The following story appeared in Investment News on October 2, 2011:
Stockbrokers who sell products that promise high returns without the approval of their broker-dealers once again have become a leading concern for state securities regulators.
The practice, known as “selling away,” is one of the most common difficulties that independent and franchisee broker-dealers face in their oversight of registered representatives.
Leading franchisee and independent broker-dealers, including Edward Jones, Raymond James Financial Services, Inc. and Woodbury Financial Services, have had former brokers investigated by states this year for their roles in alleged selling-away schemes.
Such reps typically operate in one- or two-man offices and have no branch manager looking over their shoulders on a day-to-day basis. Cases typically involve a broker’s selling a financial product that the broker-dealer didn’t approve or know about, with the investment vehicle blowing up and harming the client’s portfolio.
“There’s been an increase in selling away,” said Matt Kitzi, Missouri securities commissioner and head of the enforcement section for the North American Securities Administrators Association Inc., which represents state securities regulators.
He attributed the increase to fallout from the credit crisis.
“When the financial crisis hit, brokers and agents were left with clients who weren’t happy with the investment options they were offered. Some brokers, also looking to supplement their income, went outside the traditional market, trying to find other products to push,” Mr. Kitzi said.
According to NASAA’s 2011 survey of state securities enforcement officials, selling away ranked eighth last year on a list of the top 10 industry violations not involving fraud, with 54 reported enforcement actions against registered members of the securities industry.
Bob Webster, a spokesman for NASAA, said that he had no data from 2009 about selling away, so he couldn’t say if the number of cases regulators reported last year indicated an increase or decrease of selling-away incidents.
“Investors may have been a little more ripe for those kinds of unsolicited pitches, but I doubt that many investors approached their broker specifically looking for an off-books investment opportunity,” Mr. Kitzi said. “The mistake for brokers is using products outside the firm’s rules and the regulators’ requirements.”
Incidents of selling away are affecting leading brokerage firms.
The FBI is investigating two former Edward Jones brokers based in South Dakota for their role in a selling-away case that involved raising money from clients who invested in an alleged Ponzi scheme run by Gibraltar Partners Inc., a New York money management firm.
The Securities and Exchange Commission in February charged Thomas Keough, a broker based in Massachusetts and formerly affiliated with Raymond James Financial Services, Inc., with illegally selling unregistered promissory notes for a subprime auto lender in a scheme that raised $110 million from hundreds of investors. Investors who bought the promissory notes were promised returns of 9% to 15%, according to the SEC, Mr. Keough make more than $500,000 in referral fees between 2004 and 2009, the SEC said.
And former Woodbury Financial broker Joshua Gould was sentenced in July to 97 months in prison by a Missouri federal judge for a variety of actions, including selling unregistered securities in private businesses. Mr. Gould touted those investments as “unconventional” and bringing “an increased rate of return,” according to statements by Missouri officials.
The three firms don’t face charges from the regulators about the selling-away cases, but they do face client lawsuits in securities arbitration stemming from the brokers’ alleged actions.
Anthea Penrose, a spokes-woman for Raymond James, declined to comment about Mr. Keough.
Bob DeMallie, a spokesman for Woodbury, didn’t return a phone call seeking comment.
According to Edward Jones, a client brought the matter of Gibraltar Partners to the firm’s attention in March. As a result of its investigation, during which the company learned that the Justice Department was in the middle of a criminal investigation of Gibraltar Partners, Edward Jones fired the brokers, Jones spokesman John Boul wrote in an e-mail.
“A small number of Edward Jones clients have invested money in this scheme, away from the firm,” Mr. Boul wrote. “The firm is currently negotiating settlements with these clients.”
A group of investors in June sued Gibraltar Partners in U.S. District Court in the Southern District of New York, alleging that Gibraltar and others, including Rahfco Funds LP, were running an alleged Ponzi scheme. Investors are seeking $100 million in damages in that suit. Edward Jones wasn’t named in that lawsuit.
Gibraltar Partners couldn’t be reached for comment.
Mr. Boul didn’t reveal the names of the former Jones brokers allegedly involved in the matter. He added: “Other investors who are not clients of Edward Jones also invested in Gibraltar” and that the firm is cooperating with federal and state authorities.
The firm said last month in a filing with the SEC that the Financial Industry Regulatory Authority Inc. and the state of South Dakota also were investigating the former reps. Minnesota, meanwhile, was investigating one of the ex-reps.
Regulators in South Dakota and Minnesota declined to comment. A spokeswoman for Finra, Nancy Condon, declined to comment.
An FBI spokesman in Minneapolis, Kyle Loven, also declined to comment.
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