Alternative investment sellers: If you can’t answer these questions, step to the sidelines
You may be liable for what you don’t know. The questions to ask before offering alternative investments to your clients.
Alternative investments rise and fall on what’s trending. So too do schemes involve alternative investments. These schemes ride a wave of popularity, catching the attention of sellers when hype is highest and making a dollar based on false advertising.
This pattern has been repeated many, many times. When oil and gas prices were rising, joint venture interests in oil and gas operations were popular. When everyone needed a payphone, sale lease-back transactions were in demand. When investors heard they could buy the balance of life insurance policies from the sick and dying, viatical settlements were a sought-out investment. These deals all had a commonsense appeal to them that attracted investors as well as those that sold them.
What all these investment schemes had in common was their structure, which made the investments securities. However, they were not promoted as securities. Often promoters did not fully disclose that the structure of the investment carried exceptionally high risk. Some promoters even offered “legal opinions” drafted by lawyers that concluded the investment was not a security. When each of these investments crashed, the insurance producers and investment advisers who sold the instruments were liable.
Schemes keep coming
Promoters keep promoting that which they shouldn’t, leaving sellers exposed by what they don’t know. Insurance producers and financial advisers frequently find themselves selling an investment without having any idea that doing so may be illegal.
Yet, the law is clear on who is at fault. Unwitting sellers who effect sales of unlawful investments are subject to strict liability without regard to whether the seller knew, or even could have known, it was illegal.
Independent insurance producers and small investment advisory firms selling fixed annuities are particularly at risk of promoter schemes. Rarely do these sellers—the producers and advisers–have access to a compliance department to ask whether a particular investment might be a security that requires securities licensure.
What these agents and advisers do have, though, is ready access to a client base hungry for alternative investments and a recommendation from an adviser they trust. This client relationship can carry fiduciary duties, which makes investment advisers particularly vulnerable when schemes implode. Investment advisers who recommend an investment that turns out to be illegal are clearly not operating in their client’s best interest, compounding liability.
How could advisers have known?
Thousands of advisers over the last 20 years have had their lives crushed by the consequences of selling an investment that later was determined by regulators and courts to be a security. Regulators are reticent to warn sellers before their investigations are complete. Their view is doing so could potentially improperly harm what might be a legitimate business. By the time enforcement action in a case is announced, it may be too late for sellers to avoid liability.
The latest shiny object, initial public offerings in cryptocurrency, may be fertile ground for investment fraud. Currency is generally not considered a security. But regulators suggest that the mining element and the way cryptocurrency coin offerings are packaged make these investments a security. Regulators have yet to clarify the status of these investments.
Before offering your clients cryptocurrency or other alternative investments, make sure you can answer the following three questions completely:
• What’s the structure of the deal?
• Who’s offering the deal?
• What is the deal?
If you can’t fully answer these questions, step to the sidelines. The risk of liability is too high to get involved in alternative investments that may later prove to be non-security security sales.
Paul Vorndran, Esq., has represented the Colorado Securities and Insurance Commissioners and brought enforcement actions against both promoters and non-securities licensed, independent insurance agents. Now he works the other side, advising and defending licensed insurance agents and investors. He can be reached at firstname.lastname@example.org or 303.573.1600.Take me to The Agent Advocate
This communication is provided for your information only and is not intended to constitute legal advice or legal opinion as to any situation. You should not take, or refrain from taking, any action based on information in this article, without seeking legal counsel from an attorney on your particular facts and circumstances. Jones & Keller would be happy to provide you with specific advice about specific situations, if desired. Do not hesitate to contact us.