“These are FINRA’s first enforcement actions arising from our ongoing investigations into abuses in the marketing and sales of mortgage-backed securities such as CMOs to retail customers,” said Susan Merrill, FINRA Executive Vice President and Chief of Enforcement. “Brokers and firms have an obligation to ensure that they recommend these securities only to those customers for whom they are a suitable investment–namely sophisticated investors with a high-risk profile. Webberly, Schwartz and Berkowicz failed to fulfill this obligation when they recommended ‘inverse floaters’ to retail customers with little or no investment experience. And they compounded this misconduct by permitting the head trader to exercise discretionary authority in the customers’ accounts to purchase CMOs.”

A CMO is a security that pools together mortgages and issues shares–called “tranches”–with various characteristics and risks.The underlying mortgages serve as the collateral for the CMO and provide principal and interest payments to shareholders.

One of the most volatile and risky CMO tranches is the “inverse floater CMO,” a thinly traded mortgage-backed security which is typically highly leveraged and vulnerable to a high degree of price volatility. Rising interest rates reduce the interest earned and also may decrease the principal payments to the investor. The reduction in the repayment of principal extends the maturity date, potentially for as much as 30 years. Furthermore, since each inverse floater is uniquely structured and thinly traded, prices used for valuation purposes are determined using theoretical pricing models. These prices are strictly best estimates of value and can vary substantially from prices obtained through actual bidding or market offerings. As a result, buying inverse floaters on margin further heightens the risk of investing in the product.

Since 1993, FINRA (formerly NASD) has published warnings that inverse floaters are suitable only for sophisticated investors willing to take on high levels of risk.

In its investigation of SAMCO Financial’s Boca Raton branch, FINRA found that Webberly made unsuitable recommendations to four customers to buy these securities and that in making these unsuitable recommendations, he misrepresented or omitted material facts. FINRA further found that Schwartz and Berkowicz made unsuitable recommendations and misrepresented material facts in connection with sales to two and three of their customers, respectively. All three brokers allowed their supervisor, who was the head trader in SAMCO Financial’s Boca Raton office, to improperly exercise discretionary authority to invest in inverse floaters in the accounts of these customers. Webberly’s customers suffered realized losses of approximately $250,000 from their investments, Schwartz’s customers suffered losses of approximately $95,000 and Berkowicz’s customers lost approximately $190,000.

The head trader of that branch office focused his business on purchasing large par amounts of inverse floaters and allocating the shares among the branch’s retail customer accounts, utilizing margin borrowing to finance the customers’ investments. Webberly, Schwartz, Berkowicz and the other brokers in the office solicited potential customers for the head trader’s investment program.

FINRA found that Webberly and Schwartz failed to conduct any suitability analyses–and Berkowicz conducted inadequate suitability analyses–to ensure that inverse floaters were suitable for the customers’ individual situations. At the time each broker opened accounts for customers, the brokers knew that the head trader would be exercising discretion in the accounts, yet none of the three brokers obtained written authorization signed by the customers and a firm principal to allow the brokers or anyone else at the firm to exercise discretion in the accounts. After customers opened accounts at the branch, the head trader exercised discretion in their accounts, purchasing inverse floaters for the customers and frequently utilizing margin in their accounts to do so. In some cases, through the head trader’s exercise of discretion, those accounts borrowed as much as three times the amount the customers had initially deposited in their accounts.

FINRA’s investigation found, for example, that Webberly recommended to two couples with no prior investment experience that they invest in inverse floaters, falsely claiming that inverse floaters could not lose their principal, that there was no risk in margin borrowing costs exceeding the income earned on the investment, and that the investment was risk free. Each couple invested $50,000 in August 2005. Their deposits and margin borrowing of $100,499.75 were used to purchase inverse floaters. Ten months later, in June 2006, their accounts each earned $3,688.01 in interest, but paid $6,848.96 for the funds borrowed on margin. At that time, the shares were sold to satisfy the customers’ margin requirements. This resulted in a realized loss for each account of $70,021.77, which exceeded their principal investment.

Similarly, both Berkowicz and Schwartz recommended CMO investments to investors with limited or no prior investment experience and made material misrepresentations about the characteristics of inverse floaters–in some cases describing CMOs as secured government bonds where an investor could not lose any money. Berkowicz and Schwartz also failed to discuss the potential risks of margin use with their customers. A decrease in the value of inverse floaters resulted in the issuance of margin calls and subsequent sales of their customers’ CMO holdings–resulting in losses of approximately $190,000 for Berkowicz’s three customers and $95,000 for Schwartz’s two customers.

In concluding these settlements, Webberly, Berkowicz, and Schwartz neither admitted nor denied the charges, but consented to the entry of FIN RA’s findings. In addition to his suspension, Webberly is being required to cooperate in FINRA’s continued prosecution of matters arising from its investigation into SAMCO Financial’s Boca Raton branch office.

The Financial Industry Regulatory Authority (FINRA) has expelled Barron Moore, Inc. of Dallas, TX, and taken disciplinary action against seven individuals for violations arising from the illegal sale of unregistered penny stocks. Those sanctions range from fines and suspensions to permanent bars from the securities industry.

The individuals include five registered representatives formerly associated with three different firms–Barron Moore, Midas Securities LLC of Anaheim, CA, and Milestone Group Management, which is no longer in business–and supervisors from Barron Moore and Milestone. One registered representative was barred for failing to provide documents and testimony in FINRA’s investigation.

FINRA found that four of the registered representatives sold large quantities of unregistered stock into the public markets on behalf of customers, in violation of federal securities laws, specifically Section 5 of the Securities Act of 1933. Neither the representatives nor the supervisors took appropriate steps to determine whether the securities could be sold without violating the registration requirements of the federal securities laws. FINRA found that this conduct occurred despite the presence of numerous red flags indicating that illegal stock distributions might be taking place.

“Retail brokers are the first line of defense for the markets,” said Susan L. Merrill, Executive Vice President and Chief of Enforcement. “Brokerage firms and their employees must take action to ensure that they are not participating in illegal sales of unregistered securities. In this case, the respondents failed to take appropriate action and illegally sold millions of shares of unregistered securities into the public marketplace.”

FINRA found that Barron Moore sold more than 6.75 million shares of unregistered stock of three companies, on behalf of seven customers, resulting in unlawful proceeds of more than $975,000. Barron Moore opened accounts for numerous customers who repeatedly deposited large numbers of unregistered shares of thinly traded securities into those accounts, sold those securities and then wired the proceeds out of the accounts. FINRA found that Katherine Moore, Barron Moore’s president, chief executive officer and principal owner, failed to supervise the registered representatives who engaged in the misconduct and failed to ensure that Barron Moore had adequate supervisory procedures concerning the sale of unregistered securities.

Most of the illegal sales involved unregistered securities of one penny stock company, iStorage Networks, Inc. FINRA found that shortly after iStorage Networks engaged in a reverse merger with another company, three shareholders distributed millions of shares of the company’s unregistered stock to scores of individuals and entities. Shortly thereafter, a number of the recipients deposited large amounts of the unregistered stock into accounts at Barron Moore and the other two firms and began selling those shares into the market. FINRA found that Barron Moore also engaged in illegal sales of unregistered stock of two other penny stock companies, Consolidated Sports Media Group, Inc. and Structures USA, Inc.

FINRA also found that Barron Moore and Katherine Moore failed to develop and implement a reasonable anti-money laundering compliance program, and failed to detect and report suspicious activities by a convicted money launderer as well as in accounts ostensibly controlled by a 20-year old who washed and detailed the cars of Barron Moore employees.

In addition, FINRA found that Barron Moore and Katherine Moore failed to maintain accurate books and records in connection with the investments of six customers investing in an offering of a company known as CyberZONE, Inc. Barron Moore also failed to maintain an accurate checks-received-and-forwarded blotter for the CyberZONE offering and failed to maintain adequate net capital.

In settling these charges, FINRA expelled Barron Moore from the securities industry and suspended Katherine Moore from acting in a principal capacity for 90 days, fined her $50,000 and ordered her to requalify before acting as a general securities principal.

The other individuals disciplined are:

Benjamin Centeno and Jeffrey Santohigashi, both formerly registered representatives at Midas Securities, who served as brokers for the same customer and sold 760,000 unregistered shares of iStorage Networks on behalf of that customer. Centeno was suspended from association with any firm for 30 days and fined $10,000. Santohigashi was suspended from association with any securities firm for 20 days and fined $10,000.

William Kassar, Jr., formerly a registered representative at Milestone Group Management, who was charged with selling 227,000 unregistered shares of iStorage Networks on behalf of one customer. Kassar was suspended from association with any firm for 30 days and fined $10,000.

Paul Casella, formerly the compliance officer and manager at Milestone Group Management, who was charged with failing to supervise a registered representative who sold unregistered securities of two issuers, including iStorage Networks. Casella did not respond to the charges and a FINRA hearing officer issued a default decision suspending him from association with any FINRA - registered firm for one year and fining him $50,000.

Joshua Lankford, formerly a registered representative at Barron Moore, who consented to the imposition of a bar from the industry resulting from his failure to provide documents and testify in FINRA’s investigation.

In settling these matters, Barron Moore, Katherine Moore, Lankford, Centeno, Santohigashi, and Kassar neither admitted nor denied the charges, but consented to the entry of FINRA’s findings.