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.