Maine Joins Other States by Requiring Mandatory Reporting of Suspected Financial Exploitation

Sunday, February 2, 2020

To enhance prompt reporting of financial exploitation to state securities regulators and adult protective services, on April 2, 2019 Maine joined 25 other states by enacting the Act to Protect Vulnerable Adults from Financial Exploitation, Public Law 2019 Ch. 17.  The Act makes broker-dealers and others mandatory reporters of suspected financial exploitation of seniors and vulnerable adults. 

The Act is intended to combat financial exploitation of elderly and disabled persons, a not infrequent occurrence.  According to one reputable source as many as 20% of adults over the age of 65 have been victimized by financial fraud, and only one in 44 cases of financial abuse is ever reported.  The Maine law is largely identical to a model act developed by the North American Securities Administrators Association (NASAA), an organization of state securities administrators dedicated to protecting senior investors from financial exploitation. 

The Act contains five key elements:

  • mandatory reporting to a state securities regulator and state adult protective services agency when a qualified individual has a reasonable belief that financial exploitation--generally, wrongful or unauthorized use of money--of an eligible adult has been attempted or has occurred;
  • authorized disclosure only to third parties in instances where an eligible adult has previously designated the third party to whom disclosure may be made;
  • authority for broker-dealers and investment advisers to delay disbursing funds from an eligible adult's account if there is a reasonable belief that a disbursement would result in financial exploitation;
  • immunity from liability for reporting of suspected financial abuse and for delayed disbursements; and
  • mandatory cooperation with requests for information by state investigators in cases of suspected financial abuse (any records provided under this clause are exempt from state public records law).
The Act applies to any "eligible adult," which is defined as persons age 65 or older or who are protected under adult protective services law.  The mandatory reporting requirement applies to any agent, investment adviser representative or individual who serves in a supervisory, compliance or legal capacity for a broker-dealer or investment adviser.  According to NASAA, the "reasonable belief" standard for making a report "is intended to be both a subjective and objective standard – i.e., a qualified individual must have a subjective belief in the existence of the financial exploitation, and this belief must be objectively reasonable."

The Act will force broker-dealers to make tough calls about whether to make a report.  Broker-dealers may perceive reporting as having the potential to alienate a customer or a customer's family, who may react negatively to a report and ensuing investigation.  Although a mandatory reporter is immune from liability, that does not mean that a customer (or customer's family) is obligated to continue to do business with a broker-dealer who (in the family's view) instigated an unjustified investigation.  Many customers will, however, recognize that reporting is ultimately for their own benefit.

How well is the Act working?  The Maine Office of Securities has not made public any statistics on the number of reports, the outcome of reports, or other activity related to the Act.   Nor has it pursued any enforcement action for failure to report.   The focus of Maine regulators is on educating the regulated community about this obligation, so far.

Unpaid Arbitration Awards: An Unabated Problem

Thursday, January 16, 2020

Earlier posts highlighted a long-recognized problem in the securities industry: investors who've proven that they were harmed by bad actors  all too often wind up recovering little or nothing even after winning a legal claim.

An analysis of arbitration awards a few years ago revealed that about 25%, nearly $1 out of every $4 awarded to customers in arbitration went unpaid.  There are solutions to the problem, like requiring insurance (as is required to register an automobile), requiring that broker-dealers maintain higher minimum capital reserves, or establishing a fund that could be used to pay arbitration awards against broker-dealers who can't or won't pay, as described here.  Have these or other solutions been implemented?  No, although they remain under consideration.

And the problem remains prevalent.  The industry faces a "fresh wave" of unpaid arbitration awards, according to reporting by Bruce Kelly in Investment News.  He reports, "From 2013 to 2017, brokers and firms failed to pay $167 million in arbitration awards to customers that FINRA hearing panels had approved."  A $1 million award made in Maine not long ago remains unpaid.  That's quite a bit of money, especially considering that it represents awards obtained after a legal proceeding and the vast majority, in some instances, of investors' retirement savings. 

This a a problem in need of a solution.  At stake is not just the well-being of customers who have been defrauded and face dire personal financial and lifestyle consequences, or the injustice of leaving customers without any real-world remedy in all too many instances.  The industry needs to weigh the risk of seriously undermining consumer confidence, which could have much broader implications for the health of financial markets.

Expungement: A Seriously Flawed Process?

Tuesday, November 12, 2019

In 2017, this blog featured a post examining the standard applied to requests by brokers to cleanse (erase) their public records of customer complaints, a process called "expungement," here.  A recently released (October 2019) study by the investor protection foundation run by the Public Investors Arbitration Bar Association (PIABA) reports that the process is “broken” as a result of being “systematically gamed, exploited and abused” by brokers and brokerage firms. 

Among the problems found, according to PIABA's study are sham cases seeking nominal damages ($1.00) resulting in lower costs and fewer arbitrators, and brokerage firms which almost never (only 2% of the time) oppose brokers' requests for expungement.  Investors only rarely appear to oppose expungement requests, and may not even get notice of expungement hearings.  The result is that the dice are loaded in favor of expungement, with the result that investor complaints, including those that may be settled for a significant payment, never see the light of day.  

Are meritless claims against brokers made by investors?  Without question.  Should brokers be able to unilaterally wipe the slate clean, leaving the appearance that no claim had ever been filed in the first place?  That is a much tougher to justify--especially if the system for vetting such requests lacks sufficient safeguards to ensure that they are granted only in extraordinary cases where the request is truly justified.

Lessons From "Arbitration Nation:" an Empirical Study of 40,000+ Consumer Arbitrations

Tuesday, October 1, 2019

A recent study identifies a problem -- "we know little about what actually happens in" arbitration -- and offers a solution: find out what happened in more than 40,000 consumer arbitrations administered by four major arbitration forums over the course of six years.

In the study, "Arbitration Nation: Data from Four Providers," Professors Andra Cann Chandrasekher and David Horton analyzed "40,775 consumer, employment, and medical malpractice arbitrations filed between 2010 and 2016 in four major arbitration administrators: the AAA, Judicial Arbitration and Mediation Services (JAMS), ADR Services, Inc., and the Kaiser Health Care Office of Independent Administration (Kaiser)."

Important conclusions:

  • consumer arbitration is relatively fast and affordable, with corporate defendants paying the lion's share of the costs;
  • although the U.S. Supreme Court has repeatedly and emphatically enforced mandatory arbitration clauses in recent years, the uptick in the volume of arbitration "has been modest;"
  • plaintiffs who represent themselves in arbitration rarely win (they only prevail in 10% of employment cases)--"pro se plaintiffs struggle mightily" (but do they fare any better in court?  -- the authors don't comment) and
  • arbitration favors repeat players (what I'll call frequent flyers) on both sides--arbitration favors frequent flyer corporate defendants but also frequent flyer plaintiffs' law firms.
To encourage more lawyers to take relatively small value cases to arbitration and thus (presumably) weed out cases without merit and improve outcomes for plaintiffs who have cases with merit, the authors propose "that state lawmakers create rewards for plaintiffs’ lawyers to arbitrate. Specifically, jurisdictions should create a statutory 'arbitration multiplier': an extra bounty for winning a case in arbitration." Intriguing.  And, not likely to be preempted.

What about securities arbitration?  Alas, the authors' study did not include data on FINRA arbitrations.  That is in part because the study relied on data on consumer arbitrations made public as required by Section 1281.96 of the California Code of Civil Procedure--a law that does not cover FINRA.  

New Maine Restrictions on Non-Compete Agreements; Bans Restrictive Employment Agreements

Wednesday, August 7, 2019

A new Maine law will make it more difficult for Maine employers to enforce non-compete agreements, an issue of particular interest in the securities industry where non-competition agreements often have been used to deter brokers from changing jobs. In enacting the new legislation, Maine joins other New England states, including Rhode Island, Massachusetts, and New Hampshire, which also have new laws on the books limiting the enforceability of non-compete agreements.

On June 28, 2019, Governor Mills signed LD 733 (“An Act to Promote Keeping Workers in Maine”) into law. Under the new law, a noncompete agreement is defined as a contract or contract provision that prohibits an employee or prospective employee from working in the same or a similar profession or in a specified geographic area for a certain period of time following termination of employment.

The new law applies to noncompete agreements entered into or renewed after September 18, 2019.

The new law makes clear that noncompete agreements are “contrary to public policy” and enforceable only to the extent that they are reasonable and are no broader than necessary to protect one or more of the following legitimate business interests of the employer: the employer’s trade secrets, the employer’s confidential information that does not qualify as a trade secret, or the employer’s goodwill. A noncompete agreement may be presumed necessary if the legitimate business interest cannot be adequately protected through an alternative restrictive covenant, including but not limited to a nonsolicitation agreement or a nondisclosure or confidentiality agreement. 

Further, the new law prohibits an employer from requiring or entering into a noncompete agreement with an employee earning wages at or below 400% of the federal poverty level. 

If an employer requires a noncompete agreement for a position of employment, the employer must disclose that requirement in any advertisement for that position, and an employer must provide an employee or prospective employee with a copy of a noncompete agreement at least three business days before requiring that employee or prospective employee to sign the agreement. 

The terms of a noncompete agreement (except for a noncompete agreement with a physician) are not in effect until after an employee has been employed with the employer for at least one year or a period of six months from the date the agreement was signed, whichever is later. 

The law is enforceable as civil violation subject to a fine of $5,000 or more. The Department of Labor is responsible for enforcement of the law. 

LD 733 also addresses “Restrictive employment agreements,” defined as an agreement: (a) between two or more employers, including through a franchise agreement or a contractor and subcontractor agreement; and (b) prohibits or restricts one employer from soliciting or hiring another employer's employees or former employees. With respect to such agreements, an employer may not enter into a restrictive employment agreement or enforce or threaten to enforce a restrictive employment agreement. An employer that does so commits a civil violation subject to a fine of $5,000 or more. The Department of Labor is also responsible for enforcement of this section.

Investing in Private Companies: Opportunities Abound, But So Do Risks

Wednesday, November 21, 2018

More retail investors than ever are investing in private companies, but doing so can be "high-risk" and "more opaque" and private companies tend to be a magnet for fraud, according to the Wall Street Journal.  "More opaque" means "more secretive"--subject to lesser regulatory oversight and fewer obligations to disclose to the public how their business is performing.  Also problematic is that it can be hard to sell investments in private companies, which means that buying private companies can "tie up your money for a long time."  Sometimes, selling an investment in a private company can be subject to penalties or fees, which may not have been disclosed or understood when the investment was first made.  Investments in private companies are sometimes referred to as "private placements" and include stock and limited partnerships.

Also of concern is that tens of billions of dollars a year in securities in private companies are being sold by securities firms with a checkered past, including investor complaints and other red flags suggesting potential misconduct, according to the Journal.  Investments in private companies also tend to pay higher commissions, creating an incentive for securities professionals to overlook or justify risk in return for a larger commission.  The result is that investors facing the special risks associated with private securities are too often receiving recommendations from registered representatives at securities firms less prepared (or willing) to provide suitable recommendations and to aggressively supervise securities professionals making recommendations to buy private securities. 

Private placement memoranda and sales materials given to investors sometimes contain inaccurate statements. In addition, some materials omit information necessary to make informed investment decisions, and some firms fail to conduct an adequate investigation of the issuer to determine if the private placements were suitable for their customers, according to the Financial Industry Regulatory Authority

The Journal also reports that the Securities and Exchange Commission is planning to increase the number of people allowed to buy private companies, even though that population has "already grown 10-fold since the 1980s."   An investor typically must be "accredited" to buy stock in private companies, which requires an annual income of more than $200,000 ($300,000 with a spouse) or a net worth of more than $1 million (excluding the investor's primary residence).  But those thresholds were set more than 30 years ago in 1982.  "If the limits had been adjusted to keep pace with inflation, an accredited investor would now need an annual income of about $515,000--more than double the actual $200,000 limit--and a net worth of more than $2.5 million," according to the Journal.

To put it bluntly, $200,000 isn't the same income it used to be.  Nor does a net worth of $1 million automatically put someone in a position to make speculative investments.  A few years ago the Commission provided these examples of people who would generally be considered "accredited" investors:
  • A single working parent of three children with an annual salary of $205,000, and likely with a home mortgage to pay;
  • A recent widow who inherited $1 million, but is not earning a separate income; and
  • A senior retiree who has accumulated over $1 million in his or her retirement account and needs that money for the retirement years.
Other "accredited" investors include people who have suffered catastrophic injuries and received payments as a result of personal injury claims.  But, such persons should not be assumed to have the "financial sophistication and/or investment experience to be able to assess whether any particular investment is appropriate for them," according to the Commission. 

Of course, "each year, companies raise billions of dollars selling securities in non-public offerings that are exempt from registration under the federal securities laws. These offerings . . . can be a key source of capital for American businesses, especially small or start-up companies."  But for retail investors who receive recommendations to invest in private companies, consult the Financial Industry Regulatory Authority's list of tips and cautions before buying--the gist of which is look very, very carefully before leaping.


Public Investors Bar Association Report: Draft Reforms to FINRA Supervision Rules Leave Investors Vulnerable

Tuesday, October 9, 2018


In a report titled, FINRA’s Attempt to Gut Investor Protections: Proposed Reforms to FINRA Supervision Rules, Public Investors Arbitration Bar Association (PIABA) argues, “FINRA is currently contemplating the evisceration of crucial protections that have been in place for decades to safeguard investors against investment schemes by brokerage firms’ registered representatives, including ‘selling away’ schemes. If FINRA’s proposed changes are approved, there will likely be more investment scams perpetrated by registered representatives. If these proposals are adopted, brokerage firms will no longer be held primarily responsible for identifying and stopping rogue brokers.” 

FINRA is currently contemplating changes to FINRA Rules 3270 and 3280 as outlined in FINRA Regulatory Notice 18-08. Both rules impose broad supervisory responsibilities and obligations for registered representatives and member firms with respect to outside business activities and private securities transactions. FINRA Regulatory Notice 18-08 proposes to exempt member firms from supervising:
  • Investment-related activities at third‐party investment advisor firms;
  • Investment-related activities at member affiliates, including IAs, banks, and insurance companies;
  • Non‐investment–related work and outside business activities; and
  • Personal investments

According to PIABA, outside business activities manifest themselves in a variety of schemes and fraudulent activity every year, including but not limited to, fraudulent private placements, Ponzi schemes, and investment frauds perpetrated through third-party IAs established by the registered representative. According to PIABA, “A common modus operandi in these schemes is for a registered representative to establish a solo or small IA firm and perpetrate the fraud through outside business activities in an effort to avoid member supervision.” 

FINRA proposed Rule 3290 narrows and reduces member firms’ supervisory obligations and, according to PIABA, results in unacceptable adverse consequences, including:
  • Dramatically weakening long-standing supervisory obligations;
  • Creating glaring supervisory deficiencies;
  • Encouraging de facto violations of federal securities laws;
  • Generating inconsistencies with other FINRA rules and regulatory guidance;
  • Producing perverse incentives for registered representatives and members; and
  • Leaving investors with inadequate protection

According to Financial Advisor Magazine, the comment period for the FINRA proposal is closed. “Now all eyes are on FINRA to see what they’ll do and if they’ll put investor protection interests first and let this horrific rule die,” says Andrew Stoltman, current President and member of the Board of Directors for PIABA.