Excessive Compensation Often Leads to Fraud

As one colleague recently pointed out, as a general matter, the investment products that are most prone to fraud, are the same investment products that offer the highest compensation.

Variable annuities may offer compensation in excess of 6-7% of a customer’s initial investment. Non-traded Real Estate Investment Trusts offer compensation often in excess of 4-5% of a customer’s initial investment. Municipal bonds and corporate debt securities can be sold as principal, and notwithstanding a spread between the bid and what a seller is paid, and the offer, what a buyer is charged, which sometimes can vary up to 50%, current rules allow for the undisclosed mark-up of these transactions, without risk, based upon actual cost, of up to 5% of a customer’s initial investment. Moreover, these same securities can be bought and sold with astounding frequency. The same is true of Unit Investment Trusts, which may be inventoried and sold as principal, once again with undisclosed mark-ups of as much as 5%.

Similarly, structured products, including exchange linked notes, reverse convertible notes, and bond funds are frequently the investment products most associated with misconduct, because once again, in addition to the relatively larger commissions associated with the sale of these products earned by the broker, the brokerage firm generally earns significant compensation, and even significant on-going compensation in connection with the underwriting and affiliated management of these investments.

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