing assets, known as a fee-based account or wrap account, customers who have set investments in stocks or bonds will save money because there is very little trading activity.

Now with the advent of a very basic trading systems algorithm, broker dealers should be able to immediately register when churning occurs by cross checking the total customer’s assets under management against the trading activity in the account. If the trading activity in comparison to a customer’s assets reaches a certain threshold, known as the turnover ratio, the broker dealer should have alerts in place to identify the client, the broker or financial advisor, and inform the broker’s branch manager. The branch manager should then conduct a review of the trading activity as well as the client’s investment profile. If the trading abuse is occurring in an investment account belonging to a senior citizen, new FINRA Rule 4512 has mandated brokerage firms to create a trusted contact person. This trusted contact person should be notified in order to respond to any possible stockbroker fraud being committed in the investment account. FINRA Rule 2165 permits brokerage firms that have a reasonable basis to believe that stock broker fraud has occurred, to place a temporary hold on the “disbursement of funds.” These rules and cross checks should make it very difficult to engage in churning. But still, it occurs more frequently than most other forms of stock broker fraud.

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