The Securities and Exchange Commission (SEC) has charged a California-based registered broker-dealer and five of its brokers with violating Regulation Best Interest (Reg BI) by selling high-risk debt securities to investors who were unaware of the risks.
The SEC charged Western International Securities, of Pasadena, Calif., and representatives Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham, and Thomas Swan with violating Reg BI by recommending and selling unrated, high-risk debt securities known as L Bonds to investors on fixed incomes and with moderate risk tolerances. Between July 2020 and April 2021, Western sold $13.3 million in L Bonds.
The SEC claimed that Western's policies and procedures were not reasonably designed to comply with Reg BI.
The SEC is seeking disgorgement of any unjust enrichment received by Western and its representatives as a result of the sale of the L Bonds, as well as prejudgment interest and civil penalties, in a complaint filed Wednesday in the United States District Court for the Central District of California.
According to the SEC, the bonds were sold by GWG Holdings, a Dallas-based financial services company that bought life insurance policies from customers who no longer wanted them, continued to pay the premiums, and then received benefits when the insurer died. GWG's L Bond sales strategy would change in 2020, when the bonds would be "loans, other liquidity products, and related services to customers holding illiquid alternative assets," rather than repurchased life insurance policies, the agency said.
The bonds were a "high-risk" and "illiquid" asset that were "only suitable for persons with substantial financial resources and with no need for liquidity in this investment," according to the SEC. Even as they recommended and sold the bonds, some Western employees were unaware of GWG's strategy change, according to the agency.
According to the SEC, Western and its representatives violated Reg BI's "care obligation" by failing to exercise reasonable diligence, care, and skill in understanding the risks, rewards, and costs associated with L Bonds, as well as recommending the bonds to at least seven specific customers without a reasonable basis to believe the bonds were in their customers' best interests.
Western failed to meet Reg BI's "compliance obligation" by having ambiguous policies and procedures in place, as well as no clear guidance on who was responsible for monitoring and enforcing compliance with the rule, according to the agency.
According to the SEC, Western received approximately $187,000 in commissions and fees for L Bond sales made after June 30, 2020, while the five representatives received between $5,400 and $32,500.
In April 2021, GWG temporarily halted sales of the L Bonds in question before filing for bankruptcy.
Reg BI established a standard of conduct for broker-dealers regarding the recommendation and sale of securities transactions to retail investors, and it went into effect on June 30, 2020.
Western's chief compliance officer reviewed a third-party due diligence report on the bonds before adding them to its approved list of investments in June 2020, but did not share the report with other Western employees, according to the SEC's complaint. Western also failed to set any criteria or thresholds for its customers when purchasing L Bonds, did not limit the sale of L Bonds to customers with specific risk types or investment objectives, and did not provide adequate training to its employees on how to sell them, according to the agency.
When reviewing the sale of L Bonds, Western's compliance team double-checked that all required documents were in order and that the total sale of L Bonds did not exceed 10% of the investor's net worth. According to the complaint, "Western’s compliance department did not examine whether an investment was in the customer’s best interest."
According to the SEC, there were no written policies or procedures in place to guide supervisors' review of whether a transaction was in the best interests of the customer, or even who was supposed to conduct such a review.
A request for comment from Western was not returned.
By fLEXI tEAM