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In First Reg BI Action, SEC Hits BD Over Sales of Risky Bonds to Retirees

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What You Need to Know

  • The registered reps allegedly failed to comply with Reg BI’s care obligation.
  • L Bonds are an unrated, high-risk debt security.
  • The brokers recommended L Bonds to retail customers without sufficiently understanding them, according to the SEC.

The Securities and Exchange Commission on Thursday levied its first Regulation Best Interest enforcement action by charging registered broker-dealer Western International Securities Inc. and five of its registered reps with violating Reg BI through L Bond sales.

The brokers — Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham and Thomas Swan — violated best-interest obligations when they recommended and sold an unrated, high-risk debt security known as L Bonds to retirees and other retail investors, the SEC said.

From July 2020 through April 2021, Western sold an aggregate of $13.3 million of L Bonds.

The SEC order seeks disgorgement of any unjust enrichment received by the defendants as a result of the misconduct alleged, together with prejudgment interest.

The SEC’s complaint alleges that, between July 2020 and April 2021, Western and the brokers recommended and sold L Bonds to retail customers, “many of whom were on fixed incomes and had moderate risk tolerances, despite the issuer, GWG Holdings, Inc., stating the L bonds were high risk, illiquid, and only suitable for customers with substantial financial resources.”

As the SEC explains, Reg BI requires that a broker, dealer, or associated person act in the best interest of a retail customer when making a recommendation of a securities transaction.

Firms comply with Reg BI’s best-interest obligation only if they comply with four component obligations: the disclosure obligation, the care obligation, the conflict of interest obligation and the compliance obligation.

The registered reps allegedly failed to comply with Reg BI’s care obligation both because they did not exercise reasonable diligence, care and skill to understand the risks, rewards and costs associated with L Bonds, and also because they recommended L Bonds to at least seven particular customers without a reasonable basis to believe the bonds were in their customers’ best interests, the SEC said.

The complaint also alleges Western failed to comply with Reg BI’s compliance obligation because it did not adequately establish, maintain and enforce written policies and procedures reasonably designed to achieve compliance with Reg BI.

The brokers recommended L Bonds to retail customers, “despite having an insufficient, and sometimes erroneous, understanding of the investment,” the SEC said.

GWG, according to the SEC complaint, “has a history of net losses and has not generated sufficient operating and investing cash flows to fund its operations.”

For the year ended Dec. 31, 2019, “GWG posted a net loss from operations of $79.6 million and negative operating cash flow of $142.8 million. GWG depends on financing — primarily debt financing, such as L Bonds — to fund its operations,” the SEC states.

The brokers’ “knowledge of GWG and L Bonds was based on information and communications from GWG and its sales representatives,” according to the complaint.

“Although all of the Registered Representative Defendants took a training course on GWG L Bonds, four of them (Cole, Gitipityapon, Egan, and Swan) took that training on a prior issuance of L Bonds, not those sold pursuant to the 2020 Prospectus,” the complaint states.

Gurbir Grewal, director of the SEC’s Division of Enforcement, said in a statement that “Reg BI is clear: broker-dealers must act in the best interest of their customers. When they fail to do so, as we allege happened here, they put retail investors at risk and we’ll hold them accountable.”

Western International Securities said Thursday in a statement shared with ThinkAdvisor that it “takes its clients’ best interests very seriously and believes it complied with Reg BI and the regulatory guidance available during the pertinent timeframe. The firm intends to actively defend the claims asserted by the SEC and will not provide additional comments on this pending litigation at this time.”

Brian Rubin, partner at Eversheds Sutherland in Washington, told ThinkAdvisor Thursday in an email that “although this case was alleged as a Reg BI case, based on the facts alleged, for the most part it could easily have been brought under the prior suitability standard or as a misrep[resentation]/omission case.”

Nonetheless, Rubin continued, “firms and reps should view this case as the SEC announcing to the world that it is ready, willing, and able to bring Reg BI cases.”

Micah Hauptman, director of investor protection at the Consumer Federation of America, told ThinkAdvisor Thursday in an email that “it’s great that the SEC is beginning to enforce Reg BI and in a way that should send a strong message to firms that business as usual won’t cut it anymore.”

The complaint, Hauptman continued, “makes several important points, including that firms must recommend the securities that are the best match for retail investors and that vague policies and procedures that don’t adequately ensure reps make best interest recommendations won’t suffice. Today’s enforcement action gives me hope that we may be turning a corner with more enforcement to come.”


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