The firm may be reputable, but is the broker?

Posted on June 11, 2012

Mario Massillamany

Mario Massillamany-Securities and Class Action Attorney

Most people believe they should be safe from investment fraud

if they are working with a well-known brokerage firm. Unfortunately, we cannot say this is entirely true. Every year, hundreds — possibly thousands — of investors lose tens – perhaps hundreds – of millions of dollars in Ponzi schemes sold by brokers for the same well-known firms whose commercials play during golf tournaments and NFL games. There is really only one difference between the firms you’ve heard of and the ones you haven’t: the marketing budget.

Take this example: The FBI has investigated two former Edward Jones brokers out of South Dakota in regards to a “selling-away” case that involved raising money from clients who invested in an alleged Ponzi scheme. “Selling away” is when a broker solicits your purchase of securities not held or offered by the brokerage firm. As a general rule, such activities are a violation of securities regulations.

According to Edward Jones, a client brought the matter of Gibraltar Partners Inc. to the firm’s attention in March 2011. As a result of its investigation, during which the company learned that the Justice Department was in the middle of a criminal investigation of Gibraltar Partners, Edward Jones fired the brokers. An Edward Jones spokesman said: “A small number of Edward Jones clients have invested money in this scheme, away from the firm. The firm is currently negotiating settlements with these clients.”

“Selling away” is one of the most common difficulties independent and franchisee broker-dealers face in their oversight of their representatives. Such reps typically operate in one- or two-man offices with no branch manager supervision on a day-to-day basis. Cases typically involve a broker selling a financial product that the broker-dealer did not approve or know of, with the investment vehicle blowing up and wrecking the client’s portfolio.

Edward Jones is one of the largest brokerage firms in the country. It has more than 12,000 brokers, most of them operating from one- or two-man offices. In his statement, the Edward Jones spokesman also noted that “other investors who are not clients of Edward Jones also invested in Gibraltar.” He said the firm has cooperated with federal and state authorities.

A few things to note: Although Edward Jones did not sanction the investments in the Ponzi scheme, it is still responsible to the investors who bought the Ponzi investment from Edward Jones representatives.  It’s unlikely the investors could have known their investment was not approved by Edward Jones. In fact, the victims were most likely influenced to buy this investment by the Edward Jones name on the door and the broker’s position with the company. It can also be reasonably assumed that Edward Jones could have prevented these losses if it had had a supervisor on-site as all traditional brokerage firms do.

Traditional brokerage firms have a branch office manager watching over their brokers. Some such managers watch closely. Some of them are slack. But they are at least there and able to monitor the brokers’ activity and, accordingly, in a good position to spot a broker who is selling something not approved by the firm. Edward Jones is an independent broker-dealer, which caters to brokers who want to run their own show. Their brokers frequently operate out of one- or two-man offices, and their supervisor can be 100 miles or more away, making it difficult for the supervisor to keep his or her finger on the pulse of what the broker is selling.

Also note the spokesman said that Edward Jones is “negotiating” settlements with victims of this Ponzi scheme — meaning it is trying to pay as little as possible. Even though an Edward Jones representative sold this Ponzi scheme, that does not mean Edward Jones will pay the investors everything they lost. Rather, Edward Jones wants to pay as little as possible. They are not interested in making the investor whole. They are interested in minimizing their settlement cost. So even when such fraudsters are caught, it can be very difficult to recover all that you’ve lost.

So, sorry to say, but even a well-known name on the door can’t guarantee your investments are in good hands. The investing public has no idea of what can go on behind the closed doors of investments offices.

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