A Closer Look at Alternative Investments: Private Equity

By Michael Williford, Spring 2016 Student Intern

I’ve talked before about alternative investments, and today I’ll turn my attention to another category, private equity. What is it? The term sounds exclusive and lucrative—because it is, and it can be, if you can tolerate the risk. The short answer is that there is no clear meaning, defined by the regulatory authorities, FINRA and the SEC. Generally, private equity investments are only available to wealthy individuals and institutional investors like pension funds, but the lessons private equity teaches are just as applicable to the average investor whose pension may be tied up in private equity investments.

The best example of how private equity works concerns a frim you almost certainly remember from the 2012 presidential campaign, Mitt Romney’s Bain Capital. In 2005, Bain Capital, along with Blackstone Group, managed a buyout of the arts and crafts chain, Michael’s. Bain and Blackstone turned a healthy profit on “scrapbookers and needlepoint artists,” but that hasn’t always been the case since the buyout. Like Bain, most private equity firms launched since 2005, have failed to beat the market.

One of the most important aspects of private equity investments to consider, like traditional investments, is the transparency with which a private equity firm discloses its fees. Many of the techniques used by Bain and Blackstone in the Michael’s deal are similar to those used by investment banks. The crucial difference, however, is that investment bankers are generally registered with FINRA as broker-dealers. “This lucrative status comes at a cost,” according to the New York Times. That cost is the regulation FINRA and the SEC impose on broker-dealers. Private Equity firms are not subject to any such restrictions. The net result is that an investor, be it a wealthy retiree or a pension fund, do not have access to the same information about the internal workings of a firm, its strategy, debt-load, or a clear picture of the kind of risk a firm’s investments entail.

The bottom-line for all alternative investments, whether it’s a Real Estate Investment Trust sold by a FINRA registered broker-dealer, or the rarified air of a Bain Capital private equity deal, is the same: Do your homework. Read the prospectus or any other offering materials associated with the investment. Those documents are supposed to disclose the extent of the risk your investment entails, and should things go sideways, they are the documents the broker will rely on to say the investor understood the full extent of the investment risk.

A Closer Look at Alternative Investments: Hedge Funds

By Michael Williford, Spring 2016 Student Intern

Let’s turn our attention to perhaps the best known of all alternative investment vehicles: the hedge fund. We’ve all heard about the celebrated and vilified hedge fund manager. But what exactly does a hedge fund do, and what are the risks associated with hedge fund investment?

In February of 2013, the SEC issued an investor bulletin that explains that hedge funds “pool investors’ money and invest the money in an effort to make a positive return. Hedge funds typically have more flexible investment strategies than, for example, mutual funds.” Sounds pretty good. The bulletin goes on to highlight some of the risks with hedge funds; among them, that “hedge funds are not subject to some of the regulations that are designed to protect investors.” It also states that “some hedge fund managers may not be required to register or to file public reports with the SEC.” The overall message is that hedge funds are not subject to the same kind of industry regulation as more traditional investments like mutual funds or even individual stocks a broker may recommend to you.

Nor do hedge diffuse risk in the way index funds do. According to the SEC bulletin, often times hedge funds employ leverage—they utilize borrowed money to increase the potential return, thereby also increasing the risk of potential loss.

Finally, hedge funds don’t have the same level of transparency as mutual funds, index funds, or even individual stocks, whose parent companies issue annual reports. Hedge funds are not required to file public reports with the SEC, depending on the amount of money invested in the funds. Although federal securities laws dictate how mutual funds can advertise their performance, there are not the same strict requirements for hedge funds. Because many of the underlying investments are often relatively illiquid, it can be difficult to gauge their value.

As a result, the SEC recommends doing your due diligence to make sure the fund’s strategy lies within your tolerance for risk, and that you understand the fund’s investments strategy—whether the fund is leveraged, what the underlying investments are, and how the fund’s performance is measured. Most importantly, educate yourself. Read the fund’s offering memorandum and related materials so you can ask the right questions before you invest.

Be on the lookout for the next post, when I’ll highlight private equity investments.

A Closer Look at “Alternative Investments”

By Michael Williford, Spring 2016 Student Intern

Along with my colleagues, I’ve written about alternative investments in the past. In a five part series that begins next week, I’m going to highlight some of the more common alternative investments, discussing their structure and focusing on the risks FINRA and the Securities and Exchange Commission have highlighted for retail investors.

It’s important to realize that brokers and the financial industry at large no longer limit their pitches of alternative investments to the well-heeled. Increasingly, we are seeing retail level investment outlets encourage average investors to consider alternative investments, with almost no mention of the specific kind of risks these investments entail, and a simple disclaimer such as, “alternative asset classes are not appropriate for everyone. Check your risk tolerance and objectives before investing in new opportunities.” So, starting next week, we’ll be taking a closer look at Alternative Investments. Be sure to check in on Monday when we discuss hedge funds.

There Is No Such Thing as a Free Lunch, or in This Case, Dinner

By: Alexandra Hughes, Spring 2016 Clinic GRA

On April 4, 2016, the SEC published a press release, SEC Charges Four in Fraudulent Free Dinner Scheme, “announc[ing] it has charged four individuals in a fraud whose victims included seniors who were solicited at ‘free dinner’ investment seminars in Florida.” The “cast of characters” in this free dinner scheme were: Joseph Andrew Paul, John D. Ellis, Jr., James S. Quay, and Donald H. Ellison.

Essentially, the SEC alleges that Paul and Ellis created fraudulent marketing materials, which included materials that were literally copy and pasted from an unrelated firm’s website. According to the SEC’s allegations, false materials in hand, Quay and Ellison sent out a mass-mailing offer enticing seniors to come to a free dinner to learn about the investments. The SEC alleges in its complaint that most of the money raised from these hoodwinked senior investors was never actually invested. Instead, the money allegedly went into the palms of Paul, Ellis, Quay, and Ellison. To make matters worse, Quay was the subject of a previous 2012 enforcement action and was using an alias “Stephen Jameson.” Neither “Stephen Jameson” nor Ellison were registered during the period the scheme took place.

This certainly isn’t the first and probably isn’t the last time fraudsters will attempt to use a “free lunch” or “free dinner” scheme to convince seniors to invest in products that don’t exist. Senior investors should refer to Investor Alert for Seniors and Seniors—Beware of Investment Seminars for more information. The SEC also advises investors to check the registration status and disciplinary history of financial professionals, before making an investment, via its website.

 FINRA has also discussed the dangers of these “free lunch” investment seminars in Investor Alert: “Free Lunch” Investment Seminars—Avoiding the Heartburn of a Hard Sell. In this Investor Alert, FINRA advises investors, especially senior investors, to be on the look out for these seminars which generally put on a convincing show but not necessarily a good investment. Persuasion techniques that fraudsters may try to use at such seminars include:

  • Phantom Riches: A tactic that entices the investor with the “riches” that can be produced by the investment.
  • Source Credibility: A tactic that uses a reputable firm or an individual’s special credential to persuade the investor to invest.
  • Social Consensus: A tactic that makes the investor believe the investment is a good idea because “other savvy investors have already invested.”
  • Reciprocity: A tactic that uses a prize or meal to guilt the investor into reciprocating with an investment.
  • Scarcity: A tactic that “creat[es] a false sense of urgency by claiming limited supply.”

Reflecting on my Semester in the Clinic

By Tosha Dunn, Spring 2016 Student Intern

Working in the Investor Advocacy Clinic was my first chance to act as an attorney. It was my first chance to have an actual impact on clients—to help them, to serve them, and to guide them. This experience has been something of a stepping stone. I didn’t know how to do everything I was asked to do on the first day, and yet, somehow, I managed to get things done. I knew before that there were references and guides and forms, but working in the clinic has demonstrated to me time and again, that those things are base guidelines. They never really speak to your exact case or your exact client or their exact needs. So as an attorney, you have to be prepared to be flexible. You need all the basic tools of an attorney: (1) writing, (2) knowing where to look, and (3) bringing a measure of skepticism when listening to even your own client’s story. But once you have the basics you’re ready to set off. You can build the documents you need because you know where to look for guidance, and you know how to write (like a lawyer, that is), and you know when to ask questions and probe a little deeper with your own client and with opposing counsel. And probably the last thing in the basic tools of a lawyer is something I learned before clinic, but nonetheless, don’t let anyone foist anything off on you—their duties are their own and yours are your own. You have to be prepared to keep it that way too, with opposing counsel, with co-workers, etc.

And while I say these are the basic tools of being an attorney and now you can “set off,” at the same time, it took having an experience like the clinic to give me the certainty that I could set off. Clinic presents all the issues of the real world, even though you are still technically in the law school (a very nice part of the law school, by the way if you’re thinking of joining), and while still being in the law school gives a measure of comfort, you’re still in the deep end. You’re still responsible for meeting client needs; you’re still responsible for knowing filing deadlines; you’re still responsible for comporting yourself with candor and professionalism. The clinic makes you feel like you’re in a protected environment, practicing law, but not quite—but really, you are practicing. You really are an attorney, and you have to be ready to run the race. Your worries and doubts have to be left at the starting line because it really is a long run over rough terrain in humid weather. There are some rest stops between here and the finish line, but really, once you start, you can’t just stop. You’re on the course, and if you stop, you’re stuck in the woods somewhere. Going on, navigating the hills, reading the trail signs, that’s the only way you get back to the finish line. And once you’ve done this little part of it, this little beginning run, you know the runner’s high, and you just want to keep going. The hills aren’t so steep, and even when you run face-first into a spider web, you just shake it off and keep going. You think clinic will be training—a chance to apply your skills in a protected environment . . . not really. You’re entering grown-up, job land. It’s no joke, and nothing to blow off. You’re actually doing the job. That’s the experience that I carry forward from the clinic. I actually am an attorney. I can do the job. I have the skills, and I’m not afraid.

Investor Advocacy Clinic Builds Lawyering Confidence

By Kelly Robinson, Spring 2016 Student Intern

What’s really incredible to me is how much I’ve learned during my time in the Investor Advocacy Clinic. I don’t know that I have ever learned so much in such a short period of time. For example, I had no experience in working with clients when I first started, to now being completely comfortable working with clients and even arguing with opposing counsel. The clinic has also taught me the importance of seemingly basic office tasks, such as maintaining files and tracking correspondence and time. While these ministerial tasks may not seem to hold much importance initially, I’ve learned that those are the things that really keep everyone both happy and on the same page (teamwork is key!).

It was also a really unique experience to be able to work with the type of clients we do in the clinic. To know that we were able to help those who would otherwise had no other access to relief was really fulfilling. I also gained valuable insight into alternative dispute resolution forums; an area that I feel students are not necessarily exposed to in the core legal curriculum. We gained experience in preparing for both mediation and arbitration and we were even able to successfully negotiate a settlement on behalf of one of our clients!

The greatest improvement that I gained from the clinic was building my own confidence. I first joined the clinic during the beginning of my 2L year. Everything about the practice of law still felt very new to me, but the clinic has greatly prepared to me think, walk, talk, and act like an attorney. In a way, I feel like a lifetime has passed between our first foray into the clinic during boot camp and where we are now. While the clinic can be a lot of work, I will certainly miss my time working with my team, the professors, and the clients of the Investor Advocacy Clinic.

My Clinic Experience: Francis Laryea

By Francis Laryea, Spring 2016 Student Intern

I returned to the Investor Advocacy Clinic this semester after a semester long break spent at the Securities and Exchange Commission. I could think of no better way than to spend my last semester at law school.  The Clinic serves as a place for students to improve all their legal skills under the supervision of Professors Iannarone and Doss. The Clinic serves investors who would otherwise be unable to find representation. Working with the clients of the Clinic has been one of the most rewarding and gratifying law school experiences that I have had.   After serving as a Clinic I, intern in the spring of 2015, I realized the Clinic was one of the most comprehensive educational experiences a law student could have. The Clinic affords students the opportunity to conduct client interviews, speak with opposing counsel, draft motions, counsel clients, and negotiate with opposing counsel and come up with a plan of action. The professors provide a lot of discretion and act as a safety harness. Students in the Clinic are encouraged to think through problems and come up with solutions for the problems.  During my time in the Clinic, not only did I learn the conceptual knowledge related to securities arbitration, I also learned about the practical aspects of practicing in the field, that I believe translates to various areas of law.

I would encourage every student to participate in a Clinic before they complete their law school career. Although Clinics are demanding, students will leave the Clinic agreeing that it was well worth the experience.