A California-based registered broker-dealer and five of its brokers have been charged by the Securities and Exchange Commission (SEC) with violating Regulation Best Interest (Reg BI) when they sold high-risk debt securities to investors who weren’t fully aware of the risks.
Western International Securities, of Pasadena, Calif., and representatives Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham, and Thomas Swan were charged with violating Reg BI when they recommended and sold unrated, high-risk debt securities called L Bonds to investors on fixed incomes and with moderate risk tolerances, the SEC said Thursday in a press release. In aggregate, Western sold $13.3 million in L Bonds from July 2020 to April 2021.
The SEC alleged the policies and procedures of Western were not reasonably designed to achieve compliance with Reg BI.
In its complaint, filed Wednesday in U.S. District Court for the Central District of California, the SEC seeks disgorgement of any unjust enrichment Western and its representatives received as a result of the sale of the L Bonds, as well as prejudgment interest and civil penalties.
The details: The bonds in question were sold by GWG Holdings, a Dallas-based financial services company that purchased life insurance policies from consumers who no longer wanted them, continued to pay the premiums, and then collected benefits upon the insured’s death, according to the SEC. GWG’s strategy for the sale of its L Bonds would change in 2020, when the bonds consisted not of repurchased life insurance policies but instead were “loans, other liquidity products, and related services to customers holding illiquid alternative assets,” the agency said.
The bonds were a “high-risk” and “illiquid” asset that, according to their prospectus, are “only suitable for persons with substantial financial resources and with no need for liquidity in this investment,” the SEC stated. Some of the Western employees selling the bonds were not aware of GWG’s strategy change even as they recommended and sold them, the agency said.
Western and its representatives allegedly failed to comply with Reg BI’s “care obligation” because they did not exercise reasonable diligence, care, and skill to understand the risks, rewards, and costs associated with L Bonds and also recommended the bonds to at least seven particular customers without a reasonable basis to believe the bonds were in their customers’ best interests, the SEC said.
Western failed to comply with Reg BI’s “compliance obligation” by having vague policies and procedures regarding the rule and no clear guidance on who exactly was supposed to monitor and enforce whether those policies complied with Reg BI, the agency added.
Western received approximately $187,000 in commissions and fees for L Bond sales made after June 30, 2020, while the five representatives received between approximately $5,400 and $32,500 for their sales, the SEC alleged.
GWG temporarily stopped selling the L Bonds in question in April 2021 and later filed for bankruptcy.
Compliance lessons: Reg BI, which became effective June 30, 2020, established a standard of conduct for broker-dealers regarding the recommendation and sale of securities transactions to retail investors.
Before the L Bonds were added to its approved list of investments in June 2020, Western’s chief compliance officer reviewed a third party’s due diligence report on the bonds but did not provide the report to other Western employees, the SEC said in its complaint. Western also did not set any criteria or thresholds for its customers regarding the purchase of L Bonds, did not restrict the sale of L Bonds to customers with certain risk types or investment objectives, and did not provide adequate training to its staff regarding their sale, the agency added.
When the sale of L Bonds was being reviewed, Western’s compliance team verified required documents were in place and the total sale of L Bonds did not exceed 10 percent of the investor’s net worth. “Western’s compliance department did not examine whether an investment was in the customer’s best interest,” the complaint said.
There were no written policies and procedures in place guiding supervisors’ review of whether a transaction was in a customer’s best interest or even who was supposed to conduct such a review, the SEC said.
Western did not reply to a request for comment.