MFDA: Suitability Infractions By Mutual Fund Advisor

Suitability Infractions By Mutual Fund Advisor

Leveraged Investments

As a result of a contested hearing, an MFDA registrant was permanently prohibited from conducting any securities-related business in MFDA jurisdiction and subject to a $750,000 fine with $20,000 in costs for recommending unsuitable leverage investments in return of capital ("ROC") and conventional mutual funds to 18 clients.

The clients took out loans to invest in mutual funds and segregated funds. The Panel considered the cost of carrying loans for segregated investments was considered relative to the client's total debt obligations. The Respondent sold insurance to some clients. Those insurance costs were also considered relevant by the Panel in determining the client's total monthly debt obligation.

With one exception, the clients did not have prior experience in borrowing to invest.

Although the client signed risk disclosure documents, the panel held and found relevant that the Respondent did not discuss the contents of the disclosure document s with them.

The Panel found that a suitability analysis involved 3 stages:

Know the product and the client. Sound judgment to determining suitability. Disclosure of negative aspects of proposed investments. The analysis of the harm to client included "quantifiable harm" (their losses) and "incalculable harm", which was defined as the need to make up the shortfall to service the loans when the distributions declined. Read the full decision here.

Another mutual fund advisor was fined $40,000, plus costs of $10,000 for recommending unsuitable leveraged strategies to 25 clients. The advisor would refer the client to a mortgage broker who would determine the clients' "available equity" based on an amount equal to at least 75% of the value of the client's home less any debt owed on the home. In many instances clients used a 2:1 or 3:1 investment loan as secured by their home. All borrowed monies were used to purchase ROC mutual funds. The advisor recommended the use of distributions to make monthly and accelerated payments on their debt. The advisor also recommended they purchase a life insurance policy from him. Once the loans were paid with the ROC funds, he advised he could continue to use them for other purposes and the insurance would repay any outstanding amounts upon death.

The advisor agreed he overstated income...

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