The SEC brought a cease-and-desist order against LifeMark Securities Corp, settling the matter with the company without requiring admissions or denials, based on LifeMark’s alleged violation of the SEC’s Regulation Best Interest (RegBI) rules. The company is headquartered in Rochester, NY, as a dually registered broker-dealer and investment adviser and employs about 200 registered representatives throughout the US.

This RegBI case – its fact pattern and the painstaking way the agency breaks down how the care obligations in the rule were flouted – could be used as training material (along with some GRIP pieces) for any business subject to RegBI’s prescriptions.

The RegBI care obligation

The SEC said that between July 2020 and January 2022, LifeMark and one of Respondent’s registered representatives failed to comply with Regulation Best Interest’s Care Obligation, Exchange Act Rule 15l-1(a)(2)(ii), when the registered representative recommended a certain corporate bond known as an L Bond to retail customers without exercising reasonable diligence, care, and skill to understand the potential risks, rewards and costs associated with their recommendations (the “reasonable basis” prong of the Care Obligation).

The SEC said the firm, acting through its registered representative, also failed to comply with Regulation Best Interest’s Care Obligation when they recommended L Bonds to a retail customer without exercising reasonable diligence, care, and skill to have a reasonable basis to believe the recommendation was in that particular customer’s best interest (the “customer specific” prong of the Care Obligation).

The L Bonds – risk writ large

GWG Holdings, Inc, was a publicly traded financial services company that issued the L Bonds at issue in this case.

In its June 2020 Prospectus, GWG disclosed several risks associated with L Bonds, including that:

• investing in L Bonds involves a “high degree of risk, including the risk of losing [one’s] entire investment;”
• “[i]nvesting in L Bonds may be considered speculative;”
• “L Bonds are only suitable for persons with substantial financial resources and with no need for liquidity in this investment.”

GWG had a history of net losses and had never generated sufficient operating and investing cash flows to fund its operations. As such, GWG depended on financing – primarily debt financing, such as L Bonds – to fund its operations. Since 2012, GWG had raised funds for its operations by selling corporate bonds – initially called Renewable Secured Debentures, but since 2015 known as L Bonds – to retail customers through a nationwide network of broker-dealers.

The retail customer’s risk tolerance and his investment objective were generally inconsistent with L Bonds, a high-risk, potentially speculative investment whose risks included “losing your entire investment.”

GWG’s L Bonds were not rated by any bond rating agency and the June 2020 Prospectus made clear there was no secondary market for the bonds.

GWG’s November 2021 Prospectus Supplement and 2020 Form 10-K contained important information and disclosures about GWG and L Bonds, including (but not limited to):

• there was “substantial doubt” about GWG’s ability to continue as a going concern for the next 12 months following the filing of the 2020 Form 10-K;
• there was material weakness in GWG’s internal control over financial reporting for all periods from December 31, 2019 to December 31, 2020; and
• GWG’s ability to service and repay debt obligations would be compromised if it was forced to suspend L Bond sales again – which happened in January 2022.

The ‘reasonable basis’ prong

Regulation Best Interest’s Care Obligation requires, among other things, that in making a recommendation of any securities transaction or investment strategy involving securities to a retail customer, brokers, dealers and associated persons of a broker or dealer exercise reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with the recommendation (Exchange Act Rule 15l-1(a)(2)(ii)(A).)

The SEC points out in this case that LifeMark recommended the aforementioned L Bonds to retail customers between July 2020 and January 2022 without exercising reasonable diligence, care, and skill to understand the potential risks, rewards and costs associated with the recommendations.

Before recommending L Bonds to retail customers, the registered representative did little more than review the June 2020 Prospectus; he participated in no trainings, webinars, or anything else to understand the potential risks, rewards, and costs associated with a recommendation of L Bonds, the SEC said.

Prior to recommending L Bonds to retail customers after L Bond sales resumed in December 2021, the registered representative did not review anything, speak to anyone, or take any training to educate himself on the potential risks, rewards, and costs associated with L Bonds, the order notes. “He unreasonably disregarded, dismissed, misunderstood, or failed to take reasonable steps to understand significant disclosures and information regarding GWG and L Bonds contained in the June 2020 Prospectus, November 2021 Prospectus Supplement, and 2020 Form 10-K,” the SEC alleged.

The customer-specific prong

Regulation Best Interest’s Care Obligation also requires that, in making a recommendation of any securities transaction or investment strategy involving securities to a customer, brokers, dealers and associated persons of a broker or dealer exercise reasonable diligence, care, and skill to have a reasonable basis to believe the recommendation is in the best interest of a particular retail customer based on that retail customer’s investment profile and the potential risks, rewards, and costs associated with the recommendation.

In December 2021, Respondent, acting through its registered representative, recommended a $50,000 L Bond with a five-year term to a retail customer:

• who was a 63-year old semi-retiree;
• who had a moderate risk tolerance;
• whose only documented investment objective was preservation of capital;
• who specifically explained to the registered representative he did not want to lose his principal; and
• who used retirement funds to make the purchase.

The registered representative did not know and could not explain how it was in the customer’s best interest to buy an illiquid five-year L Bond when, at the time he made the recommendation, there was “substantial doubt” about GWG’s ability to continue as a going concern for the next 12 months following the filing of its 2020 Form 10-K.

Never mind that the registered representative’s recommendation was inconsistent with the customer’s investment profile. (The customer’s account agreement and suitability form clearly identified his only investment objective as “Preservation of Capital [I (We) cannot tolerate loss of principal.”)

The retail customer’s risk tolerance and his investment objective were generally inconsistent with L Bonds, a high-risk, potentially speculative investment whose risks included “losing your entire investment.”

LifeMark was censured and ordered to pay $4,410.18 in disgorgement, $705.30 in prejudgment interest, and a civil money penalty of $85,000 to the SEC.

And more RegBI

Another SEC case centered on RegBI violations was released this week, with an order issued against Western International Securities, Inc, alleging the firm employed a risky day trading strategy in the accounts of several customers involving the purchase and sale of options contracts, which was not in the best interest of these customers, several of whom had moderate to conservative risk profiles.

The trading strategy also resulted in these customers paying excessively large commissions and high turnover and cost-to-equity ratios in their accounts, the SEC added in its order.