Earlier this week, the nation’s largest network of financial advisers was slapped with fines and restitution totaling $3.3 million in order to settle allegations that independent brokers acted improperly in selling investment vehicles unsuited to their clients’ worth, investment goals, and risk tolerance.
The investments in question consisted of non-traded Real Estate Investment Trust shares (REITs) and leveraged Exchange Traded Funds (ETFs). The settlement was reached with the North American Securities Administration Association (NASAA) on Wednesday, September 23rd. Specifically, NASAA alleges that LPL Financial did not provide adequate oversight of its brokers, and failed to enforce its own policies on the sale of non-traded REITs. This comes in the wake of earlier action by the Financial Industry Regulatory Agency (FINRA), which ordered LPL to pay $10 million in penalties for its failure to supervise brokers’ actions in the sale of complex investments.
REITs are similar to companies that issue stocks. When investors buy shares in a REIT, they purchase an interest in income properties, such as apartment buildings, office complexes, storage and warehouse facilities, etc. The difference is that investors are relieved of the responsibility of paying property taxes and maintenance costs; these are borne by the REIT, which pays out annual dividends. Furthermore, it is far easier to sell REIT shares than to sell actual properties. While they are not tied to the ups and downs of the Wall Street stock market, the value of REITs can be affected by other factors, such as local property values and occupancy rates.
“Non-traded” REITs are slightly different from the traditional kind; whereas dividends on most REIT shares are taxed as regular income, dividends from non-traded REITs are taxed as investment income at 15%. For this reason, many investors find them more attractive. However, because of their lack of liquidity, greater risk and fees charged by brokers, they are recommended for sophisticated investors with greater risk tolerance.
An ETF is a type of hybrid investment, with characteristics of both stocks and mutual funds. Like most REITs, they offer certain tax advantages and are more easily traded. They are also flexible in that they allow investors to put their money in a wide range of sectors as well as targeted niches. There is also a downside, as was demontrated late this past August when “speed trading” resulted in a disconnect between the price of ETFs and the value of their underlying assets.
Advisers at LPL Financial allegedly sold these investments to clients for whom they were unsuitable, causing significant decreases in the values of their portfolios. In addition to settlements with the NASAA, LPL has reached agreements with the Attorneys General of Massachusetts and Delaware. Those settlements include $1.6 million in compensation for approximately 2,000 clients, whose investments were negatively impacted by their brokers’ actions between January 2009 and December 2013. A separate action by regulators in New Hampshire is still pending, and may cost LPL an additional $2.4 million.
In addition to paying monetary penalties and compensation, LPL has agreed to increase its vigilance over brokers and advisers and provide better training and supervision when it comes to the sale of ETFs.
In 2014, LPL Financial wound up paying out over $36 million in penalties and client restitution – an increase of 400% over the previous two years. Of course, that is very little compared to the company’s current assets of nearly $70 billion. The current fines and penalties may help LPL’s victims in recovering their losses, but they won’t go far toward changing the firm’s behavior. That will require much stronger actions from state and federal regulators.