FINRA Fines Three Broker-Dealers for Selling “Risky” Alternative Mutual Fund
The Financial Industry Regulatory Authority has censured and fined three broker-dealers, Cambridge Investment Research, Securities America, and J.W. Cole Financial, for failing to reasonably supervise their representatives’ recommendations of an alternative mutual fund.
The Financial Industry Regulatory Authority has censured and fined three broker-dealers, Cambridge Investment Research, Securities America, and J.W. Cole Financial, for failing to reasonably supervise their representatives’ recommendations of an alternative mutual fund—the LJM Preservation & Growth Fund. Combined, the three broker-dealers were ordered to pay $550,000 in fines and $3.5 million in restitution.
All three broker-dealers were also cited for permitting the sale of the LJM Preservation & Growth Fund on their platforms without conducting reasonable due diligence and without fully understanding its risks and features. This matter originated from FINRA’s 2019 investigation of firms that sold the LJM mutual fund to retail customers.
According to FINRA, LJM Preservation & Growth Fund pursued a risky strategy that relied, in part, on purchasing uncovered options. The fund invested primarily in purchased (long) and sold (short) call and put options on the S&P 500 futures index and did not hold any underlying stock as a part of its strategy.
On February 5, 2018, the S&P 500 fell 113 points, or roughly 4.1 percent, which contributed to an unprecedented increase in market volatility, causing the prices of the short option positions sold by LJM Preservation & Growth Fund to increase dramatically. The fund lost about 80 percent of its value in two days and closed to new investors on February 7, 2018. In late March 2018, the fund was liquidated and dissolved.
According to FINRA, Cambridge representatives sold more than $18 million in LJM Preservation & Growth Fund to approximately 550 customers, including customers with conservative and moderately conservative risk tolerances. One representative was responsible for more than 80 percent of that total, FINRA said.
FINRA claims that Cambridge followed its typical review process for mutual funds, and based on LJM’s relatively small size and short tenure, placed the fund on its watch list. The firm, however, did not identify it as an alternative or complex mutual fund and did not impose any limitations on selling the shares, the regulator said.
Cambridge was fined $400,000 and ordered to pay more than $3.1 million in restitution plus interest. FINRA said that in determining the sanction, it considered that fact that Cambridge previously hired an outside financial consultant to develop a fair restitution methodology and had already paid more than $740,000 to customers, on top of the restitution ordered by FINRA.
For Securities America, FINRA indicated that one representative was responsible for selling approximately $616,000 in shares of LJM Preservation & Growth Fund to 33 customers. The firm was fined $100,000 and ordered to pay nearly $236,000 in restitution plus interest. FINRA said that Securities America followed its review process for alternative mutual funds and did not review its investment and trading strategy and did not impose any sales limitations.
J.W. Cole’s representatives sold approximately $1 million in shares of LJM to approximately 45 customers, including customers with moderately conservative risk tolerances. One representative was responsible for more than 60 percent of that total.
FINRA said that the firm did not identify LJM as an alternative or complex mutual fund and did not impose any limitations on the sale of its shares. J.W. Cole was fined $50,000 and ordered to pay restitution of $163,527 plus interest.
According to their respective letters of acceptance, waiver and consent, the three broker-dealers agreed to establish and implement policies, procedures, and internal controls reasonably designed to address and remediate the issues identified by FINRA.
