Wells Fargo Investments LLC has been fined $2 million for failure to supervise the conduct of one of its brokers who sold unsuitable reverse convertible securities to elderly customers, the Financial Industry Regulatory Authority, or FINRA, announced on Dec. 15. The firm was also censured.
The fine also covered Wells Fargo’s also failure to provide sales charge discounts to eligible customers on unit investment trust transactions, or UITs, FINRA said.
A subsidiary of Wells Fargo Bank, Wells Fargo Investments LLC changed its name to Wells Fargo Advisors LLC in March 2010 when it merged with Wachovia Securities LLC at the same time its parent bank merged with Wachovia Bank. A broker-dealer based in St. Louis, Mo., the firm has been a member of FINRA since 1987. It has more than 6,500 branches and employs more the 25,000 brokers.
Per a Letter of Acceptance Waiver and Consent, or AWC, submitted by Wells Fargo to settle the matter, the firm will pay restitution to the elderly customers who were sold unsuitable reverse convertible securities, as well as those who did not receive UIT sales charge discounts despite being eligible. FINRA accepted the AWC on Dec. 15.
In November, FINRA filed a complaint against Alfred Chi Chen, the former Wells Fargo stockbroker who recommended and sold the unsuitable reverse convertibles to elderly customers. Chen also made unauthorized trades in several customer accounts, including accounts of deceased customers, according to the complaint.
Reverse convertibles are interest-bearing notes in which repayment of the principal is tied to the performance of an underlying asset, such as a stock or a basket of stocks. Depending on the specific terms, investors can suffer big losses if the value of the underlying equity security falls below a certain level when the note matures. Investor can also sustain losses if the value of the underlying asset falls during the term of the reverse convertible. If the asset falls below the strike price of the reverse convertible, the holder must buy the stock.
According to the AWC, when the underlying asset fell below the strike price Chen would typically re-sell the stock at a loss and invest the proceeds in more reverse convertibles.
FINRA found that Chen recommended hundreds of these reverse convertible investments to mostly elderly clients who either had limited investment experience, low risk tolerance, or both. Many of these customers had said their investment goal was to make a conservative income, such as through a low-risk, interest-bearing bond, or to preserve capital, according to the AWC. By their nature, reverse convertibles do not serve these goals.
As of June 2008, Chen had 172 accounts that held reverse convertibles. Among these account, nearly 150 of them were more than 50 percent concentrated in reverse convertibles, and 46 of the accounts were more than 90 percent concentrated in reverse convertibles, FINRA said.
Fifteen of the 21 customers who owned these accounts were over 80 years old. The over-concentration of reverse convertibles exposed them to risk inconsistent with their investment profiles.
Between 2007 and 2008, Chen received $1 million in commission from the sale of reverse convertibles. At the end of 2007, more than 75 percent of his commissions were coming from these sales.
In one example, Chen had an 88-year-old woman take her entire $175,000 account, previously in a fixed annuity, and invest it in reverse convertibles contrary to her stated investment goals. Chen then changed her investment goals to suit the purchase of reverse convertibles, the AWC said.
Although the AWC did not specify about the amounts of money lost by the elderly customers, the settlement calls for Wells Fargo to submit a plan to FINRA within 60 days as to how the firm will ascertain the financial harm suffered by these customers for the purposes of restitution.
FINRA found that Wells Fargo failed to detect this unsuitable and risky over-concentration in reverse convertibles in the accounts of elderly clients because the firm had insufficient systems and procedures to monitor for unsuitable transactions.
The firm also failed to provide some eligible customers with breakpoint and rollover and exchange discounts when they purchased UITs, also because of insufficient systems and procedures.
UITs offer sales charge discounts on purchases that exceed certain thresholds, typically known as breakpoints. In addition, discounts are supposed to be given on UITs that involve the proceeds from the redemption or termination of another UIT during the initial offering period. Between January 2006 and July 2008, Wells Fargo did not provide eligible customers with these “breakpoint” and “rollover and exchange” discounts.
In submitting the AWC to settle the matter, Wells Fargo neither admitted nor denied the charges, but consented to the entry of findings.
Wells Fargo was disciplined for a failure of its supervisory system once before. In 2009, the firm was censured and fined $275,000 for supervisory breakdowns that led to the sale of unsuitable variable annuities.
This pending action filed by FINRA in November is the only regulatory action against Chen, but public disclosure records from FINRA reveal he has been involved in 23 customer disputes.
If you have been the victim of securities fraud you should consult with an attorney. The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Firm, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.