The Financial Industry Regulatory Authority (FINRA), a securities regulator, announced that it has censured and fined Cambridge Investment Research (“Cambridge”) $400,000 and Securities America $100,000 for failing to supervise their representatives’ recommendations of an alternative mutual fund that resulted in hundreds of thousands in losses for customers. The FINRA Letters of Acceptance, Waiver & Consent (AWCs) announcing the sanctions are accessible here. Cambridge AWC SAI AWC. Cambridge also was ordered to pay a restitution of $3.13 million plus interest; and Securities America was ordered to pay a restitution of $235,979 plus interest.
According to the AWCs, Cambridge and Securities America permitted the sale of the LJM Preservation & Growth Fund (LJM) without conducting reasonable due diligence and without a sufficient understanding of LJM’s risks and features, including the fact that the fund pursued a risky strategy that relied, in part, on purchasing uncovered options.
In early February 2018, the value of LJM’s shares dropped more than 80% over the course of just two days during a spike in the volatility index (VIX), losing more than $600 million for investors. The LJM Fund was launched in January 2013 and sold in three different share classes (ticker symbols LJMAX, LJMCX, LJMIX). According to its last annual report, LJM had net assets of $768 million as of October 31, 2017.
In lay terms, the LJM fund’s “short volatility” investment strategy used to generate returns for investors was the equivalent of picking up nickels and dimes in front of a steamroller. This analogy is appropriate because, in order to execute on its “short volatility” investment strategy, the Fund implemented an options trading scheme called a “short strangle” – which is an options trading strategy that exposed investors to potentially substantial losses, with little upside growth potential. In addition to the high risk/low return proposition that the fund offered, it was a very expensive fund for customers given the high expense ratio the “I” shares carried (2.43%).
According to FINRA, Securities America and Cambridge lacked a reasonable supervisory system to review representatives’ LJM recommendations, and as a result, violated NASD Rule 3010 and FINRA Rules 3110, which set forth FINRA members’ supervisory obligations. They were also in violation of FINRA Rule 2010, which requires that each member firm “in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”
According to FINRA, Cambridge sold more than $18 million in shares of LJM between March 2016 and February 2018, to more than 550 customers, including customers with conservative and moderately conservative risk tolerances. According to FINRA, Securities America representatives sold more than $616,000 in LJM shares to 33 customers between August 2016 and February 2018.
In the AWCs, FINRA noted that it had previously issued regulatory notices highlighting the risks of “complex products,” such as alternative mutual funds, and stressing the need for firms and their representatives to understand their unique risks and features before recommending them, particularly to retail customers. Morningstar in July 2017 also reportedly issued a fund report LJM that described LJM as “an aggressive option seller with above-average returns and low correlation with equity markets, but high risk.” The report reportedly stated that “the strategy is structured to generate high income but is relatively aggressive and exposed to a steep rise in equity volatility. Even though these volatility spikes and periods of heightened uncertainty are infrequent, they could have significant, negative impact on this fund’s future performance.”
Investors who wish to discuss a possible claim concerning LJM or another high-risk investment may contact a securities arbitration lawyer at Law Office of Christopher J. Gray, P.C. at (866) 966-9598 or via email at email@example.com for a no-cost, confidential consultation. Attorneys at the firm are admitted in New York, New Jersey, Wisconsin and various federal courts around the country, and handle cases nationwide (in cooperation with attorneys located in those states if required by applicable rules).
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