On March 20, 2019, the Massachusetts Securities Division, Enforcement Section (the “Division”) filed a complaint against an investment adviser located in Massachusetts. The complaint alleged that the firm’s two owners and financial professionals “gambled away millions of dollars in client assets through high risk bets on the oil and gas market.”[1] This author vehemently disagrees with the Division’s complaint and the message it sends to the industry.

Among the injured, the complaint referenced “a widow, a charitable organization, and many senior citizens saving for retirement.” The complaint stated that the firm’s clients had different investment needs, risk tolerances, and financial situations, yet the firm invested nearly all of its clients “primarily in energy-related investments”[2]. The complaint also alleges that the firm placed the “majority”[3] of clients’ assets in energy-related investments. According to the complaint, the investments selected by the firm were “publicly-traded securities that focused on the exploration and development of natural resources, such as oil and natural gas.”

This complaint by the Division is an overreach and an incorrect application of the law, and is an injustice to the entire investment industry. The complaint can only lead to confusion in the industry about which calculated risks it can take in managing its clients’ assets. The complaint was without merit, proof of a prosecutorial mindset of the Division, and a matter of bad policy. In fact, the complaint reminded me of a statement of claim from a FINRA arbitration—not of an enforcement action brought by a state regulator for fraudulent activity by an investment adviser.

If the Division wanted to prove a point to this investment adviser that its Form ADV disclosures to clients were inaccurate, then it was well within its rights. It also was well within its rights to punish this investment adviser for not perfectly following its compliance manual. However, to allege that its investment philosophy was unsuitable is not the appropriate function of the Division.

According to its website, the Division is charged with enforcing the Massachusetts Securities Act “which was enacted to protect investors by prohibiting unlicensed and/or fraudulent activity.” While the complaint makes numerous allegations of fraudulent behavior, the Division has simply interposed its investment knowledge and judgment over that of a financial professional. It has determined that this particular investment adviser’s strategy was objectively and subjectively inappropriate. However, the Division only looked at a sampling of clients, with concentration in the energy sector, that experienced investment losses and concluded that these professionals provided unsuitable investment advice. The facts outlined in the complaint could apply to almost any investment adviser who had a bad day, week or month.

Nowhere in the complaint did they mention that the Division retained expert witnesses knowledgeable in finance or economics to confirm that this strategy was unsuitable. Instead, the Division relied on the benefit of hindsight and market performance to form the basis of their complaint. This complaint could have been written about almost any investment adviser during any bear market. Instead, this particular investment adviser was allocated to the wrong sector at the wrong time. For this reason, the complaint is entirely unjustified.

The Division should immediately rescind its complaint and allow these investors to pursue the normal avenues for recovering investment losses from their investment adviser instead of ruining the careers and reputations of two individuals.

 

 


[1] To an extent, all investing is gambling with calculated risks.

[2] The complaint stated that “roughly 30% of each client’s total portfolio was made of energy-related investments,” which can hardly be considered “primarily”. It could be said to be weighted towards energy-related investments, or even having a focus or concentration. However, to call a 30% allocation “primarily” invested is a blatant lie.

[3] However, in a footnote, the complaint acknowledges that it has used a calculation methodology that might have unfavorably skewed its figures. It appears to have used the initial investment amount as the numerator and the ending account balance as the denominator.

View Original Source
Photo of Max L. Schatzow Max L. Schatzow

Max Schatzow is an Associate and member of Stark & Stark’s Securities Group in the Lawrenceville, New Jersey office. Mr. Schatzow concentrates his practice on counseling financial service entities including investment advisers, broker-dealers and private investment companies (e.g., hedge funds, private equity funds, real estate funds and “fund of funds”) about registration, compliance, liability, and litigation issues.