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On August 14, 2018, the Enforcement Section of the Massachusetts Securities Division (the “Division”) filed a Complaint against StockCross Financial Services, Inc. (“StockCross”) (CRD# 6670), as well as one of its registered representatives, Mr. Peter E. Cunningham (“Cunningham”) (CRD# 2400211).  Through its administrative action, the Division has alleged that Cunningham engaged in “[i]mproper buys and sells of an investment known as a unit investment trust (“UIT”) throughout Cunningham’s Massachusetts client accounts.”  The Division also alleges that StockCross failed to properly supervise Cunningham, and even promoted him, despite its awareness of Mr. Cunningham’s previous checkered regulatory history — including six customer complaints resulting in approx. $330,000 in settlement payments to investors.

Piggybank in a Cage
A UIT is a type of security that shares some similarities to mutual funds and closed-end funds (CEFs), insofar as a UIT consists of a basket of different investments.  Historically, most UITs were structured as vehicles in which to purchase a basket of municipal bonds.  Over time, UITs have evolved to the point where today, retail investors might invest in a variety of UITs offering exposure to various asset classes and economic sectors.  However, unlike traditional mutual funds or CEFs, UITs are structured with a finite lifespan, and thus cease upon a given predetermined date.  Additionally, UITs generally charge investors high fees, as high as 3-5% of the initial investment.  Unfortunately, as a result of their fee structure, some brokers and investment advisers will encourage their clients to actively trade in and out of UITs, a practice commonly referred to as “switching” and akin to churning an investment portfolio, in an effort to generate excessive commissions for the benefit of the broker, and to the detriment of the uninformed investor.  Switching transactions that appear to be fee-motivated may give rise to investor claims against advisors.

As alleged by the Division, since as early as 2012, “[C]unningham has engaged in short-term UIT trading in the accounts of his Massachusetts clients.  Of [his] approximate 180 clients, nearly 60, or approximately 30%, are Massachusetts residents.  Statements from [his] Massachusetts client accounts reflect sales of UITs as soon as 26 days after purchase and sometimes years before the UIT is predetermined to reach its maturity date.  Cunningham often used proceeds of the sales to buy other UITs.”

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Money MazeOn September 25, 2017, the Financial Industry Regulatory Authority (“FINRA”) issued a fine of $3.25 million against Morgan Stanley Smith Barney LLC (“Morgan Stanley”) in connection with the brokerage firm’s alleged failure to supervise its brokers’ short-term trades of unit investment trusts.  Unit investment trusts (“UITs”) are a specific type of Investment Company, as defined by the Investment Company Act of 1940 (the ’40 Act), and subject to regulation by the SEC.  Unlike mutual funds, closed-end funds, or ETFs, UITs are unique in that they are created for a specific, limited time period (e.g., 24 months).  Furthermore, UITs consist of a static investment portfolio as part of a pre-selected pooled investment vehicle.

Typically, UITs impose a number of charges.  Some of these charges include a deferred sales charge, a creation and development fee, as well as annual operating expenses charged as an annual fee to account for portfolio administration and bookkeeping.  In aggregates, these various fees might total approximately 4% for a typical 24-month UIT.  Thus, any investor in a UIT will experience a “drag” on the performance of their UIT portfolio in the form of various fees.

Because UITs carry a substantial fee structure and are subject to termination after a given time period, there exists the potential for some financial advisors to recommend to their clients that they roll-over, or switch, from one UIT to another.  In its worst form, this sales practice amounts to a stock broker seeking enhanced income through switching clients out of one product to another on a short-term basis in order to earn commissions and fees, at the expense of the client.

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The Financial Industry Regulatory Authority (FINRA) recently fined Investors Capital Corporation $250,000 over the sale of unit investment trusts (UITs).  Investors Capital did not admit or deny the allegations leading to the fine, but also agreed to pay $841,500 in restitution to customers, bringing its total payment to over $1 million.

Abstract Businessman enters a Dollar Maze.FINRA alleged that certain Investors Capital brokers recommended that customers engage in unsuitable short-term transactions in UITs, and also alleged that the firm failed to apply sales charge discounts that should have been available to some customers. FINRA further alleged that Investors Capital Corporation lacked adequate systems and procedures to supervise the sales of UITs, leading to the violations.  Short-term trading in UITs may be uneconomical in many cases due to relatively high up-front sales charges, and UITs are typically recommended only as long-term investments.

Investors Capital’s alleged violations occurred between 2010 and 2015.

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