Smith, Brown & Groover, a Macon, Ga.-based brokerage, has settled allegations that it and its president developed and sold a trading strategy that they did not understand and that caused near-total losses for 350 clients, according to the Financial Industry Regulatory Authority.
The Finra letter, filed today, said the brokerage had agreed to $2 million in partial restitution to those clients and a censure, and former firm president Raymond Hill Smith Jr.consented to a $15,000 fine, a six-month suspension from associating with any agency member, and a four-month suspension from working with any Finra member in all principal capacities (which runs consecutively).
A voicemail left with the firm’s new president, Thomas Gaither Jr., was not returned by press time.
Smith, Brown & Groover has been in business since 1957; it employs 10 registered reps and provides brokerage services to retail investors, Finra said. It also has an registered investment advisory, called SBG Wealth Management, with $240 million in assets under management and some 460 clients, 70 of whom are wealthy individuals, according to the SEC.
Smith first joined the firm in 1981 as a registered broker and became dually registered in 2003, according to BrokerCheck. He became a general securities principal in 1986, and president of the firm in 2001, Finra said.
According to the agency, from July 2014 to February 2018, the firm and Smith allegedly recommended a trading strategy that Smith had developed “without fully understanding the features and risks of the strategy or the exchange-traded note that the strategy was primarily invested in.”
In addition, the firm and Smith allegedly failed to ensure the suitability of the strategy—and make sure the risk of loss was consistent with customers’ investment profiles, the letter said.
Non-traditional exchange-traded products, like exchange-traded notes, are designed to be used over only one trading session—usually a single day, the letter said. When used correctly, they’re supposed to return a multiple of an underlying index or benchmark, the inverse of the benchmark, or both.
In June 2009, Finra reminded members and their associated persons that these are “highly complex financial instruments,” and are unsuitable for retail investors to hold for more than one trading session, the letter said.
From July 2014 to February 2018, the firm and Smith allegedly recommended this investment to 350 customers, 260 of whom were Smith’s, without understanding the risk/reward profile of the strategy, the letter said.
“Despite developing and implementing the trading strategy at the firm, Smith did not fully understand the ETN, including its basic features, such as how the issuer maintained its inverse exposure to the underlying volatility index or that the ETN was designed to achieve its stated investment objective on a daily basis,” the letter said.
Instead, customers were allegedly kept in the exchange-traded note for an average of 72 days, even through periods of high volatility, the letter said.
In February 2018, a surge in market volatility caused the exchange-traded note to drop in price and the issuer called it, the letter said.
“As a result, holders of the ETN, including the firm’s customers, suffered near total losses on their investments,” the letter said, noting that the customer accounts participating in this trading strategy had been fully invested. “The firm discontinued the strategy shortly thereafter.”
According to BrokerCheck, clients first started complaining about these losses in 2019, and there have been three dispute settlements—one in February 2019 for $132,500, one in May 2019 for $425,000, and one in October 2019 for $554,406.
According to the SBG’s Finra disclosure report, the firm has had 16 disclosures, mostly related to its alleged operation in states where it wasn’t registered. According to the report, Smith is no longer president of the firm, having been replaced by Gaither last month. Gaither has been a general securities principal at the firm since 2017, the report said.