By Alan Rosca
When the COVID-19 crisis sent global markets crashing in March 2020, most investors heard the advice: “Don’t look at your 401-K. Don’t look at your portfolio.”
And that is excellent advice. For most investors, the best strategy is to have a well-diversified portfolio and stick with it through the ups and downs of the market.
That is, assuming you have a well-diversified, fairly plain-vanilla portfolio. No overvalued “can’t miss” biotech stocks. No private placements. No commodity, option, or narrower funds. No exposure to margin calls. No option or hedging strategies your broker assured you were safe and conservative, but that you never really understood.
If any of those are in your portfolio and you haven’t checked in the last months, do it now! Because market meltdowns like the one we’re experiencing do more than compress even well-diversified portfolios. They also expose fraud, overhyped investments, weak financial controls, overleveraged balance sheets, and lack of due diligence, as The Economist wrote. The article quotes Warren Buffett’s famous line: “You only find out who is swimming naked when the tide goes out.”
In my legal practice I often represent individual and institutional investors in disputes with financial industry members arising out of investment fraud or misconduct. Let me tell you about some current cases that illustrate the kind of things that even sophisticated investors need to watch out for when they check their portfolios.
Strategy was not low-risk after all
One lesson is that being advised by a big global bank is no guarantee that you won’t be taken advantage of.
The UBS Yield Enhancement Strategy (YES) used funds borrowed from UBS Group AG clients’ accounts to make a combination of options trades related to the movement of a stock index. UBS brokers pitched the strategy as low risk and assured clients the investment strategy had a lengthy and solid record, according to the New York Times.
However, when volatility surged in late 2018 and again in 2019 and this year, the options strategy generated heavy losses and margin calls. Losses to the UBS investors skyrocketed last year.
Were the risks associated with the strategy fully and properly disclosed to the UBS clients? Was the program an unsuitable investment for some of the investors who may have been wealthy but were not well-versed in option trading? Were some of the UBS investors’ portfolios were over-concentrated in the program? Are there investors who are haven’t been keeping an eye on their UBS portfolio and are still sustaining losses? Those are some of the questions being investigating on behalf of UBS investors. (Rule of thumb: If the name of the investment product is an acronym, stay away from it!)
In the ultra-low interest rate environment of the last decade, many investors became susceptible to promises of high returns, as their advisors urged them to diversify away from the stock market.
Launched in 2013, New York-based alternative asset management firm GPB Capital Holdings raised more than $1.5 billion from thousands of investors across the country with promised that its investments in auto dealerships and waste management companies would generate returns of 8% annually. Some 60 broker-dealers and their registered representatives sold these risky private placements to their clients, incentivized by commissions of nearly 8%.
In the summer of 2018, the wheels started to come off. The firm stopped raising new money and suspended redemptions – never a good sign. Then GPB’s outside auditor resigned and Independent investigations were launched by securities regulators Financial Industry Regulatory Authority (FINRA) and the Securities and Exchange Commission (SEC). And the FBI paid the GPB office a visit. A number of investors have filed complaints seeking to recover losses suffered in funds sold by GPB, and class action lawsuits also have been filed.
Some of the broker-dealers claim they are also victims. But then you don’t ask too many questions when 8% commissions are being offered.
Fraudulent oil and gas schemes
As anyone who has filled their gas tank recently knows, the oil and gas industry is in a world of hurt. And so are many investors who were sold private oil and gas offerings when oil prices were on the rise in 2017 and 2018.
Private oil and gas offerings typically involve a high degree of risk. All such risks must be appropriately disclosed, and the investments should only be recommended to those investors to whom they are suitable. In addition, investors should be mindful of potential conflicts of interest between the broker and the issuer or promoter.
Unfortunately, many brokers or financial advisors have made misrepresentations and omissions about the use of investors’ monies in oil and gas securities schemes. Omissions often include the existence or size of the sales commissions to brokers, the nature and size of compensation to the promoter and employees of the venture, operating and other expenses for unrelated businesses, and even using the investor money to pay for personal items.
Fraudulent oil and gas scheme are often pitched with wild claims that they are about to “strike it rich,” are using new technology, or that it is likely or even guaranteed that the returns will be too good to pass up. The salesperson may claim to be an investor, and the client may be asked to sign documents acknowledging that the securities laws do not apply to the investment. Inquiries are rising as more investors become aware of the losses they have suffered.
Problematic investment products or strategies like these are likely to be the tip of the iceberg. Investors would be well-advised to check their statements and find out whether any losses in their portfolios were caused by the COVID-19 crisis, or were the result of time-ticking bombs that were planted in their portfolios long ago, and were set off by the current crisis.
Alan Rosca is a securities lawyer with Goldman Scarlato & Penny, P.C. and an adjunct professor of securities regulation. He frequently represents institutional and individual investors in disputes with financial industry members arising out of investment fraud or misconduct.