RIA Compliance Blog
On June 25, 2018, Wells Fargo Advisors, LLC agreed to an Order settling charges brought by the Securities and Exchange Commission relating to Wells Fargo’s use of Market-Linked Investments (“MLIs”). According to the Order Instituting Administrative and Cease-and-Desist Proceedings, beginning in January 2009 and ending in about June 2013, Wells Fargo and its predecessor “improperly solicited customers to redeem their market-linked investments (“MLI”) early and purchase new MLIs without adequate analysis or consideration of the substantial costs associated with such transactions.”
An MLI is a fixed maturity investment whose interest is linked to another asset or market measurement, which could be an equity index, a commodity index, or some other security or combination of securities. MLIs are primarily illiquid, and they often have large upfront fees. Because of these characteristics, Wells Fargo adopted a policy in 2011 which forbids its representatives from participating in “short-term trading” of MLIs.
Wells Fargo’s registered representatives offered MLIs primarily to brokerage customers who were seeking some market exposure while ensuring that at least some of their principal was protected. The SEC’s Order claims that while the MLIs in question did provide some principal protection, they also had certain risks, such as the possibility of no return or significant fluctuation over the life of the product. Moreover, the MLIs’ principal protection component had some limitations and the carried significant liquidity risks. Accordingly, Wells Fargo stated in its product disclosures that MLIs should not be traded on a short-term basis and that MLIs were best suited to customers who intended to hold them until maturity.
Nevertheless, a number of Wells Fargo registered representatives advised their customers to purchase MLIs, then subsequently redeem those MLIs before they reached maturity and buy new MLIs with the redemption proceeds. When this happened, the customers would typically incur significant costs that would decrease their MLI returns. Wells Fargo and its representatives, meanwhile, often profited from this practice.
Moreover, two Wells Fargo representatives “engaged in a systematic practice of soliciting customers to engage in MLI exchanges on hundreds of occasions.” The Order recites that while Wells Fargo did make efforts to adopt policies regarding MLI liquidations, it did not implement or enforce those policies. For example, Wells Fargo personnel did not question whether any new MLIs could generate returns sufficient to overcome the cost incurred by the client in exchanging MLIs. They also did not acknowledge the fact that MLI exchanges often resulted in customers obtaining new MLIs worth less than the originals, which often had a negative impact on the customers’ portfolios. As a result, the SEC determined that Wells Fargo violated the Securities Act.
The SEC’s Order compels Wells Fargo to refrain from causing any further violations of the Securities Act. It also compels Wells Fargo to pay disgorgement of $930,377, prejudgment interest of $178,064.27, and a civil money penalty of $4,000,000.
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