1. Misalignment of Interests: While RIAs are held to a fiduciary standard by the Investment Advisers Act of 1940, this does not entirely eliminate the risk of self-interest affecting an RIA’s advice. For instance, RIAs might favor only those investment products from firms that are paying significant commissions to the RIA for selling that product. This means there is a significant potential conflict of interest causing an RIA to recommend the same small set of investment products to every potential client.
2. Limited Product Offering: Many RIAs have a limited range of investment products due to affiliations with certain investment companies. This could mean you may not have access to the full spectrum of investment options that might be more suitable for your retirement needs.
3. Lack of Transparency: Even though RIAs are required to disclose all material facts to their clients, the complexity of the investment products such as annuities and life insurance products may result in you not fully understanding certain investments, the adviser’s commission for selling a specific product, or the risks involved in an investment strategy recommended by the RIA.
4. Qualifications and Experience: RIA’s expertise and experience can vary significantly. While some have extensive experience and hold multiple qualifications, others might be newer to the industry and less experienced. A less qualified RIA might not provide the best advice or understand the intricacies of complex investment strategies. Further, it is important to check your adviser at brokercheck.org and investigate their history. There are plenty of RIAs who are and RIA because they are unable to be a stockbroker (yes, there is a huge difference.)
5. Costs: RIAs usually charge a fee based on a percentage of assets under management, which might be higher than what you’d pay if you managed your investments independently or did not invest in annuities or life insurance products. Additionally, some RIAs may have hidden costs or might charge additional fees for specific services on top of the percentage fees they charge.
6. Poor Communication: In some cases, you might find that your RIA does not communicate effectively or regularly. This could leave you feeling uninformed about your investment decisions and progress toward your retirement goals.
7. Inadequate Personalization: Some RIAs might use a one-size-fits-all approach to investment strategies, which could result in your retirement assets not being fully able to meet your specific goals, risk tolerance, and timeline to, or in, retirement.
8. Limited Accessibility: Depending on the RIA, you may face issues regarding the accessibility of your adviser. If they manage a large number of clients, they might not be available when you need them, impacting your ability to make timely decisions. This applies to the investment products that RIAs may recommend to you because the investment products often have significant penalties for early ‘surrender’ and withdrawals, or even have no option to gain access to your money.
9. Risk Management: Not all RIAs are skilled in managing risk effectively. A failure to appropriately assess and mitigate risk could potentially result in substantial losses for your retirement portfolio.
10. Lack of Oversight: While RIAs are regulated by either the Securities and Exchange Commission (SEC) or state regulators, this does not guarantee that your investments are safe. If the oversight body does not effectively regulate the RIA’s practices, your retirement assets could be at risk. Another oversight issue is that many RIA’s have no insurance to provide coverage to you for the RIA’s potential negligent or fraudulent handling of your account.

Despite these potential problems, it’s important to remember that many RIAs provide excellent service and can significantly contribute to the growth and protection of your retirement assets. The key is doing your due diligence in selecting an adviser. Check their qualifications, regulatory records, and references. Understand their fees, services offered and their investment philosophy. Good communication is essential, so ensure you feel comfortable discussing your needs and goals with them. Finally, always remember that it’s your retirement – stay informed and involved in the management of your assets.

Retirement planning can be a complex process, but knowing the potential pitfalls of entrusting your retirement assets to an RIA can help you make an informed decision that aligns with your retirement goals and financial situation.

At the heart of the civil and criminal complaints against Nikola are allegations that as its CEO, Trevor Milton, regularly spread false and misleading information about the progress of Nikola’s EV products and technologies. Nikola’s focus is on manufacturing low- and zero-emissions trucks, and the complaints allege in part that under Milton, Nikola published a promotional video of a prototype truck which did not actually work, but appeared to only because the truck was set in neutral and rolled down a hill. [1]

Promotional videos like that one, along with Milton’s enthusiastic social media posts and numerous podcast and television appearances, all painted a picture of exciting and impressive forward progress at Nikola, which Federal prosecutors and SEC regulators allege was nothing more than an illusion. [2]

This illusion allegedly created by Milton came at a steep cost – and was seemingly targeted retail investors in particular. Nikola went public via a Special Purpose Acquisition Company (“SPAC”) in June 2020, and once it began trading publicly, the value of its shares increased by $7 billion. However, Nikola’s value dropped steeply once the public learned of ongoing federal investigations into the company and its operations, leading to huge losses borne by retail investors who had been misled. [1]

Of course, EV companies and their executives are in a unique position given the bounding public interest in, and relative infancy of, the EV market. When attempting to evaluate a new or existing EV company, projections into the future must be made, and no fool-proof roadmap for this technology currently exists.

However, these uncertainties pose a particularly risky situation for prospective retail investors who can be easily misled by companies making false claims about their highly complex products or technologies – especially when, as here, these claims are being shared rapidly over social media.

Here, Nikola’s non-traditional IPO process put unsuspecting retail investors at even greater risk. When a company goes public via a SPAC, the traditional “quiet period” after a company is publicly listed is not required. This allowed Milton to continue amplifying false claims about Nikola on social media just after going public, thereby attracting additional retail investors, and driving the stock price up further. [3]

In pursuing these securities fraud charges against Nikola, the SEC continues to signal its sharp focus on SPAC regulation in the interest of protecting investors. As we all navigate the rapid influx of SPACs along with the continued push for broad adoption of EVs, retail investors should continue to carefully research prospective investments by identifying concrete achievements such as milestones hit and actual sales or delivery figures to date, while steering clear of “bandwagon effect” investing. These careful considerations, along with continued scrutiny by regulators, are some of the best ways to protect your assets in the market.

Sources:

[1] https://www.marketwatch.com/story/nikola-electric-truck-prototypes-were-powered-by-hidden-wall-sockets-towed-into-position-and-rolled-down-hills-prosecutors-say-11627572394

[2] https://www.sec.gov/news/press-release/2021-141

[3] https://www.nytimes.com/2021/07/29/business/nikola-trevor-milton-fraud.html

There are some situations in which FINRA arbitration is required, such as when a written agreement between the parties mandates it. In order to be eligible for FINRA arbitration, an investor must be seeking to file a claim stemming from the business activities of their broker or brokerage firm, and the event in question must have taken place within the last six years (in most states). [1]

Generally, FINRA arbitration allows an investor to seek either monetary or securities damages resulting from the business activities of their broker or brokerage firm. To get the filing process started, an investor must submit a Statement of Claim, a FINRA Submission Agreement, and related filing fees, all of which are available to view on FINRA’s website. [2]

The format and related fees for the arbitration itself vary based on the amount of money in controversy. When the amount in controversy is below $10,000, a hearing session will be conducted with just one arbitrator, and the session fee will be between $50 and $450. If the amount in controversy is above $10,000, a panel of three arbitrators may be used instead, and the hearing session fee will range from a minimum of $600 to a maximum of $1,575. [3]

Once FINRA receives all of the initial required documents, they analyze the claim and determine whether a one- or three-person arbitration panel will be used. A case number is created, and FINRA will notify the respondent – the party the investor has filed their claim against – about the case. So long as the respondent is registered with FINRA, they will be required to arbitrate.

The respondent then has 45 days to research the claim lodged against them and to respond. FINRA analyzes the response along with any counter claims or cross claims.

Next, the parties choose their arbitrators from a randomly generated list of names supplied by FINRA. FINRA arbitrators are not FINRA employees, instead they are contractors who are evaluated by FINRA on the basis of their employment, professional licenses, and education. They are chosen from diverse backgrounds and must take an oath to remain neutral and decide cases solely on the facts and meris.

Once arbitrators are chosen and agreed upon by both parties, there will be an initial pre-hearing conference, where investors are typically represented by an attorney. The arbitration hearing is scheduled, and discovery begins.

Discovery allows both parties to exchange documents and identify witnesses and is governed by rules within FINRA’s Discovery Guide. After discovery is completed, the arbitration hearing takes place.

The arbitration hearing takes place around a conference table, with arbitrators at the head of the table and the parties on each side. The claimant presents their side of the case first, complete with an opening statement, witnesses, and evidence, and is followed by the respondent. Objections are permitted, and the arbitrators determine whether or not they will accept evidence.

At the completion of the hearing, the arbitrator(s) will deliberate, and render their award, typically within 30 days. The award is legally binding on both parties, and FINRA offers no internal appeals process. While a party may choose to appeal an arbitration award in court, it should be noted that judges rarely overturn these awards.

From start to finish, FINRA arbitration cases that don’t settle before their hearing take approximately 16 months. The process allows for a streamlined and more private alternative to litigation in the courtroom, as FINRA arbitration documents are not made public like court documents. We invite you to contact us for details and support on your potential FINRA arbitration claim.

Sources: [1] https://www.finra.org/arbitration-mediation/arbitration-overview] [2] https://www.finra.org/sites/default/files/Education/p117486.pdf [3] https://www.finra.org/rules-guidance/rulebooks/finra-rules/12902]

Let’s consider an example of margin investing with Robinhood. An investor deposits $5,000 cash into a margin account, and Robinhood lends another $5,000 to allow the investor $10,000 worth of securities. The “margin” is the difference between the value of the securities and the loan from Robinhood. This type of investing increases both purchasing power and financial leverage. [1]

If the securities in the margin account increase in value, the investor has the opportunity for a higher profit than they would have had they invested $10,000 of their own.

On the other hand, if the securities decrease in value, the margin investor is at risk of losing more than they would have had they invested $10,000 of their own.

One of the most significant risks of margin investing stems from margin calls. Because securities purchased on margin are used as collateral against the loan Robinhood extends, Robinhood sets “margin maintenance requirements” on each margin account. These requirements are minimum portfolio values that must be maintained by the investor, and they help Robinhood protect the money they’ve loaned. [2]

So, if the market is volatile, as it has been recently, and the value of securities in a margin account falls too far, Robinhood will issue a margin call. The investor must then either deposit additional cash into their account to meet the margin maintenance requirement or close out their position(s).

However, per Robinhood’s Margin Account Agreement and Margin Disclosure Statement, when Robinhood issues a margin call, they also have the right to sell the account holder’s securities without notice nor consultation. [3],[4]

The language of the agreement specifically states that Robinhood is authorized to liquidate or sell the securities in a margin account to cover any margin deficiency, and that they are not required to notify the account holder before making such a sale. The agreement also stipulates that Robinhood has the sole authority to choose which securities are sold in order to satisfy a margin call, and that Robinhood’s margin maintenance requirements are subject to increase at any time, with no advanced written notice required. [3],[4]

Based on this agreement, which all Robinhood margin investors are required to sign, Robinhood has quite a bit of power over margin accounts. Understood in context, however, these stipulations are designed not to put the investor at risk, but instead to allow Robinhood to protect the money they’ve loaned to investors via immediate liquidation and/or covering losses by requiring additional cash deposits. [3],[4]

Margin investors should also be aware that Robinhood’s margin account agreement explicitly states that any disputes must be resolved via arbitration, so neither party to the agreement may sue one another in court. If a dispute arises, an arbitration case would be filed with the Financial Industry Regulatory Authority (FINRA) in order to reach a resolution or settlement. [3],[4] FINRA arbitration is designed to create a fair and expedited alternative to a traditional court case, but it’s important to understand the arbitration process before deciding to make the leap into margin investing.

So, depending on your risk tolerance, margin trading may or may not be an investment tool you want to use in your accounts.

In our next post, we’ll be sharing a start-to-finish overview of what you can expect from the FINRA arbitration process, particularly as it pertains to margin investing.

Sources: [1] https://www.investopedia.com/ask/answers/041315/why-purchasing-stocks-margin-considered-more-risky-traditional-investing.asp [2] https://robinhood.com/us/en/support/articles/margin-overview/ [3]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Customer%20Margin%20and%20Short%20Account%20Agreement.pdf [4]https://cdn.robinhood.com/assets/robinhood/legal/RHS%20Margin%20Disclosure%20Statement.pdf

As has been widely reported this week, when Reddit retail investors discovered that hedge fund managers were widely shorting GameStop, AMC, and others, they urged fellow users to begin buying up these stocks. This frenzy of investment activity resulted in a short squeeze, sending GameStop’s stock price soaring, causing hedge funds to incur huge losses on their short positions, and placing popular online trading platforms in a precarious financial situation. GameStop shares closed the week of January 25, 2021 up 400% in spite of market volatility and restrictions, and without any material change to the prospects of company.

But how did we get here?

For one, through the rise of simple, fee-free, online investment platforms like Robinhood. These platforms have empowered retail investors by providing an easy-to-use interface to enter the market and trade shares at the click of a button. But this innovation hasn’t come without its critics, who counter that the platforms may paint investments as form of gambling for users who may not have the requisite knowledge to make informed decisions about the risk they take on in their accounts.

As trading activity exploded on Robinhood this week, the platform became strained and suspended trading on a group of 13 popular stocks on Thursday, January 29^th. The restrictions disallowed further purchasing of the stocks but allowed selling – making it difficult for prices to continue to rise. As reported by the New York Times, in order to continue operating Robinhood needed funds to pay both its clearing facility and its users who were owed money from prior trades. To that end, Robinhood raised over $1 billion from its credit lines on Thursday night, enabling trading to resume on Friday, albeit with significant stock-quantity restrictions.

Of course, this period of restricted trading has raised some important legal and regulatory questions. First, some Robinhood users viewed the trading restrictions as unjust behavior in the free market, with over a dozen lawsuits, including a class action, filed against the company this week. The lawsuits claim that Robinhood breached its contract with users when it began restricting their trading activity. Further, the class action lawsuit claims that Robinhood’s “actions were done purposefully and knowingly to manipulate the market for the benefit of people and financial institutions who were not Robinhood’s customers.”

According to several legal experts cited by Thompson Reuters, it is unlikely that these lawsuits will succeed, because Robinhood’s user agreement reserves the right to “prohibit or restrict” its users from trading securities at its own discretion. Additionally, federal securities law places strict limits on class actions against brokers, and users will face the tough task of proving the specific damages they suffered because of the restrictions. They will also likely need to show concrete evidence that Robinhood’s restrictions were made for an some “improper reason, such as to favor certain investors” to succeed.

Given the intense public scrutiny and media attention, it’s difficult not to wonder what comes next. In the regulatory realm, the SEC has released a statement vowing that they “will closely review actions taken by regulated entities that may disadvantage investors or otherwise unduly inhibit their ability to trade certain securities.” In fact, the SEC has already had its eyes on Robinhood in recent months. They issued a $65 million fine against the company in December 2020, alleging that Robinhood misled its customers about their main revenue source, causing users to lose $34.1 million between 2015 and 2018.

With commitment this week from both the White House and Treasury to monitor the situation, along with bipartisan support in Congress to investigate, this fast-evolving situation will be one to watch in the coming weeks.

It is fundamental to full and fair disclosure that if an individual investor wants to know whether their financial adviser, or a financial adviser they want to hire, has any legal or regulatory problems, that this information is easy for an investor to obtain. To that end, the Securities and Exchange Commission (“SEC”) sought to simplify the process by which an individual investor can access this information. The result of the SEC’s efforts was the “Form CRS.” “CRS” stands for customer (or client) relationship summary.

This information has been available. However, for the average “Main Street” individual investor, the information was not easy to find. And when the customer complaint and regulatory history was found, the disclosures were difficult to understand. The Form CRS[2] was intended to address this complexity and difficulty through simplification. Thus, the SEC created what SEC Chairman Jay Clayton said in November 2018 would be a “clear and concise” document. I think they succeeded. Wall Street, however, failed.

One question on the Form CRS asks is “Do you or your financial professionals have legal or regulatory history.” This is a simple yes or no question. Or so you would think. The SEC’s instructions for Form CRS elaborate, telling financial advisers to answer ‘yes’ if they or their financial professionals have disclosed such legal or regulatory history. The SEC instructs financial advisers to disclose if they or their advisers have disclosed any legal disputes with customers, regulatory penalties or have been terminated while working at prior employers.

Pretty straight forward, right? Well, apparently not if you are a financial professional! According to the Wall Street Journal’s analysis, an astonishingly high number of firms failed to report legal and regulatory issues. 1,300 firms failed to list disclosures on approximately 2,300 individual employees. The Wall Street Journal reports that their analysis shows that approximately 1,600, or almost 70%, of the non-disclosures related to customer complaints.

The failure to answer ‘yes’ approximately 2,300 times by almost 1,300 financial firms on this Form CRS is more than a mistake.

It is the financial industry’s continued attempt to hide this important information from investors. Transparency is important and by ignoring the rules and intentionally (or at least grossly negligently) hiding customer complaints from investors, these firms weaken investors’ trust.

This mass failure to be transparent can only be seen as an intentional attempt by Wall Street to mislead Main Street investors.

When seeking to hire a financial professional, the prudent investor will try to find out if the financial professional they want to hire is trustworthy or has any customer complaints. This information is vital not only to protect individual investors, but it is important to help ‘clean up’ the financial industry by helping to rid the industry of those financial professionals that have significant or numerous customer complaints. Even with the SEC’s simple Form CRS, the Main Street individual investor is at a disadvantage since the firms are not properly disclosing the information.

It is my hope that the SEC acts strongly to prevent a re-occurrence of the Wall Street’s attempt to hide the truth from investors. I also hope that Wall Street becomes more transparent so that individual investors can finally move towards having a level playing field. Proper disclosure by financial professionals of their legal and regulatory history is a big step in the right direction.

[1] https://www.wsj.com/articles/financial-firms-fail-to-own-up-to-advisers-past-misdeeds-11598698800?mod=searchresults&page=1&pos=1 [2] https://www.sec.gov/info/smallbus/secg/form-crs-relationship-summary

Interactive Brokers that Saroop and two others (collectively, the “Investors”) opened accounts with Interactive Brokers where they were required to sign the contracts that provided that all transactions were subject to “rules and policies of relevant market and clearinghouses, and applicable laws and regulations.” Interactive Brokers hired a third-party to trade the Investors’ accounts (the “Manager”). Using the Investors’ margin accounts, the Manager invested in short-term futures, with a symbol of VXX. The Manager sold naked call options for VXX, meaning that the Investors had the right to buy VVX at a set price until the option expired. This works great if the market price increases but is a serious problem if the value decreases. To make matters worse, the Manager traded using the Investors’ margin accounts. A margin account is when you borrow money to purchase stock. This means that you can lose more money than you invested.

The high risk associated with margin trading prompted FINRA to prohibit purchases of VXX using margin.

The Manager was heavily invested in VXX when the market dropped and the Investors’ accounts dropping 80%. The drop triggered a ‘margin call’ for the Investors to deposit money or marketable securities to get the margin balance back to the minimum required. Interactive brokers began auto-liquidating wiping out the Investors’ accounts. The end result was that the Investors owed hundreds of thousands of dollars to Interactive Broker in their margin accounts.

The Investors filed arbitration against Interactive Brokers to recoup their losses alleging, among other things, breach of contract. The arbitration panel found for the Investors and awarded damages based on the account values before the margin trading started.

Interactive Brokers moved to vacate the award and the court criticized the arbitrators, essentially saying that they were not fit to make the decision. This court remanded to the arbitrators to explain their award. The arbitrators explained that the liability was based on FINRA Rule 4120 and that the damages came from value of the Investors accounts before the ineligible VXX investment. Interactive Brokers again asked the court to vacate the arbitration award, and the court did.

The Investors appealed to the Fourth Circuit that held that it is not ‘manifest disregard of the law’ to premise liability on a breach of contract. ‘Manifest disregard’ is one of the ways to overturn an arbitration award. In this case, Interactive Brokers admitted that parties may incorporate FINRA rules into a contract and the arbitrators found that Interactive Brokers had not complied with FINRA rules. As such, the Fourth Circuit held that since the contracts between the parties invoked the FINRA rules, Interactive Brokers breached the contract.

The Fourth Circuit reaffirmed that contract damages are awarded to place the injured parties in the same position had there been no breach of contract. The court found that even if this is not the best reading of the law, a court cannot overturn an arbitration award because it believes the arbitrators misinterpreted the applicable law.

This case is of interest because it holds that when investors sign contracts with a brokerage firm that incorporates FINRA rules, a finding that the brokerage firm did not comply with FINRA rules is a breach of contract. Another interesting feature of this case is that the court pointed out very clearly that it supports arbitration as a valid resolution forum.