The Securities and Exchange Commission settled charges and levied a multi-million-dollar penalty against a New York–based brokerage firm after numerous reps allegedly made "unsuitable recommendations" of variable interest rate structured products for retail clients.
But as the SEC cracks down on so-called "complex products," Commissioner Hester Peirce worried the terms of the settlement could have a chilling effect on other firms mulling whether to use the investments appropriately.
According to the SEC complaint, Alan Appelbaum made numerous recommendations of complex variable interest rate structured products (VRSPs) to seven customers between July 2017 and May 2019. Applebaum, a Boca Raton, Fla., resident, was a registered rep and managing director with Aegis Capital Corporation, eventually co-heading the firm’s Fixed Income Desk. Aegis, which was headquartered in New York, managed more than $761 million in assets for about 1,466 clients, according to its Form ADV from June 2021.
The VRSPs Appelbaum suggested were unlike conventional debt securities in that they did not pay a fixed amount of the principal when they matured, instead relying on a complex structure in which their recovery was predicated on certain derivative features tied to equity indexes. In other words, the setup meant investors could lose some or all of their investment, even if the issuer of the VRSP didn’t default, according to the commission (customers’ interest payments were also tied to these derivative features).
Nevertheless, Appelbaum recommended and purchased these VRSPs for seven customers with "moderate" risk tolerances who were not willing to lose their entire principal, according to the SEC.
“Appelbaum knew that he was required to make customer-specific suitability determinations and to recommend securities that were suitable for his customers,” the complaint asserted. “In fact, Appelbaum testified that brokers who are not aware of these requirements ‘don’t belong in the business.’”
Starting in July 2017, Aegis required reps to offer a “Structured Products Disclosure” form to customers considering product purchases like the VRSPs, in which the firm warned the products offered “no guarantee” of specific principal returns. The disclosures also linked to a 2015 SEC investor bulletin laying out the potential pitfalls of products like VRSPs for investors.
But according to the SEC, Appelbaum didn’t provide the disclosure form to any of the seven customers before beginning to purchase the VRSPs, and didn’t do so for almost two years; he also didn’t take mandatory trainings from Aegis on structured product sales. By July 2019, he’d purchased more than 140 VRSPs for the harmed customers, most of whom were trusts for retired investors in their 80s. The commission argued he’d also made misleading statements to his clients about the stability of the investments.
Appelbaum had been the subject of numerous regulatory run-ins, according to the SEC complaint; he’d been the subject of at least 14 arbitration claims and customer complaints from FINRA or the National Association of Securities Dealers, and faced regulatory inquiries from the SEC going as far back as 1982.
But Appelbaum wasn’t the only rep at Aegis pushing such products, according to the commission. In a separate order, the SEC argued that 14 Aegis brokers had recommended VRSPs to 48 customers for whom the products were not suitable. Reps in both the Melville, N.Y., and Boca Raton offices made the recommendations, and the SEC argued Aegis failed to implement written procedures for training reps and unauthorized trading. Aegis still failed to properly implement those procedures after amending them in late 2016 for New York and July 2017 in Florida, according to the SEC order.
The commission also filed a separate, specific order against Paul Gallivan, a former registered rep for Aegis, for allegedly making unsuitable VRSP recommendations to four customers and for making “materially false and misleading” statements about the products to those investors.
But Commissioner Peirce believed the Aegis order contained a “highly problematic aspect” that led her to withdraw her support. The commission noted in its settlement that Aegis had stopped reps from purchasing VRSPs for retail accounts. While Peirce understood why Aegis might adopt such a policy, Peirce worried that the order could give the impression that these products should always be unavailable to retail clients.
“Other firms might think they have to follow suit,” Peirce wrote. “And what if Aegis later determined that a subset of investors would be well-served by these products? Could it change its policy without running afoul of the Commission’s order?”
Peirce acknowledged that products like VRSPs were unsuitable for many retail investors but nevertheless stressed that the SEC should not be hinting that certain products are never appropriate.
“I am concerned that the Commission’s acknowledgement of, and reliance on, the remedial step taken here by Aegis may be read either as implying that an absolute prohibition on the sale of a specific product is the only acceptable remedial measure here or as an expectation for other firms dealing with retail clients,” Peirce wrote.
Aegis didn’t admit or deny the findings, but agreed to disgorgement and prejudgment interest of $220,865 and a civil penalty totaling $2.5 million.
Representatives from Aegis did not respond to a request for comment.
Gallivan agreed to pay disgorgement and prejudgment interest of $29,973 and a $25,000 civil penalty, as well as 12-month associational and penny stock suspensions and a one-year investment company prohibition (both the brokerage firm and Gallivan agreed to a cease and desist).
