Articles Posted in Regulatory Audits & Investigations

Headline news charting the dramatic peaks and valleys of select Credit Suisse and Barclays properties prompted the Financial Industry Regulatory Authority Inc. (FINRA) to issue a July warning to investors detailing the potential risks inherent to exchange-traded notes (or ETNs). The investor alert, entitled “Exchange Traded Notes – Avoid Unpleasant Surprises“, details vital notices to consumers on the nature of such properties.

“ETNs are complex products and can carry a raft of risks,” said Gerri Walsh, FINRA’s Vice President of Investor Education in a July 15th statement to Investment News. “Investors considering ETNs should only invest if they are confident the ETN can help them meet their investment objectives, and they fully understand and are comfortable with the risks.” Unfortunately, all too often these risks can be hidden from investors by their financial advisor.

Many investors may believe that ETNs are just like exchange-traded funds (or ETFs). However, despite their similar naming and being commonly categorized together, ETNs are quite different than ETFs. ETFs can be essentially characterized as a grouping of bonds or stocks that trade within the same day on an exchange. ETNs meanwhile, do not in fact hold anything, but rather are bank-drafted promissory notes intended to deliver the returns of an index. Unlike an ETF, an ETN in many respects is an uncollateralized loan to a bank, albeit one that offers theoretically great rewards to an index’s return. The value of an ETN is largely dependent on the given day’s market value of the index it tracks.

After years of concerns raised but never fully investigated by futures industry regulation, the Commodity Futures Trading Commission (CFTC) and National Futures Association (NFA) took enforcement action July 9th against brokerage firm Peregrine Financial Group, also known as PFGBest. Peregrine founder Russell Wasendorf subsequently confessed to committing acts of embezzlement and fraud over the course of two decades, illegally acquiring over $100 million. Wasendorf was then arrested on charges of having lied to government regulators.

$215 million is believed to be missing from Peregrine’s pool of customer funds, with a recently forged bank statement claiming $221 million in company accounts with U.S. Bank, while the bank has Peregrine on file for only $6.3 million. Four regulatory actions have been against Peregrine since 1996 – with allegations including inaccurate accounting, insufficient capital, and problems with segregating customer money.

Wasendorf in writing confessed to having spent most of the funds embezzled over the course of his career, using the money to secure firm capital, purchase PFG’s corporate headquarters, and even pay regulatory fines and fees. In July, a half dozen customer claims on PFG were met with quotes of twenty-two to twenty-five cents on the dollar by CRT Capital Group, a limited liability company which deals in distressed debt.

Recent front page woes of JPMorgan Chase and MFGlobal – as well as Barclays manipulation of Libor interest rates – have spurred debate as to whether our regulatory bodies are failing to meet watchdog standards of prosecuting financial crimes on Wall Street, and to what degree offending banks and brokers alone should be held accountable for their illegal activities. When Timothy Geithner, the current Treasury secretary and ex-president of the Federal Reserve Bank of New York (herein referred to as “the Fed”) testified before the House Financial Services Committee last Wednesday, the discourse centered around concerns of cronyism between regulators and those they supervise, as well as a lack of legislative power for regulators to prosecute financial crime. For a thorough listing of New York regulators and industry associations available to consumers, visit the Resources page of our firm’s website.

The Fed, located in Lower Manhattan, places examiners inside the office’s of the nation’s largest banks. The office believes that those examiners sent into the field are said to be among the most “battle tested” and willing to challenge Wall Street wrongdoers on their violations. Yet the Fed itself does not enforce financial law, leaving punishments and fines to the Federal Reserve and other agencies such as the CFTC and SEC. “They focus on the safety and soundness of the banks, which ultimately means they are not particularly focused on market manipulation,” said Sheila C. Bair, the former chairwoman of the Federal Deposit Insurance Corporation, a fellow regulation branch.

The Fed is at once hindered by its lack of jurisdiction, while also being criticized for being considered by many to be excessively corroborative with the banks they are to supervise. Particularly noteworthy is the revelation that the Fed has allegedly known Barclays had been reporting false rates since 2008, yet did not stop (or in their view, were not authorized to stop) these actions. Given that the Fed cannot levy fines, it instead typically requests policy changes from a bank, alerting authorities at the Federal Reserve board only when the bank fails to comply for a sustained time period. It is then up to Federal Reserve to take disciplinary action.

Last week’s July 3rd edition of the New York Times reports that past and present brokers from mutual fund giant JPMorgan Chase were encouraged to favor JPMorgan products in their financial advisement to customers, even when competitor products were better performing or better suited to a consumer’s budget. Moreover, JPMorgan marketing materials are said to have exaggerated the profits made from at least one major offering. For a further definition of misrepresentation and unsuitability, as well as an understanding of potentially defective products, visit the Investors section of our firm’s website.

JPMorgan’s marketing measures appear to have led to several profitable post-crisis years for the company. This success has come despite a volatile market that has shaken investor confidence in funds, and findings from fund researcher Morningstar that since 2009, 42% of JPMorgan funds have failed to meet the average performance of comparable products.

There has been concern from market analysts that consumers in many cases are being sold JPMorgan products based on theoretical returns over actual performance. Apparently, one balanced JPMorgan portfolio boasts professes a hypothetical return of 15.39% of fees after fees over three years, the reported return was 13.87%, lower not only than the advertised hypothetical, but also the standard of comparison JPMorgan depicts in marketing materials.

In the wake of $2 billion of trading losses at the UK unit of JPMorgan Chase, new focus from US regulators has been placed upon London as a haven for excessive trading risks and broker negligence. And while JPMorgan Chase is said to have begun its own analysis into how safe it is to conduct major decisions pertaining to American investors from London offices, the issues of how and why London holds such appeal for investment firms remain arguably worrisome. To learn more about sales practice violations, visit the Investors page of our firm’s website.

Last month Gary Gensler, the chairman of the Commodity Futures Trading Commission, cited on trading losses from JPMorgan, AIG, and Citigroup as instances of supposedly risky maneuvers from London having consequences for US investors.

“So often it comes right back here, crashing to our shores… if the American taxpayer bails out JPMorgan, they’d be bailing out that London entity as well,” he told the House financial services committee.

The New York Times‘s Dealbook section last week reports that the Commodity Futures Trading Commission has fined financial services giant Barclays $200 million, effective June 27th, as a result of the company’s attempts to manipulate a key interest rate – the London Interbank Offered Rate, or “Libor”. To learn more about defining market manipulation and its effect on consumer investment, visit the Investors section of our firm’s website.

In a follow up to this news, the July 3rd edition of the Wall Street Journal reports that Barclays CEO Robert Diamond has apologized for the scandal in a letter to employees, pledging to implement new controls to prevent such incidents in future. While company chairman Marcus Agius has resigned in the alleged manipulation’s wake, Diamond is said to have no intentions of doing the same. Investigations into potential manipulation by Barclays and other banks have British officials debating how to set Libor rate, and how to deter these supposed corrupt practices.

This proverbial reeling in of a big fish has caused CFTC supporters on Washington – among them members of the Obama administration and Congressional Democrats – to bring attention to the commission’s value as surveyors of the financial industry, and to propose a CFTC budget increase. U.S. regulators are said to have been impressed with what they deemed the “nature and value of Barclays’ cooperation has exceeded what other entities have provided in the course of this investigation.”

Three New York investors have filed a class action complaint – dated May 23rd – against Facebook and chief executive Mark Zuckerberg, in addition to lead underwriter Morgan Stanley and an array of secondary underwriters (including JPMorgan Chase, Barclays Capital, Goldman Sachs, and Merrill Lynch) claiming that negative information about the social network’s initial public offering was withheld. Monetary damages are to date unspecified. The suit was filed by Robbins Geller, a firm that years ago earned plaintiffs $7 billion in a suit against Enron.

A failure to disclose information unilaterally among all investors could potentially be considered a form of misrepresentation and fraud, as well as a breach of fiduciary duty. For further explanation of these possible charges and more, visit our Investors page.

Particularly interesting and possibly advantageous for the plaintiffs is that Morgan Stanley’s chief analyst Scott Devitt – famed for his accurate, bearish predictions in recent years that Google and Amazon stock would drop – is alleged to have cautioned preferred customers against zealous purchase of Facebook stock. Morgan Stanley controlled both the process of Facebook’s trading and over 38 percent of Facebook shares sold. Devitt’s and other analysts’ revised revenue forecasts were shared via phone calls with institutional investors – but not with retail investors – before public trading of the stock began. These forecasts outlined expectations for how Facebook would fare into the second quarter and throughout 2012. Robbins Geller’s statement against the underwriters thus argues that the prospectus “contained untrue statements of material facts.”

Since the financial crisis of 2008 collapse of Lehman Brothers and beyond, the need for regulators to create new means of quelling excessive risk has been met with questions remain as to how effective these rules have been. Many of the new post-crisis rules have not yet gone into effect, and even once executed, a broker’s capability for evasion remains. To learn more about regulation on a national scale, visit the Governmental, Regulatory, and Self-Regulatory Proceedings page of our firm’s website.

A section of the Dodd-Frank Act legislation, the Volcker Rule, is to be implemented over the next two years with an aim at averting certain types of trading. While this regulation prevents banks from doing speculative trades with their own money, it will not stop hedging activities. The Volcker Rule contains guidelines that are meant to help regulators decide whether a hedge masks proprietary trading.

Other parts of Dodd-Frank resist undue risk more covertly. The Act looks to shift many derivatives to central clearing houses, the groups who collect the payments on a trade. This is said to theoretically strengthen the market, because companies are required to back their trades with margin payments of cash or safe securities. In theory, the financial burden of supplying margin to clearinghouses could make excessively risky trades restrictively expensive, and therefore less attractive for banks.