SEC indicts California broker in First Reg BI violation case
The Securities and Exchange Commission has charged a California-based brokerage firm and five of its representatives with violating regulatory best interest obligations when recommending and selling a high-risk debt security to retail investors and retirees.
It is the first time the commission has charged a defendant with breaching Reg BI, which came into force in 2020.
“Reg BI is clear; brokers must act in the best interests of their clients,” said SEC Enforcement Division Director Gurbir S. Grewal. “When they don’t, as we claim here, they put retail investors at risk and we will hold them accountable.”
The SEC sued in California federal court against Western International Securities, a Pasadena, California-based dual-registration company owned by Atria Wealth Solutions. The five representatives charged included Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham and Thomas Swan.
The commission alleged that the firm and these five representatives violated Reg BI by recommending and selling “L” bonds offered by issuer GWG Holdings.
These corporate bonds promised to pay interest on the principal lent to the issuer, but GWG’s 2020 prospectus disclosed the risks associated with the bonds, including that an investor could lose their entire investment. The bonds were also illiquid and suitable “only for persons with substantial financial resources and no need for cash” in the investment, according to the prospectus.
Effective Jan. 10, 2022, GWG Holdings suspended all new sales of L bonds, according to the SEC complaint.
But between July 2020 and April 2021, Western reps sold about $13.3 million in L bonds to retail customers. While Western’s CCO produced a due diligence report on the bonds, detailing their potential and pitfalls, Western’s representatives, supervisors and other compliance officials never acted on them, and the company does not set no threshold that customers had to meet to purchase the bonds, despite warnings in GWG’s prospectus.
Western required reps to complete an online L-bond training course, although it did not require it if a rep had taken such a course on a previous issue, according to the commission.
“These registered representatives recommended L Bonds to retail clients, despite having insufficient, and sometimes misguided, understanding of investing,” the complaint reads. “The Defendants’ Registered Representatives’ knowledge of GWG and the L Bonds was based on information and communications from GWG and its sales representatives.”
The commission argued that the company and the five representatives had violated Reg BI’s duty of care, which requires that an associate or individual, when making a recommendation, “show due diligence.” reasonable diligence, care and skill in understanding the potential risks, benefits and costs associated with the recommendation.” Defendants allegedly breached this duty by recommending the L Bonds to at least seven retail clients without reasonable cause to believing that these sales were in the best interest of the customers.
The complaint does not name the retail investors affected, but describes a number of retirees and retail clients mostly with moderate risk tolerance. In one situation, Graham recommended a purchase of $100,000 in two-year L bonds to a 79-year-old retired truck driver with “general knowledge of investing and limited knowledge of bonds.” At the time he made the purchase, the retiree’s annual income was $35,000 and his liquid net worth was $300,000; the L Bond investment represented 33% of his liquid net worth, according to the commission.
According to the SEC, the representatives’ supervisors, their delegate, or the corporate compliance department at no time raised concerns about the bond purchases by the seven retail clients named in the complaint.
“The Company takes the interests of its clients very seriously and believes that it has complied with Reg BI and available regulatory guidance during the relevant period,” Julian Arenzon, spokesman for Western International Securities, said. of action. “The firm intends to actively defend the claims of the SEC and will not provide additional comment on this ongoing litigation at this time.”
The case marks the first time the SEC will pursue legal action alleging violations of Reg BI, although many have been waiting for an inevitable first action (there have been several lawsuits filed against companies for violate mandates related to the CRS formwhich came into force at the same time as Reg BI).
In an interview with WealthManagement.com, Micah Hauptman, director of investor protection at the Consumer Federation of America, welcomed the action:
“This case sends a strong message that conduct that might have been tolerated under the previous fitness rule will not be tolerated under Reg BI, and I think that’s important,” he said. declared.
In particular, Hauptman found it significant that the case was directed at the underlying conduct surrounding the kinds of recommendations the reps were making and the company’s allegedly paltry compliance policies and procedures and that the case did not rest on a detail. technique or a lack of disclosure on the part of the defendants. . He also noted that the matter was in litigation, as opposed to settlement.
“I think that may suggest a more aggressive approach at the SEC, which we would welcome and have been pushing for all along,” he said. “It’s the SEC doing what we want it to do.”