Power of Attorney. Trustee. Executor. Beneficiary. Those are all terms that should set off alarms for any registered representative asked to accept such a role for a customer. And even if the lights aren't flashing and the bells are ringing in your head, rest assured that something will light up and sound off in your firm's compliance department -- and ultimately at an industry regulator. Yes, you can, under certain circumstances, accept such roles; but you better make sure you're up to snuff with both your firm's compliance rule and industry regulators' regulations.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Shelby Lee Bowles submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In the Matter of Shelby Lee Bowles, Respondent (AWC 2012031886901, December 5, 2013).
In 1989, Bowles first became registered and during the times relevant to this matter, he was with FINRA member firm Securities Service Network, Inc. (“SSNI”) from January 1, 2010, until March 22, 2012.
Elderly Client's POA
Although Bowles had served since 2007 as power of attorney for an elderly customer, when Bowles registered in January 2010 with SSNI, he did not disclose that relationship to the firm. The AWC asserts that the customer is now deceased.
A Matter Of Preparation
In March 2011, Bowles prepared a Trust Agreement for the elderly client’s trust ("Trust Agreement") and a Last Will and Testament ("the Will").
On March 17, 2011, the client executed the Trust Agreement to house all of her assets, which exceeded $1,000,000; and she appointed Bowles as the sole trustee (the designation of a beneficiary was in the "sole discretion of the trustee") -- Bowles made his wife the beneficiary.
On March 23, 2011, the client executed the Will, which named Bowles as the executor and sole beneficiary.
SIDE BAR: FINRA Rule 3270: Outside Business Activities of Registered Persons
No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member, in such form as specified by the member. Passive investments and activities subject to the requirements of NASD Rule 3040 shall be exempted from this requirement.
.01 Obligations of Member Receiving Notice. Upon receipt of a written notice under Rule 3270, a member shall consider whether the proposed activity will: (1) interfere with or otherwise compromise the registered person’s responsibilities to the member and/or the member’s customers or (2) be viewed by customers or the public as part of the member’s business based upon, among other factors, the nature of the proposed activity and the manner in which it will be offered. Based on the member’s review of such factors, the member must evaluate the advisability of imposing specific conditions or limitations on a registered person’s outside business activity, including where circumstances warrant, prohibiting the activity. A member also must evaluate the proposed activity to determine whether the activity properly is characterized as an outside business activity or whether it should be treated as an outside securities activity subject to the requirements of NASD Rule 3040. A member must keep a record of its compliance with these obligations with respect to each written notice received and must preserve this record for the period of time and accessibility specified in SEA Rule 17a-4(e)(1).
In addition to FINRA’s Outside Business Activity Rule, SSNI's in-house procedures required disclosure of all outside business activities ("OBA") by its registered representatives and required representatives to obtain approval before serving as a customer’s power of attorney, trustee or executor.
The AWC asserts that Bowles did not provide prior written notice to SSNI about his service as a power of attorney, trustee, executor, and beneficiary; and such conduct was deemed to constituted separate OBA.
On January 1, 2010, Bowles falsely indicated that he had not and would not serve as a trustee,guardian, executor, power of attorney, custodian, etc. without SSNI's prior written approval.
During an October 6, 2011 office audit, Bowles was specifically asked by his supervisor whether he had disclosed all OBA, and whether he served as trustee, joint signatory or power of attorney for any customer. Bowles falsely stated that he had disclosed all OBA and failed to disclose that he served as trustee and power of attorney.
Finally, on October 31, 2011, Bowles completed a 13-page SSNI document titled, Survey Title Rep Questionnaire. Section 8 of the survey addressed OBA and posed the question:
Are you named in any of the following over any assets, client or non-clients, family or non-family?
The question required the entering of a check mark for each applicable role: trustee, successor, trustee, co-trustee, beneficiary, executor, power of attorney, conservator, guardian/custodian, or N/A. Bowles falsely answered "N/A," despite the fact that he was acting as a trustee, the executor and beneficiary of the Will, and exercising a power of attorney at that time.
According to online FINRA documents as of December 12, 2013, SSNI “Discharged” Bowles on March 22, 2013, based upon allegations that:
MR. BOWLES VIOLATED COMPANY POLICY BY SERVING AS TRUSTEE, EXECUTOR AND SOLE BENEFICIARY FOR A CLIENT NOW DECEASED WITHOUT PRODUCING NOTICE OR RECEIVING APPROVAL FROM THE FIRM.
Pursuant to FINRA Rule 8210 request letters dated April 3, 2013, July 9, 2013, and September 11, 2013, were sent by FINRA to Bowles, seeking copies of Bowles's 2010 and 2011 personal federal and state tax returns, and certain bank account statements. To date, the AWC asserts that Bowles has failed to produce these documents, in violation of FINRA Rules 8210 and 2010.
FINRA deemed that Bowles:
- failed to disclose his OBA as more fully set forth above in violation of NASD Rule 3030, and FINRA Rules 3270 and 2010;
- submitted two false compliance questionnaires to SSNI in which he denied that he acted in any fiduciary capacity for customers or served as power of attorney, executor, trustee or beneficiary. He also denied any such relationships to his supervisor during an office examination, in violation of FINRA Rule 2010; and
- failed to provide requested documents and information in violation of FINRA Rules 8210 and 2010.
In consideration of the terms of the AWC, FINRA iposed upon Bowles a $40,000 fine and a 10-month suspension from association with any member of FINRA in any and all capacities.
On Wall Street, a little discretion can sometimes go a long way -- perhaps even leading to a regulatory fine and suspension. Then there's that whole dispute between the industry and its regulators as to whether it's okay or not okay or sort of okay or sort of not okay to recommend leveraged exchange traded funds ("ETFs"). In today's BrokeAndBroker blog we examine one regulatory settlement involving both the use of discretion and leveraged ETFs.
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority (“FINRA”), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Stuart A. Epley submitted a Letter of Acceptance, Waiver and Consent (“AWC”), which FINRA accepted. In the Matter of Stuart A. Epley, Respondent (AWC 2012032504801, December 3, 2013).
In 1998, Epley entered the securities industry and from 2009 until he was permitted to resign on May 2, 2012, he was registered with FINRA member firm Ameriprise Financial Services, Inc. The AWC asserts that he had no prior disciplinary history.
Starting around March 2010 through April 2012, Epley allegedly executed 87 transactions in eight customer accounts without obtaining prior written authorization from the customers and without having the accounts accepted as discretionary by his firm. At the times of the cited transaction, the firm did not permit discretionary trading with the exception of very limited use of time and price discretion.
Getting Some Leverage
The AWC further alleges that around April 2011 through January 2012, Epley mismarked 24 order tickets in eight customer accounts in order to facilitate the purchase of leveraged ETFs. Although he had solicited the trades, Epley purportedly marked them as “Unsolicited.” At the relevant times, the firm’s policies prohibited registered representatives from recommending leveraged ETFs. As a consequence of the mismarked order tickets, Epley caused the firm's books and records to be inaccurate.
SIDE BAR: In order to better understand the issues in this matter, read:
Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track—or both—are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.
This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met. . .
In accordance with the terms of the AWC, FINRA imposed upon Epley a three month suspension in all capacities with any FINRA member firm. The AWC asserts that no monetary sanction was imposed because of Epley’s September 30, 2013, Chapter 7 bankruptcy petition.
HedgeLender LLC apparently had this idea – frankly, it sounds wonderful but for the fact that the Feds seem to characterize it as a “scheme” and a crime. I mean, geez, what's not to like about a transaction that transforms your capital gains into non-taxable loans? Oh well, those government types are such party poopers.
A Capital Idea: a loan
You got some stock with unrealized profits but you don't want to sell the shares and get hit with capital gains tax. What's an investor flush with unrealized profit to do when he or she is allergic to paying tax?
You could have gotten in touch with HedgeLender, which magically transformed your untapped profits into, voila, a loan. And what collateralized this loan? Why the very shares that you are trying to ring some profit out of, albeit without paying tax. A loan that HedgeLender asserted avoided the recognition of profit for capital gains purposes. A loan that supposedly didn't need to get reported to any taxing authority.
Wow! Just imagine. I buy XYZ for $10 and it goes up to $20 and someone loans me money in a way that allows me to realize my $10 profit without having to pay a penny’s worth of tax. Even better, my un-sold stock will serve as the collateral for the loan. Sign me up!!
Plan or Scam?
Unfortunately, on June 16, 2011, the Justice Department announced that the U.S. District Court for the Eastern District of Virginia entered a permanent injunction against HedgeLender LLC that barred the company from promoting a stock-loan tax scheme. The Complaint against HedgeLender also named two alleged owners of HedgeLender, Daniel Stafford and Fred R. Wahler, Jr., as well as William Chapman and two companies he allegedly owned, Alexander Capital Markets LLC and Alexander Financial LLC. All five of those defendants previously agreed to permanent injunctions without admitting the allegations in the complaint.
It seems that the Court found that HedgeLender knowingly made false statements when it characterized its tax-avoidance program as a loan secured by the customer’s stock. Apparently, the Court was troubled by the fact that the subject stock was sold immediately and the proceeds of that sale were then paid to the customer. This nuance sort of killed the whole idea that the customers were getting “loans,” and really made the transaction look like little else than the payment of capital gains, which are subject to federal taxes.
Still, I gotta hand it to HedgeLender. Before the feds turned off the lights on this party, the defendant engaged in sales of more than $268 million in securities . The other brassy aspect of this deal was that even after the Securities and Exchange Commission sued two of its owners, who agreed to stop promoting a similar stock-loan product, HedgeLender stayed the course.
Chapman was the founder and owner of Alexander Capital Markets ("ACM"), whose primary business was structuring a fully hedged loan at an above-market rate of interest against a customer’s securities. In exchange for a customer’s stock, ACM might extend a cash loan to that customer worth 85 or 90% of the stock’s value.
After the expiration of the term of the loan (which ran between two and seven years; typically three years) and subject to repayment of principal with accrued interest, the customer could reacquire their securities or receive the equivalent cash value. On the other hand, the customer also had the option of simply walking away with the loan proceeds in lieu of re-acquisition of the pledged shares or payment of their present market value.
The 10% Solution
In reality, ACM simply sold the securities upon receipt, remitted up to 90 percent of the sales proceeds to its customers as a purported loan, and retained the remaining sales proceeds for itself and the parties who sold, marketed or facilitated the product. So, sure – the customers got a whopping percentage of the present value of their shares; and, you might ask, what’s the harm? A lousy 10%? Big deal, that's sorta like a haircut or a modest finder's fee. Gimme my 90% tax free and keep the tip.
All well and fine, except what was structured as a “loan” turned into a “sale” (which had negative capital gains tax consequences). Moreover, if there were any appreciation in the price of the purportedly collateralizing shares, that was all lost because those securities had been sold.
So what happened with the misbegotten profits? Turns out that Chapman purchased a custom-built $3 million home in Great Falls, Va.; condominiums in the Turks & Caicos and Pompano Beach, Fla.; and a Lamborghini and Ferrari. Unfortunately, on the heels of that spending spree, by April 2008, ACM was functionally insolvent, although the Feds alleged that Chapman continued to solicit new customers. Apparently, when all was said and done, Chapman managed to steal about $35 million for himself.
READ the following full-text source documents:
Bill Singer's Comment
Wow, ya gotta hand it to Chapman -- could you have come up with a simpler scam? He's taking your stock, selling it behind your back, giving you 90% of its value, and then simply pocketing the other 10%.
One of the more comical (unintended, as it were) aspects of this case is found in the Sentencing Minutes. There you will find that Chapman has been ordered to immediately repay $34 million in restitution. Further down the Sentencing Minutes, under the "Special Conditions" heading, you will note that the Court ordered the restitution as follows:
Ooooooooookay, so let's do the quick math. Ya got yer $34 million restitution. Ya got the court order of repayment at the minimal rate of $150 a month. So, we divide $34 million by $150 and get 226,666.67 monthly payments. Then we divide that by 12 and come out with 18,888.89 years to fully repay the restitution. Ahhh, the sweet smell of justice! Say . . . what the hell is that stink?
Dft. must pay restitution in monthly install, of $150 up to 25% of net income to begin 60 days after release