Certified Financial Planner

Wall Street‘s self-regulating agency wants to increase its power over more financial advisory firms.

Financial Industry Regulatory Authority’s (FINRA) currently performs financial regulation of member brokerage firms and their employees but now with the endorsement of politicians like Rep. Spencer Bachus it’s pushing to regulate Registered Investment Advisors (RIAs) which are currently regulated directly by the Federal and State Governments.

RIAs, which typically serve as financial advisors to individual investors, are currently required to operate under the highest standard of investor protection called the Fiduciary Standard–putting the client’s interest before their own. Most of Wall Street however operates under the Suitability Standard, which provides a much lower safeguard for investors.

FINRA oversees all the securities dealers in the country and they as a group have no desire to operate under the fiduciary standard. There is a concern that FINRA could over-regulate RIA’s and many small RIA’s would fold, which would harm the public and eliminate completion for its Securities Dealers members. FINRA’s press liaison Nancy Conrad disputes that possibility.

The National Association of Securities Dealers (NASD) a self-regulatory organization changed its name to FINRA in 2007. The change of name obscures the purpose of the organization to this writer and can confuse the public or mislead investors that FINRA is best suited to protect the public from its own members. Some believe that FINRA protecting the public is about as disastrous as the “Fox guarding the hen house”. Again FINRA spokes men states that FINRA

FINRA seems to more accurately protect the interests of the Financial Services Companies as demonstrated by:

1. FINRA’s CEO opposes the imposition of the current fiduciary standard on it’s Broker Dealer members when he said “…one-size-fits-all approach won’t work for every client, advisor and transaction.” Ms Conrad said that  ”FINRA Chairman and CEO, Rick Ketchum has long supported a fiduciary standard for both securities firms (BDs) and Investment Adviser firms.” Come on, if thats the case why don’t BD Reps operate as a fiduciary now?
2. FINRA self admits that they have done a poor job with “shortcomings in our examination program”.
3. FINRA arbitration process seemingly protects the Industry where in over 14,000 FINRA arbitration awards over a ten-year period, investors with large claims against major brokerage firms recovered only 12 percent of the amount claimed.
4. Another example is who serves on FINRA committees and Board. Bernard Madoff was on the NASD’s Board of Governors and served as Vice Chairman. Mary Schapiro the former FINRA CEO, appointed Mark Madoff, one of Bernard Madoff’s sons, to a regulatory body that reviews disciplinary decisions made by FINRA. Madoff’s niece, Shana Madoff who was a “Compliance Officer” of Madoff until the firm’s collapse was a member of a compliance advisory committee of FINRA. Conrad states that ” Our organization has demonstrated time and time again that it is not afraid to discipline firms or individuals for wrongdoing, regardless of their service on FINRA’s Board.”
5. Please see the following as to how poorly those companies who have an employee on the FINRA Board have done at regulating their own business practices and employees. Yet the public should believe by FINRA which is governed by its Board of Directors with members for these offending firms are qualified to oversee FINRA which regulates the other Securities Dealers and soon to be RIA’s?

These company violations include willful violation of State and Federal Laws, failure to supervise its own employees, lack of procedural safeguards, submitting false information to the Regulators, improper sales and on and on.

Morgan Stanley Smith Barney Violations- Board Member Gregory J. Fleming

• 2002 Illegal rewards for selling affiliated mutual funds $2.25 fine
• 2003 Conflicts of interest research analysts $75 million payment
• 2003 Inappropriate influence and improper “spinning”- $400 million fine
• 2003 Censure & penalty for illegal marketing and IPO’s $100 million
• 2004 Failure to deliver documents to investors- $13 million fine
• 2005 IPO Violations  $40 million
• 2005 Failure to disclose info to mutual fund clients $6.25 million
• 2005 Willful violation of the Advisors act of 1940 $208 million
• 2005 Failure to supervise its sales force $5 million
• 2006 Failure to maintain and enforce policies $10 million
• 2007 Failures for best execution $7 million
• 2007 Failure to supervise sales peoples deceptive actions $15 million
• 2007 Provided false information to regulators $12million
• 2007 Failure to provide customers with required information $17 million
• 2005 Improper sales of securities $8.5 million
• 2008 Inappropriate ales of auction vrate securities  $35 million
• 2008 Misled tens of thousands of investors $100 million
• 2009 Failed to supervise sales people $5.4 million

All of the above can be confirmed in greater detail here.

MSSB has had other issues such as: race discrimination lawsuit, discrimination against women another to sex discrimination suit, and charging excessive fees to the Indiana State Teachers Association (ISTA) Insurance Trust.

Edward Jones
Violations- Board member James D. Weddle

• 1990’s Failure to disclose revenue sharing to clients $7.5 million
• 2000 Sale of unregistered stock
• 2002 Transactions without the proper registration
• 2003 Fail to disclose incentives to sell mutual funds -$75 million
• 2003 failure to supervise a financial advisor
• 2004 failed to properly deal with a complaint a complaint.
• 2008 failed to reasonably supervise the financial advisor
• 2009 failed to reasonably supervise its financial advisor
• 2010 Misappropriation of Client Funds $449,000
• 2009 Failed to supervise the activities of advisor.
• 2003 Failure to supervise a financial advisor
• 2002 Advisor recommendation of margin use to client
• 2000 Failed to supervise a financial advisor
• 2003 Improperly included its markup/markdown
• 2006 Mishandling of NAV transfer programs $25,250,000
• 2004 Willfully violated rules with sale of 529 plans
• 2008 Failed to report transactions on time
• 2006 Failing to timely deliver of official statements to clients
• 2009 Failing to establish and enforce a supervisory system, $200,000.
• 2004 Failing to establish and maintain a supervisory system, $200,000.
• 2004 Failure to achieve compliance with its Article V reporting obligations.
• 2005 Improper sales of municipal securities to clients
• 2003 Employing those that failed statutory qualification- $100,000

For the complete listing view the Form ADV.

Violations- Board member Seth H. Waugh

• 2002 Fail recordkeeping requirements of the SEC – $1,650,000.
• 2004 Research analyst conflicts of interest – $50 million,
• 2006 Engaged in market-timing and late trading of mutual funds,
• 2004 Sale of initial public offerings violations $5 million
• 2004 Research report conflict disclosures – $950,000
• 2007 Failure to ensure delivery of prospectuses – $1.25 million
• 2009 Misled customers about auction rate securities- Had to buy back ARS
• 2009 Failed to establish supervisory IPO procedures – $100,000

For more details review Deutsche Bank Securities Inc. ADV Form.

LPL Financial Violations- Board Member Mark S. Casady

• 2004 Illegal breakpoint sales – $1,116,402
• 2008 Failed to have procedures to protect customer records and $275,000
• 2011 Procedures regarding its review of e-mail-fine of $100,000
• 2011 Procedures on transmittals of cash and securities-$100,000
• 2010 Lack of supervision of variable annuity exchanges Fine $175,000
• 2008 Use of UITs, censure and fine of $125,000
• 2006 Supervision of variable annuity exchanges. Fine $300,000
• 2005 Mutual fund sales – $2,400,000
• 2005 Failure to supervise supervision wire transfers, fine $75,000
• 2005 Preferential treatment for some Mutual funds. fine $3,602,398
• 2004 FINRA reporting obligations,  a censure and fine of $450,000
• 2004 Mutual fund breakpoint discounts, censure and fine $2,232,805.

For complete information go to the firms ADV form.

Morgan Stanley is reportedly facing at least two lawsuits and a U.S. Senate Committee hearing, all stemming from the recent Facebook IPO debacle. The suits allege that analysts at Morgan Stanley (MS) had lowered their second-quarter and full-year forecasts for Facebook in the days ahead of the IPO and shared their findings via phone calls with certain institutional investors, but not with the small retail investors. Morgan Stanley’s CEO says, “we did nothing wrong.”

Why any investor would willingly do business with Morgan Stanley is hard to understand given their track record of governmental violations and questionable business operations. Could it be perhaps that investors’ opinion of MS is based primarily on the image projected through their not inconsiderable budget for public relations, marketing and advertising rather then these public facts?

Morgan Stanley’s governmental investment violations with fines and/or restitution or penalties

• 2002 Illegal rewards for selling affiliated mutual funds $2.25 million
• 2003 Conflicts of interest research analysts $75 million
• 2003 Inappropriate influence and improper “spinning” $400 million
• 2003 Censure and penalty for illegal marketing of IPOs $100 million
• 2004 Failure to deliver documents to investors $13 million
• 2005 IPO Violations $40 million
• 2005 Failure to disclose info to mutual fund clients $6.25 million
• 2005 Willful violation of the Advisors Act of 1940 $208 million
• 2005 Failure to supervise its sales force $5 million
• 2006 Failure to maintain and enforce policies $10 million
• 2007 Failures for best execution $7 million
• 2007 Failure to supervise sales peoples deceptive actions $15 million
• 2007 Provided false information to regulators $12 million
• 2007 Failure to provide customers with required information $17 million
• 2005 Improper sales of securities $8.5 million
• 2008 Inappropriate sales of auction rate securities $35 million
• 2008 Misled tens of thousands of investors $100 million
• 2009 Failed to supervise sales people $5.4 million

All of the above can be confirmed in greater detail here.

Other Illegal Practices

In addition to violations of governmental investment regulations, Morgan Stanley has a history of violating the rights of women, minorities, teachers and others.

Morgan Stanley was sued for having engaged in a pattern of discrimination against women. In one case, Morgan Stanley agreed to pay $54 million to settle a sex discrimination suit, while a second sex-discrimination lawsuit was settled for $46 million.

In a national, class-action race discrimination lawsuit, Morgan Stanley was charged with engaging in race discrimination and paid $16 million.

The Missouri Department of Insurance filed a lawsuit alleging that Morgan Stanley had conflicts of interest that damaged the value of an insurance holding company. Morgan Stanley agreed to pay $95 million to settle fraud charges from its role in the company’s collapse.

Morgan Stanly was accused of fraudulently inducing bond insurer MBIA Inc (MBI.N) to insure $223.2 million of risky mortgage debt. Morgan Stanley reached a settlement with MBIA to resolve the litigation between the two companies.

In another case, Morgan Stanley was charged with excessive fees to the Indiana State Teachers Association.

What to do if you invest with Morgan Stanley

If you are an investor with Morgan Stanley and are uncertain as to how you are or will be treated, print this oath and ask your Morgan Stanley sales associate to sign it. If he or she refuses, now you know why.

Most investors are familiar with open-ended mutual funds, which are bought and sold at the end of the day based on the Net Asset Value (NAV) of the fund’s holdings. As new money comes into these open-ended funds, more shares are issued by the mutual fund company.

But too few investors have ever heard of a Closed End Mutual Fund (CEF), which is unfortunate since they can be a beneficial investment option for some investors.

CEFs are similar to open-ended Mutual Funds in that they own a collection of investments (stocks, bonds, REITs, etc.), however the number of shares do not increase or decrease based on demand. CEFs start with a fixed pool of dollars with which a fixed number of shares are issued, and that number does not change over time.

Because the numbers of shares are fixed, CEF shares are bought and sold in a manner similar to a share of regular stock. One main advantage of this structure is that the price of the CEF is determined by the market, not the value of the underlying investments. This means, essentially, that it is possible to buy a collection of stocks or bonds at a discount to NAV, and to sell them at a premium to NAV.  Prices for shares of conventional open-ended Mutual Funds always track exactly to the NAV.

Adding CEFs to a diversified portfolio could provide increased tax-free income with a leveraged muni bond fund (ex. AKP, VCV, NAC), enhanced dividend yields with a covered call or preferred stock CEF (ex. FVT, PDT, JGV). A CEF can also provide exposure to alternative asset classes in an actively managed fund that can be purchased at a discount to the NAV.

Gary Cohen, a Financial Planner and Investment Fiduciary in CA, has personally invested in CEF’s for some time and has the following insights.

CEF advantages include:

1. No big inflows of cash chasing performance or redemptions when investors begin jumping ship due to a poorly performing fund.
2. Stays fully invested during market cycles since no cash is needed to redeem shares.
3. Can purchase and redeem CEFs throughout the trading day.

CEF disadvantages include:

1. Typically, a very small number of shares trade in a given day, meaning large orders can affect prices.
2. Wider bid/ask spreads than is typical for mutual funds.
3. Possible higher expense ratios due to the smaller capital pool being managed.
4. Some CEFs are somewhat more expensive versions of conventional mutual funds, but others use the inherent CEF structure to provide distinct advantages which could include:
   • Leverage:  CEFs can borrow against their holdings to increase returns (and concurrently increase risk).  Typically, CEF bond funds will leverage 20-40%, boosting yields by 1% or 2% over conventional funds.
   • Covered call writing:  Some CEFs use a covered-call strategy to boost yields and income, trading capital appreciation for current income.
   • Preferred stock investing: Some CEFs can arbitrage among preferred stocks, bonds and common stock to increase current income and provide capital appreciation.
   • Investing in alternative assets like REITs, commodities, floating rate notes or other “exotic” investment classes.

Some guidelines for investing in CEFs:

1. Buy at a discount or even at par, but never at a premium.
2. Always buy and sell in small quantities using limit orders. Never buy or sell more than 1,000 shares at a time. Plan to buy or sell over a number of days to minimize the effect on prices.
3. Use leverage wisely; leverage low risk investments (e.g. AAA muni bonds or blue chip stocks) but not speculative investments.
4. Understand that most CEFs provide higher levels of current income but that often comes at the expense of long term capital gains.
5. Avoid investing in CEFs that have been returning capital and not earning their distributions via investments or trading activities.
6. Do not automatically invest dividends and capital gains distributions.  The purchase of CEFs should be a conscious decision, not automatic, since their prices can move significantly.