What are Dividends vs. Capital Gains?

Dividend income is generally generated when a corporation distributes a portion or all of its profits to its shareholders during the year on a pro rata basis according to each shareholder’s ownership percentage in the Company, whether shares are owned directly or through a fund. Dividends are typically treated as ordinary income and are subject to the tax rate applicable to the shareholder who receives the dividend income.

Certain dividends, called “qualified dividends,” are subject to the preferential long-term capital gains rates. For the dividend to be a “qualified dividend,” the taxpayer, whether directly or indirectly through the fund, must hold the shares for more than 60 days during the 121-day period that begins before the ex-dividend date (which is the date after the dividend has been paid and processed).

Capital gain is generally generated when a taxpayer sells (directly or through a fund) a capital asset, such as stocks, bonds, real estate, or other investment property. Certain capital gains are typically taxed at a rate of 20% if the assets in question have been held by the taxpayer for more than 12 months. If the investment has been held for less than 12 months, the capital gains are classified as short-term and are subject to the higher ordinary individual income tax rates.

This is best illustrated with an example. Let’s say you received the following Informational Tax Reporting Statement from your fund.

The amount reported as “Qualifying Dividends” is also included in the “Total Ordinary Dividends.” However, the amount included in “Qualifying Dividends” is subject to the lower preferential long-term capital gains rates as opposed to ordinary income, subject to the higher individual tax rates. As such, you would report $80,000 in ordinary income and $20,000 in capital gain.

Understanding Dividends

It’s important to understand which types of dividends are subject to the higher individual tax rates versus those eligible for the lower long-term capital gains rates to properly determine your tax liability for the year in question.

Additionally, if you sell a capital asset, such as real property or other assets held for investment purposes, it’s vital to understand the holding period tax implications related to the sale. If the investor holds the asset for 12 months or less, any resulting capital gain will be considered a short-term capital gain subject to the ordinary individual income tax rates.

Finally, if you are serving as a trustee of a trust, the same rules apply regarding dividends and capital gains. However, trusts are subject to additional regulations governing the distribution of dividends and interest, which must be carefully considered when managing the trust’s tax obligations.

In summary, the above example highlights the importance of consulting with a qualified tax advisor to assist you with reviewing and interpreting the tax forms related to your investments. Doing so ensures accurate reporting and helps prevent overpayment of taxes.

For more information or to seek counsel from our Taxation group, please reach out to request a consultation or call us at 216-696-1422. 

*Please note that Christine Townsend is licensed only in Massachusetts.

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Your Investment Adviser Owes You A Fiduciary Duty

Your investment adviser was right – they are held to a fiduciary standard as a matter of law. But what they didn’t tell you is that they consider that duty for marketing purposes alone. When it’s time to actually do the job, they’re going to sell you on ideas that line their pockets first. Unfortunately, greed will always serve to corrupt a number of people and lead to bad results.

Determining whether the investment advice offered was appropriate for you isn’t terribly difficult for a disinterested party to determine. Attorneys, experts, and subsequent financial professionals are all capable of reviewing a portfolio and reaching a conclusion regarding the quality of the adviser’s work.

But Your Investment Advisor Might Have Breached That Fiduciary Duty By Trying To Make Accountability Impossible

An insidious, but common, breach of fiduciary duty is often found buried in the advisory services agreement(s) you signed when you hired the adviser. The language of those agreements could potentially serve to prevent you from ever seeking a recovery from the adviser who acted wrongfully.

Had you decided to do business with a stockbroker, your efforts to recover the money they lost you would proceed before a panel of arbitrators in the Financial Industry Regulatory Authority’s (“FINRA’s”) arbitration system. While not perfect, the FINRA arbitration program offers modest expense and a known structure for fact-finding and evidence presentation. FINRA prevents its members from including class-action waivers or hedge clauses meant to scare investors away from bringing claims. An example of a hedge clause we see too often is a provision that says, “If you bring a claim against me and lose, you’ll pay my legal fees.” FINRA members are barred from forcing you to travel across the country for the arbitration. They’re also forbidden from including choice of law provisions that would deprive you of rights your local law would otherwise provide.

Your investment adviser isn’t subject to such explicit prohibitions. That said, it is not uncommon for investment advisers to use the contract that you signed as a shield against liability. Too often, investment advisers attempt to:

• Require you to select an arbitration forum that could alone cost you hundreds of thousands of dollars just to have your claim heard;
• Include contractual terms that require you to travel across the country to participate in the arbitration for a chance to recover your money;
• Forbid you from participating in class action lawsuits; and,
• Include contractual provisions that would put you at great risk if you attempted to file a claim against them.

In short, while your adviser told you (correctly) that they have a fiduciary duty to you, they often violate that duty by making it difficult, if not impossible, to file and prosecute a claim against them.

These are not hypothetical scenarios. In fact, they are so important that they gained the attention of the Securities and Exchange Commission, which addressed the issue in a report issued in June 2023. Late last year, the SEC’s Office of the Investor Advocate’s year-end ‘2023 Report on Activities’ included the Ombuds’ message in which she recommended that the SEC consider “temporarily suspending the use of mandatory arbitration clauses in advisory agreements until further exploration of the associated costs and benefits to advisory clients is undertaken.” What the SEC itself will do with that recommendation remains to be seen. However, the fact remains that countless investors may find themselves subject to fundamentally inappropriate dispute resolution requirements until, and unless, the regulators step in to level the playing field.

The vast majority of investment advisers mean their clients no harm. It’s a business relationship that, in an ideal world, provides benefits to both adviser and client alike. The problems with investment adviser arbitration are increasing thanks to the fact that the number of investment advisers is growing (44% growth in ten years according to the SEC), and the number of clients has grown accordingly.  

Do yourself a favor and if you’re already using an investment adviser, review the terms of your agreement. If things go wrong, are the dispute resolution terms in your agreement fair? If not, and if the adviser won’t change those terms, you may want to consider whether you want to continue to do business with them. If you’re considering hiring a new investment adviser, check the agreement for the same thing: what happens if they violate their duty to you? If you find that you’d have to travel across the globe just to pursue your claim, consider whether that adviser really has your interests at heart.

Our Team Has Experience With Investment Adviser Claims

As the number of advisers and advisory clients steadily increases, we are receiving more and more calls from investors questioning whether they were the victim of an adviser’s wrongdoing. We have experience in not only working through the investment portfolios, but the advisory contracts themselves, and helping investors determine whether they can, or should, pursue a claim. And our input in that process costs the investors nothing until they decide to hire us to pursue a claim. If we need an expert’s help in assessing the case, expenses can be incurred in the claim review process, but our time and input before we’re hired is free.

Advertising a fiduciary duty is great marketing. Honoring the duty is more difficult. If you believe you’ve been the victim of your investment adviser’s wrongdoing, let’s discuss your particular circumstances.

For more information or to seek counsel from our investor claims group, please reach out to request a consultation or call us at 216-696-1422.

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The vast majority of stockbrokers try to put their clients’ interests first, offering advice with each client’s unique needs in mind. Unfortunately, because brokers are often paid a commission to sell particular products, there’s an incentive for a broker to put their own interests first and foremost. The problem is particularly acute when dealing with non-traded non-public securities, like promissory notes, non-traded real estate investment trusts (“NTRs”), or other private placements not registered with any regulator, all of which tend to pay much higher commissions than would standard investments like listed stocks, bonds, or mutual funds. While all brokerage firms understand the tension such alternative investments present – high payment to the broker versus what’s best for the client – good brokerage firms maintain a culture that promotes supervision to ensure that rogue brokers aren’t out selling improper or fraudulent investments.

It should be obvious that visiting the site where a broker works is a key element in ensuring that the broker is acting appropriately.  FINRA’s new rules undercut that concept to a meaningful degree.  In the wake of the COVID shutdowns, brokers started working at home and firms struggled with how best to supervise those folks.  FINRA, charged with oversight of the brokerage industry, proposed four different versions of rules that relaxed their member firms’ obligations to conduct in-person site visits for remote offices.  Ultimately, the SEC approved the proposed changes to FINRA’s Rule 3110 regarding supervision.  We’ll avoid getting into the weeds on the details regarding the new rule changes, but the conclusion is inescapable: the new rules will make it easier for brokers to hide their wrongful conduct from the prying eyes of the firms for which they work.

How, then, does this rule change affect YOU?  In the simplest terms, you’ll need to be more vigilant when you work with a broker who isn’t working in the brokerage firm’s offices.  When your broker works out of their house, or a far-flung single office, and offers you an investment opportunity that sounds too good to be true, it probably IS and you should stay away.  If the pitch is that the investment provides guaranteed income and no meaningful risk, it’s very likely that the truth is that the promised income is guaranteed to fail and there’s tremendous risk you’ll never see your investment again. 

Private placements – securities that aren’t traded on a securities exchange like the New York Stock Exchange – pay a much higher commission than you’d see with a stock, bond, or mutual fund that are traded every moment of every day.  A broker might be paid 1 or 2% to sell you shares of Apple, but 7% to sell you NeverTradedCo’s private security.   If your broker is offering you such a security, you need to confirm a few things before saying “yes” to the proposal.  Be sure to ask: (1) Did your firm approve this transaction?  (2) Can I see your due diligence report concerning this offering?  (3) How much are you being paid if I buy this security?  (4) If I need my money back, how do I get it back and how long will that take?  If any of the responses seem “off,” or even vaguely wishy-washy, you’d be well served to decline the invitation to invest.  And, if your broker told you to sign forms that are blank (since the broker will fill them in later for you), or if the broker told you to inflate your reported income or net worth so that you’d be eligible to buy what they’re selling, those are huge red flags, and you should absolutely decline the invitation to invest.  If, however, you said “yes,” and now find that you weren’t sold a high-quality investment, but rather a bill of goods, now would be a good time to engage the expertise of an attorney.

For more information or to seek counsel from our investor claims practice, please reach out to request a consultation or call us at 216-696-1422.

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While stockbrokers often call themselves “financial advisors,” there is a type of professional who is officially called an “investment advisor.” There is a difference between the two, and it could have a huge impact on individual investors because when things go wrong the difference between the two becomes stark and meaningful.

Stockbrokers

• Stockbrokers are regulated by the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization that sits under and is subject to SEC oversight
• A stockbroker can effectuate a trade on behalf of a client
• Some stockbrokers are fiduciaries by operation of law

Investment Advisors

• Investment advisors are regulated by the SEC or their local states – depending on how much money they’re managing
• An investment advisor makes a recommendation that is ultimately carried out through a broker dealer
• All investment advisors are fiduciaries as a matter of law.

Almost every brokerage firm requires clients to agree that any disputes will be heard in a FINRA-overseen arbitration process, as opposed to in a court of law. FINRA’s arbitration process isn’t perfect, but it has made great strides toward being a fair, efficient, and fairly priced forum. FINRA requires its members, including firms and individual brokers, agree to arbitrate if the client requests, even if the firm’s customer agreement doesn’t require arbitration. If a client proceeds in a FINRA arbitration, one of the best aspects is that the hearing will be held in a FINRA hearing location closest to the investor’s residence, with the brokerage firm subsidizing a significant portion of the arbitration forum expenses. FINRA has hearing locations throughout the country and are convenient for the vast majority of Americans.

Investment advisors, on the other hand, are free to include whatever dispute resolution provisions they want in their client agreements. They can require that a client travel across the country in order to pursue a recovery. They can require the client use a dispute resolution forum that’s tremendously expensive (some require tens of thousands of dollars to be deposited before they’ll even start administering the case), to the point where it’s simply not economical to pursue claims under $100,000. They can require that the dispute be heard under some other state’s law, when the client had every expectation that the advisor providing services would be subject to the investor’s local law. The bottom line is that investment advisors can make arbitration so difficult or expensive that only large claims could be heard, and even then, at great expense and difficulty to the investor. Those investment advisors use their arbitration clauses as a shield against potential claims.

The number of investment advisors is growing, and growing quickly. Where there were slightly more than 10,500 registered investment advisors in 2012, that number has grown to more than 14,000 in 2021. At the same time, the number of firms serving as broker-dealers alone fell from 3,545 to 2,921 over the same period. McKinsey reports that registered investment advisory firms represent the fastest growing category in the US wealth management market since 2016. There’s no doubt that the investment advisory space is growing by leaps and bounds, and there’s no doubt that the lack of a standardized dispute resolution forum for those increasing number of investment advisors means that an ever-growing number of investors could have unexpected difficulty in seeking recovery if they have the misfortune of having dealt with an investment advisor who did not take their fiduciary duty seriously. Well-informed investors using investment advisors would do well to check the dispute-resolution terms in their account agreements before any sort of problem arises. If the terms seem offensive, or heavy-handed, there may be an opportunity to renegotiate the terms in order to keep the business with that advisor.

An investor who was trying to be careful with their money likely spent time researching to find a well-regarded, trustworthy financial advisor. If the investor later has questions about whether they made the right choice or not, it is best to address the question without delay. If the advisor’s answers are unsatisfactory or just plain confusing, we stand ready, willing, and able to work with you to figure out whether you were the victim of a lousy market, or a lousy advisor. If it turns out we believe the advisor is at fault and responsible to you, we’ll work with you to determine the best, or perhaps only, avenue to pursue a recovery. Our initial review is performed at no cost to you, though if we require the use of an outside expert, we’ll talk to you about that expert’s cost before we retain them.

Time is of the essence in these situations. If you have concerns or questions, reach out now to request a consultation, call us at 216-696-1422, or visit Hugh’s bio for his contact information to reach out to him directly. And, for more information about investor claims and securities fraud, visit our partner website, StockMarketLoss.com.

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If the market is down, why wouldn’t we be flooded with calls from angry investors asking for help?

The answer is simple: most investors understand that markets go up and down. They also understand that a well-diversified portfolio should recover its value as the market goes back up. In times like these, financial services professionals repeat the mantra, “Stay the course. Wait for the market to come back.” And it is good advice if the portfolio really is diversified, and there aren’t needs to liquidate and raise cash while prices are depressed. However, the problem arises when that advice to stay the course is a little more than the financial advisor praying that his poor selections will rebound in a way they almost certainly won’t. In other words, “Stay the course” can often mean “Please, please, please let these lousy investments rebound so you don’t realize I gave you terrible advice.”

Considering our experience with these cases, we know there’s typically a six to nine-month gap between a market event and a meaningful rise in cases. It usually takes that long for people to realize that “Stay the course” simply meant “Wait to sue me.” Most commonly, as the market rebounds and people start talking about their accounts are getting back to where they were previously, or that they are seeing additional growth, those investors who have claims against their brokers wonder why their accounts aren’t seeing the same activity. Concerned, these investors will start pushing their financial professionals for answers and will often receive the standard response, “You have to wait and be patient – your accounts will come back.” At some point, usually as their friends are solidly back into gain territory, those investors will begin to realize that their accounts are not going to come back. With this realization, they want to know why and if anything can be done.

What’s an investor to do when he or she is told to stay the course?

A good place to start is determining whether the investment portfolio is actually diversified. Here is a tip: among the first pages of many brokerage account statements are summaries of the account’s makeup. Note what percentage of the account is held in equities, fixed income, alternatives, and cash. While this is an oversimplification, look for an unusually high or low number in a particular category or security. An account comprised 100% in equities is typically considered aggressive (volatile) and an account comprised 100% in fixed income is typically considered conservative. To be fair, in most circumstances, an account shouldn’t be 100% in any category. The best way to avoid risk is to build a mix of equities, fixed income, and cash (and sometimes alternatives). An 80-year-old investor who needs income likely shouldn’t have 80% of their portfolio in equities. A 35-year-old investor who’s saving for the long term probably shouldn’t have 90% in fixed income and cash. Similarly, having more than 10% in any particular security carries a particular risk associated with the concentration.

The bottom line is that the failure to diversify and build an appropriate portfolio can provide a foundation for an investor’s claim against their broker or investment advisor.

Sometimes, however, the account can be well-diversified, but the individual investments selected are inappropriate. We’ve seen a variety of investment products over the years that promised safety and were almost certainly guaranteed to fail. The broker sold them because they didn’t understand the true nature of the products and believed the marketing hype themselves, or they wanted the higher commissions those products paid. It’s far more difficult for an investor to determine that a particular bad product, or series of products, is to blame for the poor performance of the account.

You tried to do the right thing by hiring a high-quality financial advisor, but now you wonder if you’ve become the victim of an unscrupulous one. You have nothing to lose by reaching out to discuss your situation. We’ll talk it through, review the appropriate provided documentation, and let you know whether we think we can help you recover your lost savings. Time is not your friend here as there are time limits that apply to your ability to bring a claim. If you have a question now, reach out now.

Please reach out to request a consultation or call us at (866) 932-1295. And, for more information about investor claims and securities fraud, visit our partner website, StockMarketLoss.com.

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However, there are very specific and complex rules that must be followed in order to qualify for the QOZ tax benefits.

Due to the potential deferral of tax on capital gains and because they are often tied to real estate, QOZ investments may be confused with §1031 Like-Kind Exchanges which allow a taxpayer to sell a piece of investment real property and defer tax on the capital gains if the sale proceeds are timely re-invested in “like-kind” real property. Like QOZs, §1031 transactions are subject to very precise rules. The §1031 tax deferral allows a real estate investor’s investment to grow from one property to the next without the investor immediately paying capital gain tax along the way.  In a §1031 transaction, the investment must be in real estate but can be, and usually is, structured as a very low risk passive investment for the investor-landlord (e.g., via a triple-net lease under which the tenant pays all taxes, maintenance, and insurance on the property, in addition to rent).

Though there are similarities between QOZ deals and §1031 transactions, they are not the same. For example, a QOZ business investment must be an “active” trade or business. A §1031 transaction, on the other hand, can qualify for its intended tax benefits if the investor-landlord swaps one passive triple-net leased property for another. That type of passive real estate investment cannot qualify for QOZ benefits, though, because standard triple net leases, by themselves, do not qualify as an active trade or business. Afterall, the intent behind QOZs is to spur economic development and job growth, not to reward passive portfolio income with additional tax benefits.

Despite potential roadblocks, the tax benefits of QOZ investments have caused many real estate investors to try and fit a typical triple net real estate deal into the QOZ framework. Creative advisors are pushed to find ways to structure the deal to qualify as a QOZ investment that still achieves the investor’s desired economic outcome. The overarching idea to keep in mind is that the investment should be an active trade or business, not just a passive investment, and that the investor should have some risk.

The recently issued IRS regulations have indicated that triple net leases, in and of themselves, will not qualify as a QOZ investment. That is because in a triple net lease all the risk is pushed onto the tenant – obviously desirable from an economic standpoint for the landlord-investor, but not considered an active trade or business from the IRS’ perspective.

One way to try and capture the economic value of a triple net lease, but still leave some risk with the landlord, might be to gross-up the project’s rent but have the landlord pay for some or all of the typical triple net pass-through items. For example, rather than charging tenants $15 per square foot triple net, charge them $22 per square foot and have the landlord-investor pay for taxes, maintenance and insurance. That way the landlord-investor has the risk/reward if those triple net costs are higher or lower than the $7 increase in rent.

In addition, to further bolster the concept that the landlord investor is in an active trade or business, consider creating a consulting / strategic advisory role for the landlord in the tenant’s business. If these roles are legitimate and structured the right way, they may be sufficient to demonstrate the QOZ investment is not a typical passive real estate investment and is truly an active trade or business that is spurring economic growth and development within the QOZ.

Unfortunately, QOZs are still new and have yet to face significant IRS scrutiny such that reliable guidance is available to demonstrate the IRS’s position on these (and other) ideas. Investors weighing their options between a §1031 transaction and a QOZ project should consult with competent advisors to make sure they get the right deal with the proper economic structure that maximizes the associated tax benefits.

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As the federal law continues to develop, certain States have also been responding by enacting their own laws to provide similar tax benefits. Ohio recently passed its Biennial Budget Bill for the two years beginning July 1, 2019, thereby creating a new Ohio tax credit related to Opportunity Zones.

The benefit in Ohio is a tax credit equal to 10% of the investor’s investment in the Ohio Qualified Opportunity Fund. Whereas the federal rules require that investors must reinvest capital gains to obtain the federal tax benefits, Ohio opens its tax credit to anyone making an investment in a Qualified Opportunity Fund that holds 100% of its property in an Ohio qualified opportunity zone. Therefore, the Ohio program enables more investors to participate but requires a higher percentage of asset deployment in Ohio.

The Ohio credit is capped at $1 million per investor and the maximum credit allowed to all Ohio taxpayers is $50 million during the biennium budget. While the credit is not refundable, it may be carried forward up to five years. This means that investors seeking to capitalize on Ohio’s credit must act fast.  Applications will be processed by the State on a first come, first served basis. Those investors planning to utilize this Ohio tax credit should start talking to their advisors now! There is no related limitation at the federal level.

To obtain the federal tax benefits, the Qualified Opportunity Fund must invest at least 90% of its assets in qualified opportunity zone property. As noted above, to obtain the Ohio tax credit, the Qualified Opportunity Fund must hold 100% of its assets in qualified opportunity zone property. This is an important distinction for funds placed in Ohio when investors want to capture both the federal and state tax benefits.

The law governing Opportunity Zones continues to develop and can be challenging. Our tax attorneys have experience working with Opportunity Zone Funds and can help investors navigate the complexity while capturing the benefits. We are happy to discuss your federal and Ohio investment plans further.

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When an investor provides equity to a company, they acquire an ownership interest. As a result, they are entitled to certain benefits such as decision-making rights and access to financial information. A founder must deal with each investor’s requests and demands while still trying to operate a fledgling company. As the investor list grows, so too will the requirements. It could become very challenging to focus on the company while also attending to all of the investors.

One common structure to address these issues is through a Special Purpose Vehicle (“SPV”). A SPV is a legal entity that allows multiple investors to pool their money to invest in the start-up. Each investor buys an ownership in the SPV rather than investing directly in the start-up. The SPV, in turn, invests in the company. However, there are pros and cons to an SPV for both the start-up and for individual investors.

For the Start-Up Company

A SPV greatly simplifies the company’s capitalization table. Imagine that instead of having to list forty owners that each own 1% of the company, there can be one SPV that owns 40% of the company. Further, the founder would only deal with one entity rather than forty individual voices. On the other hand, this arrangement may afford the SPV with a significant ownership interest in the company. As a result, the SVP can exert a much louder voice in the direction of the company.

For the Investor

As the corollary to the above point, a SPV may provide an individual investor with much more leverage with the company than the investor would otherwise have on its own. In using the above example, instead of having a 1% ownership interest, the investor effectively has the same rights as a 40% owner while still contributing the same capital amount as before. The SPV, however, adds a level of complexity and cost as there will be agreements setting forth the terms and management of the SPV itself. An investor will not have individual rights in the company anymore. The SPV will also likely be managed by a third party so an investor will not have direct access to the company.

Whether you are looking to  start a company or invest in one, there are advantages and disadvantages to a SPV that need to be weighed carefully. Contact one of our Mergers & Acquisitions and Business & Corporate attorneys today to discuss how you may be affected by these factors.

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XIV is the trading symbol for VelocityShares Daily Inverse XIV ST ETNs. These investments are exchange-traded notes issued by Credit Suisse. If you’re reading this entry, your interest may have been piqued by the fact that you lost nearly your entire investment in XIV virtually overnight and you want to know if there’s anything you can do to recover your losses. We’ll answer that question, but first, the uninitiated might need a little background about the concept of volatility.

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