We aggressively protect our client’s rights, whether they’re businesses, investors, financial professionals, or whistleblowers. The tools of our trade are federal and state laws that regulate the securities industry and protect those who may be abused by it. Other laws or legal doctrines may also apply to participants in the securities industry. They include state common law doctrines of negligence and fraud, state statutes prohibiting elder financial exploitation, and unfair trade practices.  

In general, the federal system of regulation of investments is a disclosure system. The U.S. Securities & Exchange Commission (SEC) does not verify that securities offered to investors are valid, much less good investments. Most states and territories also have their own securities laws and commissioners who seek to ensure that securities offered by or to its residents comply with state/territorial and federal laws. 

The SEC and most state/territorial securities regulators seek to ensure that investors are provided with certain information that they can assess to determine whether to invest. They also seek to ensure that participants in the securities industry – like brokerage firms, individual brokers, investment advisory firms, and individual investment advisers – are complying with the law. 

There are a host of “self-regulatory organizations” like the Financial Industry Regulatory Authority (FINRA) that regulate certain participants in the securities industry. Those “SROs” have their own sets of rules with which regulated entities and individuals must comply.  Many of these laws and rules are virtually identical, but they give the government the ability to bring multiple, distinct claims based on the same conduct and also to seek additional relief like penalties.  FINRA also operates a dispute resolution forum that brokerage firms and their clients are required to use to resolve claims and disputes. 

Investment advisers are not regulated by FINRA or subject to any SRO rules, but they are required to fulfill common law fiduciary duties to their customers and comply with the Investment Adviser Act of 1940. The fiduciary duties of investment advisers historically were determined by courts of law, derived in part from cases filed in those courts. In recent years, however, investment advisory firms have often required that their customers consent to mandatory arbitration. This is usually buried in the fine print of account opening documents. 

Those arbitrations sometimes are with FINRA but often are with other more costly arbitration forums like the American Arbitration Association (AAA) and JAMS, another private arbitration provider. The filing fees and arbitrator costs in AAA and JAMS can easily reach tens of thousands of dollars. When investor losses are in the tens or even low hundreds of thousands of dollars, that can mean the investor has no practical way to vindicate their rights. 

Securities Act of 1933

The Securities Act of 1933 requires that issuers and others who are involved in the offer and sale of securities provide certain information when those securities are publicly offered and provide truthful information whether the offering is public or not. The SEC views this statute as having two objectives:

• Requiring that investors get specific financial and business information about securities offered for public sale, and
• Prohibiting and preventing fraud, misrepresentation, and deceit in connection with the sale of securities, whether those securities are publicly offered or not

For securities (like stocks and bonds) offered to the public, this law mandates that the offeror file a registration statement with the SEC. That registration statement is reviewed by the SEC, but that does not provide investors with assurance that the information is accurate or complete. 

A company offering securities to the public is required to disclose certain important facts in a registration form, like:

• The company’s business and properties
• A description of the security to be sold (like common stock, preferred stock, bond)
• Information on the company’s management
• Financial statements that are certified by independent accountants

Registration statements and prospectuses are made available to the public shortly after filing via the SEC’s Electronic Data Gathering, Analysis, and Retrieval (EDGAR) system.  While the SEC Staff examines registration statements, the SEC does not verify the accuracy of the information that is disclosed. Investors must do that themselves.

Companies and others involved in offerings may be charged by the SEC with failing to correct previously disclosed information in registration statements that is no longer accurate. They also may be charged with failing to timely disclose material information they learn to investors. 

This information is made available to permit investors to make informed decisions about whether to buy a company’s securities. Investors purchasing securities and later suffering losses have recovery rights if they prove essential disclosures were incomplete or inaccurate.

There are many securities offerings that are not required to be registered with the SEC. Those offerings are made under certain exemptions included in the law. Those exemptions include private offerings to a limited number of institutions or people and intrastate offerings. 

Companies making offerings under the exemptions are not required to file a public registration statement and are not required to disclose the specific information that a public offeror would have to disclose. The law still prohibits those offerings from being fraudulent, containing misrepresentations, or failing to include material information. 

Securities Exchange Act of 1934

Congress created the SEC with this law which empowers it with broad authority over the securities industry. The agency can regulate, register, and oversee transfer agents, brokerage firms, clearing agencies, and SROs like FINRA.  The SEC used its authority under this law to enact its antifraud rule, called Rule 10b-5. 

This law prohibits some types of market conduct and equips the SEC with disciplinary powers over regulated entities and people connected to them. Under this law, the SEC can also require companies with publicly traded securities to report information periodically (quarterly, annually). The law permits the SEC and individuals to file legal actions. 

This law prohibits fraud in connection with the offer, purchase, or sale of securities. The SEC often brings charges under the antifraud provisions of this act as well as the provisions prohibiting the sale of unregistered securities (that are not subject to a valid exemption) and to persons or entities acting as unregistered broker-dealers. SEC charges of unlawful insider trading are generally brought under the antifraud provisions of the act.  

The federal securities laws are periodically revised or amended by Act of Congress. They include the Sarbanes-Oxley Act of 2002, Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, and the Jump Start Our Business Startups (JOBS) Act of 2012. 

Illinois Securities Law of 1953

Federal laws get more attention than state statutes regulating securities, and state agencies don’t have the resources of the SEC and the Department of Justice. Still, they may be helpful in your situation because state law may cover securities that federal laws do not. For example, Illinois has a state statute that is enforced by the Illinois Securities Department of the Secretary of State’s office.

The Illinois Securities Law of 1953 prohibits: 

• Selling unregistered securities
• Making false or misleading material statements in reports filed under the law
• Obtaining money or property by selling securities based on an untrue statement
• Circulating a prospectus while knowing it contains material, false statements 

Other states have similar laws, but each has its own idiosyncrasies. Under Illinois law, a securities purchaser who suffers harm because the law was violated may seek a rescission of the sale. If successful, the seller must take back the security, refund the purchase price, and pay interest. Part of the process involves giving notice to responsible parties within six months of learning of the legal violation. 

FINRA Rules

FINRA has general and specific conduct rules. Brokerage firms and their registered representatives, as well as other individuals associated with brokerage firms, are regulated by FINRA. It has its own enforcement staff to investigate potential violations of its rules and of federal securities laws and regulations. 

Generally, those investigations are brought under FINRA Rule 8210, which permits FINRA to compel those it regulates to produce documents, answer questions, and appear to provide on-the-record testimony. FINRA has general and specific conduct rules. 

• Rule 2010 is a general conduct rule, which requires that a member (brokerage firm) observe high standards of commercial honor and just and equitable principles of trade
• Rule 2111 is a more specific conduct rule, which requires that any recommendation of a transaction or investment strategy involving securities be “suitable” for the investor

FINRA issues notices to clarify what its rules mean. 

Schedule a Free Consultation With Bragança Law Today

Whether you’re involved in an SEC/FINRA investigation, an investor seeking recovery of losses, or a whistleblower punished for doing the right thing, Lisa Bragança at Bragança Law can help. Your case’s outcome could affect you and your family for the rest of your life, which is why Lisa works tirelessly to get the best possible results for her clients.

Lisa Bragança works with clients nationwide, as well as those living in Chicago and its suburbs. Her office is about 26 miles from the Chicago Midway International Airport (MDW) and approximately 13 miles from the O’Hare International Airport (ORD). To schedule your free consultation, call Bragança Law at (847) 906-3460 or fill out our website’s contact form.

Short selling is selling a share of stock that you do not own. In order to engage in a short sale (with a few exceptions), a short seller is required to locate and borrow a share of stock before it engages in a short sale. Short selling is an artifice that our securities regulators allow to take place. But it has big fans – the hedge funds that use it to make significant profits by trading in the dark. 

Not even the SEC knows the amount of borrowing and lending of securities that takes place right under its nose. The SEC estimates that this market in late 2020 was almost $1.5 trillion. But that is just an estimate because all this borrowing and lending takes place in the shadows. It is stunning that the federal securities regulator would not know the volume of borrowing and lending of securities. 

The good news is that the SEC is finally getting around to using authority it was granted over ten years ago by the Dodd-Frank Act, in the wake of the collapse of another virtually unregulated market for credit default swaps. Although the SEC and CFTC were given broad powers to increase transparency in securities and derivatives marketplaces, the SEC has virtually ignored the massive opaque marketplace for borrowing and lending securities, even though AIG, which was a huge contributor to the 2007-2009 financial crisis, was a significant lender of securities. 

The SEC Proposal for Disclosure of Borrowing and Lending

Recently the SEC proposed a rule to require the public reporting of securities borrowing and lending transactions. The SEC proposal would require borrowing and lending of securities be reported promptly – within 15 minutes. This would allow regulators to finally have access to information on a timely basis about this enormous market. That information would then have to be made public as soon as practicable, but not later than the next business day. This still provides high-frequency traders – including hedge funds – with plenty of time to profit from an informational advantage. Thus, it does not appear to be overly onerous.  

The SEC is certainly not a trailblazer in this area. Since 2015, financial regulators in the European Union have been working on regulations that would require the disclosure of securities & commodities borrowing and lending, repurchase transactions, and margin lending. The SEC is at least seven years behind Europe on this.

Industry Objections to Disclosure

It is not surprising that the hedge fund industry opposes this proposed regulation. Hedge funds complain that this proposed rule requiring the disclosure of more information is likely to reduce overall short selling activity and lead to less efficient price discovery and lower market efficiency. Whether you like short selling or not, it is pretty audacious to argue that publicly disclosing these market transactions would make markets less efficient. 

A more reasonable objection is that releasing this information would reveal trading strategies and possibly permit front running. This is undoubtedly true. But why should hedge funds engaging in these kinds of transactions be protected any more than retail traders of stocks and bonds? 

Hedge fund trade associations filed comments in opposition to the rule, but seem to acknowledge some form of reporting is going to be required. The Managed Funds Association (a hedge fund interest group) complains about the excessive costs that this kind of reporting will impose on the industry. 

Industry Objects to Public Reporting of Individual Borrow / Lend Transactions

The MFA opposes the reporting of individual transactions. Another hedge fund interest group, the Alternative Asset Management Association (AIMA), says the SEC should limit reporting of securities borrowing/lending to the “wholesale market” and leaving out the “retail market.”  Reporting only “wholesale market” borrowing/lending means that only bulk transactions between lenders (like pension funds and mutual funds) and broker-dealers (like JP Morgan) would be publicly reported. The industry is fighting to keep the “retail market” transactions between the individual hedge fund and the broker-dealer from being made public. 

Industry Objects to 15-Minute Reporting

These industry groups also object to the proposed requirement that any information be reported within 15 minutes. They argue information should be reported to regulators  the next day (T+1) because it would be unduly burdensome to report earlier. That is hard to square with the contemporaneous reporting of stock and bond trades. It would be a huge change from the current reporting of  short positions – which make up only a part of securities lending/borrowing activity – which are required to be reported by broker-dealers to FINRA just twice a month. 

Another objection is that because all the borrowing/lending information could not be reported within 15 minutes the information that is reported would be misleading. (Fidelity Investments Comment). This is something that better reporting systems would be designed to solve. 

It is hard to square this with the current reporting scheme. Objectors seem to ignore the extensive securities transaction reporting systems that are already operating. FINRA’s comment cites its extensive experience establishing and maintaining systems to capture and disseminate financial transactions like the securities lending and borrowing transactions the SEC seeks to capture. FINRA specifically mentions it is well-positioned to do the kind of trade-by-trade reporting of securities lending/borrowing transactions required under the proposal because it already operates the Alternative Display Facility, OTC, ATS, TRACE, and other securities transaction reporting systems. It is hard to argue that FINRA lacks the ability to do this kind of reporting of securities borrowing/lending. 

In sum, it is audacious for hedge funds to argue that their trading activity should remain private when much of their trading is based on a steady stream of information about other people’s trades, which are almost instantaneously released publicly. This is simply an industry seeking to maintain an unfair advantage for as long as it can.

If you are an investor, how can you research a broker before turning over your hard-earned savings to them? The SEC, FINRA, state securities regulators, and others encourage investors to research a broker before turning over your hard-earned money to that broker to invest. The primary tool that these regulators and others recommend investors use is BrokerCheck. However, as investment loss recovery attorney and PIABA Foundation vice-president Lisa Bragança recently told Barron’s, “BrokerCheck is no longer a reliable record.”

BrokerCheck is a public database generated and maintained by FINRA from its Central Registration Depository (CRD) records. CRD contains information that brokers and brokerage firms are required to submit about their registrations, enforcement actions, regulatory settlements, terminations of brokers, and customer complaints. BrokerCheck contains some, but not all, of the information on CRD. Importantly, BrokerCheck includes customer complaints. The SEC, FINRA, state regulators and others encourage investors to consider customer complaints reported on BrokerCheck in deciding whether to work with a broker. But brokers use a process called expungement to erase perfectly valid customer complaints from their records.

What is Expungement?

Expungement is a process that was created so that brokers could erase false, factually incorrect or clearly erroneous complaints against them from the CRD/BrokerCheck public record. For example, a customer complaint might be reported on the wrong broker’s CRD record. Expungement is the process for the broker to have that improperly reported complaint removed from their record.

The expungement process is handled by FINRA, which delegates it almost completely to arbitrators. FINRA’s rules permit a broker to seek expungement by bringing a “claim” against their current or former brokerage firm in FINRA Dispute Resolution. This is a sham proceeding because the brokerage firm rarely objects or opposes a broker seeking expungement. State securities regulators are not given an opportunity to object in the arbitration proceeding. It is only after the broker gets an arbitration award of expungement and is seeking to have it blessed (confirmed) by a court of law that state regulators are notified. Then, state regulators must decide very quickly and without adequate information whether to object to confirmation of the expungement award. Most of the time, the broker obtains confirmation of the arbitration decision granting expungement in a court of law by misrepresenting that the decision is the result of a true dispute. Courts of law are not informed by FINRA or the parties of the truly collusive nature of the expungement process. As a result, courts routinely confirm expungement awards and FINRA erases the customer complaint from the broker’s CRD/BrokerCheck record.

PIABA and the PIABA Foundation have studied 14 years of expungement data. Attorney Bragança, who is also a former branch chief in the Division of Enforcement of the Securities & Exchange Commission (SEC), is a co-author of the most recent “2021 Updated Study on FINRA Expungements,” released on May 18, 2021. The study is a follow-up to a 2019 expungement report she co-authored and a 2013 expungement report. The study demonstrated that proposed expungement rules that FINRA sought to have the SEC approve would not make an appreciable difference in the process. The study showed that the proposed expungement rules failed to address the fundamental flaw in the process – the lack in almost all expungement proceedings of any opposing viewpoint.

Less than two weeks after the release of the 2021 Updated Study on FINRA Expungements, FINRA announced that it was “temporarily” withdrawing its proposed rules and that it would work with NASAA (North American Securities Administrator Association) to redesign the current expungement process as well as including “stakeholders with insight on the expungement process”.

For the first time, FINRA created a page on its website on expungement of customer disputes.

Now that FINRA has withdrawn its proposal, we hope it will temporarily embed an investor advocate in the arbitration process to make the proceedings more adversarial and less one-sided. But the ultimate goal, as Attorney Bragança told FinancialPlanning.com, is to move expungement away from arbitration altogether and into a regulatory process, where officials from state agencies, the SEC or FINRA would make the final determination of whether to remove a complaint from a broker’s record. “So far, she says, FINRA hasn’t warmed to those ideas. ‘Has FINRA been receptive? In a word, no,’ Bragança says. ‘I’m still waiting for a phone call. I would absolutely welcome the opportunity to work with FINRA on this.’”

Why Can’t Investors Trust BrokerCheck?

Why can’t investors trust BrokerCheck to provide reliable customer complaint information about brokers? For years, FINRA has permitted brokers to erase valid customer complaints from their CRD/BrokerCheck regulatory records through the process of expungement. Since 2013, PIABA and the PIABA Foundation have steadily documented how FINRA’s expungement process allows brokers and brokerage firms in the United States to erase legitimate customer complaints from their BrokerCheck records. Many of the customer complaints that brokers have erased from their records have been resolved through confidential settlements of FINRA arbitrations. Brokers or brokerage firms have often paid substantial sums – sometimes more than $1 million – to settle these customer claims.

How Serious is the Problem With the Expungement Process?

How extensive is this abuse of the expungement process? 90% of the time a broker seeks expungement, they are successful. Brokers know this and are bringing more expungement cases and getting more customer complaints erased from BrokerCheck. Each day more and more customer complaints are expunged from BrokerCheck. Arbitrators are still granting broker requests to have claims that were settled for far more than nuisance value — like this claim against a UBS broker that was settled for $165,000 – permanently expunged from CRD and BrokerCheck. The expungement request was filed in March 2021 and by the end of May an arbitrator had heard the “dispute” and granted expungement.

Here is how expungement operates today. A broker may request expungement by bringing an arbitration claim against his or her current or former brokerage firm. FINRA calls this a straight-in expungement. The so-called dispute is between the broker and their own brokerage firm. 98% of the time the brokerage firm does not object to the broker’s request for expungement. The process is more like a consent order than a dispute. Yet it is still run through the FINRA Dispute Resolution process.

Under FINRA rules, the customer whose complaint the broker is seeking to expunge has the right to appear and object. In reality, the customer not given meaningful notice that an expungement hearing is taking place. The customer has no right to see the evidence or documentation that will be considered at an expungement hearing before the hearing takes place. The expungement process is “designed for people not to participate,” according to Jason Doss, president of the PIABA Foundation and a co-author of the 2021 PIABA report.

What is FINRA Doing About the Expungement Process?

FINRA has been aware of abuses of the expungement process for years and taken some steps to rein in brokers. Early on FINRA address the problem of brokerage firms requiring in settlements of customer complaints that the customer agree not to oppose expungement. FINRA adopted a rule that addressed that one particular problem. That merely caused brokerage firms to pivot to get substantially the same result by including non-disparagement and confidentiality provisions in agreements to settle customer complaints. This leaves customers opposing expungement at risk of being sued by a broker or firm for breach of contract.

The proposal that FINRA just withdrew proposed conducting enhanced training of arbitrators on the expungement process and creating a specialized roster of arbitrators to hear expungements, which likely would make things worse. While FINRA proposed a number of changes in its now-withdrawn proposal, the fact remains that expungement cases are rarely disputes. Yet, FINRA forces them to be decided in a dispute resolution forum. This is like forcing a square peg into a round hole.

What Steps Need to Be Taken?

The best answer is to have regulators make the regulatory decision of whether to grant a broker’s request for expungement of a customer complaint. A regulator would decide whether the customer complaint has regulatory or investor protection value or not.

PIABA and the PIABA Foundation recognize that it is unlikely that expungement will be decided by regulators in the near term. As a result, PIABA and the PIABA Foundation propose the creation of a new “independent investor advocate” position to represent the interests of unrepresented stakeholders at expungement hearings. “If FINRA is going to have a monopoly on the expungement process, we need someone that is responsible for minding the store – to make sure that valid customer complaints are not erased from the public record,” states Attorney Bragança.

The 2021 PIABA report suggests that an independent investor advocate in the arbitration process could serve a function comparable to that of a guardian ad litem in a court of law. An independent investor advocate could represent the interests of state securities regulators, customers, and the public in opposing expungement of valid customer complaints that have regulatory and investor protection value.

In a live-streamed video conference conducted on May 18, PIABA Foundation president Jason Doss said, “An investor advocate empowered to intervene to oppose expungements . . . is the only way to fix this system and keep thousands of additional customer complaints from being wrongfully erased from the public records.”

Lisa Bragança will continue to advocate for accurate information on BrokerCheck, for meaningful reform of the expungement process, and for investors seeking to recover their investment losses because of broker fraud and misconduct.

With good reason, financial elder abuse has been characterized by some experts as “the crime of the 21st Century.”

– Broken Trust: Elders, Family and Finances. Metlife Study, March 2009

The second edition of Aging and Money was just released including a chapter that I co-wrote with Lisa Bleier of SIFMA, entitled Perspectives from Financial Institutions. This is a subject that I have been working on for years and this was a great opportunity to contribute to a book written for healthcare professionals.  

The risk of financial exploitation of elders today is significant. In one case that haunts me, a financial advisor and his family took advantage of a customer as her dementia progressed. After befriending her, they isolated her from her family and abused a power of attorney they obtained to take unauthorized actions – including secretly maintaining complete control of the customer’s bank and brokerage accounts. They knew that the customer had an estate plan that provided for a family member to handle her affairs should she lose the capacity to do so. Yet, when the customer’s family, who lived far away, asked whether the customer had an estate plan, the financial advisor threatened to drag them through court. As a result, the truth did not come out for over six years, until after the customer died.

I also have an elderly family member whose declining cognition caused her to repeatedly fall victim to scams, including the Nigerian prince, even after she learned they were scams. She would continue to send money when she received phone calls. Nevertheless, I have elderly family members who refuse to take steps to protect themselves should their cognitive abilities decline. Many other lawyers, financial advisors, and law enforcement personnel have family members who they cannot convince to take precautions to protect themselves from elder financial exploitation. 

Many of us are fiercely independent and want to remain that way until the very end. Many of us do not want to talk about money with family and friends. That is dangerous as we age. We need to connect with family, friends, or professionals who can step in when needed to protect us from financial predators. 

Aging and Money is an important resource for healthcare practitioners to use in working with all patients to prepare for the cognitive decline that is common as we age. There were 52 million people over the age of 65 in 2018. Estimates are that over 5% of this group has been a victim of elder financial exploitation. This pool of victims will only grow as baby boomers age. 

Many of us may not notice cognitive decline as we age. Others of us may refuse to recognize it. I have spoken to many family members of elders who have been swindled and remain unwilling to acknowledge that they need help. Despite my work on this important issue and my own family member being a victim, I have older family members who refuse to take steps to protect themselves from financial exploitation. 

This subject gets media attention periodically when the victim is someone famous like Mickey Rooney or Brooke Astor. That might lead people to believe that this is a problem only for wealthy older people. That is not true. Many low-income and middle-income elders experience financial exploitation. 

Healthcare professionals can be an important part of the effort to reduce elder financial exploitation. Clinicians are in a good position to assess and document the risk factors of patients. Medical records documenting the symptoms of dementia can be instrumental in the prosecution of the perpetrators of financial exploitation as well as in civil actions to recover the funds. By recovering funds or at least halting the exploitation, clinicians can play an important part in keeping an elderly patient from the extreme stress of losing a home, having to move to a nursing facility, or becoming a ward of the state. 

The identification of risk factors along with advice about preventive steps can be an important part of healthcare for aging patients. This is a conversation that can start at a younger age when a person may be less concerned about losing their autonomy. People in their 40s and 50s may be more open to taking steps to protect themselves when contemplating financial exploitation that could take place years in the future. 

In the chapter I wrote with Lisa Bleier, we address what financial institutions, including banks, brokerage firms, and investment advisers are doing to prevent elder financial exploitation. What clinicians call “mild cognitive impairment” affects a significant number of individuals over the age of 75 and can have a significant impact on an individual’s ability to make financial decisions. There are steps that financial institutions can take if they become aware that a person is at risk of financial exploitation. Organizations like SIFMA have created a great deal of educational material about elder financial exploitation. Our chapter identifies websites where clinicians can find these resources. 

Abuse of Trust

A consistent theme in elder financial exploitation is that the perpetrator is usually someone who the elderly victim trusts: a family member, a close friend, a nursing home staffer, or a trusted financial advisor or accountant.

Clinicians are in a good position to not just identify when this exploitation has already happened, but to identify those at risk of falling victim in the future to such exploitation. Clinicians can encourage patients to establish a preventive system of checks and balances before cognition declines. For example, clinicians can ask patients if they have identified a trusted contact on brokerage accounts and if they have set up with their banks and investment firms to have statements sent to two unaffiliated persons – like a family member and an accountant. 

Resources 

Here are links to a few of the resources that SIFMA publishes showing what financial institutions can do to detect and prevent elder financial exploitation. 

SIFMA Senior Investor Protection Initiative Client Protection Playbook, available at Toolkit Client Protection Playbook, Senior Investor Protection Toolkit.  

The Red Flags of Financial Exploitation and Cognitive Decline, available here.  

It was a pleasure to write Chapter 9 with Lisa Bleier of SIFMA. I appreciate the work that SIFMA is doing to overcome legal obstacles to financial personnel reporting suspected elder exploitation as well as SIFMA’s education and outreach work in this area. I look forward to future collaborations with Lisa. I also want to thank Dr. Ronan Factora and his colleagues for editing the book and Dr. Robert E. Roush for contacting me about the second edition and his tireless advocacy in this area. His enthusiasm and energy inspire me to do more. 

You can learn more about the book here. Here is the table of contents.

This information is not legal advice and is provided for educational purposes only. This information does not create an attorney-client relationship. For legal advice, consult with a qualified attorney about your specific circumstances.

Many people are understandably concerned about their investments right now (spring 2020). News of the global pandemic is enough to cause the resolve of even the most steadfast investor to falter.

Why are Investors at Risk of Making Bad Investment Decisions?

We have never had a time where this kind of stress was affecting this number of individual investors. The Spanish Flu pandemic took place over a century ago – before the advent of IRA, Roth IRA, 401(k), 403(b) accounts – so a relative few people were making investment decisions. The more recent Great Recession, while affecting millions of individual investors, did not directly threaten the health and safety of individuals.

Stress makes all of us more likely to making bad decisions. Stress makes it more likely that we will succumb to behavioral biases that affect us all. For example, people are generally loss averse – we have losing a dollar more than making a dollar. So market downturns and volatility like we are experiencing can cause folks to cash out precipitously. People also tend to overweight recent events versus putting them in historical perspective. It is important to remember that markets go down as well as up. We have just experienced over ten years of a rising market. To put recent events in perspective, consider markets over the last century:

Many of those folks coming to you with investment suggestions are likely to be overconfident. It is hard for investment professionals to say “I don’t know.” It is hard for most people to say that. But that is what financial advisors should be saying – often. Beware folks who seem to have all the answers. 

What that means right now is we, as investors, should be even more careful than usual. We should take our time before executing any investment decision. There will be folks out there claiming that they have a safe alternative for scared investors. Some of these folks will be hawking fraudulent investments. Some of these folks will genuinely, but wrongly, believe that what they are selling is safe. 

Beware So-Called Safe Investments Like Fixed Indexed Annuities and Non-Traded REITs

There are two kinds of investment products that are likely to be misrepresented as “safe” investments that are not. They are fixed indexed annuities and non-traded REITs. 

Fixed Indexed Annuities Lock Up Your Money for Many Years and Charge High Fees

What could be more comforting than the prospect of having a fixed income stream for life? That is the promise of annuities. Many of us already have some form of annuity – Social Security. Many of us pay Social Security taxes (like premiums) for many years and once we reach a certain age, we expect to collect a steady stream of income. Others are part of various pension plans for teachers, military personnel, federal and state employees, and sometimes employees of private entities. In those cases, you already have an annuity as part of your retirement portfolio.

I have written about the problems of fixed indexed annuities before. Since I wrote that piece, the sales of fixed indexed annuities have continued to skyrocket. Here is why those annuities are not the answer to our prayers.

Fixed indexed annuities are high fee products. You pay layer upon layer of fees to the insurance company that sell these products. Those fees are buried in the fine print that even the selling agent probably has not read. Moreover, all those nifty add-ons that you can get with the annuity are going to cost you. Those fees reduce your returns in ways that are not clearly disclosed in the hundreds of pages of documents you are given.

Fixed indexed annuities have long surrender periods. That means your money is locked up for a long period of time – like 7 to 20 years. You can get withdraw small amounts of money without paying surrender charges. But if you withdraw more, you have to pay surrender charges to the insurance company. Those surrender charges can be over 15%. That is a hefty fee to get your money in a pinch. Because these products pay big commissions to selling agents, the agents tend to emphasize the features (often including upfront bonuses) and downplay the risks (fees and index returns that fail to include dividends). Tara Siegel Bernard recently wrote an excellent article in the New York Times about fixed indexed annuities. You can access it here.

Finally, fixed indexed annuities are riskier than social security and other federal, state, and local pensions because they are issued by a company, not the government. While issuers are generally big stable insurance companies, even those insurance companies can become insolvent. Remember how AIG had to be bailed out by the federal government in the Great Recession? While state and municipal pensions might reduce benefits in the future, it is possible to lose all of your annuity investment if the issuer becomes insolvent.

Before you buy a fixed indexed annuity, consult with an independent advisor who understands these things. Some of those folks are identified in the Tara Siegel Bernard New York Times article mentioned above.

Non-traded REITs are Illiquid Investments With High Fees

Non-traded real estate investment trusts (REITs) are bad investments for many of the same reasons that fixed indexed annuities are bad investments. They charge high fees, some of which are used to pay high commissions to the financial advisors selling them. Non-traded REITs are not traded on any exchange so you cannot sell your shares if you need money. Non-traded REITs are also hard to value. Since the underlying real estate is not traded on an exchange, you have to rely on the REIT’s management to value those assets. There are long periods of time when markets may be volatile when it may wrongly appear that your non-traded REIT is stable. That is not the case. The fact that REIT management has not revalued the underlying assets does not mean that those assets are not worthless. You won’t see that until management sends out the next valuation.

Before you decide to invest in a fixed indexed annuity, a non-traded REIT, or a similar investment product, take the time to have it evaluated by an independent expert. While we routinely have a used car inspected by an independent mechanic and a house inspected by an independent expert before we buy, we do not do that with investments. That is a good way to avoid making a big investment mistake now and in the future.

Beware the substantial risks of buying annuities, particularly when you are older. When you buy an annuity you pay a chunk of money to an insurance company to get payments in the future. Sounds good, but for excessive fees you pay and the fact that you lose access to your money. What if you or a family member has an emergency? Until you are out of the surrender period, you will have to pay substantial penalties to get access to your money.

What are Annuities?

An annuity is a contract under which you make a lump-sum payment or series of payments to an insurance company. In return, the insurance company agrees to make periodic payments to you beginning immediately or at some future date.

There are generally three types of annuities — fixed, indexed, and variable.

In a fixed annuity, the insurance company agrees to pay you periodically a specified amount per dollar in your account. These periodic payments may last for a definite period, such as 20 years, or an indefinite period, such as your lifetime or the lifetime of you and your spouse.

In an indexed annuity, the insurance company credits you with a return that is based on changes in an index, such as the S&P 500 Composite Stock Price Index. Indexed annuity contracts also provide that the contract value will be no less than a specified minimum, regardless of index performance.

In a variable annuity, you can choose to invest your purchase payments in different investment options, typically mutual funds. The rate of return on your annuity and the amount of the periodic payments you eventually receive, will vary depending on the performance of the investment options you have selected.

Fixed and indexed annuities are generally not considered securities by federal and state regulators. They are regulated by state law and state insurance commissioners and sold by insurance agents.

What are the Benefits of an Annuity?

Annuities can provide peace of mind. You can lock in a fixed payment for the rest of your life. That can be valuable to a retiree who fears outliving his or her savings.

Annuities can offer tax-deferred growth of earnings. That may be useful for retirees who are still earning a lot and in a high tax bracket.

Annuities may be useful in estate planning. They often include a death benefit that will pay your beneficiary a specified minimum amount, such as your total purchase payments. Some annuities may help you become eligible for Medicaid.

Annuities offer bonuses! Insurance companies have all kinds of great offers. For example, you might qualify for an upfront credit of $10,000 for a $100,000 annuity. That looks like free money. It is not.

What’s Not to Love About Annuities?

Annuities are high fee products. You pay layer upon layer of fees to the insurance company. You pay fees for all the bells and whistles that are added to the annuity.

Annuities also limit your access to your money. Most annuities have a surrender charge period of 7 to 20 years. If you withdraw your money during the surrender charge period, you have to pay surrender charges to the insurance company. Those surrender charges can be 10% or more of the amount you invested.

Let’s get back to those nifty bonuses. The bigger the bonus an insurance company is offering, the worse the terms of your annuity contract are likely to be. For example, for a 10% upfront bonus, you are likely to be locked into an annuity contract for 10 to 20 years. That is a long time to not have access to your own money. That lock-up period is defined by the length of time you have to pay “surrender charges” to withdraw your money. What if you or a family member becomes ill or disabled? You will pay a big penalty to get access to your money.

Why Would My Agent Recommend an Annuity?

Financial advisors and insurance agents love annuities because annuities generate substantial commissions. Insurance companies spend a lot of money marketing annuities to advisors and agents. The companies pay substantial commissions to encourage advisors and agents to sell annuities to their customers.

Because annuities are so profitable, it is easy for advisors and agents to convince themselves that they are good for their customers. An agent could earn a $35,000 commission upfront for selling a $500,000 indexed annuity to a customer. That big commission means that advisors and agents have a powerful incentive to search for annuities that are “right” for their customers.

What are Regulators Doing to Protect Me?

If you purchased a variable annuity, the agent and insurance company are subject to regulations of the SEC, FINRA, and state securities commissions. Your financial advisor has a duty to recommend only those variable annuities that are “suitable.” Your state law may impose a higher standard.

If you purchased a fixed or indexed annuity, the agent and insurance company are subject to much weaker regulation. Fixed and indexed annuities are generally considered insurance — not securities. As a result, they avoid having to comply with regulations of the SEC, FINRA, and state securities commissions. Customers must rely upon much weaker state insurance laws and regulations for protection.

Insurance regulation by some states, like Illinois, is virtually useless for purchasers of annuities. If you are in Illinois, a seller of insurance products has a virtual license to take advantage of you. You are required to file a lawsuit within two years of the date you purchased the fixed or indexed annuity — even if you don’t have any idea that you have been taken advantage of.

What happens when you discover a problem more than two years after you purchased a fixed or indexed annuity? If you are in a state like Illinois, you may not be able to recover any of your losses. Thanks to the state legislature and the insurance lobby you are likely more protected buying a used car than a fixed or indexed annuity.

What Can You Do if Someone Recommends an Annuity?

• Get help! Annuities are complex products so don’t count on understanding how an annuity works on your own. Here are some articles that anyone selling you an annuity should understand: Annuity, Calculate Annuity Payments. Don’t be afraid of admitting you don’t understand because the agent selling you the annuity probably does not understand how the annuity works. Ask the agent recommending the annuity to explain it to your CPA, attorney, or a trusted friend or family member.
• Hire an experienced and independent attorney to review the annuity contract before you sign it. You would hire a real estate attorney to review a contract to purchase a house, right? Why not hire an estate planning/elder law attorney to review an annuity contract that might be bigger than your mortgage? Attorneys who are actively involved in advocating for elders can be particularly helpful because they often see how annuities are misused. The National Association of Elder Law Attorneys (NAELA) is one place to find a qualified attorney. (Disclosure: I am a member of NAELA.)
• Hire an insurance consultant for a fixed fee to look at the annuity. There are consultants out there who can tell you whether a particular annuity is a good product for you. One is the Fee Advisors Network.
• If your agent is rushing you, RUN. Your agent is likely gunning for a big commission. There might be a “deadline” looming on a bonus offer — that’s a popular sales pressure tactic. That bonus won’t be worth the cost of being stuck with a bad annuity for 10 or 20 years. There are lots of insurance companies out there with lots of annuities. Take your time and get good advice before you act.

Fran Tarkenton loves equity indexed annuities. That does not mean you should. Tarkenton is 79 years old and encouraging elders to purchase equity indexed annuities (also called fixed indexed annuities) as a way to protect themselves from elder financial abuse.

That’s right. Fran Tarkenton is encouraging elders to purchase these high fees, non-liquid insurance products instead of investing in low fee, highly liquid investments like broadly diversified stock and bond index funds. Tarkenton has even written a book touting equity indexed annuities as the answer to protecting seniors from financial abuse by family members.

Tarkenton has good reason to love equity indexed annuities — he sells them. They are good for him because they generate substantial commissions and fees for him. If you read this article, you will learn that Tarkenton owns some of these annuity products, but also lots of stocks.

While family members do engage in elder financial abuse, so do financial advisors and insurance salesmen. Selling unsuitable equity-indexed annuities to elders often is elder financial abuse because of their high fees and lack of liquidity. These annuities often have surrender periods of over 10 years. What happens when the elder investor needs money for medical expenses or long term care? The investor is out of luck – that’s what happens. Why do agents sell them to unsuspecting elders? Because the agent can earn an upfront commission from the insurance company of as much as 10%. A commission that is not disclosed to the purchaser.

Purchasers of equity indexed annuities are not protected by law the same way that purchasers of mutual funds, stocks, bonds, and even variable annuities are. That is because the powerful insurance industry convinced Congress that equity indexed annuities are insurance products — not securities — even when folks hawking them are obviously selling them as investments. If those annuities are not part of an overall investment plan, you might not be able to recover damages in FINRA arbitration.

I address the problems of annuities for retirees in another post that you can find here.

Getting back to Tarkenton, here is another reason he might prefer to sell annuities, rather than securities products. Twenty years ago, Tarkenton settled SEC charges of engaging in a fraudulent scheme to inflate his company’s earnings. 

In its complaint, the SEC charged the following: “Tarkenton, Addington, Gossett, Fontaine, Hammersla, Alvarez, and Welch engaged in a fraudulent scheme to inflate KnowledgeWare’s financial results to meet sales and earnings projections. In all, KnowledgeWare reported at least $8 million in revenue from sham software sales. KnowledgeWare “parked” inventory with software resellers and other supposed customers that were given the right not to pay for the software, either orally or in “side letters” that were kept separate from the other sales documents. As a result of this scheme, KnowledgeWare falsely reported record sales revenue and dramatic increases in earnings in press releases and in quarterly reports filed with the Commission and disseminated to the public in 1993 and 1994 (“Quarterly Reports”).”

“Even when KnowledgeWare later restated those quarterly results, KnowledgeWare continued to mislead the investing public by claiming, in its annual report for Fiscal Year 1994 and other public documents, that the restatement resulted from a problem with the “collectibility” of reseller receivables — without disclosing that KnowledgeWare had created the problem by “selling” software and simultaneously granting the “purchaser” the right not to pay for it.”

“Tarkenton, Addington, and Gossett directed the fraudulent scheme and made materially false and misleading statements to purchasers of KnowledgeWare stock. Gossett also made materially false and misleading statements to KnowledgeWare’s auditors…. With the exception of Fontaine, each defendant received excess incentive compensation as a result of the scheme.”

According to the SEC, “Tarkenton consented to the issuance of a final judgment permanently enjoining him from (i) committing securities fraud in violation of Section 17(a) of the Securities Act of 1933 (“Securities Act”) or Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”) and Rule 10b-5; (ii) falsifying corporate books and records or engaging in other conduct in violation of Section 13(b)(5) of the Exchange Act or Rule 13b2-1; and (iii) from engaging in conduct as a controlling person that would render him liable pursuant to Section 20(a) of the Exchange Act for violations of corporate reporting, recordkeeping and internal control provisions of the Exchange Act (Sections 13(a) and 13(b)(2) and Rules 12b-20, 13a-1 and 13a-13). Tarkenton also agreed to pay a civil money penalty of $100,000 and disgorge $54,187, the amount of the incentive compensation he received in Fiscal Year 1994 on the basis of KnowledgeWare’s materially overstated quarterly earnings, plus prejudgment interest thereon.”

Tarkenton might love equity indexed annuities more than securities because he could not get a license to sell securities.That’s just my opinion. I could be wrong. – Lisa Bragança

The American Bar Association recently published some very helpful guidance for lawyers in considering client capacity to make legal and other decisions. The most important directive is that the correct question is NOT whether a client has capacity — it is whether a client has capacity TO DO A PARTICULAR THING.

Persons with significant cognitive impairments still have the capacity to make certain decisions in their lives. It is important for a lawyer to determine whether a client has the capacity to make decisions about legal matters. This is increasingly important as we serve more aging baby boomer clients.

The ABA notes that “capacity is defined as the ability to perform a task — or make a decision. State laws set out standards of legal capacity for various tasks — to consent to treatment, make a will or deed, make a gift or contract.” A client may have significant cognitive impairments and still have the capacity to make certain important decisions.

The ABA reports that “recent changes have called the legal term “capacity” into question. The U.N. Convention on the Rights of Persons with Disabilities in Article 12 recognizes that “persons with disabilities enjoy legal capacity on an equal basis with others in all aspects of life” and that governments must take measures to assist individuals in exercising their capacity. The emerging principle of supported decision-making focuses on providing the needed support to help people make decisions. Finally, the 2017 Uniform Guardianship, Conservatorship and Other Protective Arrangements Act (UGCOPAA), approved by the Uniform Law Commission for adoption by state legislatures, do not use the term “capacity” – rather, it guides courts in determining whether there is a “basis” for the appointment of a guardian, taking into account needed supports and supported decision-making.”

But, the ABA notes, client capacity is still the touchstone in many statutes and in much case law. Below are the ABA’s 10 commandments of capacity. Check out the description of each of these “commandments” here.

I. Thou shalt presume capacity.

II. Thou shalt talk to the client alone.

III. Thou shalt take steps to maximize client abilities.

IV. Thou shalt not worship anyone standard for capacity.

V. Thou shalt not covet the mini-mental status exam.

VI. Thou shalt not end any query with only the word “capacity.” Yea, the proper query shall be, “Capacity to do What?”

VII. Thou shalt seek the big picture, with all its variability, intermittency, and nuance.

VIII. Thou shalt honor thy client’s own considered or habitual standards of behavior, goals, and values, not those held by you or others.

IX. Thou shalt honor thy client’s confidentiality and autonomy even in the face of incapacity.

X. Thou shalt plan ahead to ensure that one’s wishes are respected.

Would you fix a pipe if you thought it might be leaking? Just like pipes in your home, your retirement accounts can be leaking excessive fees — which is money you could use in retirement.

If you have a retirement account — like a 401(k) or 403(b) account — with a small or medium-sized employer, your hard-earned money may be leaking. According to Barron’s, “the industry’s priciest funds are in accounts that are too small to get much attention. Sometimes they’re in the 401(k) plans of small businesses. Sometimes they’re in target-date funds. Sometimes they’re simply in portfolios with less than the $1 million needed to command the attention of advisors.”  Read article.

Mutual fund fees have declined substantially over the years, but those fee reductions have primarily benefited large investors and the retirement plans of larger employers. It is likely that the lawsuits filed against large plan sponsors and the Department of Labor’s proposed fiduciary rule for retirement accounts helped. But many folks working for small and medium employers are still paying excessive fees.

Employer Retirement Plan Offerings With Excessive Fees

Retirement plans offered by smaller employers often are chock full of high fee investments. According to  Micah Hauptman, financial-services counsel at the Consumer Federation of America, “investors who have small 401(k) plans pay costs that are orders of magnitude higher than they could pay for similar products in the self-directed retail market.” Read article.

A smaller employer may have a retirement plan that offers many “proprietary funds” — funds that are run by and pay fees to the company managing the retirement plan. Those proprietary funds may charge excessive fees — which reduces the money you have for retirement.

Excessive fees can be buried in different share classes — particularly “C” class shares. “C” shares are charged a 12b-1 sales and marketing fee that is not charged to “institutional” shares. Those fees reduce the money you will have for retirement.

Excessive fees can be in the form of “loads” — which are basically commissions. Investors who pay those loads may believe that they are getting a better investment option. Sadly, that is often not the case. Often those “load” funds also have higher fees. It seems that Wall Street has figured out that investors who do not object to paying a load do not notice higher fees. Loads and other fees reduce the money you will have for retirement.

To be fair, the administrative expenses of smaller retirement plans must be spread over a smaller number of participants leading to higher expenses per participant. But, that does not mean the investors in those plans should be gouged by paying hidden and excessive fees.

Target-Date Funds Charging Excessive Fees

Faced with an array of overwhelming and confusing investment options, many investors choose to invest in a target-date fund. That can also be a default option in a retirement plan. A target-date fund is a set-and-forget-it option. It makes sense for many people who don’t want to think about their investments.

A target-date fund will cost a little more in fees than putting together your own basket of funds because you are paying someone to manage the fund for you. That is reasonable.

What is not reasonable is a target-date fund loading up on excessive fee investments that benefit the fund manager. On the one hand, a target-date fund run by Vanguard and full of Vanguard’s low fee index funds can be a great option. On the other hand, a target-date fund run by a company like Voya and full of underperforming funds and small expensive funds that Voya manages can be a lousy option.

It can be hard to figure out whether you are in a good or bad target-date fund. One good place to start is to ask your employer to check. You can also do some online research or your own using Morningstar or Yahoo Finance.

Bottom line – If you work for a small to the medium employer, don’t assume the investment options in your retirement plan are good. Ask your employer to include index funds, no-load funds, institutional shares, and lower fee target-date funds.

What should you do if you discover that your mother, father, or an elderly relative has inappropriate or suspicious investments? Do not ignore it. As difficult as this situation is for families, it is important to take action to protect our elderly family members before they lose a lifetime of hard-earned savings.

Research

1) Go to BrokerCheck to do some research on the brokerage firm and individual financial advisor. On BrokerCheck, you can find out if the brokerage firm or financial advisor has been the subject of regulatory actions or customer complaints.

BrokerCheck provides investors with information about regulatory actions and customer complaints. Most financial advisors have few, if any, customer complaints or regulatory actions.

Be aware that BrokerCheck is not comprehensive. Financial advisors who are not found liable in a customer case or who settle a customer case often have those complaints “expunged” or removed from BrokerCheck. Even with that caveat, BrokerCheck is the best resource available to investors to research brokers and financial advisors.

Consult Experienced Attorney

2) Review recent account statements and other documentation of the investments with an experienced investment loss attorney. Typically, an attorney who recovers losses for investors will, for no charge, review a potential client’s investment portfolio. An experienced attorney can identify red flags that may mean you can recover investment losses.

• Do not delay! The longer you wait to bring claims, the more difficult it can be to recover losses.

Get a Second Opinion

3) Get a second opinion by having your accountant or financial advisor review the relative’s investments. These professionals can give you some idea of whether the portfolio is diversified and appropriate for an elderly investor. Consult only those professionals who are completely independent of the broker and financial advisor. Make sure you do not rely on a nonlawyer for legal advice on whether you can recover investment losses. This is not a substitute for consulting with an attorney.

Protect Elderly Investor Going Forward

4) Establish checks and balances going forward:

• Ask your relative to identify a trusted contact person on all brokerage accounts.
• Ask your relative to have copies of brokerage account statements sent to a trusted family member.
• Some elderly investors grant a trusted family member a power of attorney over the account as a precaution. Ensure that anyone with power over the account is trustworthy and monitored.

Address Cognitive Disabilities

5) If your relative has a cognitive disability, such as dementia or Alzheimer’s, consult with a qualified elder law attorney (many are members of the National Association of Elder Law Attorneys – naela.org) who can help you determine how to protect your relative while maintaining his or her dignity and autonomy to the greatest extent possible. Together you can consider a number of alternatives.

Monitor Even Trusted Advisors

6) Many investors have longstanding relationships of trust with their financial advisors. They may be personal friends. They may attend the same church or temple or belong to the same civic organizations. That is not a reason to defer to a financial advisor. Financial advisors, just like the rest of us, can rationalize doing things that are in their best interests.

For more help with protecting the elderly against inappropriate investments, contact the law office of Lisa Bragança. Sometimes even the most seemingly trusted advisors can take advantage of older folks who are not being cautious or fully-informed about their investments and the volatility of the financial market.

It is nice to see a state court take a skeptical look at Delaware corporate governance law.

The Minnesota Supreme Court chose not to adopt Delaware law on an important corporate governance question — when is a shareholder’s claim “direct” as opposed to “derivative.” The decision is available here: In re Medtronic, Inc. Shareholder Litigation. 

The test of whether a shareholder’s claim is “direct” or “derivative” is important to the outcome of a corporate governance case. As the Minnesota Supreme Court noted “when shareholders are injured only indirectly, the action is derivative; when shareholders show an injury that is not shared with the corporation, the action is direct.” There are procedural obstacles to bringing derivative claims that are not present in direct claims.

In the decision, the Minnesota Supreme Court rejected the Delaware direct/derivative test set forth in Tooley v. Donaldson, Lufkin & Jenrette, Inc., 845 A.2d 1031 (Del. 2004), which had been applied by the district and appellate courts below. The Supreme Court noted “[w]e do not see a need to resort to Delaware law to answer the direct-versus-derivative question here given the guidance available from our own precedent. Moreover, the Tooley test has been limited to claims asserting breach of fiduciary duty.”

The Minnesota Supreme Court concluded that claims alleging injuries to shareholders arising out of overpayments made in a business transaction were not derivative claims. In a derivative claim of overpayment, shareholders claim that their shares have diminished in value by reason of the decrease in value of the corporation’s assets. But here, the claims were that shareholder ownership interest and voting power were diluted by the overpayments made in the business transaction. Not only did the shareholders allege losses in the value of their individual shares, they also alleged an injury based on the loss of certain shareholder rights.  Thus, the Supreme court found the shareholders had sufficiently alleged individual shareholder injury.

For more detail, see the analysis of Stephen Quilivan of Stinson Leonard Street LLP available here.