Monthly Archives: November 2014

Variable Life Insurance: The Devil is in the Details

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By Jack Korte

For most investors, the goals of their investments change with time. As investors age they often seek to secure their financial future for retirement, while also providing and protecting an inheritance for their loved ones. As such, traditional, equity based investing often becomes less appealing. As a result, investors tend to look to more complex and structured investment vehicles to safely accomplish their various investment goals. However, hidden behind the structure and complexity of these investments can lie details, fees, and risks that go unforeseen by even experienced investors. A relatively new example of such an investment is Variable Life Insurance.

Variable Life Insurance (“VLI”) policies are appealing to investors for a variety of reasons. At their most basic level, they offer investors the traditional benefits of a life insurance policy (a death benefit with the option for additional features). Additionally, the policies provide the opportunity for capital growth and also provide a preferable tax status. These are the facets of the investment that brokers and insurance salesman are sure to share with potential clients. However, it is the more nuanced aspects of the policy that should be reviewed thoroughly.

For the right investor and under the right circumstances, a VLI policy can be both an appropriate and a successful investment. Unfortunately, too often the policy is purchased without appropriate review. The first trap that investors fail to notice is the most apparent; fees and commissions. VLI plans can carry some of the highest fees and commission rates in the insurance industry. While the promised return might seem appealing, it is essential to properly balance the return with the actual cost of investment. Premiums for such policies may appear either lower or higher than they actually are. In some cases, an investor may falsely perceive that all the money they are paying as premiums each month is increasing the value of their investment. In reality, a sizable portion of that premium may be consumed by fees, meaning it will never be returned to the investor. Additionally, a premium may appear lower than it actually is in cases where an investor mistakes the amount needed to fund their accounts as the total amount needed to subsidize the account. Either way, when unclear, these miscalculations can lead to serious problems with properly funding the investment and/or ensuring the investment’s profitability.

The second major issue with VLI policies is the autonomy over an investment that insurance companies retain for the majority of the policy. While insurance salesmen and brokers may tout an investor’s ability to withdraw money without tax penalties, they may fail to address the fees that their own company will charge if you try to touch your money too early. Most VLI policies stipulate that an investor cannot remove any of their investment for a certain period of time (usually 10 years) without suffering a substantial surrender fee. What further complicates this feature is what can happen to an investment while it’s locked up. For many policies, the insurer has the ability to collect premium payments not only from the investor but also from the investment. Meaning, if an individual misses a monthly payment of $8,000, the policy will automatically deduct the $8,000 from the investor’s funding of the policy. This process creates a dangerous paradox. The people who need to access the money in their policy the most (those who are short on cash) are also those who are most likely to not be able to make their monthly payments. If this cycle goes unchecked, an investor may be forced to watch as the insurance company writes monthly or yearly checks to itself as their principal investment decays to nothing.

Although VLI policies are classified as securities, they very much fall in a grey area both in administrative oversight and enforcement. They can be very complex investment vehicles with equally complex prospectuses and statements. As such, potential investors should be cautious with the product and discuss it thoroughly with their broker, insurance salesmen, or financial advisor before purchasing.

Counter-suing Investors Jeopardizes Integrity of Arbitral Forum

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By Neda Ghomeshi

Investors take their cases to arbitration before the Financial Industry Regulatory Authority, (FINRA), as they are typically required to in any dispute with their broker or brokerage firm. Often, investors sue their brokerage firms for suitability, fraud, negligence, breach of fiduciary duty, failure to supervise, among many other causes of action. Recently, however, some brokerage firms have been responding by countersuing investors and accusing them of reneging on their indemnification commitments.

FINRA records show 13 examples of firms counter-suing investors for breach of indemnification obligations. However, this number is not an accurate reflection of the frequency with which this tactic is being used; cases that are settled before a hearing are generally not recorded in FINRA’s databases.

This method practiced by brokers is intended to intimidate investors and discourage them from suing. Although this practice is not common, it has the potential of becoming widespread. This practice can and likely will dissuade investors from suing their brokers, even when they are potentially entitled to relief.

Essentially, brokers are claiming that the investor signed a private placement memorandum and therefore counter-suing is warranted. This strategy is based on a questionable interpretation of the language in the documents that investors sign when opening their accounts.

Berthel Fisher & Company, based in Marion, Iowa, has been applying this strategy. Berthel Fisher seized on the language in their documents to bolster two counterclaims against 32 investors from Midwestern states who had lost all of the money they had invested in a private placement in a cellphone company. Although Berthel Fisher did not prevail on its counterclaims, it escaped liability on the investors’ claims in both cases last year. The investors said they had been pitched the product by Berthel Fisher brokers who had an obligation to sell them a suitable investment.

This strategy that is being applied by several firms goes against FINRA’s policies. Michelle Ong, a FINRA spokeswoman, explained that indemnification clauses do not shield firms from their legal and regulatory obligations to comply with federal securities laws and FINRA rules. She stated, “The use of any clause or tactic designed to intimidate or keep a customer from exercising his/her right to proceed in arbitration would violate FINRA conduct rules and we may investigate the use accordingly.”

Not only is this a dangerous tactic against FINRA’s policies, but it is against public policy. An investor trusts their broker and relies on their broker to purchase suitable investments on their behalf. Indemnification clauses should not be designed to protect brokers who sell unsuitable investments. Countersuing amounts to a scare tactic designed to prevent investors from taking action for losses they suffered at the hand of their brokers. If this strategy becomes more prevalent, it will jeopardize the integrity of the FINRA arbitration forum.

Securities and Exchange Commission Files Suit Against Jupiter Based Penny Stock Fraudsters

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By George Pita

On September 30, 2014, The Securities and Exchange Commission (“SEC”) filed a civil injunctive action against Positron Corporation (“Positron), a microcap company based in Illinois, Patrick G. Rooney, the company’s then-CEO, and John R. Rooney of Jupiter, Florida. The SEC charged the three with masterminding a manipulation scheme involving the company’s stock.

Positron is a self-described nuclear medicine company, which reported $1.6 million dollars in revenue in 2013, but lost $7.1 million. Positron’s shares are currently trading at less than a penny.

The SEC alleged that through several meetings that took place in Palm Beach, the Rooney brothers hired stock promoters to inflate shares of the lightly traded company by purchasing them on the open market. Fortunately for the public, and unfortunately for the Rooney brothers, these stock promoters were cooperating with the FBI. According to the complaint, John Rooney ordered the stock promoters to purchase 20,000 shares of Positron on the open market in exchange for a cash payment of $4,000. He also gave them advance copies of Positron press releases so they could coordinate their purchases to look like the market reacted positively to them.

In August 2012, the FBI, through its cooperating stock promoters, purchased shares of Positron after receiving instructions from Patrick Rooney. Mr. Rooney paid the stock promoters only $1,000 of the agreed-upon $4,000 bribe. The SEC asked that the court penalize the Rooney brothers with civil fines, a bar against participating in penny stock offerings, and a bar against Patrick Rooney serving as an officer or director of a public company.

The Rooney Brothers are notorious to the SEC. In July of this year, the United States District Court for the Northern District of Illinois entered a judgment imposing $715,700 in disgorgement, plus prejudgment interest of $166,476 against Patrick Rooney. In Securities and Exchange Commission v. Patrick G. Rooney and Solaris Management, LLC, the SEC alleged that Rooney and Solaris radically changed the investment strategy of the Solaris Opportunity Fund LP (“Solaris Fund”), contrary to Solaris Fund’s offering documents and marketing materials, by becoming wholly invested in Positron, the company whose stock Mr. Rooney allegedly attempted to manipulate.

The SEC further alleged that Patrick Rooney, who had been chairman of Positron since 2004 and received salary and stock options from Positron since September 2005, misused the Solaris Fund’s money by investing more than $3.6 million in Positron through private transactions and market purchases. Many of these private transactions were undocumented while other investments were interest-free loans to Positron. Rooney and his compatriots hid the Positron investments and Rooney’s relationship with the company from the Solaris fund’s investors for over four years. Although Rooney finally told investors about the Positron investments in a March 2009 newsletter, the SEC’s complaint alleges he falsely told them he became chairman to safeguard Solaris Fund’s investments, while in reality these investments benefited Positron and Rooney while providing Solaris Fund with a concentrated, undiversified, and illiquid position in a cash-poor company with a lengthy track record of losses.

The actions of the Rooney brothers illustrate the need for investors to be cautious in investing in highly risky stock. While the SEC and law enforcement are working diligently to prevent stock manipulation schemes from taking place, the first line of defense against them is diligence and caution. It is important that you perform your own investigation into any stocks that a broker recommends, and it is important to review your broker’s reputation before entering into business with them.