South Carolina FINRA Arbitration Lawyers

The Securities Commissioner of South Carolina recently issued two consent order settlements reached with two financial firms for failing to supervise the sale of illiquid, alternative investments products to its retail customers — LPL Financial concerning its sale of non-traded Real Estate Investment Trusts (REITs) and Business Development Companies (BDCs), and Raymond James & Associates regarding its sale of Unit Investment Trusts (UITs). South Carolina investors and retirees who did not understand the risks of these products learned the hard way, suffering losses to their retirement savings from their financial adviser’s unsuitable recommendations of these alternative securities products. Under both South Carolina and federal securities laws, brokerage firms and other financial firms have a duty to supervise retirement accounts and financial advisors to ensure they are acting in the best interests of their customers, and not recommending these products which are unsuitable for most retirees given their high fees and speculative risks.

Investors seeking legal recourse to recover their lost funds usually find out that their cases are ineligible to be brought in court because their accounts are subject to an arbitration agreement that requires their cases to be heard in arbitration before the Financial Industry Regulatory Authority (FINRA). Malecki Law is a FINRA arbitration law firm with skilled practitioners in the FINRA forum — whether in South Carolina or nationally — the law firm has recovered tens of millions of dollars for retiree and senior investors who have suffered losses from alternative, illiquid securities like non-traded REITs, BDCs, and UITs.

In 2019, the Securities Division of the Office of the Attorney General of South Carolina issued a Consent Order settlement with LPL Financial LLC, sanctioning the firm for misrepresenting to investors on their monthly statements that certain non-traded REITs and BDCs were ordinary, publicly-traded equities. The regulator stated that these misrepresentations had occurred since at least 2012, where “LPL was aware” that these alternative products were misclassified on the second page of client monthly statements under the Portfolio Investment Summary, which breaks down the client’s portfolio by listing the investment type, the dollar amount, and the overall percentage of the customer’s overall holdings. At a glance, a customer would be able to understand from this graphic whether they were over-concentrated in a particular type of security. Monthly account statements are considered by regulators to be “communications with the public” under state and federal securities laws, and therefore, misclassifying alternative products as regular equities had the potential to mislead investors that their funds were more safely invested in traditional equities.

Malecki Law’s FINRA arbitration attorneys have seen many financial product cases over the years, so we know that alternative investment products have become more popular than ever. The array of alternative products being marketed to seniors and retail investors is just too many to keep track of, and many are of the non-traded variety, including REITs, BDCs, and UITs just to name a few. But these products have extremely high fees that most retail investors are never made aware of. In another South Carolina Securities Division Consent Order against Raymond James & Associates, the regulator explained how the fees in certain UIT products add up and eat into an investor’s potential returns:

“Most of a UIT’s fees are non-recurring charges that occur in the first six months of the UIT’s lifecycle. These non-recurring fees include sales charges, creation and development fees, and pass-through costs related to organizing the trust. The sales charges are paid to the recommending broker-dealer agent. The remainder of the charges are paid to the UIT’s sponsor. Because sales charges and other costs reduce the overall investment return, UITs are often more beneficial for investors who adopt a “buy and hold” strategy. Repeatedly selling UITs well before their maturity date, a practice often referred to as “Short Holds,” and then repeatedly purchasing newly issued UITs is a practice that will cause investors to incur sales charges with greater frequency than if they followed a longer term “buy and hold” approach. When an investor liquidates a UIT prior to termination, the upfront sales charges will amortize over a shorter period, resulting in higher costs to the UIT Investor. UITs also charge recurring fees that accrue on an annual basis. These fees include administration costs and the trustee’s fees.” [Emphasis added.]

In addition to these costs, the regulator admonished Raymond James for failing to monitor UITs that were being bought and sold frequently and in high concentration, inconsistent with a buy and hold strategy.

Whether a non-traded REIT or a UIT, alternative products have complex and a different set of risks that retail investors should be fully made aware of before investing them. Financial advisers have a duty to disclose these risks and features.

Another common risk in alternative products, in particular for non-traded products, is their risk of illiquidity. Liquid investments means investors can exit the investment at a time of their choosing without selling at a massive discount. That is not the case with illiquid non-traded products because they have sale and hold restrictions that are different from regular equities. As explained by the U.S. Securities and Exchange Commission in one of its Investor Bulletins:

“Non-traded REITs are illiquid investments, which mean that they cannot be sold readily in the market. Instead, investors generally must wait until the non-traded REIT lists its shares on an exchange or liquidates its assets to achieve liquidity. These liquidity events, however, might not occur until more than 10 years after your investment.”

Malecki Law’s FINRA arbitration lawyers recognize that many investors, and especially seniors and retirees, do not have ten years to wait before exiting their investments. Retirees are no longer working and, therefore, need liquidity to be able to access their money for daily living and the increased medical expenses that are typically associated with aging. A younger investor may want to use the funds towards the purchase of a home in two or three years — a 10-year lock-up of their investment would make their funds illiquid and would defeat the investment objectives. Our team understands that many investors who are recommended these products are often never made aware until too late. Investors attempting to exit these positions any earlier than the product’s “liquidity events” will be unsuccessful because there is usually no existing secondary market for investors to sell them (i.e., there are no buyers!). Conversely, products sold on a public exchange can be entered and exited at any time without being forced to “sell low” in order to exit.

With all these drawbacks, investors might assume that they are at least being compensated for taking on the risk of an illiquid product because of the opportunity to gain higher yields. But that is not the case, as studies have shown that annual returns for publicly traded REITs, for instance, have far outperformed non-traded REITs by nearly double.

In attempting to recover investment losses from these alternative products, misled South Carolina investors and retirees should consider consulting an experienced FINRA arbitration law firm such as Malecki Law, whose lawyers are fully familiar with the relevant securities laws and relevant industry rules. When investors find themselves unable to rid themselves of their illiquid securities, other traditional remedies of recovery may be available if the investor is still holding them in their portfolio. Rescission, for example, is one legal remedy that allows a judge or arbitrator to cancel the transaction as if it never happened, returning the full initial principal to the investor in exchange for the illiquid security being returned to the firm. South Carolina investors who have been misled by financial advisers into alternative investments like non-traded REITs, BDCs, or UITs should explore their representation options. Our team handles a wide variety of securities matters to recover lost investment funds, whether due to fraud, misrepresentations and omissions, negligence, or firm supervisory failures. To schedule a free initial consultation with Malecki Law, please call (212) 943-1233, or email jenice@maleckilaw.com.