The Securities and Exchange Commission (SEC) today announced settled charges against Texas-based broker-dealer Lion Street Financial, LLC for violating Regulation Best Interest.
Without admitting or denying the SEC’s findings, Lion Street has agreed to a cease-and-desist order, a censure, disgorgement of $14,899.55, prejudgment interest of $3,683.32, and a civil money penalty of $135,000.
According to the SEC’s Order, between June 30, 2020 and April 2021, Lion Street failed to comply with Regulation Best Interest’s Care Obligation by recommending high-risk debt securities known as “L Bonds,” which were issued by GWG Holdings, Inc, to retail customers without exercising reasonable diligence, care, and skill to understand the potential risks, rewards, and costs associated with the recommendations.
As alleged in the Order, GWG’s June 2020 Prospectus disclosed risks associated with L Bonds, including that: L Bonds involved a “high degree of risk,” including the risk of losing one’s entire investment; “[i]nvesting in L Bonds may be considered speculative”; and “L Bonds are only suitable for persons with substantial financial resources and with no need for liquidity in this investment.”
The Order finds that Lion Street did not assess the risks, rewards, and costs associated with L Bonds after GWG underwent fundamental changes in its business model and finances following corporate transactions in 2018 and 2019, and therefore lacked a reasonable basis to recommend L Bonds to its customers as required by Regulation Best Interest.
The SEC’s Order also finds that Lion Street did not comply with Regulation Best Interest’s Care Obligation by recommending L Bonds to six retail customers for whom Lion Street did not have a reasonable basis to believe that the L Bonds were in the customers’ best interest. According to the Order, the totality of these retail customers’ circumstances were a mismatch for high-risk, potentially speculative, illiquid investments such as L Bonds.
As described in the Order, each of these customers was at or near retirement age, and most invested a substantial percentage of their liquid net worth in L Bonds that exceeded Lion Street’s own concentration limits for an alternative investment such as L Bonds, based on a recommendation by Lion Street and one of its registered representatives.
The SEC’s Order finds that Lion Street also did not comply with Regulation Best Interest’s Compliance Obligation, which requires brokers or dealers to establish, maintain, and enforce written policies and procedures reasonably designed to achieve compliance with Regulation Best Interest, and Regulation Best Interest’s Conflict of Interest Obligation, which requires broker-dealer firms to establish, maintain, and enforce reasonably designed written policies and procedures identifying and addressing conflicts of interest.
Lion Street did not update its written policies and procedures to incorporate and provide reasonable guidance on how to comply with Regulation Best Interest until eight to nine months after Regulation Best Interest’s compliance date, despite having a year in advance to prepare, and did not enforce certain of its policies and procedures which would have helped achieve compliance with Regulation Best Interest in connection with its recommendations of L Bonds.
As a result, Lion Street also did not establish written policies and procedures reasonably designed to identify conflicts of interest associated with recommendations and to disclose, mitigate, or eliminate such conflicts of interest.
The SEC’s Order finds that by failing to comply with Regulation Best Interest’s Care Obligation, Compliance Obligation, and Conflict of Interest Obligation, Lion Street willfully violated Regulation Best Interest’s General Obligation found in Exchange Act Rule 15l-1(a)(1).
