Clients of First Southern Securities of Alpharetta, Georgia may have paid too much for their municipal bonds, or get paid too little if they ever sell them.
According to settlement documents between First Southern Securities and the Financial Industry Regulatory Authority (FINRA), First Southern Securities made three important mistakes in over fifty different municipal bond transactions:
1) They sold municipal bonds in amounts that were below the minimum denomination;
2) They did not disclose to investors that the sales were below the minimum denomination; and
3) They had inadequate supervision in place to catch such sales.
To analogize to something that is more familiar, think of donuts! Donuts are usually sold by a “lot” of a dozen donuts. If there were a big market for donuts, people would be buying and selling them over the phone in dozens.
A bond’s minimum denomination is the smallest lot size that is commonly sold in the marketplace. So, selling an amount of bonds under the minimum denomination is like selling five donuts instead of a dozen.
This matters for a few different reasons.
First, there are transaction costs associated with bond purchases. If First Southern Securities had any fixed transaction costs (similar to a minimum credit card charge at your favorite donut shop), then buying a small amount of bonds might make much less sense for investors, while still profiting the brokerage firm.
Second, bond investors might want to sell their bonds, and three bad things can happen at that point for an investor who holds an amount of bonds that is lower than the minimum denomination:
1) There can be high fixed sales charges, just like there were high fixed purchase charges;
2) It can be difficult to sell an odd lot of bonds. If everyone is trading dozens of donuts, and you only have five to sell, it can take more time to find a buyer. Your bonds may be less liquid than an amount of bonds that is above the minimum denomination.
3) When you finally do find a buyer, they might offer an unusually low price, because they are doing you a favor by entering into an unusually small transaction for an unusual number of bonds.
It is surprising that First Southern Securities made these mistakes because, as their own website states, “The firm’s cornerstone business is trading tax-exempt and taxable municipal bonds.” According to FINRA, municipal bonds generate 94% of the firm’s revenue.
To be fair to First Southern Securities, it looks this is the first time that they’ve gotten in trouble with FINRA, and running a broker-dealer can be complicated. Additionally, this misconduct may have been accidental rather than intentional, and the head of First Southern Securities, Heath Hawk, has not had any problems with FINRA, according to his FINRA BrokerCheck report. This may be why the firm was only censured and fined $25,000 for these violations, although they also must offer to buy back bonds they improperly sold to investors at fair prices.
Still, these issues at First Southern Securities highlight the fact that municipal bonds—attractive though they may be—carry significant risks for investors. The market for these securities is much murkier than the market for stocks listed on an exchange, and this can result in profits for brokerage firms, and losses for investors.
If you have questions about investment losses, the securities litigation attorneys at Investor Defense Law LLP may be able to help, and offer free consultations. Investor Defense Law LLP is a law firm dedicated to helping investors in California, Georgia, and Washington State recover investment losses. We understand investment fraud and know how to sue investment advisors, brokerage firms, and financial advisors. To learn more, contact an investment fraud attorney at 800.487.4660.