The Securities and Exchange Commission charged a California-based brokerage firm and five of its reps with violating Regulation Best Interest obligations when recommending and selling a high-risk debt security to retail investors and retirees.
It is the commission’s first time charging a defendant with violating Reg BI, which went into effect in 2020.
“Reg BI is clear; broker-dealers must act in the best interest of their customers,” SEC Enforcement Division Director Gurbir S. Grewal said. “When they fail to do so, as we allege happened here, they put retail investors at risk and we’ll hold them accountable.”
The SEC filed the complaint in California federal court against Western International Securities, a Pasadena, Calif.-based dual registrant owned by Atria Wealth Solutions. The five charged reps are Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham and Thomas Swan.
The commission alleged the firm and these five reps violated Reg BI through recommending and selling “L” Bonds offered by the issuer GWG Holdings.
These corporate bonds promised to pay interest on the principal lent to the issuer, but GWG’s 2020 prospectus disclosed risks associated with the bonds, including that an investor could lose their entire investment. The bonds were also illiquid and were “only suitable for persons with substantial financial resources and no need for liquidity” in the investment, according to the prospectus.
As of Jan. 10, 2022, GWG Holdings suspended all further sales of L Bonds, according to the SEC complaint.
But between July 2020 and April 2021, Western reps sold about $13.3 million in L Bonds to retail customers. While Western's CCO produced a due diligence report on the bonds, detailing their potential and pitfalls, Western reps, supervisors and other compliance officers never acted on it, and the firm didn’t set any thresholds customers needed to meet to purchase the bonds, despite the warnings in GWG’s prospectus.
Western required reps to take an online training course on L Bonds, although it didn’t mandate it if a rep had taken such a course on a prior issuance, according to the commission.
“These registered representatives recommended L Bonds to retail customers, despite having an insufficient, and sometimes erroneous, understanding of the investment,” the complaint read. “The Registered Representative Defendants’ knowledge of GWG and L Bonds was based on information and communications from GWG and its sales representatives.”
The commission argued the firm and the five reps violated Reg BI’s Care Obligation, which requires a b/d or associated person, when making a recommendation, to “exercise reasonable diligence, care and skill to understand the potential risks, rewards and costs associated with the recommendation.” The defendants allegedly violated this obligation by recommending the L Bonds to at least seven retail customers without a reasonable basis for believing those sales were in the clients’ best interests.
The complaint doesn’t name the affected retail investors but describes a number of retirees and retail customers with mostly moderate risk tolerances. In one situation, Graham recommended a $100,000 purchase in two-year L Bonds to a 79-year-old retired truck driver with “general investment knowledge and limited knowledge of bonds.” At the time he made the purchase, the retiree’s annual income was $35,000 and his liquid net worth was $300,000; the L Bond investment comprised 33% of his liquid net worth, according to the commission.
At no point did the reps’ supervisors, their delegate or the firm’s compliance department raise concerns about the bond purchases by the seven retail customers cited in the complaint, according to the SEC.
"The Firm takes its clients’ best interests very seriously and believes it complied with Reg BI and the regulatory guidance available during the pertinent timeframe," Julian Arenzon, a spokesperson on behalf of Western International Securities, said about the action. "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."
The case marks the first time that the SEC will pursue an enforcement action citing violations of Reg BI, though many have been awaiting an inevitable first action (there have been several actions brought against firms for violating mandates related to Form CRS, which went into effect at the same time as Reg BI).
In an interview with WealthManagement.com, Micah Hauptman, the director of investor protection at the Consumer Federation of America, welcomed the action:
“This case sends a strong message that conduct that may have been tolerated under the previous suitability rule won’t be tolerated under Reg BI, and I think that’s important,” he said.
Particularly, Hauptman found it important that the case targeted underlying conduct surrounding the types of recommendations reps were making and the firm's alleged paltry compliance policies and procedures and that the matter didn’t hinge on a technicality or lack of disclosure on the part of the defendants. He also noted the case was being litigated, as opposed to a settlement.
“I think that this may suggest a more aggressive approach at the SEC, which we’d welcome and we’ve been calling for all along,” he said. “This is the SEC acting as we want them to."