The Securities and Exchange Commission has charged broker-dealer Western International Securities and five of its brokers with Reg BI violations related to their sale of unrated high-risk ‘L bonds’ to retirees and other investors.

Reg BI, the SEC’s new standard for brokers, went into effect in June 2020. This the first Reg BI action that the SEC has brought, not counting those pertaining to the new Form CRS requirement. 

Created by GWG Holdings, L bonds were privately issued high-yield products designed to fund the purchases of life insurance policies on the secondary market. One reason they are considered risky investments is that there is no real market for L bonds, so customers may not be able to sell them before maturity.

The SEC found that five brokers with Western International, a dually registered broker-dealer and RIA based in Pasadena, Calif., recommended and sold $13.3m in L bonds issued by GWG Holdings between July 2020 and April 2021 — and received chunky commissions for doing so. The brokers are Nancy Cole, Patrick Egan, Andy Gitipityapon, Steven Graham and Thomas Swan. 

The bonds advertised fixed interest rates of between 5.5% and 8.5%. At the time the bonds were sold, however, GWG was not making enough money to repay its L bond debt. ‘The fair value of GWG’s life insurance portfolio, less the amounts owed on the senior credit facility, is insufficient to repay GWG’s outstanding L Bond debt,’ states the SEC complaint.

In January, GWG missed a $10.4m interest payment and a $3.3m principal payment on the L bonds and notified the SEC it had suspended further sales of the product.

Then in April, the firm filed for Chapter 11 bankruptcy.

The SEC alleges that Western International and the five defendant brokers ‘failed to exercise reasonable diligence, care, and skill to understand the risks, rewards, and costs associated with L Bonds,’ and repeatedly recommended the products to clients ‘without a reasonable basis to believe L Bonds were in those customers’ best interests.’

‘Western did not set any criteria or thresholds for its customers to invest in L Bonds. Western also did not restrict the sale of L Bonds to customers with certain risk profiles or investment objectives,’ the complaint continues, noting that some customers were encouraged to invest more than 10% of their net worth in L bonds.

‘Reg BI is clear: broker-dealers must act in the best interest of their customers,’ said SEC enforcement division director Gurbir Grewal. ‘When they fail to do so, as we allege happened here, they put retail investors at risk and we’ll hold them accountable.’

By earning commissions of between 3.25% to 5% on L bond sales, Western received approximately $187,000 in compensation during the relevant period.

The SEC is seeking to bring disgorgement and prejudgment interest plus civil penalties against the defendants.

You can read the SEC’s full complaint here.