Martindale-Hubbell
State Bar of Georgia
PIAMBA
Atlanta Bar Association

Non-Conventional (Alternative) Investments

In the near-zero interest rate environment of recent years, retirees seeking investment income have been forced to settle for little or no return on relatively safe investments, such as certificates of deposit and treasury securities, or required to venture further out on the risk spectrum (such as investing in dividend paying stocks) to receive a modestly better return. Some brokerage firms, knowing of this predicament, have made the selling of non-conventional investments a large part of their business. Many independent broker-dealers derive a majority of their revenues from sales of these investment products.

Non-conventional or alternative investments are offered and sold as alternatives to conventional equity and fixed income investments. These alternative investments are often presented to investors as "stable value" and safe income investments that pay above-average income. Because they are illiquid - i.e., not traded on an exchange and difficult to sell - the pricing of alternative investments is based largely on models and guesswork, and the appearance of a stable value has often been illusory. The illusion of value stability occurs because there is no market value since the investments are illiquid and the true intrinsic value is not reflected on customer account statements. A typical situation could involve an unlisted real estate investment trust (non-traded REIT) that invests in office properties and is sold at a purchase price of $10.00 per share. The commercial real estate market declines, so the inherent value of the investment declines, but it is still priced at $10.00 per share on account statements sent to investors until, as a result of regulatory and other pressure, the investment is abruptly repriced at a much lower value.

Sam Brannan is a Georgia FINRA lawyer with 30 years of experience. Brannan Law, LLC has extensive experience in helping investors recover losses in non-conventional investments. If you lost money in non-conventional (alternative) investments, we can evaluate your potential claims and recommend a course of action at no charge. Call us for a free consultation at 404-907-4642.

There are many non-conventional (alternative) investments that share the hallmarks of being complex, opaque, illiquid, and high-risk. Those we have seen in recent years include the following:

Non-traded REITs

FINRA requires brokerage firms to conduct sufficient due diligence to understand the features and risks of a non-traded REIT, and to provide full and fair disclosure of all material risks to potential investors, prior to recommending the purchase of a non-traded REIT. In addition, FINRA requires that selling firms perform a reasonable-basis suitability analysis as well as a customer-specific suitability analysis in connection with any purchase recommendation, and train their registered representatives about the risks (not just the beneficial features) of these products. Unfortunately, due diligence and disclosure are sometimes inadequate because the selling broker is conflicted. Sales of these products are driven by high commissions. Risk disclosure puts a damper on sales. Consequently there are problems and issues with these products that are not disclosed to potential investors. Those problems and issues include lack of transparency in pricing and the operation of the non-traded REIT, valuation problems, such as listing them on customer statements at cost rather than a current intrinsic value, and illiquidity. In addition, distributions that are made to investors are sometimes merely a return of the investor's capital or are paid with borrowed money rather than earnings.

Non-traded REITs have been subject to a number of regulatory problems over the years. FINRA has issued investor alerts and the SEC has conducted investigations and filed disciplinary proceedings against independent broker-dealers whose revenues are or were largely derived from sales of non-traded REITs.

Sam Brannan is a FINRA arbitration lawyer experienced in helping Atlanta residents recover investment losses. Brannan Law, LLC has extensive experience in representing investors who have suffered losses in non-traded REITs in FINRA arbitrations in Georgia and nationwide. If you lost money in non-traded REITs, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Structured Products

Structured Products are complex products in which the payment of principal and income depends on the performance of an embedded derivative (e.g., an option). Because structured products are linked to a derivative that puts the investor's principal at risk, FINRA generally requires member firms to limit sales of structured products to investors that have accounts that have been approved for options trading. Just as options trading is unsuitable for most investors, so are structured products.

Structured certificates of deposit (structured CDs) are often issued by investment banks and sold to investors by independent broker dealers. A structured CD contains a derivative that may be an option or an interest rate swap. Structured CDs do not perform like traditional CDs. Unlike traditional CDs, the market value of a structured CD can decrease during the life of the investments. Nevertheless, structured CDs have been marketed as if they were traditional CDs that pay an above-average interest rate, which, without a thorough explanation of how it actually operates and the attendant risks, is highly misleading. Other common structured products include structured corporate notes and "steepener" notes that provide a high introductory teaser rate of interest after which the rate varies in accordance with the steepness of a yield curve.

In both structured CDs and structured notes, the publicly advertised high initial interest rate is recalculated after an introductory period based on complex and obscure metrics which often results in the reduction to zero or near zero of the interest rates payable for the remaining length of the investments. The maturities are measured in decades (often 30 + years) and in many cases are longer than the investors' life expectancies. These features mean that investors who purchase these investment products cannot access their funds in the interim without substantial losses, if a secondary market even exists for such investments.

Brannan Law, LLC has extensive experience in representing investors who have suffered losses in structured products in FINRA arbitrations in Georgia and nationwide. If you list money in structured products, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Promissory Notes

Brokerage firms sometimes recommend that a customer invest in a promissory note. Such investments are highly risky to say the least, and are frequently part of a fraudulent scheme (e.g., a Ponzi scheme). They are unsuitable for most if not all investors. All too often, investors' money is never invested but is quickly routed to a bank account controlled by the fraudster(s) and spent on personal expenses. FINRA has issued warnings about fraudulent schemes associated with promissory notes. In addition, promissory notes are among the Top Ten Investor Traps identified by the National Association of State Securities Administrators (i.e., state securities regulators). Under the Georgia Securities Act, a promissory note is a security subject to the anti-fraud laws.

These notes are difficult to value or sell (i.e., illiquid). The ultimate value of the note is dependent on the creditworthiness of the issuer and the quality of due diligence and disclosures done by the selling broker, which are usually non-existent. Since these are private investments, not registered with the SEC and the issuer is not required to file audited financial statements, the risk of fraud and default is very high. Promissory notes are sold to investors regardless of unsuitability because they pay high sales commissions. They should be avoided.

Brannan Law, LLC has extensive experience in representing investors who have suffered losses in promissory notes in FINRA arbitrations in Georgia and nationwide. If you were sold a promissory note investment, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Private Offerings

Private offerings are non-conventional (alternative) investments that claim exemption from registration with the SEC under Regulation D, which provides an exemption from registration that is commonly used for private offerings. These offerings may be presented as real estate partnerships, oil & gas ventures, promissory notes, leasing deals, etc. Private offerings have been identified as Top Ten Investor Traps by the National Association of State Securities Administrators (i.e., state securities regulators). All too often, they are associated with Ponzi schemes. They are sold to investors by brokerage firms regardless of unsuitability because they pay high sales commissions. These offerings have high fees that eat into any returns, have low or no transparency regarding business operations and the people behind them, and they are illiquid (hard to sell and value). Distributions may be suspended or eliminated and may be merely a return of investor capital and paid with borrowed funds instead of earnings from operations.

Brannan Law, LLC has extensive experience in representing investors who have suffered losses in private offerings in FINRA arbitrations in Georgia and nationwide. If you lost money in a private offering, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Variable Annuities

The reputation of variable annuities has suffered over the years from a number of associated problems and sales practice abuses. Variable annuities are high-cost traps that are pushed by selling brokers because of their high sales commissions. They are subject to surrender charges the practical effect of which makes them illiquid. They are very complex insurance products and that complexity benefits the insurance company at the expense of the investor. The life insurance benefit is also overly expensive. It is not that uncommon for a variable annuity to be sold in an IRA account, even though the tax deferral benefit of a variable annuity is wasted in an IRA because the IRA itself provides tax deferral. Variable annuity switching or churning is another problem. Selling brokers do this to generate new commissions. For example, a broker may persuade a customer to surrender an existing variable annuity to buy a new one with supposedly more beneficial features including an up-front bonus that will make up for the surrender charge and the new surrender period. However, the so-called up-front bonus is usually illusory since it is not triggered unless and until the new variable annuity is annuitized, which happens (if at all) after the deferral period. In fact, brokers know that most investors never annuitize a variable annuity.

Sam Brannan is a FINRA arbitration attorney experienced in helping Georgia residents recover investment losses. Brannan Law, LLC has extensive experience in representing investors who have suffered losses in variable annuities in FINRA arbitrations in Georgia and nationwide. If you lost money in a variable annuity, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.

Exchange Traded Products

Exchange traded products (a/k/a exchange traded funds or ETFs) are like mutual funds to the extent they invest in a basket of securities. Unlike mutual funds, ETFs are traded on an exchange whereas a mutual fund is only purchased and sold and valued at its net asset value on a once a day basis. One benefit of a mutual fund over an ETF is that it is considered to be a long-term investment and, therefore, less subject to in-and-out trading, whereas ETFs, being traded on an exchange, are subject to that most dangerous human flaw for investing - emotion, which leads to in-and-out trading so damaging to investment returns.

Exchange traded products are subject to a number of problems and risks. The availability of ever-narrower niche funds is problematic due to lack of diversification and illiquidity of those products. Leveraged and inverse leveraged products are far more volatile than non-leveraged products because leverage (the use of borrowed funds) amplifies returns. Leveraged and inverse leveraged exchange traded products are day-trading vehicles that are unsuitable for most if not all investors.

Embedded derivatives and compounding of returns on a daily basis renders leveraged and inverse leveraged exchange traded products unsuitable for long-term investors. Leveraged and inverse leveraged products may lose many times their value in a single day, and may lose value even if the underlying index rises. As exchange traded products have increased in popularity, so have overall market volatility and portfolio risk for many unsuspecting investors. Exchange traded products are often used by high-frequency traders, which can result in extreme price swings such as the volatility that led to the infamous flash crash of May 2011.

Sam Brannan is an experienced Georgia FINRA attorney. Brannan Law, LLC has extensive experience in representing investors who have suffered losses in exchange traded products in FINRA arbitrations in Georgia and nationwide. If you lost money in an exchange traded product, we can evaluate your potential claims and make a recommendation on how to proceed at no charge. Call us at 404-907-4642 for a free consultation.