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Cadaret entered into a regulatory settlement with the Financial Industry Regulatory Authority on September 11, 2018. Cadaret agreed to pay an $800,000 fine. It also agreed to a censure and to review and change its policies to detect inappropriate sales practices by its brokers. One focus was on the sale and exchanges of variable annuities.
Cadaret failed to employ sufficient compliance personnel to adequately supervise its brokers. Brokers have many incentives to recommend investments that are too aggressive or otherwise unsuitable for an investor. Sufficient compliance personnel are needed and required by regulators to protect investors from this known risk.
All licensed securities brokers have a legal obligation to recommend only suitable investments. Investments are all known to have a certain range of risk when recommended. Certain investments are known to have higher risks than others. Investments that can increase sharply in value can sometimes decrease equally as fast. Investments can only be recommended when the risk the investment poses is consistent with the risk consistent with the investor. For example, a retired individual should only be recommended investments with little to no risk. So when such an individual loses 20% or more of portfolio value in a year, the portfolio was likely unsuitable when first recommended.
As a result of its insufficient compliance, Cadaret had only three compliance people overlooking weekly trades, or “blotter reviews.” Such reviews are needed to detect over-concentration of portfolios, such as portfolios being invested too heavily in either one investment, a single industry, or being too heavily weighted in a single investment vehicle, such as stocks or annuities. Such concentration is unsuitable because it greatly increases the level of risk in the portfolio.
The blotter review also protected investors from broker churning. This is an action where a broker puts his/her own interest ahead of the investor. Excessive trades are made that work more to generate commissions for the broker than to protect the interests of the investor.
Churning depends on the cost of the exchange. With products such as variable annuities, churning can happen with a single exchange. One of the issues faced by Cadaret is from the replacement of one variable annuity with another. There are very few circumstances where variable annuity exchanges are justified.
Cadaret’s supervisory procedures also required examiners in the compliance department to conduct periodic inspections of branch offices to detect and prevent violations by registered representatives in those locations. However, Cadaret employed an insufficient number of compliance examiners for this purpose. For instance, in 2014, the Firm tasked three compliance examiners with inspecting over 400 geographically-disperse branches. As a result, these inspections were conducted in a manner not reasonably designed to identify violative activity.
Jeffrey Pederson has represented investors across the United States in suitability suits. These suits are largely handled through FINRA arbitration. Please call for consultation.