On July 28, 2022, Aegis Captial Corp agreed to settle with the United States Securities & Exchange Commission an Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b) and 21C of the Securities Exchange Act of 1934, and Section 203(e) of the Investment Advisers Act of 1940, Making Findings, and Imposing Remedial Sanctions and a Cease-and-Desist Order for $2,520,865 which includes a civil money penalty in the amount of $2,300,000, pay disgorgement of $165,828 plus prejudgment interest of $55,037 in connection with the unsuitable recommendations of highly-complex variable interest rate structured products by certain Aegis Registered Representatives to forty-eight-retail customers, and Aegis’s supervisory failures relating to unauthorized trading and material misstatements and omissions made by Aegis Registered Representatives concerning the VRSPs.
According to the SEC Action, eleven Aegis Registered Representatives in Aegis’s Melville, New York branch office and three Aegis Registered Representatives in Aegis’s Boca Raton, Florida branch office recommended VRSPs to forty-eight Customers for whom the investments were unsuitable in light of each Customer’s investor profile and account information.
An Aegis RR in the Boca Branch, who also was a Managing Director, made at least 1,000 unauthorized trades in seven Customers’ non-discretionary brokerage accounts between September 2015 and May 2019. One Aegis Registered Representatives Aegis and another Aegis Registered Representative in the Boca Branch was also found to have made material misstatements and omissions about the VRSPs to Customers, falsely stating, in substance, that the Customers were guaranteed to receive their full invested principal at maturity from investing in VRSPs that, in fact, did not guarantee principal protection. That individual, Paul F. Gallivan, a registered representative in Aegis’ Florida office, was also fined and suspended for one year by the SEC for making knowingly false statements regarding the characteristics and risks associated with VRSPs to customers.
According to the SEC Order, from January 2015 through May 2019, Aegis failed reasonably to implement its: (1) Written Supervisory Procedures; (2) structured products procedures, including the training requirements for structured products; and (3) policies and procedures concerning unauthorized trading, all with a view to preventing and detecting Aegis Registered Representatives’s violations of Sections 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder.
In addition, from January 2015 through May 2019, it was also determined that Aegis also failed to create certain required records relating to customer accounts. In particular, Aegis failed to make and keep current a record, as required by Rule 17a-3(a)(17)(i)(B)(1) under the Exchange Act, indicating that it furnished to each customer, at intervals no greater than thirty-six months, a copy of the account record or an alternate document with all information required by Rule 17a-3(a)(17)(i)(A) under the Exchange Act, including, among other things, the customer’s annual income and net worth, and the account’s investment objectives.
The SEC also found that Aegis failed to make and keep current a record indicating that, for each change in a customer’s account investment objectives, Aegis furnished the customer with a copy of the updated account record or alternative document containing the information required by Rule 17a-3(a)(17)(i)(B)(1) on or before the thirtieth day after receiving notice of a change, as required by Rule 17a-3(a)(17)(i)(B)(3).
Variable Interest Rate Structured Products
Variable Interest Rate Structured Products (“VRSPs”) are complex, structured securities, typically issued by large well-known financial institutions, that offer guaranteed periodic fixed-interest rate payments, typically for one to three years.
However, after the fixed-interest rate periods ends, VRSPs make periodic variable-interest rate payments, but only if a spread exists in which the long-term Constant Maturity Swap (“CMS”) rate is greater than the short-term CMS rate and certain reference securities indexes, such as the S&P 500 and/or the Russell 2000 stock indexes, do not decline by more than a specified percentage.
Accordingly, once the fixed-interest rate payment periods end, the Customers are not guaranteed to receive any further interest payments from the VRSPs. Most VRSPs also disclosed the risk of non-payment of interest, stating, for example, that, “there can be no assurance that [investors] will receive a contingent interest payment on any interest payment date” and that “the securities are not a suitable investment for investors who require regular fixed income payments, since the contingent interest payments are variable and may be zero.”
VRSPs are different from traditional bonds issued by financial institutions in several important ways. First, unlike traditional bonds, which provide periodic fixed-interest payments that are directly linked to a bond issuer’s ability to make periodic payments and which repay principal at maturity, the VRSPs offer variable interest payments based on formulas tied to differences in Constant Maturity Swap (“CMS”) rates for longer term and shorter term United States Treasury obligations, as well as to the performance of reference assets, such as certain equity indexes.
While the VRSPs initially pay fixed introductory or “teaser” rates for one to five years. After the introductory period, additional interest payments are not guaranteed and are contingent on the performance and interplay of the VRSPs derivative components such as the CMS rates and underlying reference indexes. These characteristics contribute to their unsuitability for the customers, who relied on periodic interest payments from their investments to meet their income needs.
Also, most VRSPs have maturity periods of fifteen years or more and typically lack active secondary markets, with no assurance of liquidity. These characteristics contribute to their unsuitability for the customers, who had investment time horizons of less than fifteen years and moderate or higher liquidity needs.
Also unlike traditional bonds, the VRSPs are “principal-at-risk” securities, which means that the customers can lose some or all of their invested principal at maturity if the VRSPs’ respective reference assets fail to perform within pre-determined ranges at maturity.
As several preliminary prospectuses for the VRSPs expressly warn: “There is no minimum payment at maturity. Accordingly, investors may lose up to their entire initial investment in the securities.” This characteristic contributes to their unsuitability for the customers, who were unwilling to risk losing their entire invested principal from their investments.
VRSPs are also “principal-at-risk” securities, which means that the Customers can lose some or all of their invested principal if the VRSPs’ respective reference securities indexes fail to perform within pre-determined ranges at maturity. For example, preliminary prospectuses for VRSPs sold to the Customers expressly warned that: “There is no minimum payment at maturity on the securities. Accordingly, investors may lose up to their entire initial investment in the securities.”
VRSPs also typically have maturity periods of fifteen years or more and are not certain to trade in a liquid secondary market, which means investors may not be able to sell them. The prospectuses, which typically the broker is expected to read to support their “reasonable basis” suitability obligations typically disclose that: “The securities will not be listed on any securities exchange. Therefore, there may be little or no secondary market for the securities. Even if there is a secondary market, it may not provide enough liquidity to allow you to trade or sell the securities easily. Accordingly, you should be willing to hold your securities to maturity.”
