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.