Proposed Pay Hike for FINRA Aribtrators

Will parties to FINRA arbitration soon see an upgrade in the quality of arbitrators?  Will increased arbitrator compensation attract more arbitrators?  Will arbitrators already on panel take their roles more seriously or spend more time considering the merits of claims (leading, presumably, to better results)?  Will the parties to arbitration -- including those least able to afford the cost (investors) -- see an increase in arbitration fees? 

These are some of the questions the players in securities arbitration are considering in the wake of FINRA's proposal to increase compensation to arbitrators from $400 to $600 per day -- a 50% pay raise. 

The summary posted to the FINRA website explains:

The Board authorized FINRA to file with the SEC amendments to the Customer and Industry Codes of Arbitration Procedures to increase some arbitration fees for the sole purpose of increasing arbitrator honoraria for the first time since 1999. For example, under this proposal, FINRA would pay arbitrators $600 for each hearing day ($300 per hearing session) instead of the current $400 rate, and the chairperson of the panel would receive an extra $125 per day instead of the current $75 rate. To cover these honoraria increases, FINRA would increase the member firm surcharges and case processing fees for claims larger than $250,000. The proposal would also increase filing fees for investors, associated persons, or firms bringing claims of more than $500,000. The proposal would also raise hearing session fees for claims of more than $500,000; arbitrators may allocate responsibility for the hearing session fees in their award. FINRA believes that the proposed honoraria increases are needed to recruit and retain a roster of high-quality arbitrators.

It seems hard to argue that a fee that has remained static for more than a dozen years ought to keep falling behind inflation.  When FINRA fees are compared to other arbitrator forums (such as AAA or JAMS), the FINRA fees remain very low.  However, compared to state or federal court -- funded by the taxpayers -- FINRA fees are much higher.  No matter the size of a civil claim filed in court, filing, jury trial, and other fees remain the same and those fees are measured in the hundreds of dollars, not the thousands. 

The way I see it the increase in arbitrator fees is over due.  Arbitrators perform important service, should be compensated for that service fairly, and higher fees should attract more arbitrators and quite possibly higher caliber arbitrators -- with the caveat that FINRA should work hard to keep the cost of FINRA arbitration modest since filing fees do deter claimants from filing claims, creating access to justice concerns.  After all, FINRA arbitration remains mandatory for most investors, and arbitration clauses amount to contracts of adhesion for 99% of small investors. 

SEC Approves FINRA's Proposed Amendment to Discovery Guide

The SEC has approved a proposed rule change (SR-FINRA-2013-024), filed by the Financial Industry Regulatory Authority, Inc., to amend its Discovery Guide used in customer arbitration proceedings. The amendments provide guidance on electronic discovery issues, product cases and clarify the existing provision relating to affirmations made when a party does not produce documents specified in the Discovery Guide.

Under the revisions, the parties must produce electronic files in a "reasonably usable format." When presented with contested motions about the form of document production, arbitrators can evaluate whether a document produced in a given format is consistent with the form in which it is ordinarily maintained. If not, a party must state the reasons.  Arbitrators can also look at whether the other party’s ability to use the document is impaired (i.e. searchability, metadata, etc.). Arbitrators will have the power to order a different format for production if warranted. In conjunction with the guidance on e-discovery, there will also be guidance on the cost or burden of production. FINRA intends to amend the current provision to give arbitrators the discretion to order a different form of production if it would lessen the cost or burden of producing electronic documents.

With regard to affirmations, which are currently provided for when a party indicates there are no responsive documents, the amendments provided that a party must indicate that they performed a good-faith search and indicate the sources searched.

Publication of the rule change is expected in the Federal Register during the week of September 16th. (Release No. 34-70419)

Schwab's Efforts to Ban Securities Class-Actions Draws Criticism, Calls Into Question Mandatory Arbitration as a Whole

The Court system has been essentially unavailable to retail investors seeking relief from their broker-dealers since the 1987 U.S. Supreme Court decision in Shearson v. McMahon, which held that a brokerage firm could compel customers to agree to mandatory arbitration. Since that ruling, nearly every brokerage firm has included mandatory arbitration agreements in all new account documents. The one exception to mandatory arbitration is for issues so pervasive, that they warranted class-action status, in which groups of investors could sue a firm or firms, in court.

As the New York Times reports, in 2011, Charles Schwab sought to address this exception, adding a clause to its customer agreement requiring clients to agree not to pursue or participate in class-action litigation. FINRA responded by filing an enforcement action to force Schwab to do away with the provision. Schwab challenged the decision, and won at a panel hearing this past February. FINRA appealed, and the case is set to go before FINRA’s adjudicatory panel shortly.

The decision has caused significant concern among investors (and their lawyers), who worry that if Schwab is successful, other firms will follow, resulting in significant erosion of investor protection. These proceedings, however, have had a more profound impact, calling into question the entire mandatory arbitration process. Investor concerns with the arbitration process range from criticism that arbitrators do not follow the law, concern about arbitrator qualifications and selection process, arbitrators’ perceived unwillingness to award full damages (including punitive damages), and limitations on discovery, including the absence of depositions.

These concerns also come just weeks after a federal judge in Pennsylvania overturned an arbitration decision in August in which Goldman Sachs prevailed, after it became apparent that one of the arbitrators had recently been indicated by a grand jury. FINRA is now ramping up efforts to perform periodic background checks on its arbitrators.

Time will tell whether the ban on class-action proceedings will live on in Schwab’s investor agreements, but if they do other brokerage firms will almost certainly follow Schwab’s lead. If Schwab succeeds, watch for greater pressure to make mandatory arbitration optional.
 

 

 

 

 

 

Recent IRS Private Letter Ruling on Post-Death Tax Free Annuity Exchanges

The IRS recently issued a private letter ruling with regard to the income tax free exchange of annuity contracts under Section 1035 of the Internal Revenue Code. In PLR 201330016, the IRS approved the tax-free exchange by a post-death beneficiary of multiple annuity contracts (five contracts) for one new contract issued by a different company since the new contract did not extend the payout period under the original contracts. The result is not a watermark event (many tax advisors thought that 1035 exchange treatment was available to post-death beneficiaries of such contracts), but it does provide annuitants and their advisors with comfort regarding the use of the technique.

While a PLR can only be relied upon by the taxpayer requesting the ruling (and thus it has no precedential value), it does provide insight into the IRS’s thinking on this issue. Advisors and their clients should be aware of the ruling as it could be a platform for flexible planning as well as potential abuse (such as churning contracts).

For more information on planning, contact Preti Flaherty estate planning attorney Richard Ploss and for concerns about unsuitable or improper annuities-related advice contact Preti Flaherty attorney Sigmund Schutz.

Former Top New Hampshire Securities Regulator, Mark Connolly, Available for Securities Consulting

For several years now Mark Connolly, former New Hampshire Director of Securities Regulation, has operated a registered investment advisory firm, New Castle Investment Advisors, LLC in Portsmouth, New Hampshire. 

Mark served as Director Securities Regulation from 2002 through 2010, where he led the agency with responsibility for securites regulation in New Hampshire, including enforcement and oversight of a thirty-five million dollar revenue budget; regulatory authority over 50,000 licensed agents and investment advisors and 1200 broker-dealers.  Mark served on the Board of the North American Securities Administrators Association, in several leadership roles at NASAA, and received that organization's Award for Enforcement in 2007.

On Mark's watch, New Hampshire became the first state to legislatively adopt provisions based on NASAA's Model Rule on the Use of Senior Certifications and Professional Designations.  The model rule prohibits the misleading use of senior and retiree designations while also providing a means by which a securities administrator may recognize the use of certain designations conferred by an accredited organization.  The model rule addresses the growing use of financial designations or certifications that ostensibly convey expertise in advising seniors and retirees. The use of a senior designation by salespersons, whether registered or not, confers an impression that the salesperson has special qualifications or specialized education in addressing the needs of senior citizens or retirees, particular areas of finance, financial planning, estate planning, or investing.

Mark left the agency in the wake of the Financial Resources Mortgage ponzi scheme.  He has answered questions about his reasons for resigning as Director in an interview published in the New Hampshire Business Review, and wrote a book, Cover-Up, on the ponzi scheme as he experienced it as a regulator.

His practice at New Castle includes portfolio management as well as expert consulting services for securities-related matters, including supervision, suitability, due diligence, and securities regulatory issues.

FINRA Dealing With Repercussions From Undisclosed Arbitrator Misconduct

According to Reuters, the Financial Industry Regulatory Authority (FINRA), Wall-Street’s industry-funded watchdog, is in high-gear to ensure it vets the backgrounds of its arbitrators before appointing them to cases. This, after an incident last June where an investor who lost a $1.4 million case against Goldman Sachs asked a federal court to overturn the ruling. The reason: he alleged that the arbitrator did not fully disclose his involvement in a criminal proceeding. A judge for the U.S. District Court for the Eastern District of Pennsylvania agreed, throwing out the arbitration ruling in a decision focusing on the arbitrator's misconduct.

In response, FINRA is running Google searches on arbitrators immediately before appointing them to cases. It is also gearing up to run yearly background checks on its 6,500 arbitrators, who were previously put through the process only when they applied for the job.

The goal is to prevent future arbitration rulings from being invalidated due to problems with arbitrators, including last-minute details that undisclosed by arbitrators. These “details” could include everything from a conflict of interest triggered by an employment change, or even an arrest.

This recent revelation also added fuel to the fire for those who oppose the current practice of mandatory arbitration in disputes between brokers and investors. This practice, which investors agree to when they open a brokerage account, bars them from bringing an action in court.

Insurance against paying the other side's legal fees?

All attorneys are used to the "American Rule" whereby each side bears their own legal fees, win or lose.  That is the default rule only, and many contracts contain dispute resolution language allowing the prevailing party to recover legal fees.  These clauses are thought to deter frivolous claims and increase incentives to settle.  The risk of paying the other side their potentially substantial attorneys' fees is reason to consider whether a compromise might be better than trial. 

What if . . . you could take that risk off the table?  Yes, there is insurance for that.

Kevin B. Martin at Sonoma Risk Insurance Agency recently briefed me on Contract Litigation Insurance (CLI), which can be purchased after litigation has already commenced to insure contract litigants (Plaintiffs or Defendants) against the risk of paying their adversary's legal fees in a contract dispute.  With the ever spiraling cost of litigation, the product is worth considering to mitigate risk through an up-front insurance premium.

My understanding is that CLI is not available (or not yet available) in arbitrations, although an arbitrable claim filed in court first and then stayed pending arbitration might qualify.  Worth considering. 

Maine Securities & Business Litigation = Maine Business Court

Yes we can . . . find a more efficient, tailored, and effective process for resolving business and consumer disputes in Maine.  Welcome to Maine's Business Court, sometimes referred to as the Business and Consumer Docket (BCD).  The Judicial Branch website describes the BCD and its purpose this way:

The Business and Consumer Court , also known as the BCD, is a statewide docket comprised of selected actions involving business and /or consumer disputes, and shall be managed by two judges from either trial court designated by the Chief Justice of the Supreme Judicial Court.
The goals of the Business and Consumer Court are to provide predictable judicial action in selected cases involving business and or consumer disputes, avoid placing unnecessary burdens on the court and the litigants in such cases, keep litigation costs reasonable, and promote an effective and efficient process for resolving such disputes.
Cases that may be considered for transfer to the Business and Consumer Court are jury and nonjury civil actions and family matters that do not involve children, in which:

1. the principal claim or claims involve matters of significance to the transactions, operation or governance of a business entity and/or the rights of a consumer arising out of transactions or other dealings with a business entity, and
2. the case requires specialized and differentiated judicial management.

Any case can be transferred at any time to the BCD, at the Court's discretion.  The BCD offers specialized case management tailored to the circumstances of the case, a quasi-electronic filing protocol (e-mail filings, but no fancy ECF / Pacer system akin to what the federal courts use), a trial date setting at the first conference with the assigned Justice (there are two), and other benefits.   The Rules can be found on the Judicial Branch website.

The BCD should be on the checklist of options in every business (including securities) and consumer case.

Brokers Pay Heavily For REIT Sales In Massachusetts

Real-Estate Investment Trusts (REITs) are back in the spotlight, at least in Massachusetts. REITs, which own and manage income-producing property or other are otherwise involved in real-estate financing, may be considered risky investments. This is due part to the fact that they may not trade on exchanges and may be illiquid for long periods of time.

As Fox Business reports Massachusetts Secretary of State William Galvin recently announced that Ameriprise Financial Inc., Lincoln National Corp., Commonwealth Financial Corp., Royal Alliance Associates and Securities America will pay a total of $975,000 in fines and $8.6 million in restitution for allegedly improperly selling non-traded REITs.

As the Boston Business Journal also reports, the violations center on a rule in Massachusetts that permits investors to put no more than an 10% of the investor's liquid net worth into REITs.
 

Secretary Galvin reported that an investigation found significant and widespread problems with the firms' compliance with their own policies, practices and procedures and adherence with Massachusetts prospectus requirements, which left some investors locked into illiquid and underperforming financial products.
 

In addition to hefty monetary fines, the settlement also requires each of the firms above to examine the REITs they deal with to ensure proper sales and investment procedures were followed.

 

Massachusetts Secretary of State Fines Merill Lynch For Securities Violations

The Boston Herald recently reported that Merrill Lynch & Co. was fined $250,000 by Massachusetts Secretary of State William Galvin following its sale of over $39,000,000 in unregistered securities to two Massachusetts cooperative banks. As USA Today notes, the sale involved auction-rate securities, which, according to Galvin, Merill Lynch brokers assured investors that any cash put into these securities could be redeemed with ease – despite what some believe were warning signs to the contrary. The auction-rate securities market allows investors to purchase long-term bonds with the assurance of the access to their cash by selling at weekly or monthly auctions where investment banks act as market-makers.

Galvin accused Merill Lynch of manipulating research reports that failed to position auction rate securities in a positive light. In addition to the $250,000 fine, Galvin also wants Merill Lynch to make investors who invested whole, as their cash is now tied up in long-term bonds.

Merrill Lynch released the following statement: "We are disappointed that Massachusetts filed this action because it ignores the only reason our advisers sold auction-rate securities: They believed they were good investments for clients willing to trade some liquidity for higher return. … Our research reflected the honest belief that (ARS) offered higher returns in exchange for less liquidity and noted that market changes had begun to occur."

Auction-rate securities have been in the headlines in recent years. Since at least 2008, the SEC has been involved in various enforcement actions and the like related to auction-rate securities.

 

 

 

 

 

 

 

 

 

Increasing Compliance Costs Hit Financial Industry In Maine

Regulations in the financial services industry have steadily increased in number and extent over the past ten years. Since 2008 alone, 120 regulatory changes have been announced by 15 federal agencies for credit unions and a whopping 921 compliance changes for Banks.  This, according to a recent article from MaineBiz which highlights just how far-reaching the effects of these regulations are. Not surprisingly, the impetus behind much of these regulations is the recent mortgage and lending crisis and resulting economic recession. This, of course, led to the Dodd-Frank Wall Street Reform and Consumer Protection Act, one of the most comprehensive financial reform acts in history.

 Perhaps most concerning is the uncertainty surrounding the costs of regulations. One source notes that the FDIC is unsure of what compliance with these financial regulations actually costs the financial services industry. Here is what we know:  compliance costs account for 12% of total operating expenses ($50 billion) across the country’s banking industry. Maine is no exception to the trend. A regional survey in Maine reveals that compliance costs on average have increased nearly 19% since 2009.

 On the brighter side, much of the oversight under the new rules issued by the Consumer Financial Protection Bureau (the regulatory agency established under Dodd-Frank) only applies to banks and non-bank financial service providers with assets over $10 billion. Those with assets under $10 billion (which includes all such institutions in Maine) are regulated by separate authorities. However, as Chris Pinkham, Maine Bankers Association President warns, such rules can set a precedent that regulators find difficult to ignore.

Time will tell the full effect and costs of regulations on the financial industry, in and outside of Maine.

 

 

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S&P Credit Rating Litigation in Maine Short-Lived?

Odds are, yes.  Maine is among the nearly twenty states that have sued Standard & Poor's Financial Services, LLC and McGraw-Hill Companies, Inc. for alleged unfair trade practices in violation of state law, but that litigation is now in federal court and subject to a motion to transfer pending before the U.S. Judicial Panel on Multidistrict Litigation, according to the National Law Journal. 

Preti Flaherty attorneys Sigmund D. Schutz and Michael S. Smith serve as Maine counsel for Standard & Poors and McGraw-Hill in coordination with Cahill Gordon in New York City.

U.S. Supreme Court Paves the Way for Securities Class Actions

On February 27, 2013, the U.S. Supreme Court issued its decision in Amgen, Inc. et al. v. Connecticut Retirement Plans and Trust Funds, U.S. Supreme Court, No. 11-1085 (2013). In Amgen, the Court addressed the issue of whether plaintiffs seeking class certification of a securities fraud claim brought under Rule 10b-5 must prove the materiality of the alleged misstatements and omissions as a predicate to class certification.

In a much-anticipated decision, the U.S. Supreme Court allowed shareholders of Amgen to sue Amgen, as a group, without first having to show that Amgen had materially and fraudulently inflated its stock price.

According to the majority, the early stages of class action litigation are intended to ensure that cases are litigated fairly and efficiently. In the Court’s eyes, to hold otherwise "would have us put the cart before the horse." Moreover, the Court believes this holding does not run afoul of Federal Rule of Civil Procedure 23 (governing class actions) because the question of materiality is one that is common to all class members.

Of course, while plaintiffs do not have to meet this hurdle at the class certification stage, plaintiffs will need to meet this requirement once the case is evaluated on the merits, either at trial or by summary judgment. With this decision, there is also the likelihood for more motions for summary judgment filed sooner than later following class certification in Rule 10b-5 cases.

Maine Supreme Court Upholds Order Requiring Insurer to Pay Restitution and Civil Penalty Stemming From Deceptive Practices by its Agent

The pertinent facts are as follows. In 2007, a Bankers Life insurance agent met with a 75 year-old woman who had recently been treated for cancer to discuss issues related to Medicare, health and prescription insurance. These meetings resulted in the elderly woman purchasing three Bankers Life annuities. To purchase these annuities, the woman liquidated three certificates of deposit, sold General Electric stock and rolled over an IRA. The sales contained several irregularities: (1) a required summary of the woman’s financial situation failed to quantify many items, including debts; (2) the suitability of the IRA annuity rollover was questionable for several reasons (not the least of which was that the annuity would not mature until a time period after the woman’s life expectancy terminated); (3) mathematical considerations used to justify the recommendations were improperly compared, and omitted in part; (4) the timing of the stock sale was questionable given the substantial capital gains tax and the negative tax liability; and (5) the woman’s access to funds was diminished and delayed.

The Maine Superintendent of Insurance (which has oversight over insurance companies and agents that sell insurance and annuity products to the public) found the Bankers Life agent failed to evaluate the suitability of his recommendations, was incompetent, untrustworthy and financially irresponsible in his annuity sales, and made misleading comparisons between the woman’s existing investments and those offered by Bankers Life.  The Superintendent ordered Bankers Life to pay restitution and a $100,000 civil penalty stemming from these deceptive practices.

Bankers Life appealed to the Superior Court. The Superior Court affirmed the decision of the Superintendent. Bankers Life appealed to the Maine Supreme Court.

In Bankers Life and Casualty Company v Superintendent of Insurance, 2013 ME 17 (January 10, 2013), the Maine Supreme Court affirmed the Superintendent’s decision, finding the Superintendent did not abuse her discretion in imposing restitution and a civil penalty against Bankers Life.

The Bankers Life decision is significant in at least two respects. First, it seems that the Maine Bureau of Insurance has taken a keen interest in pursuing actions against insurers for unsuitable sales of annuities to the elderly. In all likelihood, this will be an ongoing trend, particularly given Maine's aging populations. Second, the decision highlights the challenge in overturning agency decisions. Under the applicable standard a court will reverse administrative fact findings by a state agency only if the decision "plainly compels a contrary result." That means that focus in defending such matters should be at the administrative level.

New York Times Shines Spotlight on “Mini-Madoffs”

by Michael S. Smith
On January 6, the New York Times ran a story on Philip Horn, a Wells Fargo financial adviser in the Los Angeles area who recently pleaded guilty to defrauding Wells Fargo and more than a dozen of his clients out of at least $732,000. 

Horn, described by clients as charismatic and outgoing, “a great guy and a straight shooter,” spent a good deal of his time at the upscale Braemar Country Club.  The club was a lucrative source of clients for Horn, as well as the scene of a tense, public confrontation with one of his defrauded investors.  It appears that Horn bilked numerous of his fellow club members out of sums rising into the six figures and perhaps beyond.

Though the Horn affair provides the article’s narrative hook, its true focus is on a much bigger issue: 

While Mr. Horn is a relatively minor player in the pantheon of financial fraud, his actions highlight the persistent problems with policing the industry, even after the wave of rules enacted since the collapse of Bernard L. Madoff’s giant Ponzi scheme in 2008 ... Every month, the Financial Industry Regulatory Authority, a Wall Street watchdog, penalizes more than 100 brokers for various actions, including unauthorized trading and fraudulent activities ….

Unfortunately, the Horn case and others like it show that financial fraud is alive and well in the post-Madoff era.  The SEC and other federal and state regulators have more than enough large-scale investigations to keep them busy.  As a result, relatively small-scale financial advisers like Horn who defraud their clients are often able to slip under the enforcement authorities’ radar for years.  

For more information, contact Preti Flaherty Attorney Michael S. Smith or visit Preti's Financial Services Practice Group page to learn more.

Massachusetts Quick to Crack Down on Crowdfunding

Crowdfunding, which allows smaller private companies to sell directly to investors, has recently come under fire in Massachusetts. Secretary of State William Galvin has filed fraud charges against two out-of-state oil and gas operations relative to their sale of unregistered securities to investors in Massachusetts.

In the first instance, Prodigy Oil and Gas LLC allegedly employed a cold-caller who had been found gulty of theft. Prodigy sold at least $464,000 in unregistered securities to one Massachusetts investor. In the second case, Synergy Oil LLC of Oklahoma allegedly sold $35,000 of unregistered securities to two investors.

Through the JOBS Act, signed into law April 5, 2012, small business and entrepreneurs will be able to sell equity (up to $1,000,000 annually) directly to investors to finance their business venture. Crowdfunding is technically not legal yet. Once it is allowed, it must occur on SEC- registered websites. The SEC has until 2014 to adopt rules relative to crowdfunding.

Would-be investors should heed the warning that Crowdfunding is not yet legal or regulated. Proceed at your peril.

 

Crowdfunding Isn't Legal Yet, Regulators Say

 

Crowdfunding Takes Early Hit in Massachusetts

 

Are Massachusetts Crowdfunding Actions a Sign of Things to Come?

 

Top Investor Threats of 2012

What were the top investor threats of 2012?  According to a speaker during the NASAA roundtable session at the November, 2012 annual meeting of the Public Investors Arbitration Bar Association, the top four new threats were:

1. Crowd funding / internet securities offerings
2. Inappropriate advice or practices by investment advisors
3. Scams involving self-directed IRAs to mask fraud
4. EB-5 investment for visa scams

The top six persistent threats were:

1. Gold / precious metals
2. Risky oil / gas drilling schemes
3. Promissory notes
4. Real estate investment schemes
5. Reg. D / Rule 506 private offerings
6. Unlicensed salespersons giving liquidation recommendations (for example, recommendations to sell stocks to buy a variable annuity by an insurance agent not licensed as an investment advisor or stockbroker)