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Blue Capital Securities, a broker dealer with its primary office in New York, New York, was censured and fined $50,000 after accepting and consenting to Financial Industry Regulatory Authority (FINRA) findings that the firm provided misleading marketing materials by failing to disclose risks and failed to educate staff on collateralized mortgage obligations (CMO) prior to firm sales of CMO’s. Letter of Acceptance, Waiver, and Consent, No. 2013035242501 (May 8, 2015).
According to the AWC, BCS had provided at least six customers with a seven page document explaining a proposed restructuring transaction involving CMO’s, in which FINRA found their marketing material to be misleading because it did not provide any details about the risks of investing in CMOs generally, or Inverse IO CMOs specifically. The AWC indicated that the document did not indicate that inverse IO’s are highly sensitive to changes in interest rates and changes in the prepayment rates of the mortgage loans underlying the CMO and that the structure of inverse IO’s exaggerates the effect of prepayments on cash flows and market value. The documents also reportedly failed to indicate that Inverse IO CMO’s presented risks that investors could lose their entire principal. The AWC additionally indicated that the document did not discuss liquidity risks and did not state that the market for inverse IOs might be highly illiquid and that it could be difficult for customers to sell the inverse IO’s. FINRA found BCS’s conduct in this regard to be in violation of FINRA Rule 2010 and NASD Conduct Rule 2210(d)(1)(A).
A CMO is a security that is collateralized by mortgage backed securities (“MBS”). A MBS, in turn, is an undivided interest in a pool of mortgages. The principal and interest from the mortgages underlying the MBS are used to pay CMO investors principal and/or interest, depending on the type of CMOs owned (referred to as the a tranche). According to FINRA, CMOs come with differing levels of yield, risk, and volatility, and are considered risk and sensitive to market interest rate changes.
The AWC further indicated that BCS failed to timely provide education materials to at least seven of the firm’s customers prior to the sale of a CMO to the customers. BCS reportedly failed in providing materials prior to customer’s participation in the restructuring transactions in the purchase of GNR 12-130 GS Inverse IO CMO. Consequently, FINRA found BCS conduct in this regard to be in violation of IM-2210-8 (now FINRA Rule 2216) and FINRA Rule 2010.
According to FINRA Rule 2216, prior to the sale of a CMO to any person other than an institutional investor, a member like BCS is required to offer customer educational material that includes a discussion of various characteristics of risks of CMOs, structure of CMO, and relationship between mortgage loans and securities, FAQ, and glossary of terms.
The AWC further indicated that from August, 2012 – December, 2012, BCS had failed to establish and enforce an adequate supervisory system including written supervisory procedures designed to address the firm’s sales of MBS and CMOs. FINRA found that BCS failed to have systems in place in order to ensure that disclosure documents for CMOs were timely provided to customers, resulting in their failure to provide customers with such documents. The AWC stated that BCS failed to have written procedures in place concerning the CMO educational material and supervisory review of the CMO transactions. FINRA found that BCS violated Rules 3010 and Rule 2010 as a consequence of this conduct.
Guiliano Law Group
If you have been the victim of securities fraud and you have a complaint, you should consult with an attorney. The practice of Nicholas J. Guiliano, Esquire, and The Guiliano Law Group, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.