JW Cole Financial Inc. a securities broker dealer headquartered in Tampa Florida has been censured and fined $50,000.00 by Financial Industry Regulatory Authority (FINRA) based upon findings that the securities broker dealer failed to supervise its stockbrokers’ recommendations of alternative investments. Letter of Acceptance Waiver and Consent No. 2019061764801 (Mar. 18, 2021).
According to the AWC, JW Cole did not possess an adequate supervision system relating to recommendations of alternative mutual funds which are publicly traded securities that aim to achieve investment objectives through the use of atypical investments and trading strategies.
The regulator first mentioned that there was no supervision system or written supervisory procedures that were put in place to identify if a mutual fund offered through JW Cole constituted either an alternative mutual fund or a complex product warranting extra due diligence. The securities broker dealer instead categorized complex mutual funds and alternative mutual funds as traditional mutual funds. This standard did not take into account the possible risks relating to the strategy of those funds. JW Cole rested on the due diligence of its clearing firm for authorizing mutual funds on the platform. No independent due diligence was undertaken by JW Cole in this respect.
FINRA next stated that there was no training or guidance that JW Cole provided to stockbrokers as it pertained to the features and risks of alternative mutual funds. The securities broker dealer possessed no written supervisory procedures that helped securities principals monitor alternative mutual fund recommendations.
The AWC additionally stated that there was an electronic trade review system utilized by JW Cole that was intended to help supervisors review stockbrokers’ trading activities. But the securities broker dealer overlooked whether that review system’s rules related only to traditional mutual funds. There were no steps taken by JW Cole to assess whether the trade review system was sufficient for reviewing alternative mutual funds. This resulted in transactions not being flagged for a heightened suitability review.
FINRA highlighted JW Cole’s supervisory failures in regard to LJM which was an alternative mutual fund investment aiming to profit from the difference between implied volatility and realized market volatility. LJM aimed to achieve its goal through long and short call and put options on the SP500 futures index.
JW Cole’s stockbrokers were permitted to sell LJM when it became available on the platform used by JW Cole’s clearing firm. The investment and trading strategy of LJM was not reviewed by JW Cole though. LJM was not identified by the securities broker dealer as a complex mutual fund or alternative mutual fund, so no limitations or restrictions were imposed on LJM sales.
Between May of 2017 and December of 2017, 45 customers had been sold a collective $1,000,000.00 in LJM shares. Some of those customers maintained conservative-to-moderate risk tolerances. The AWC stated that on February 5, 2018, there was a historic increase in market volatility. CBOE Volatility Index (VIX) increased from 17 to 37 – the highest daily rise in VXX’s history at the time. The volatility caused a drastic increase in the short options positions that LJM sold. FINRA indicated that on February 5th and February 6th, LJM’s value fell by 80 percent. The fund stopped taking in new investors by February 7th. And by March 29th, the fund was liquidated and dissolved. Those investors who held LJM positions through February 6, 2018 sustained 80 percent losses.
FINRA determined that JW Cole failed to supervise alternative mutual fund transactions in violation of FINRA Rules 2010 and 3110.