By Mathew Slootsky

On May 30, 2019, the President issued a threat to apply tariffs of up to twenty-five percent on goods imported from Mexico. Although the President later canceled the planned tariffs, he may decide to impose tariffs at a later date. The first thing that comes to mind when reading this for most consumers is, “How will this affect me?”

The popular fast-food restaurant Chipotle experienced a 7% dip in their stock price as a result of the news of the threatened tariffs. Chipotle uses avocados grown in Mexico and sells Corona and Modelo, two Mexican beers. A typical investor would reasonably believe Chipotle to be a reliable stock. Their restaurants are typically busy and there has been impressive expansion throughout much of the United States. But those investors lost a significant amount of value based upon the rumored tariffs. If rumors of the tariff are causing a ripple-down effect, imagine what could happen if these tariffs came into effect? Under this scenario, it is likely that consumers will see additional losses.

Not only is the food and beverage industry at risk for consumers holding securities because of lurking tariffs, there are other industries that are also affected. For example, Samsung Electronics Co. produces many of their televisions in Mexico. The Samsung televisions that are sold to the United States from Mexico could potentially see a price increase. As a result of this possibility, Samsung’s stock also fell on the threatened tariffs news. Additionally, the auto industry is affected by this threatened tariff. Many vehicles are manufactured in Mexico, including Audi, Volkswagen, and others. This rumored tariff will cause an increase in price for these vehicles as well, which will likely cause the stock price to decrease in value.

Many investors believe that a trade war against Mexico may become the catalyst that starts the next recession in the American economy. In fact, a recent study from Duke University showed that the two-thirds of chief financial officers believe that the economy will fall into a recession by the third quarter of next year, as a result of this plausible trade war.

As securities prices fall due to the trade war with Mexico, many investments will likely lose money. Consumers will be hesitant to spend extra money for a Samsung television made in Mexico when they can purchase a Sony television manufactured in a country that is not paying a 25% tariff. Mexican and American trade is heavily intertwined, and a trade war affects nearly every citizen. Automobiles, electronics, and food are only some of the most popular securities that will be directly affected by these tariffs. Many of these securities were previously considered relatively conservative, as the past trade relationship between the United States and Mexico was not only predictable, but very stable. Now, the relationship between these two countries is not as stable as it once was.

Consumers will need to be cognizant about where products are manufactured, and where companies import their goods from. If these tariffs against Mexico are enacted, then consumers may want to avoid investing their hard-earned monies in companies that are doing business in Mexico.

By David McDonald

The 2008 crisis exposed critical regulatory and supervisory failures in the current financial system. This is not news, and, in fact, some would argue that oversights and loopholes are part and parcel to the system. After all, there is always a potential for mismanagement where regulation must be reactive to new disruptors in markets. However, developments since the ’08 crash have emerged that might have the power to encourage a new proactive stance. Enter the rise of “RegTech” or regulatory technology. As a subsector of financial technologies (“FinTech”), RegTech was initially created as a way for financial companies to reduce compliance costs by automating information gathering and reporting. Since then, however, the niche has exploded at an alarming rate. Technologies include everything from machine learning to cut down on time filling out forms to real-time authentication for digital transactions. Considering the World Bank estimates that eight percent of gross national product (GNP) is spent on regulatory compliance, any technologies that can streamline processes and reduce costs are certainly welcome.

However, this is where our issue arises. As more entrepreneurial companies enter the RegTech sector, financial institutions are receiving multitudes of disjointed possible answers rather than one uniform solution. To use a simplified example, consider software such as TurboTax. It’s an efficient way for households to fill out multitudes of tax forms in one convenient system. However, when the “household” is an international financial institution with countless regulatory agencies across the globe to report to, the household is going to need some crazy computing power to make sense of everything. RegTech is an opportunity to use technology in order to streamline the filling out of these regulatory forms and reduce the amount of manpower needed simply to disclose that information. But, the system only works if there is one comprehensive solution. To return to the TurboTax example, there needs to be one TurboTax rather than fifty different firms all trying to sell their niche version of the software.

There are two likely ways to achieve this goal: a RegTech innovator will come up with a solution that dominates the market and becomes the main supplier of regulatory technology or, ironically enough, through continued restrictive regulations. To expand on the second option, if regulators can detail exactly what standards a RegTech firm should be catering to, then the regulators have an opportunity to save these financial institutions billions in manpower that could be dedicated elsewhere. It would require a proactive approach by regulating this new sector in a way that ultimately benefits the financial institutions, rather than waiting for some failure in the market (a data breach caused by a cyber-attack, for example) to spur lawmakers into action. Taking such steps can be extremely beneficial as it sets a list of regulations for a still fledgling market that can then grow into what regulators want it to be, rather than letting the sector run rampant until regulators are forced to react to a catastrophe that they could have prevented.

By Lucas Hsu

Most investors are familiar with mutual funds, a form of investment company regulated by the Securities and Exchange Commission under the Investment Company Act of 1940.  In fact, a majority of investors’ retirement and taxable investment accounts are comprised of mutual funds. However, investors are often unaware of another type of investment company, called a closed-end fund (CEF).  Unlike mutual funds, which represent $18.7 trillion in assets, CEFs hold over $300-billion in assets.

Unlike mutual funds, which offer an unlimited number of shares to investors, CEFs only offer a fixed number of shares during the fund’s IPO. Following this initial sale, investors have an opportunity to buy these shares on a secondary market, such as the NYSE or the Nasdaq Stock Market. In a secondary market, investors can often buy CEF shares at a discount, which means the price of a share is less than the value of the assets held in the fund. The benefit of the discount is realized when a CEF becomes popular. As the market demand goes up, share prices also go up, which in turn increases the return on investment. Also, the use of an IPO creates “a solid base of capital” that allows a fund manager to buy riskier, but potentially more profitable assets, such as those in emerging markets or real estate deals.

Additionally, CEF managers have the ability to use leverage to “double down” on winning positions. This makes a closed-end fund attractive to the income focused investor because the CEF’s gains will be amplified in a rising market, leading to higher yields. However, the use of leverage is a double-edged sword. Rising interest rates can lead to a reduced payout and a decrease in the value of the individual securities held by the fund. Furthermore, investors cannot assume that the distribution they are receiving comes from the income generated from the securities in which the fund is invested. These distributions may be a return of capital, which is simply the fund returning shareholders’ money.

Before diving head first into a CEF, it is a good idea to do more research by carefully reading the CEF’s prospectus in order to understand its investment objectives and the risks involved. Additionally, investors may also refer to the SEC’s information page regarding CEFs, as well as, FINRA’s Investor Alerts page in order to properly determine whether a CEF is the right investment for their portfolio.

By Tiffany Colt

On April 3, 2019, Turnkey Jet, Inc. became the first business to acquire the ability to sell digital tokens that are not regulated by the U.S. Securities and Exchange commission (SEC). The SEC’s no-action letter stated that the SEC would not bring an enforcement action against Turnkey if it offered, and sold its tokens without registration under the Securities Act and the Exchange Act. Until this no-action letter, the SEC has held in multiple instances that other ICOs, or initial coin offerings, are securities and, therefore, subject to SEC regulation.

An ICO is a fundraising mechanism in which new projects sell their underlying crypto tokens in exchange for virtual currencies like Ether and Bitcoin. Promoters may tell purchasers that the capital raised from sales of the tokens may be used to fund development of a digital platform or software, or other project that the tokens can be used for. ICO’s have existed in a regulatory grey area. Depending on the facts and circumstances, particularly if the promoters suggest that the tokens may increase in value, the ICO may be considered an unregistered offering of securities.

Until the Turnkey no-action letter, the SEC has held that ICOs are securities based on the application of a time-honored test – namely, the Howey test. This three-part analysis, determines when an economic transaction is an investment and therefore a security. Following Howey, an ICO is typically a security if the token’s only purpose is to increase in market value, and an ICO is typically not a security in cases where the tokens give the owner access to a specific protocol or network. The SEC’s no-action letter pertaining to Turnkey, the SEC stated that based on the information provided by the company, Turnkey’s ICO is not a security under Howey. This no-action letter provided some guidance on what type of ICOs would not be considered securities and thus not subject to SEC regulation.

So what factors did the SEC take into consideration when deciding whether Turnkey’s ICO should be classified as a security? Well, the first factor is that those who buy Turnkey’s tokens will not be granted shares of the company. Turnkey is also barred from using the proceeds raised from the sale of its tokens to further its network and the tokens must be instantly usable once they are sold. Additionally, the tokens can only be transferred on the company’s trading platform, purchased at a price of $1, and marketed in a way that establishes the functionality of the token i.e. for air charter services. Therefore, these tokens cannot have the potential to increase in market value.

Turnkey’s ability to sell these tokens free from regulation by the SEC has commenters pondering the benefits and negatives of the SEC’s release. Advocates state that this historical action will give business-travel startup companies the push they need to succeed. Proponents also argue that customers will benefit from a company’s ability to sell tokens in this matter because customers will acquire special benefits i.e., assistance with booking private jets. Others argue that the SEC’s no-action letter fails to provide long-term guidelines for incoming startup companies looking to implement ICOs, arguing that the no-action letter provides no clarity regarding who decides whether an ICO falls under the necessary criteria to avoid federal regulation, and whether companies can explain their ICO model at a later date. While these concerns remain unanswered, one fact is undisputed– the SEC’s no-action letter will likely lead to an increase in ICOs. For investors looking to invest in ICOs it is beneficial to consult the SEC website, SEC.gov, for additional guidance and to avoid any potential fraud.

By Y. Tatiana Clavijo

Technology disrupts the status quo. Through innovations, the standards are challenged, and new possibilities arise. Every sector of our lives is being impacted, disrupted, and constantly altered by innovations, and our finances are no exception. FinTech, or financial technology, is the new and exciting area of innovation for financial services changing how we manage our money, how we invest, and how we interact with financial firms. FINRA has been monitoring closely these developments which include pioneering products and creating new client-centric business models among others. The innovations rely on digital banking, the internet, and Blockchain technology. Consequently, private capital is pouring into innovation through investors across the board. Although the regulatory framework is not robust yet, supportive laws may lead to a balanced environment such that could foster innovation while protecting investors too – investors who often face the risk of losing the entirety of their investments.

FinTech and Blockchain innovations are shaking the financial markets to the core. FinTech’s developments have the potential to transform investment banking, wealth management, trading, research through artificial intelligence, machine learning, Blockchain, and many others. Meanwhile, Blockchain allows and supports much of the innovations. BlockChain is a digital ledger that maintains and stores complex databases and records of transactions. Facing this technological revolution, regulators face a split in their path to policy. Some regulators welcome development while others resist change.

Several initiatives grant the financial advancements room to grow, or the very least provide some legal framework to invite certainty without failing to protect investors. From a macro level, financial regulation is primarily intended to achieve market efficiency and integrity while insuring consumer and investor protection to ensure all market participants are safe from fraud, discrimination, manipulation, theft or other exploitative or abusive practices. Innovation drives change and economic growth. Therefore, the interest of FINRA to be an active participant in recent developments is well founded. FINRA’s Office of Emerging Regulatory Issues and a cross-departmental team created the Innovation Outreach Initiative, an initiative in support of Fintech innovation to “foster an ongoing dialogue with the securities industry” around Fintech that requests commentary from the business side on potential measures.

But, is investing in innovation something that suits your goals and appetite for risk? Most new innovations fail. As a result, most of the investments in innovation will fail. Prior to committing to a highly risky investment, obtain professional advice to prevent losing all your funds as Fintech becomes more complex thanks to technology.

By Blayne Justus Yudis

Picture this: You just found out your broker was fired from a larger firm only two months ago for numerous violations of company policies and regulatory rules. Now he services your needs at the local firm down the street. A Boca Raton firm exemplifies this industry-wide practice, and it is a cause for concern. The Boca Raton firm hired a broker after a larger firm discharged him for violating various firm policies while under heightened supervision—which occurred only two months prior to his hire at the Boca Raton firm. The broker’s conduct was not unique. His BrokerCheck report cites 15 more incidents over the course of his career, including customer disputes, regulatory issuances, and a criminal charge.

Unfortunately, the Boca Raton firm has a history of employing bad apples: one former broker at the firm pled guilty to securities fraud as part of a $131 million market-manipulation scheme and, in 2010, the SEC temporarily barred one of the firm’s owner because he failed to reasonably supervise a trader at the firm. Even the firm itself has over 30 disclosures on it’s BrokerCheck since its registration was approved in 2000.

FINRA spokeswoman Nancy Condon stated that “[w]hile FINRA monitors and tracks problem brokers and will examine high-risk firms more frequently, FINRA cannot forbid a firm from hiring someone.” However, change may be impending.

At FINRA’s Board of Governors meeting earlier this year, the Board approved moving forward with proposed rules related to firms that have a disproportionately high number of regulatory disclosure events by the firm and/or its registered representatives. This decision follows pressure on FINRA to more closely regulate the hiring practices of brokerage firms. Although FINRA has made past efforts, regulatory guidance issued in April 2018 did not provide specifics about what constitutes a risky broker hire and how many risky brokers must be hired before a firm incurs liability.

FINRA understands the vital role firms play in protecting consumers from harm. In its April 2018 regulatory guidance, FINRA states that “[m]ember firms often serve as the first line of defense against customer harm through establishing and maintaining effective supervisory systems, particularly with regard to associated persons who may pose higher risks of causing customer harm. As such, FINRA would be wise to impose heightened liability on firms that assume the risk of hiring rogue brokers in order to caution firms against doing so. Heightened liability will incentive firms to sufficiently invest in their supervisory and employment processes. In doing so, investors will ultimately be better protected from rogue investors that can move across the industry as permitted under existing law. The opportunity for FINRA to more closely target bad apples is here.

As a next step in the rule making process, FINRA will soon publish a Regulatory Notice seeking comment on the proposed rules.

By Kevin Warger

Though seen by many as the speedy and efficient dispute forum, timely resolution of FINRA arbitration claims can be a life or death matter for some. When senior or ill claimants have lost large sums of money due to misconduct by their brokers, they can be left destitute and in dire need of a reward to help pay for medical bills. Where urgent health matters require immediate attention, the need to reach an investment dispute resolution becomes great, and lengthy deadlines could become very costly. The length of these deadlines, however, has been under review in recent years and may be undergoing some drastic changes. In recent weeks, FINRA Office of Dispute Resolution director Richard Berry stated that his office is currently preparing a draft rule to expedite the process for those over the age of 75. Under this rule, the deadlines for procedures like selecting arbitrators, preparing an answer, and producing discovery documents would be significantly shortened.

The idea is not a new one: In 2004, FINRA implemented an expedited arbitration process, still in effect, for those with serious illness or that are 65 years or older. That process, however, is an option rather than a requirement and has not been as widely used as anticipated. The 2004 process only applies to the way that FINRA facilitates arbitration proceedings—it does not require the parties themselves to move things along more quickly. Almost 10 years ago, a supervising attorney for the Investor Justice Clinic at the University of San Francisco said that the time to arbitrate a FINRA case takes 1.25 years, and that those who chose the shorter route per the 2004 option resolved their cases 31 percent sooner. However, sick and elderly claimants seeking investment remedies are often unsophisticated laypeople and simply would not know about the expedited option. The new rule, on the other hand, would trigger the expedited process automatically.

Though this new proposal isn’t the only measure meant to protect senior investors (for example, FINRA Rule 2165 attempts to curtail the exploitation of elderly or incapacitated investors), it is a step toward resolving some of the disputes common to the intersection of old age and financial investment.

By Cesar Mejia-Duenas

“The plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty.” (Proverbs 21:5)

It is not surprising that saving and investment decisions have always been a part of our lives. For this reason, we are called to learn about the different investment vehicles we might use to maximize our savings for retirement. In this article, we explain some of the differences between traditional IRAs and Roth IRAs.

Definitions

The term IRA stands for Individual Retirement Account. Financial institutions provide for IRAs that allow you to make tax-advantaged contributions to save for retirement.

There are several types of IRAs. However, the most common are the traditional IRA and the Roth IRA.  It is essential to understand the differences between these accounts because selecting the type of account might have significant consequences on your retirement funds.

Major Differences

Some of the major differences between the traditional and Roth IRAs are: (i) the moment when contributions are taxed, and (ii) the withdrawal rules.

First, for the traditional IRA, contributions are not taxed up front. Furthermore, these contributions can be fully or partially deductible from your income, depending on your circumstances. On the other hand, in a Roth IRA, contributions are taxed upfront at the moment they are made. Thus, the amount in the account grows tax-free. However, the contributions made to the Roth IRA are not deductible.

Second, both traditional and Roth IRAs have different withdrawals rules.  For the traditional IRA, the account holder is required to make annual withdrawals from the account at age 70 ½. This rule can be an important decision for senior investors who are seeking to make their retirement grow or to conserve their capital. To the contrary, Roth IRAs don’t require any withdrawals during the owner’s lifetime. Thus, if the owner does not need the income from the Roth IRA, the account can continue to grow tax-free even after the owner reaches the age of 70 ½.

It is important to point out that for the traditional IRA, withdrawals are penalty-free beginning at age 59 ½. For the Roth IRA, the withdrawal rules vary. Contributions can be withdrawn at any time tax-free because the taxes were paid in advance. However, the earnings can be withdrawn penalty-free only after the account has been open for five years, and the person has reached the age of 59 ½.

Finally, we recommend that you visit your accountant to evaluate what account would be best for your particular situation. Also, remember that the number one factor in determining how much you will have at retirement is the consistency in which you make contributions to your account.  Plan in advance, and plan for abundance.

By Caitlyn Cullen

In January 2019, competing documentaries on Fyre Festival were released. The “Greatest Party That Never Happened” cast a new, darker light on the power of viral marketing as social media influencers lured to a tropical island by promises of luxury villas and a Coachella-style music festival, scrambled in the rain to claim one of the few hurricane tents on the otherwise-barren site. The documentaries portrayed a millennial catastrophe ripe for mocking, but also highlighted the consumers, stakeholders, and investors that were left as victims in the wake of high price tags and material misrepresentations.

In a legal setting, these misrepresentations go by another name: Fraud. After the festival, William “Billy” McFarland, the founder and CEO of Fyre Festival, found himself under the microscope of the SEC and U.S. Attorney’s Office facing allegations of civil and criminal fraud, respectively. Civil fraud claims can be filed by individuals or by government entities like the SEC, which regulates financial markets to protect investors from securities violations. Only the government can file criminal charges.

The SEC filed a civil complaint against McFarland for making false statements and material misrepresentations to fraudulently induce investments. The complaint alleged violations of the Exchange Act under § 10b (15 U.S.C. § 78j) and Rule 10b-5 (17 C.F.R. §240.10b-5) and of the Securities Act under § 17(a) (15 U.S.C. § 77q). While both provisions prohibit making false or misleading statements to defraud investors, 10b-5 claims require a showing of intent to defraud, but 17(a) claims require only a showing of negligence. In this way, the complaint captured McFarland’s conduct under the umbrella of fraud regardless of whether he purposely mislead investors at the time he solicited their investment or negligently allowed them to believe the concert would be successful, despite his catastrophic lack of planning.  In civil cases brought by the SEC, courts may grant injunctions and may impose civil penalties. McFarland and the SEC settled their claims with both an injunction and a fine. McFarland will be permanently banned from serving as an officer or director of a company and has agreed to a disgorgement of the $27.4 million his scheme raised from investors.

In contrast, the consequences of criminal proceedings can include imprisonment, restitution, and criminal fines. In the criminal case filed by the U.S. Attorney’s Office in the Southern District of New York, McFarland pled guilty to three counts of wire fraud, one count of bank fraud, and one count of making false statements to a federal agent. For these offenses, McFarland was sentenced to six years in prison and ordered to forfeit $26 million dollars.

Though the remedies for each case are distinct, the relief each may provide for victims is related, as the imprisonment will prevent McFarland from engaging in further deceptive practices, at least while in prison, the SEC settlement will bar him from similar activities after prison, and criminal forfeiture will be used to pay the disgorgement in the SEC settlement, which, in turn, may flow through as a payment for the victim-investors.

By Franco Piccinini

Non-traded REITs offer unique investment opportunities for highly sophisticated, well capitalized investors, but they can present significant risks for average investors. In order to mitigate losses, investors should understand those risks before investing in a non-traded REIT.

What is a REIT?

So, you want to invest in real estate, but you lack the capital and expertise required to purchase and manage a rental property of your own: what can you do? You might consider investing in a REIT. A REIT—or real estate investment trust—can provide an accessible vehicle for everyday investors to place their capital in real estate. In short, a REIT is a company that owns, and often manages, real estate assets on behalf of a group of investors. REITs fund the purchase of real estate by pooling investor capital into one fund and then using that capital to target certain classes of real estate.

Often, REITs focus on specific asset classes. There are residential REITs, office REITs, industrial REITs, and hospitality REITs, to name a few. REITs offer attractive investment opportunities because they allow ordinary people to invest in real estate without having to wade into the complexities of construction, financing, or managing of real estate.

Publicly Traded REITs vs. Non-Traded REITs: Distinguishing Characteristics

Yet, not all REITs are created equal. Generally, REITs fall into two distinct categories: publicly traded REITs and non-traded REITs. Notably, publicly traded REITs list their shares on a public stock exchange, allowing for a secondary trading market. This feature means that shares of publicly traded REITs are often liquid, and most investors purchase them with the hope that the value of their shares will appreciate over time. Even publicly traded REITs have risks. On the other hand, non-traded REITs do not list their shares on a public stock exchange, so they possess a very limited secondary trading market. This limited market makes shares of non-traded REITs highly illiquid, meaning that investors cannot easily sell their investment. As opposed to capital appreciation, investors often purchase non-traded REITs to earn income from dividends. But dividends from non-traded REITs are typically funded from new share purchases or debt, meaning that even the dividends initially offered may dry up over time.

Notable Risks and FINRA Warnings & Tips

In addition to the lack of liquidity and precarious source of distributions, non-traded REITs often charge high fees upfront—sometimes as much as 15% of the offering price—which significantly lowers the return of investment. Moreover, as opposed to publicly traded REITs, it is not uncommon for non-traded REITs to solicit new investments before actually purchasing any real estate. This means that investors often cannot accurately assess the risks of any given non-traded REIT, since the risk profile for any given class of real estate may vary. To make matters worse, neither FINRA nor the SEC monitor the selection of assets by non-traded REITs. Instead, those entities police the brokers who sell non-traded REITs and rely on investors to read the mandatory disclosures.

In response to these risks, FINRA has published several tips for investors considering investing in non-traded REITs: (1) understand the source of funding for the REIT’s distributions, (2) understand that your shares will likely be illiquid, (3) expect high fees, and (4) read the prospectus to understand the REIT’s borrowing policy and to determine whether the REIT has yet to purchase any real estate.

In short, investors should exercise caution and conduct significant due diligence before investing in non-traded REITs.