SEC bring charges against Western International Securities for Reg BI violations
The Securities and Exchange Commission (SEC) has brought an action against Western International Securities, Inc., Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham, and Thomas Swan. The SEC complaint was filed with the California Central District Court on June 15, 2022.
The lawsuit concerns violations by Western and five of its registered representatives of the Best Interest Obligation under Rule 15l-1(a) of the Securities Exchange Act of 1934 (“Reg BI”) in connection with their recommendations to retail customers to purchase an unrated debt security known as an L Bond.
L Bonds were corporate bonds offered by GWG Holdings, Inc. L Bonds were high-risk, illiquid, and only suitable for customers with substantial financial resources. The L Bonds relevant to this Complaint paid fixed interest rates of between 5.50% and 8.50%, depending on the maturity period of the bond. GWG offered maturity periods of two, three, five, or seven years.
Between July of 2020 and April of 2021, registered representatives of Western recommended and sold approximately $13.3 million in L Bonds to retail customers. These recommendations violated Regulation Best Interest in several ways.
Regulation Best Interest requires that a broker, dealer, or associated person act in the best interest of a retail customer when making a recommendation of a securities transaction. Firms comply with Reg BI’s Best Interest Obligation only if they comply with four component obligations: the Disclosure Obligation, the Care Obligation, Conflict of Interest Obligation, and the Compliance Obligation. Similarly, associated persons of broker-dealers comply with Reg BI’s Best Interest Obligation only if they comply with the Disclosure Obligation and the Care Obligation.
Reg BI’s Care Obligation requires a broker, dealer, or associated person of a broker or dealer, in making a recommendation of a securities transaction, to exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with the recommendation.
Western and its registered representatives Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham, and Thomas Swan allegedly failed to comply with this aspect of their Care Obligation, because they failed to exercise reasonable diligence, care, and skill to understand the risks, rewards, and costs associated with L Bonds. At the time they recommended L Bonds to retail customers, the Registered Representative Defendants did not understand key risks associated with L Bonds and GWG.
Reg BI’s Care Obligation also requires a broker, dealer, or associated person, in recommending a securities transaction to a retail customer, to exercise reasonable diligence, care, and skill to have a reasonable basis to believe the recommendation is in the best interests of that customer, based on the customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation.
The SEC alleges that the defendants failed to comply with this component of the Care Obligation as well, by recommending L Bonds to at least seven retail customers without a reasonable basis to believe L Bonds were in those customers’ best interests. Among other things, these customers had moderate-conservative or moderate risk tolerances, investment objectives that did not include speculation, limited investment experience, limited liquid net worth, and/or they were retired. The Registered Representative Defendants nevertheless recommended L Bonds to these seven customers without reasonable bases for doing so.
Reg BI’s Compliance Obligation, another Component Obligation of the Best Interest Obligation, requires brokers or dealers to (a) establish, (b) maintain, and (c) enforce written policies and procedures reasonably designed to achieve compliance with Reg BI. Western failed to comply with its Compliance Obligation. Its written policies and procedures were not reasonably designed to achieve compliance with Reg BI’s Care Obligation.
Western’s written policies and procedures merely recited the objectives of Reg BI, without offering registered representatives specific guidance tailored to Western’s operations. Western also had inadequate procedures for enforcing what limited policies it had regarding compliance with the Care Obligation of Reg BI.
The SEC seeks permanent injunctions, disgorgement and prejudgment interest, and civil penalties against Western and the Registered Representative Defendants, based on their violations of Rules 15l-1(a)(1) of the Exchange Act, and, in the alternative, against Western as a control person pursuant to Section 20(a) of the Exchange Act.