Last week, J.W. Cole Financial, Inc. (“J.W. Cole”) was fined $50,000 by the Financial Industry Regulatory Authority (“FINRA”) for failure to supervise representatives in the sale and recommendation of the LJM Preservation & Growth Fund (“LJM”). FINRA also ordered J.W. Cole to pay $163,527 in restitution to investors.
J.W. Cole’s Letter of Acceptance, Waiver, and Consent (the “Letter”) states that, between May 2017 and December 2017, J.W. Cole “failed to reasonably supervise representatives’ recommendations of an alternative mutual fund” called LJM. The Letter also states that J.W. Cole permitted the sale of LJM without conducting reasonable due diligence and without understanding its risks. Specifically, LJM involved the purchase of uncovered options.
In total, J.W. Cole representatives sold approximately $1 million in LJM to customers. In February 2018, LJM dropped about 80%, leading LJM to liquidate and close. As a result, LJM customers suffered thousands of dollars in damages.
What is an Uncovered Option and Why is It Risky?
An uncovered option is an option that is sold or written where the seller does not own the underlying security. A strategy using uncovered options is inherently risky because there is significant downside potential and limited upside potential. Therefore, uncovered options are only suitable for investors who are experienced and knowledgeable and can afford significant losses.
Uncovered options are used to “short,” or bet against, the market, as seen in the 2015 film “The Big Short.”
What is an Alternative Mutual Fund?
FINRA describes alternative mutual funds as a way for ordinary customers to invest in “sophisticated, actively-managed hedge fund-like strategies.” Alternative mutual funds claim to “reduce volatility, increase diversification, and produce non-correlated returns and higher yields compared to traditional long-only equity and fixed income funds, all while offering daily liquidity.” In other words, alternative mutual funds are sold as a way to guard against drastic market changes while offering potential for high returns.
Alternative mutual funds have raised concerns for FINRA in recent years. In fact, in a 2015 Regulatory Examination and Priorities Letter, FINRA stated that it was concerned about representatives and customers failing to “understand how the funds will respond to various market conditions.” In the same letter, FINRA also indicated that “some firms are not reviewing alt funds through their new-product review process.”
If you have concerns about your investment in LJM, another alternative mutual fund, or an investment-related claim contact Regina Gilmour at Mika Meyers PLC.