Brokers Are Not Just "Order-Takers"

The financial world has been undergoing several years of reform, to varying degrees of success. But the more circumscribed world of financial advisers has lagged behind--until now. If you’re an investor or even just a casual reader of the Business or Financial pages of the newspaper, get ready to hear a lot more about “fiduciary standard” in the next few years.

According to several recent articles, the SEC is gearing up its campaign to raise the standard for financial advisers who often claim, especially when they’re being sued for misconduct or negligence, that they’re only “order-takers” when it comes to important investment decisions. Yeah, right. Then why all the fees? And why call themselves “advisers” at all?

The truth is, at the moment, financial advisers are held to a somewhat lower standard of fiduciary obligation known as “suitability.” This standard involves a suitable match between a customer’s stated investment objectives and risk-tolerance and the financial products a financial advisor places them in. The SEC’s new standard would raise the bar. Brokers would not simply be asked to ensure that investments comply with suitability, but that brokers uphold the interests of their clients absolutely. As an article on CNBC mentions, “The current regulatory system means that brokers are legally permitted to recommend a higher-priced mutual fund to investors even if they know a low-cost one with better returns exists. Many brokers are compensated partly by commissions from mutual funds.”

With the SEC’s help, the world of investment just may become a little safer and more friendly to the interests of investors whose money is at stake in the first place. After all, shouldn’t financial advisors who are responsible for the life-savings of many of their customers, be held to professional standards that resemble the standards of lawyers, doctors, and CPAs? Of course they should. Right now, brokers are having it both ways. They take significant fees for their expertise, but they deny responsibility when that “expertise” fails them and damages customers.

Bad Apple REIT Spoils a Bunch

Sometimes a bad investment is just a bad investment. At least, that's the message that was sent by a recent ruling from a US federal judge in a class-action suit against Richmond-based Apple REIT Co, a real estate investment trust which invests primarily in hotels. The story begins in Washington back in October 2012 when FINRA sanctioned brokerage David Lerner Associates (DLA) of Syosset, NY to the tune of $14 million for restitutions to customers and fines. FINRA's sanction was punishment for what the regulatory agency determined was a whole lot of unfair practices by DLA related to offering Apple REIT Ten, as well as excessive markups on municipal bonds and CMOs. To read the full complaint, click here.

As sole distributor of Apple REITs, DLA was found to be targeting unsophisticated investors and the elderly; selling the illiquid securities without determining if they were suitable for customers; using misleading marketing materials; and touting the REIT's performance as a "fabulous cash cow" and "gold mine." FINRA slapped them up for all of that, and suspended Lerner personally from the securities business for one-year, plus a two-year suspension from being a principal in a brokerage business. But here's where the story gets more interesting than just your average misbehaving brokerage...

he same customers who won restitution from DLA got together in a class-action suit and sued Apple REIT Co. Why not, right? If DLA was messing around, maybe Apple REIT was, too. But, somewhat surprisingly, as the April 3, 2013 ruling on the matter by US District Judge Kiyo Matsumoto of the Eastern District of New York stipulates, "investors had received sufficient disclosure to understand the risks of investing" and that Apple’s investment objectives “did not constitute actionable misrepresentations or omissions.” In other words, Apple REIT did nothing wrong. They had a high-risk product that had a real chance to be an illiquid investment given the nature of the real estate market, and apparently they had disclosed all relevant information in their marketing and promotional material. In this case, the bad Apple wasn't Apple REIT: it was DLA.

The takeaway: if a REIT discloses the nature of their product in all the small print and legalese in their offering material, that does not remove the duty of the financial adviser to make sure that this investment is suitable for an individual customer. It's the financial adviser's responsibility not only to ensure suitability, but to make a full disclosure to the customer about the risks and liquidity issues involved in an investment of this (or any) type.

If you or anyone you know has been the victim of misleading marketing material or any other form of broker misconduct, please contact us for a free consultation.