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William Galvin, Secretary of the Commonwealth of Massachusetts, announced a second round of settlements with five independent broker-dealers regarding the sale of nontraded real estate investment trusts (“REITS”) for $10.75 million in restitution. The $10.75 million will be distributed to customers and investors who purchased nontraded REITS from 2005 to the present at the following five investment firms: Securities America Inc., Ameriprise Financial Services Inc., Lincoln Financial Advisors Corp., Commonwealth Financial Network, and Royal Alliance Associates, Inc. In May 2013, these five independent broker-dealers had already agreed to pay $6.1 million in restitution, as well as $975,000 in fines, regarding their sale of the nontraded REITS. Similarly, LPL Financial LLC agreed to pay $4.8 million in restitution to investors earlier this year. After the first round of settlements earlier this year, the Massachusetts Securities Division commenced a broader investigation into the sale of alternative investments, including REITS, to senior citizens, which sparked this second round of settlements. Mr. Galvin made the following statement, “These investments are popular, but risky. Our investigation showed widespread problems with adherence to the firms’ own policies as wells as the state rule that an investor’s purchase of REITs cannot be more than 10% of that person’s liquid net worth.”

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The Securities and Exchange Commission Enforcement Division (“SEC”) filed an Order Instituting Administrative And Cease-And-Desist Proceedings (“Order”) which alleges that J.S. Oliver Capital Management (“J.S. Oliver”), its President Ian O. Mausner, and a portfolio manager and chief compliance officer Douglas Drennan, were involved in a cherry-picking scheme in which J.S. Oliver, Mausner and Drennan would attribute profitable trades to hedge funds which were affiliated with J.S. Oliver. The SEC Order also claims that Mausner misappropriated over $1.1 million in “soft dollars,” which was not disclosed to customers. According to the Order, “[s]oft dollar credits arise from the client commission arrangement between an investment adviser and the broker-dealer that handles the trades for the adviser. Generally, a client’s investment assets are used to pay additional commissions – called ‘soft dollar credits’ – that the broker-dealer sets aside as payment for legitimate research and brokerage expenses of the adviser.” Further, the Order alleges that from June 2008 through November 2009, J.S. Oliver’s clients lost $10.7 million from the cherry-picking scheme. In a press release issued by the SEC, Marshall S. Sprung, Co-Chief of the SEC Enforcement Division’s Asset Management Unit stated, “Mausner’s fraudulent schemes were a one-two punch that betrayed his clients and cost them millions of dollars . . . Investment advisers must allocate trades and use soft dollars consistent with their fiduciary duty to put client interests first.”

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In 2005, a discrimination lawsuit was filed against Merrill Lynch by an African-American financial advisor in the United States District Court for the Northern District Of Illinois Eastern Division. Eventually, the lawsuit grew into a class action with 1,200 African-American financial advisors as class representatives. The class alleged racial discrimination in violation of 42 U.S.C. Section 1981, Equal Rights. The main claim in the class action discrimination lawsuit was that African-American financial advisors were not provided with the same business opportunities, or the same account distributions, as their white counterparts on investment banking teams. Moreover, the class action representatives alleged that African-American financial advisors were segregated and excluded from the formation of investment banking and adviser teams, which was crucial to developing business strategies. Initially, Judge Robert Gettleman, the District Court Judge in Chicago that was presiding over the matter, rejected the case as a class action three times before a federal appeals court provided class certification. Following the federal appeals court ruling, Judge Gettleman certified the class of “all African-Americans employed by Merrill Lynch at any time since July 10, 2004, as financial advisors or financial advisors trainees” in domestic retail brokerage units of Merrill Lynch’s global private client division. Merrill Lynch has agreed to pay $160 million to settle the discrimination lawsuit. The settlement agreement will be presented to Judge Gettleman on September 3, 2013 for review and approval.

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UBS AG (“UBS”) has agreed to pay $98,184.84 in civil penalties to the New Jersey Bureau of Securities regarding an investigation into whether UBS sales assistants were registered in the states where they accepted orders on behalf of investors. According to a News Release issued on Monday, August 26, 2013 by the New Jersey securities regulator, UBS’s “client service associates” took investor orders without having the requisite state registrations and UBS failed to supervise the client services assistants who accepted the client orders. Further, Abbe R. Tiger, New Jersey’s Bureau of Securities Chief, made the following statement in the New Jersey Bureau Of Securities News Release, “over a six-year period, UBS failed to recognize a flaw in its order-entry systems that allowed unregistered persons to accept customer orders.” The investigation involved an undisclosed number of the 2,277 sales assistants UBS employed from 2004 through 2010, who were not licensed in New Jersey, and were also not properly registered in many other states. The New Jersey Bureau Of Securities News Release further states, “UBS settled the multi-state investigation, coordinated by the North American Securities Administrators Association (“NASAA”) and led by the New Jersey Bureau of Securities, by agreeing to pay up to a total of $4.58 million in civil penalties among the 50 states, District of Columbia, Puerto Rico and the U.S. Virgin Islands.” As a result of the investigation, in November 2010, UBS implemented a new order-entry system to ensure employees’ state registrations.

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Recently, the Securities and Exchange Commission (“SEC”) banned registered representative, Carl Johns, of Boulder Investment Advisers, from the securities industry for a period of 5 years for misleading and obstructing his Chief Compliance Officer (“CCO”). According to reports, the SEC investigated Johns and found that from 2006 through 2010, Johns failed to pre-clear or report hundreds of securities trades in his personal accounts; failed to disclose those trades in his trading reports; and then created fake documents to mislead his firm’s CCO during the firm’s internal investigation of Johns’ trading practices. Specifically, it was reported that Johns failed to pre-clear or report 640 trades, 90 of which involved securities held or acquired by funds which were managed by Boulder Investment Advisers. Moreover, the reports stated that Johns deleted those transactions from his personal brokerage statements before providing the account statements to Boulder Investment Advisers’ CCO in an effort to mislead the CCO’s investigation. Johns settled the SEC charges by agreeing to pay $231,168 of disgorgement, prejudgment interest of $23,889 and a $100,000 penalty. Moreover, Johns will be banned from the securities industry for 5 years. According to a statement made by Julie Lutz, co-director of the SEC’s Denver regional office, “Securities industry professionals have an obligation to adhere to compliance policies, and they certainly must not interfere with the chief compliance officers who enforce those policies . . . Johns set out to cover up his compliance failures by creating false documents and misleading his firm’s CCO.”

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On August 19, 2013, the Financial Industry Regulatory Authority Inc. (“FINRA”) filed a proposed rule amendment with the Securities and Exchange Commission (“SEC”) seeking to revise the Form U-4 Uniform Application For Securities Industry Registration Or Transfer (“Form U-4”). A Form U-4 is completed by broker-dealers for registered associated persons, in order to file relevant information relating to the broker on the FINRA Web Central Registration Depository (“CRD”). In its proposed amendment, FINRA stated that the rule change was “non-controversial,” and requested that the SEC make the amendment effective immediately. Despite this request, the SEC will allow the public to provide comments to the proposed amendment. The SEC has stated in its announcement of the amendment that the change will not require any changes in the text of the FINRA rules (SEC Rel. No. 34-70227). Instead, the amendment adds to the information a broker-dealer is required to disclose in Section 14 of the Form U-4, specifically question 14M, regarding outstanding judgments and liens. Currently, the broker-dealer is required to disclose that a broker or registered representative is the subject of an unsatisfied judgment or lien within 30 days of the broker learning of the event. The broker-dealer responds “yes” or “no” to Question 14M and then completes a corresponding Disclosure Reporting Page (“DRP”) in order to provide further details. On the DRP, the broker-dealer need only disclose the date of the judgment/lien, not the date the broker learned of the event. The amendment to the rule would require broker-dealers to disclose the date the broker learned of the event. FINRA hopes this change would decrease the instances when FINRA sends late disclosure fee assessments to firms. All comments to this proposed rule change must be submitted within 21 days from the date the proposed rule was published on the Federal Register.

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Glen Galemmo, a Cincinnati money manager and former registered representative, has been sued by a two groups of investors in two separate lawsuits for operating an elaborate Ponzi scheme, which incurred approximately $300 million in losses for about 200 investors. Galemmo was most recently affiliated with FINRA member firm Landmark Investment Group, Inc., and Queen City Hedge Fund II, LLC. According to 2 complaints filed by investors, between 2006 and 2011, Galemmo claimed to have earned a 432% return by investing in stocks. Further, one of the complaints alleges that Galemmo, his wife, and his business partner, Edward Blackledge, used investor funds as “a cookie jar . . . withdrawing whatever they personally needed without detection or challenge.” The investor lawsuits also allege that investors began to notice irregularities in Galemmo’s reporting procedures. For example, on the annual K-1s that were sent to each investor, Galemmo failed to fill out the percentage of the managed funds belonging to that investor. Furthermore, according to the complaints, monthly update reports sent to investors contained many figures that were clearly rounded up. Investor suspicions were confirmed when, on July 17, 2013, Galemmo sent investors an e-mail stating that he would no longer be in business. According to the complaints, Galemmo’s July 17, 2013 correspondence instructed investors not to contact him, and that all investor inquiries should be directed to the Internal Revenue Service.

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Robert Keenan, the chief executive at St. Bernard Financial Services Inc. (“St. Bernard”), was elected to the Board of the Financial Industry Regulatory Authority, Inc. (“FINRA”) as a small-firm representative in August 2013. Recently, in June 2013, federal prosecutors indicted Arkansas treasurer, Martha Shoffner, for allegedly receiving $36,000 from a St. Bernard broker in exchange for the State of Arkansas’s investment business. Pursuant to media reports, Shoffner’s office purchased $1.69 billion in bonds from St. Bernard, and from a different broker-dealer, between July 2008 and March 2013. It was further reported that FBI investigators taped Shoffner accepting a $6,000 payment from the St. Bernard broker, who also, on at least two occasions delivered additional cash payments to Shoffner hidden inside pie boxes. According to a statement made by Arkansas securities commissioner, Heath Abshure, “typically the treasurer’s office had held bonds to maturity, but then all of a sudden started selling prior to maturity . . . Replacement bonds all started going to [Mr.] Keenan’s firm . . . That’s what got the state’s attention.” It will be interesting to see what action, if any, FINRA takes regarding Keenan’s board seat due to his affiliation with St. Bernard and the bribery scandal.

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According to media reports, the Financial Industry Regulatory Authority, Inc. (“FINRA”) filed a complaint against well-known real estate investor Tony Thompson, owner of Thompson National Properties LLC (“Thompson National Properties”), and his broker-dealer, TNP Securities LLC (“TNP Securities”), for allegedly deceiving and defrauding investors who purchased at least $50 million in high-yield real estate promissory notes sponsored by Thompson National Properties. Reports indicated that the FINRA Complaint alleges that Thompson National Properties sold three note programs, known as the TNP 12% Notes Program LLC, the TNP 2008 Participating Notes Program LLC and the TNP Profit Participation Program LLC, from 2008 through 2012, through various independent broker-dealers. Reportedly, the FINRA Complaint states that Thompson National Properties incurred losses due to the decline in value of the equity of the note programs and that the losses were not disclosed to investors in the promissory note’s offering documents or private-placement memorandum. News reports made the following quotes from the FINRA Complaint, “Consequently, by no later than Jan. 1, 2009, the increasing operating losses and declines in total equity that [Thompson National Properties] suffered comprised material changes on the financial condition of [Thompson National Properties] that only worsened as time went on . . . During the offering periods for 12% Notes and 2008 Participating Notes, losses in 2009 of [$25.6 million] took the company’s equity to [-$13.6 million].” Reportedly, the FINRA Complaint alleges that Mr. Thompson and TNP Securities violated the Securities and Exchange Act of 1934, FINR Rule 2020, which prohibits manipulative, deceptive or other fraudulent devices by registered representatives and broker dealers, and FINRA Rule 2010, which requires registered representatives and broker dealers to act with a high standard of commercial honor and trade.

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On July 3, 2013, the Financial Industry Regulatory Authority, Inc. (“FINRA”) issued an award against Wells Fargo Advisors, LLC (f/k/a Wells Fargo Securities, LLC) (“Wells Fargo”) for over $2.2 million in damages for failing to safeguard customer assets by allowing unauthorized withdrawal of funds. See College Health and Investment, Ltd. vs. Wells Fargo Advisors, LLC (f/k/a Wachovia Securities, LLC) vs. Shari Jacobowitz and Esther Spero (a/k/a Esther Burstyn) – FINRA NO. 10-3554. According to a statement made by counsel for College Health, the unauthorized withdrawals of College Health’s funds were made by a rogue secretary. On August 6, 2010, Claimant College Health and Investment, Ltd. (“College Health”) filed a Statement of Claim alleging breach of fiduciary duty, negligence, negligent supervision and breach of contract relating to the theft of cash and unspecified securities deposited in College Health’s account held in custodian of Wells Fargo. Thereafter, on October 8, 2010, Wells Fargo filed an Answer which denied the allegations in the Statement of Claim and asserted various affirmative defenses. Wells Fargo also filed Third Party Claims against Shari Jacobowitz (“Jacobowitz”) and Esther Spero (a/k/a Esther Burstyn) (“Spero”) asserting indemnification and contribution. College Health filed an Amended Statement of Claim, alleging the same causes of action, but requesting $6 million in compensatory damages, margin interest expense, prejudgment interest, punitive damages and costs. Jacobowitz and Spero did not file a Statement of Answer to Wells Fargo’s Third Party Claim. The Panel allowed extensive discovery in this matter, which included issuing nearly 50 subpoenas and permitting the parties to depose Spero. Wells Fargo filed a Motion to Strike and/or Exclude the deposition testimony from being admitted into evidence. The Arbitration Panel denied Wells Fargo’s motion and allowed Spero’s deposition transcript to be entered into evidence since Spero was unavailable to testify at the hearing. In rendering the arbitration award (“Award”), the Panel declined to make any determination regarding Wells Fargo’s Third Party Claims against Jacobowitz and Spero since they are not registered representatives associated with FINRA. The Award stated that Wells Fargo was liable to College Health for $2,298,062 in compensatory damages, which includes prejudgment interest at the legal rate permitted by Florida law. This large compensatory damage figure also includes a minor $5,000 monetary sanction imposed upon Claimant for sending letters to all nonparties who received subpoenas that were drafted by Wells Fargo. The Award states, “Claimant did not provide these letters to FINRA or to Respondent’s counsel. The letters can best be understood as intended to discourage the recipients from producing all responsive documents.” The Award also granted College Health’s request for margin interest expense in the amount of $418,987.00, including prejudgment interest, as well as $35,000 in costs.

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