The Financial Industry Regulatory Authority has censured and fined Cambridge Investment Research $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.
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 a Finra letter of acceptance, waiver and consent, both 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 its risks and features, including the fact that the fund pursued a risky strategy that relied, in part, on purchasing uncovered options.
The firms also 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,” Finra said.
Finra said Cambridge first sold LJM in March 2016, but most sales occurred during or after May 2016, at which time a wholesaler associated with LJM contacted certain Cambridge financial professionals. It said the last purchase of LJM by a Cambridge customer occurred on February 5. 2018. More than $18 million in shares of LJM were sold by representatives between March 2016 and February 2018, to more than 550 customers, including customers with conservative and moderately conservative risk tolerances. Finra said one representative was responsible for more than 80% of that total.
Securities America representatives sold more than $616,000 in LJM to 33 between August 2016 and February 2018, Finra said.
Finra noted that on Feb. 5, 2018, the S&P 500 fell 113 points (around 4.1%), which contributed to an unprecedented increase in market volatility as measured by the CBOE Volatility Index. The fund, on Feb. 5 and Feb. 6, 2018, lost about 80% of its value, and on February 7, it announced that it was closing itself to new investors. On March 29, 2018, LJM was liquidated and dissolved. Investors who held shares as of February 6, 2018 lost approximately 80% of their investment, Finra said.
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 warned against the LJM, issuing 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 further 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.”
Both firms also consented to a certification signed by an officer and registered principal of the firm that, as of the date of the certification, Cambridge has established and implemented policies, procedures, and internal controls reasonably designed to address and remediate the issues identified in this AWC.