‘Friendly’ brokerage’s supervisory failures cost clients $2.3M, Galvin says

A brokerage known in the industry as being “friendly” to hybrid RIAs allegedly failed to review unsuitable leveraged ETF transactions that cost clients of one of its practices millions of dollars.

Purshe Kaplan Sterling Investments didn’t adequately supervise Harvest Group Wealth Management, a Waltham, Massachusetts-based hybrid RIA whose clients lost $2.3 million on unsuitable investments in the products designed to generate multiples of the daily gains of a given ETF’s index or another benchmark, according to the Feb. 17 complaint filed by Secretary of the Commonwealth William Galvin’s office. Hundreds of clients invested in leveraged ETFs for much longer periods than the products’ typical use for daily objectives, investigators say.

A different firm than PKS carried out the thousands of leveraged ETF trades allegedly at issue in the case — the latest example of the compliance risks posed by so-called private securities transactions or outside business activities. Harvest Group has six employees and $217.6 million in assets under management held outside PKS, according to its SEC Form ADV.

“PKS' failures resulted in the loss of millions of dollars for Massachusetts clients of the Harvest Group and unknown harm to clients of PKS' [dually registered agents] with other investment advisors,” according to the administrative complaint filed by the Securities Division of Galvin’s office, which states that some of the clients held the same leveraged ETF for more than a year.

Leveraged ETFs are highly complex financial instruments typically designed to achieve their stated objectives on a daily basis,” the complaint continues. “The prospectuses for the products state in clear terms to monitor investments in the leveraged ETF as frequently as daily.”

The products and the issue of rep supervision
Representatives for Albany, New York-based PKS didn’t respond to requests for comment. Harvest Group Managing Partner Laurie Ingwersen declined to comment. Representatives for the manager of the two leveraged ETFs, the Proshares Ultra QQQ and the Proshares Ultra S&P 500, declined to comment. Neither Harvest nor Proshares are accused of any wrongdoing in the case, which doesn’t identify the particular rep or reps who sold and executed the trades.

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“Because they reset each day, leveraged and inverse ETFs typically are inappropriate as an intermediate or long-term investment,” FINRA said in a frequently asked questions post after its 2009 risk alert on the products. “They may be appropriate, however, if recommended as part of a sophisticated trading or hedging strategy that will be closely monitored by a financial professional. At times, these strategies might justify a decision to hold a leveraged or inverse ETF longer than one day. However, a registered representative must carefully address the question of how to engage in these strategies in a manner consistent with the suitability rule.”

Brokerage firms may be accused of failing to supervise the registered representatives who sold certain investments even if the transactions occurred through external companies. Since PKS operates as a smaller firm working with hybrid practices that have their own RIAs, the firm faces a challenge in supervising its 70 reps using outside advisory firms. A few years earlier, it paid more than $13.5 million in fines, restitution and settlements with the Saginaw Chippewa Indian Tribe of Michigan in a case involving a rep’s huge sales of nontraded REITs and business development corporations.

Even matters as small as a couple of text messages back and forth between advisors and clients pose potential supervisory risks to brokerage firms, according to Gary Godshaw, the chief revenue officer of financial technology and infrastructure firm Symphony.

“By definition, financial advisors are generally tethered to the consumer world — advisors cover and serve people, not firms. Those end user clients are not bound by the same regulatory surveillance framework,” Godshaw said in an emailed statement. “From an institutional perspective, firms need a comprehensive approach and framework to make sure all their interactions are compliant with the regulations of the countries they’re conducting business in.”

Hundreds of client accounts
In the case of PKS, the company approved a 2016 request by at least three Harvest Group reps to operate outside business activities through the RIA, according to investigators. Between August 2017 and April 2020, the advisors carried out at least 2,814 transactions involving the two leveraged ETFs in more than 340 client accounts, the complaint states. One single rep “participated in” all of the “transactions for compensation” in which client accounts held the products for longer than a day, according to investigators.

Not surprisingly, 91% of the accounts that held either of the products for more than a day experienced losses, the complaint states. A significant number held on to them for over a week, a month or even a year, according to investigators. Harvest Group’s advisors failed to disclose the risks involved with leveraged ETFs to three clients later interviewed by investigators in Galvin’s office or even to monitor the investments frequently, let alone daily, as the funds’ prospectuses “clearly and plainly advise” to do, the complaint states.

“PKS did not review or flag any of these transactions,” according to the document. “As a result of failing to review private securities transactions, PKS did not meaningfully understand the suitability of the use of leveraged ETFs by the Harvest Group [dually registered agents] in Massachusetts client accounts.”

The firm had failed in its duty to review private securities transactions at Harvest Group for years before it “finally amended its policies” in 2019, according to a statement from Galvin’s office. Despite its stated change to its guidelines, PKS didn’t conduct any risk-based reviews that year and only one in 2020, investigators say. The regulator’s office is seeking full restitution of client losses, a censure and an administrative fine.

Five years ago, FINRA ordered PKS to pay $3.4 million in restitution and a fine of $750,000 over its failure to supervise a rep who allegedly sold a Native American tribe $190 million in nontraded REITs and BDCs while receiving $9 million in commissions. The tribe, the Saginaw Chippewa Indian Tribe of Michigan, later received millions of dollars in additional damages and settlements from PKS through arbitration. Wentworth Management Services, a brokerage operating firm focusing on wealth management, acquired PKS in November 2017.