LOS ANGELES– The Guiliano Law Group, P.C. announced today it has filed a securities arbitration claim on behalf of certain investors before the Financial Industry Regulatory Authority or FINRA against a national securities broker-dealer for the violation of the federal securities laws, the recommendation of unsuitable securities, the failure to conduct due diligence, negligence, common law fraud, breach of fiduciary duty, the failure to supervise, and the violation of Regulation Best Interest (Reg. BI) and Section §25401 of the California Corporations Code in connection with the recommendation and sale of GWG Class L Bonds.
GWG Class L Bonds
GWG Holdings, Inc. is a Delaware corporation headquartered in Minnesota, which through its subsidiaries, purchases life insurance policies on the secondary market at a discount to the face value of the policies.
According to the company’s offering materials, once GWG purchases a policy, it has the obligation to keep the policy in effect by paying the policy premiums until the insured passes away. Upon the insured’s death, GWG supposedly collects the face value of the insurance benefit. The objective of this business is to earn returns by collecting more money upon the insured’s death than the amount that GWG pays to purchase, finance, and service the policies.
However, it was disclosed at the time of sale that:
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- GWG had a very limited operating history;
- GWG Class L Bonds were not rated by any bond rating agency;
- GWG purchased almost all of the policies it owns with funds borrowed from financial institutions or investors.
- GWG had a history of losses and insufficient cash flows to fund its operations. For the year ended December 31, 2019, GWG posted negative operating cash flow of $142.8 million.
- there was no trading market for the GWG bonds and investors cannot access their principal prior to maturity absent death, bankruptcy, or total disability;
- the GWG bonds were not directly secured by life insurance policies;
- the underlying life insurance policies were not collateral for obligations under the GWG bonds. Instead, those policies have been separately pledged to a bank as collateral for the line of credit used by GWG to purchase the policies; and that
- the GWG bonds were “illiquid, speculative, investments that involve a high degree of risk-including the risk of losing the entire investment.”
In April of 2021, GWG Holdings temporarily ceased its sale of L Bonds because it was unable to file its 2020 SEC Form 10-K. On November 5, 2021, when it was able to file its SEC Form 10K, GWG Holdings disclosed that its auditor had issued a going concern qualification to their audited financial statements for 2020 due to serious concerns about the viability of the company. Shortly thereafter, on January 10, 2022 GWG suspended further sales of L Bonds due to an inability to make interest payments on the L Bonds, and on April 20, 2022, GWG filed for Chapter 11 bankruptcy. In re GWG Holdings, Inc., et al. 22-BK-90032 (Bankr. S.D. Tex.).
Most investors lost substantially their entire investment.
Sale of Unsuitable Securities
FINRA Rule 2111 with regard to suitability, specifically provides that:
(a) In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
(b) Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
(1) the customer’s financial status;
(2) the customer’s tax status;
(3) the customer’s investment objectives; and
(4) such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
FINRA Manual Rule 2111.
In addition to particular investments which may be unsuitable, FINRA Manual Rule 2111 requires that a member or an associated person must have a reasonable basis to believe that a recommended investment strategy involving a security or securities is suitable for the customer, and specifically provides that:
(a) A member or an associated person must have a reasonable basis to believe that a recommended transaction or investment strategy involving a security or securities is suitable for the customer, based on the information obtained through the reasonable diligence of the member or associated person to ascertain the customer’s investment profile.
A customer’s investment profile includes, but is not limited to, the customer’s age, other investments, financial situation and needs, tax status, investment objectives, investment experience, investment time horizon, liquidity needs, risk tolerance, and any other information the customer may disclose to the member or associated person in connection with such recommendation.
FINRA Manual, FINRA Conduct Rule 2111 (CCH 2023).
Suitability determinations are a two-step process: the first step is reasonable diligence as to the risks associated with a particular security to determine if the product is suitable at all; the second step is to determine whether it is suitable for a specific client given their overall financial condition and expressed investment objectives.
As the US Securities & Exchange Commission, in its approval of the consolidated FINRA Suitability Rule observed:
Reasonable-basis suitability requires a broker to have a reasonable basis to believe, based on reasonable diligence, that the recommendation is suitable for at least some investors.
In general, what constitutes reasonable diligence will vary depending upon, among other things, the complexity of and risks associated with the security or investment strategy and the firm’s or associated person’s familiarity with the security or investment strategy.
A firm’s or associated person’s reasonable diligence must provide the firm or associated person with an understanding of the potential risks and rewards associated with the recommended security or strategy.
See Securities Exchange Act Release No. 63325 (November 17, 2010)(emphasis added).
With respect to alternative investment such as GWG Class L Bonds, in April 2010, FINRA issued Notice to Members 10-22, reminding its members that:
Rule 2310 requires broker-dealers to conduct a suitability analysis when recommending securities to both accredited and non-accredited investors that will take into account the investors’ knowledge and experience. The fact that an investor meets the net worth or income test for being an accredited investor is only one factor to be considered in the course of a complete suitability analysis. The broker-dealer must make reasonable efforts to gather and analyze information about the customer’s other holdings, financial situation and needs, tax status, investment objectives and such other information that would enable the firm to make its suitability determination. A broker-dealer also must be satisfied that the customer “fully understands the risks involved and is…able…to take those risks.”
As stated in FINRA Notice to Members 10-22:
The Securities and Exchange Commission (SEC) and federal courts have long held that a broker-dealer that recommends a security is under a duty to conduct a reasonable investigation concerning that security and the issuer’s representations about it. This duty emanates from the broker-dealer’s “special relationship” to the customer, and from the fact that in recommending the security, the broker-dealer represents to the customer “that a reasonable investigation has been made and that [its] recommendation rests on the conclusions based on such investigation.”
Failure to comply with this duty can constitute a violation of the antifraud provisions of the federal securities laws and, particularly, Section 17(a) of the Securities Act, Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. It also can constitute a violation of FINRA Rule 2010, requiring adherence to just and equitable principles of trade, and FINRA Rule 2020, prohibiting manipulative and fraudulent devices.
FINRA Notice to Members 10-22 (April 2010). Notice to Members 10-22 also provides that a broker dealer must conduct a reasonable investigation into each offering, must maintain supervisory procedures under Rule 3010 that are reasonably designed to ensure that these securities are suitable for particular customers, and retain records documenting both the process and results of its investigation.
In addition, FINRA has also reminded its members that “In order to ensure that it has fulfilled its suitability responsibilities, a broker-dealer should, at a minimum, conduct a reasonable investigation concerning:
- the issuer and its management;
- the business prospects of the issuer;
- the assets held by or to be acquired by the issuer;
- the claims being made; and
- the intended use of proceeds of the offering.
A broker-dealer must conduct a reasonable investigation in connection with each offering, notwithstanding that a subsequent offering may be for the same issuer. (Id. at 5).
Regulation Best Interest
Regulation Best Interest or “Reg BI,” which became effective on June 30, 2020, established a standard of conduct for broker-dealers and associated persons when they recommend securities transactions to retail customers. Rule 15l-1(a)(1) of the Exchange Act, 17 CFR § 240.15l-1(a)(1).
Reg BI’s Best Interest Obligation requires a broker, dealer, or a natural person associated with a broker or dealer, when making a recommendation of any securities transaction to a retail customer, to act in the best interest of that retail customer at the time the recommendation is made, without placing the financial or other interest of the broker, dealer, or associated person over of the interest of the retail customer.
The Best Interest Obligation is satisfied only by compliance with four Component Obligations: (1) Disclosure Obligation, (2) Care Obligation, (3) Conflict of Interest Obligation, and (4) Compliance Obligation.
The Care Obligation requires a broker, dealer, or associated person to exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with a recommendation of a securities transaction to a retail customer.
The Care Obligation also requires a broker, dealer, or associated person to exercise reasonable diligence, care, and skill to have a reasonable basis to believe that their recommendation is in the best interest of the particular retail customer, based on that customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation.
Reg BI also requires that a registered representative establish that it had a reasonable belief that the recommendation was in the best interest of the retail customer, and to consider reasonably available alternatives.
In addition, Reg BI’s Compliance Obligation requires a broker-dealer to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. According to the Adopting Release, a broker “should consider the nature of that firm’s operations and how to design such policies and procedures to prevent violations from occurring, detect violations that have occurred, and to correct promptly any violations that have occurred.”
Recommendations made by stockbrokers without exercising reasonable diligence, care, and skill, to have a reasonable basis to believe the recommendations were in the customer’s best interest based upon their investment profile and the potential risks, rewards, and costs associated with the recommendation, is a violation of Regulation Best Interest, Rule 15l-1(a)(1) of the Exchange Act, 17 CFR § 240.15l-1(a)(1).
The Statement of Claim alleges that agents of the securities broker-dealer made misstatements and omissions of material fact in connection with the sale of securities in violation of § 10(b) of the Securities Act of 1934, and SEC Rule 10b-5, as promulgated thereunder. The Statement of Claim also alleges that this conduct is a violation of FINRA Conduct Rule 2110, which is alsoactionable under §10(b) of the Securities Exchange Act of 1934, and SEC Rule 10b-5 as promulgated thereunder.
In addition to compensatory and punitive damages, the Statement of Claim also seeks interest and reasonable attorneys’ fee pursuant to the antifraud provisions of the California Corporation Code §25403.
The Guiliano Law Group, P.C. is a national securities and investment fraud law firm representing investors across America and around the globe for more than thirty years with offices in Philadelphia, Pennsylvania, Los Angeles, California, and Miami, Florida.
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