The Securities Litigation Expert Blog

FINRA: Santander Failed to Update Risk on Puerto Rico Munis - See Our Suitability Matrix

Posted by Jack Duval

Oct 14, 2015 10:37:00 AM


Yesterday FINRA announced a $6.4 million fine and Acceptance, Waiver and Consent by Santander for sales practice and supervisory violations at its Puerto Rico offices.  (FINRA Press Release and Santander AWC - search under Case Number: 2014041355501)

The AWC and sanctions revolve around a number of failures to supervise the sales of Puerto Rico municipal bonds and closed-end funds.  The AWC highlights a number of supervisory failures, including:

  • The failure of Santander to update its proprietary risk-classification tool for the unique and changing risks of Puerto Rico municipal bonds; (See our Suitability Matrix, below.)
  • The failure to monitor for the use of margin in connection with the purchase of Puerto Rico municipal bonds;
  • The failure to monitor for over-concentrated positions in Puerto Rico municipal bonds and closed-end funds;
  • The failure to monitor for Registered Representatives selling personal Puerto Rico municipal bond holdings to their clients. 

The "Securities Master"

Santander used a proprietary risk-classification tool that categorized securities into three risk levels: low, moderate, and high.  The AWC noted the "vast majority of Santander's clients were moderate-risk investors" and that almost all the Puerto Rico municipal bonds sold to their clients were coded moderate-risk.  However, Santander did not update the Securities Master to reflect the dramatically increasing risks in the Puerto Rico municipal bond market.

The FINRA press release stated:

Santander did not review or assess the tool's Puerto Rico municipal bond risk classifications following significant market events such as the December 13, 2012, Moody's downgrade of certain (bonds) to one level above junk.

Santander and its Registered Representatives Sold Their Puerto Rico Municipal Bonds While Customers Held or Purchased Them

While Santander was holding its moderate risk classification steady for Puerto Rico municipal bonds, it was reducing it's trading desk inventory.  The AWC states:

On November 29, 2012, Santander began reducing its Puerto Rico municipal bond inventory.  (The December 13, 2012 Moody's downgrade) acceleranted the Firm's efforts to reduce its inventory of Puerto Rico municipal bonds, reflecting Santander's concerns about changed risks in the market for Puerto Rico municpial bonds and Santander's exposure to those risks.

The next day, on December 14, 2012, Santander closed its Puerto Rico trading desk to any new purchases of Puerto Rico municipal bonds... The Firm, however, continued to reduce its market exposure and entirely eliminated its inventory of Puerto Rico municipal bonds by October 2013.

... employees sold securities directly from their accounts to customer accounts.


FINRAs sanctions include:

  • A centure;
  • A fine of $2 million;
  • Restitution of approximately $4.3 million.


The most significant finding in the AWC is that Santander failed to update it's risk-classification for Puerto Rico municipal bonds in the face of overwhelming evidence that the economy had been in a long-term decline, and the fact that the bonds had been downgraded a number of times.  (Puerto Rico GO bonds were downgraded on 8/8/11, 12/13/12, and 3/13/13.)

These increasing risks made the bonds less and less suitable for investors going back to the beginning of the economic decline in 2006.

The Accelerant Puerto Rico Municipal Bond Suitability Matrix

Accelerant has created a suitability matrix showing how Puerto Rico municipal bonds became more risky and less suitable over time.  It provides a framework for evaluating the suitability of client positions in Puerto Rico municipal bonds, by level of client account concentration. Key features:

  • Identifies three distinct phases of increasing risks in Puerto Rico municipal bonds;
  • Highlights two milestones where continuing to hold the bonds required higher risk tolerances or lower allocations;
  • Provides a clear and consistent method for evaluating damage claims.

For a high resolution version of the Suitability Matrix, go here.



For information about Puerto Rico municipal bonds expert Jack Duval, click here.

For my previous coverage of the Puerto Rico municipal bond crisis, see this.


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Topics: municipal bond crisis, FINRA, closed-end funds, Puerto Rico, UBS, supervision, securities litigation, Compliance, Santander

Jack Duval Quoted on Wells Fargo AWC over Complex Investments

Posted by Jack Duval

Aug 7, 2015 1:26:06 PM


Accelerant Managing Partner Jack Duval was quoted in a Thomson Reuters Regulatory Intelligence article.  The article can be found on the Thomson Reuters Risk website here.  (Behind a paywall.)  For thost without access, the entire article is copied below:



Wells Fargo Fined Over Investment Product Too Complex for Brokers, Clients

Aug 05 2015 Richard Satran, Regulatory Intelligence

The sale of an investment that the U.S. securities industry regulator found too complicated for the amount of training and preparation on the part of Wells Fargo's sales team has generated a long tail of fees and legal costs for the broker dealer.

The Financial Industry Regulatory Authority said Tuesday it had reached an agreement with Wells Fargo on a censure and fine of $500,000 for the broker dealer's failure to educate and train brokers on the risk of the complicated floating-rate loan fund first sold in 2008 by the company's predecessor, Wachovia.

"This is one of those cases where complexity itself is the risk," said Jack Duval, managing partner of Accelerant, a securities litigation consulting firm. "The complexity comes back to bite everybody -- first at the client level and then at the broker level. Many investments have gone wrong because brokers misunderstood what they were selling." 

FINRA already has awarded restitution and assessed fines against Wells Fargo for the selling "unsuitable" investments in the case of the floating rate securities it calls STRATS, an acronym that stands for Structured Repackaged Asset-Backed Trust Securities.

Clients were sold on the STRATS for their safe, enhanced yield by brokers who were not made aware risks of the products, FINRA said in the action announced Tuesday. The STRATS were constructed from bonds whose fixed income interest payments were swapped for floating rate swap agreements. Far from simple, conservative securities, the STRATS were structured products loaded with fees for early termination and a capital security whose value fluctuated in the market.

The brokers "were generally not familiar" with the investments they were selling and the firm did not provide the training and supervision to sell them. In its investigation, FINRA reviewed internal marketing collateral and found that brokers would have "no reasonable basis for recommending the STRATS to retail customers."

The case shows how costly and time consuming a complicated financial offering can become. The broker has paid out some $10 million in fines and restitution for fund sales of only $12 million. While it pales compared with the $5.42 billion Wells reported for its quarterly profit last month the case generated untold legal costs over five years, along with reputational damage. Wells Fargo said it does not comment on FINRA cases.

In the latest action this week, Wells Fargo was still paying out for the complex investments that were initially packaged by Wachovia, a firm it acquired in a government supervised distress sale in 2008. In addition to the half-million dollars in new fines, the new agreement required new restitution of $241,974.34 in 2012 to pay customers for unexpected costs at the final redemption for those who held the securities issued six years ago. FINRA found that holders were not made aware of the risk that they would lose part of the principal on their investment on account of a termination fee.

"At the time of the STRATS termination many customers holding the STRATS received less and in some cases significantly less, than they paid for the STRATS." For Wells Fargo, the costs have also mounted for an ostensibly conservative trading instrument that kept on claiming time and money.


Learn more about complex investment expert Jack Duval.

   Get Updates on Complex Investments

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Topics: Structured Products, Complex Investments, Compliance, Investment Complexity, Complex Investment Expert, Wells Fargo, FINRA Regulation, STRATS, AWC

FINRA Issues Regulatory Notice 13-31 Suitability

Posted by Jack Duval

Oct 23, 2013 7:36:07 AM

FINRA has issued RN 13-31 to highlight effective practices for member firms when complying with Suitability Rule 2111.  (RN 13-31)

A number of highlights are worth noting, including:

  •  The manner in which the firm supervises explicit hold recommendations, including the method of documentation the firm uses when documentation occurs, as well as the information the firm considers in conducting the review...

  • Transaction red flags such as: those that appear to deviate from the firm’s internal suitability guidelines for a particular security; a long-term investment for an investor with a short-term horizon; a speculative investment or strategy held in the account of an investor with a conservative investment objective; and the same security held in the account or strategy implemented for...

The RN also emphasized compliance with the reasonable-basis component of Rule 2111:
As referenced above, reasonable-basis suitability requires a firm or associated person to perform reasonable diligence to understand the nature of a recommended security or investment strategy involving a security, as well as its potential risks and rewards, and to determine whether the recommendation is suitable for at least some investors based on that understanding. FINRA observed during examinations that many firms have in place a new product vetting process that assists them in executing reasonable diligence obligations. While many large firms have extensive frameworks for assessing products, even smaller firms established investment committees to vet complex or risky products to determine whether the product met the reasonable-basis suitability standard for retail customers, and if so, the type of customer profile for which the product would be suitable if recommended.

A firm’s vetting of new products does not, standing alone, satisfy the need for associated persons to understand the securities and investment strategies they recommend to customers.  In this regard, some firms post due diligence on products (and accompanying documents) to an internal website that associated persons can access when recommending a product. Such information includes audited financial statements, notes of interviews with key individuals of the product sponsor or issuer, and other information relevant to understanding the product and its features. Some firms use the vetting process to aid in product-focused training of their associated persons, supervisors and compliance staff.

Compliance with the reasonable-basis suitability requirement will be an important issue in the next securities litigation cycle.  Chief Compliance Officers are right to focus on this issue before the next cycle is upon them.
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Topics: reasonable basis suitability, FINRA, RN 13-31, litigation, investments, supervision, Due Diligence, SEC, Compliance, regulation.

FINRA Moves Closer to Fiduciary Standard with Conflicts Report

Posted by Jack Duval

Oct 22, 2013 10:54:25 AM

According to a release by FINRA CEO Richard G. Ketchum, the regulator is stepping up it's focus on conflicts of interest at Broker-Dealer firms.  (Release)  This increase in focus is significant because it takes a step closer to a fiduciary standard for Registered Representatives.  The full, 44 page report can be found here.

Some areas for BD focus include:

  • identifying and managing conflicts on an ongoing basis through an enterprise-level approach that is scaled to the size and complexity of a firm's business and that starts with a "tone from the top" that carries through to the organization's structures, policies, processes, training and culture;

  • establishing new product review processes that include perspectives independent from the business proposing products, that identify potential conflicts raised by new products, that restrict distribution of products that may pose conflicts that cannot be effectively mitigated and that periodically re-assesses products through post-launch reviews;

  • making independent decisions in the wealth management business about the products they offer without pressure to favor proprietary products or products for which the firm has revenue-sharing agreements;

  • minimizing conflicts in compensation structures between customer and broker or firm interests where possible and including heightened supervision when conflicts remain; for example, around thresholds in a firm's compensation structure;

  • mitigating conflicts of interest through disclosures and other information that enables customers to understand the factors that may affect a product's financial outcome—such as the use of scenarios and graphics for a particular product; and

  • including "best-interest-of-the-customer" standards in codes of conduct that apply to brokers' personalized recommendations to retail customers in order to maintain and increase investor trust.

Broker-Dealer compliance departments will need to establish a framework of policies and procedures to address actual and potential conflicts of interest.


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Topics: FINRA, Richard G. Ketchum, litigation, Conflicts of Interest, investments, report, SEC, Compliance, Dodd-Frank Act, regulation.

Accelerant Publishes New White Paper: "Suitability Obligations When Using Specialists"

Posted by Jack Duval

Oct 16, 2013 4:10:45 AM

The white paper can be found here.

From the introduction:

The specialist system has existed in the brokerage world since the 1980’s, however, it has not received a great deal of regulatory or expert commentary. This is remarkable since the use of specialists is common throughout the industry, particularly in the sales of complex products.

This paper explores the suitability obligations of Registered Representatives and product specialists when jointly making recommendations to clients. The origin and evolution of the specialist system is examined along with the functions typical of specialists. The industry distinction between “inside” and “outside” specialists is described, and selling agreements between Broker-Dealers (“BDs”) and outside specialists are examined as well.

Most importantly, a critical potential dilemma is explored in regards to suitability: what happens if the Registered Representative knows the client, the product specialist knows the product, but neither knows both?

The answer, in short, is that the Registered Representative has ultimate responsibility for the suitability of all recommendations to the client. However, if the Registered Representative involves a specialist in the recommendation at any time, then both must know the client and the investment well enough to make a suitability determination. If either fails in this regard, then the recommendation cannot be said to be suitable.

The paper is co-authored by John Duval, Sr. and Jack Duval.



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Topics: FINRA, registered representative, broker dealer, litigation, white paper, suitability, supervision, Accelerant, SEC, specialists, Jack Duval, John Duval Sr., Compliance, regulation.

FINRA Focusing on Private Placements

Posted by Jack Duval

Sep 9, 2013 5:54:14 AM

FINRA has been focusing on new private placements this summer, Reuters reports here.  Recent actions are the result of the new rules requiring the filing of private placements offering documents.

Recent changes to industry rules require brokerages to hand over private offering documents to FINRA within 15 days of the first sale. That makes it easier for the regulator to sniff out possible wrongdoing, said J. Bradley Bennett, FINRA's enforcement head, in an interview on Tuesday.

The regulator has received 1,900 offerings since December, 2012, when the rule took effect, Bennett said, who added that FINRA's staff has referred numerous concerns to its enforcement unit for review because of the new trove of information.

The shale bubble has also drawn focus:
Some red flags that can trigger a closer look by FINRA's enforcement team include offerings tied to fields that are the subject of a lot of hype, such as natural gas extraction, said Bennett

See our previous coverage of private placements here, here, and here.
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Topics: FINRA, Investment Advisors, private placements, litigation, investments, SEC, Compliance

Leveraged and Inverse ETFs: Trojan Horses for Long-Term Investors

Posted by Jack Duval

Aug 28, 2013 2:34:25 AM

Accelerant has a new white paper about leveraged and inverse Exchange Traded Funds ("ETFs"), here.  The paper includes the following:

  • Historical background on ETFs;

  • The introduction of leveraged and inverse ETFs;

  • How leveraged and inverse ETFs have been misused;

  • An explanation of the internal rebalancing mechanism of leveraged and inverse ETFs;

  • A review of prospectus language;

  • A literature review, including popular and financial press, academic, and industry sources;

  • FINRA Suitability Rules;

  • RIA Suitability Regulations, including the fiduciary duty;

  • Supervision and compliance implications for both Broker-Dealers and RIA firms.



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Topics: FINRA, RIA, Leveraged and Inverse, Investment Advisors, litigation, Senior Investors, investments, rebalancing; investments; FINRA, '40 Act; Suitability; Supervision; Compliance, SEC, ETF, Compliance, regulation.

3 Dangerous Trends for Senior Investors

Posted by Jack Duval

Jun 6, 2013 2:39:24 AM

After 13 years of volatile markets that have left many retirees with their assets depleted, some of them are taking desperate measures to make ends meet.  Recent articles have highlighted three of these methods:

  • Reverse Mortgages.  Allow a homeowner to monetize their home while living in it. (CNBC)

  • Early IRA Withdrawals.  Allow an IRA holder to make withdrawals before age 59 1/2 or before Required Minimum Distributions start. (Forbes)

  • Pension Loans.  Allow a pensioner to monetize their income stream. (NYT)

None of these are sustainable and they all put the retirees at risk of running out of money.  If utilized, they should be used to fund living expenses and not investments.

Under the FINRA Suitability Rules (2111), "investment strategies" are covered, so a recommendation by a Registered Representative for a client to use one of these strategies would come under the rule.  This is similar to the "Liquified Home Equity" strategy that became common during the housing bubble.  (NTM 04-89)

Compliance and supervisory personnel should monitor accounts for deposits from these strategies and insure that they are not going into securities - a sequence that would almost certainly involve fees and/or penalties from the liquidity source and fees from the subsequent reinvestment.

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Topics: Rule 2111, FINRA, Pension Loans, Investment Advisors, early IRA withdrawals, reverse mortgages, Senior Investors, investments, SEC, Compliance, NTM 04-89, regulation.

FINRA Issues NTM Regarding Unlisted REITs

Posted by Jack Duval

May 7, 2013 4:58:50 AM

FINRA has issued NTM 13-18 Communications with the Public, providing guidance on communications with the public concerning unlisted REITs and DPPs.  (NTM 13-18)  Several things are of note:

1. As always, providing a prospectus does not satisfy the required disclosures in written and oral communication.

 Providing risk disclosure in a separate document, such as the prospectus, does not substitute for the required disclosure, even if a communication is accompanied or preceded by a prospectus.

2. Firms may not state the distribution rate is a "yield" or "current yield".  This is because distributions have historically included a return of principal.

3.  Firms may not imply that the values of the fund are stable just because they are offered at the initial offering price.

 The fact that a program offers its securities at par value, or at another relatively stable price, does not evidence stability in the value of the underlying assets.  A communication also may not state that the price at which the program is offered is stable or that its volatility is limited without disclosing that price stability does not indicate stability in the value of the underlying assets, which will fluctuate and may be worth less than the real estate program initially paid, and that the investor may not be able to sell the investment.

4. Firms may not compare the performance of an unlisted REIT to a listed REIT.

Compliance and supervisory personel would be wise to implement this guidance when conducting their reasonable basis suitability determinations, review of advertising, Registered Representative communications, and customer specific suitability.  Especially in light of investor's yield chasing.

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Topics: FINRA, Apple REIT 10, suitability, investments, supervision, REIT, DPP, SEC, fixed income, Compliance, regulation.

New York City Bar Securities Arbitration and Mediation CLE Program

Posted by Jack Duval

May 6, 2013 2:44:41 AM

The New York City Bar Association is sponsoring a half-day program on Securities Arbitration and Mediation on June 4, 2013 from 9am to 1:15pm.  (NYCB)  Here's the schedule:

9:00 - 9:05 a.m. Introduction 

9:05 - 9:25 a.m. FINRA: Breaking News… New Rules, Proposed Rules, Large Case Pilot Project, Pre-Dispute Arbitration Agreements and the Class Action Waiver Linda D. Fienberg 

9:25 – 9:45 a.m. All Public Arbitrator Panels: Special Advocacy Tips, The Importance of Experts, & Expanded Discovery Rules Scott C. Ilgenfritz & Theodore Krebsbach 

9:45 – 10:00 a.m. Who is a Customer? Sandra D. Grannum & Joseph Peiffer 

10:00 - 10:20 a.m. Expungement, In Rem Proceedings & Joint Representation Issues Sandra D. Grannum & Joseph Peiffer 

10:20 - 10:30 a.m. Break 

10:30 - 11:00 a.m. Supervision of “Complex” Products, Non-traded REIT’s, & Leveraged/Inverse ETF’s Darya Geetter & Joseph Peiffer 

11:00 - 11:30 a.m. New Suitability Rule Scott C. Ilgenfritz, Michael Schwartzberg & James Wrona 

11:30 – 11:45 a.m. Claims by and Related to Seniors Theodore Krebsbach & Joseph Peiffer 

11:45 - 12:00 p.m. Interplay Between Arbitration Proceedings and Regulatory Proceedings Sandra D. Grannum, Joseph Peiffer & Michael Schwartzberg 

12:00 – 12:15 p.m. Conversation Between the Audience and the Panel: What do arbitrators want from advocates; The increasing complexity of arbitration

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Topics: FINRA, litigation, supervision, SEC, NYC Bar, Compliance, regulation., education

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