Securities Industry Commentator by Bill Singer Esq

October 16, 2019

featured in today's Securities Industry Commentator:

A new study from the nonprofit PIABA Foundation will expose a troubling and large-scale pattern of abuse of the "expungement" process that brokers can use to erase investor disputes from public records. Reviewing the handling of nearly 2,200 investor complaints between 2015 and 2018, the PIABA Foundation finds the expungement system is being manipulated by brokers, attorneys, and brokerage firms to eliminate references to misconduct, cut out investor input, and rig the process so that brokers can wipe away past abuses resulting in the avoidance of more than $8,000 in costs per filing that have led to FINRA subsidizing often bogus expungement proceedings by about $6 million.

The PIABA Release characterizes the FINRA expungement process as an "out-of-control" scenario: 

in which investors are largely sidelined allows brokers to present false and misleading information in order to erase their misconduct.  Not only does what has degenerated into a "get out of jail free" process make a mockery of FINRA arbitration, it also destroys, among other things, the reliability of the FINRA BrokerCheck system, which investors are urged to consult to learn about the background of brokers and brokerage firms. The report will outline a range of major steps that must be taken immediately to halt the growing problem of abuse of the FINRA expungement process.  (Recent minor adjustments made by FINRA to the expungement regimen do not begin to address the fundamentally flawed and widely abused process.)

As set forth on Page 5 of the PIABA Report, PIABA makes the following recommendations:

  • FINRA should halt all expungement proceedings immediately and impose a moratorium on the filing of Expungement-Only cases until procedural safeguards are put into place to correct the problems identified in this Study;
  • FINRA should commission an independent outside investigation of whether expungements have been granted based upon false and/or fraudulent information;
  • FINRA's BrokerCheck and the state sponsored-FINRA Central Registration Depository (CRD) should carry a prominent warning that they are unreliable inasmuch as they do not include all customer complaints because expungement may have resulted in the removal of pertinent information; and
  • The SEC or FINRA should establish an Investor Protection Advocate who would be named as a party in every expungement proceeding to ensure the integrity of the process.
Bill Singer's Comment: All in all, the PIABA Report makes a number of fair and compelling points that must be addressed. Similarly, the four bullet-points of recommendations noted above present relatively reasonable first-steps towards fixing the broker expungement system. That being said, PIABA, by definition was the Public Investor ARBITRATION Bar Association but now seems to be the Public Investor ADVOCATE Bar Association -- as a long-time opponent of Wall Street's mandatory public-customer and associated-person arbitration process, I found myself viewing PIABA as fostering an unfair, biased, and conflicted system of mandatory arbitration. With the organization's apparent rebranding, much of my ambivalence attendant to its self-professed mission has dissipated. Accordingly, I applaud PIABA's efforts to initiate long overdue reforms to mandatory arbitration of all stripes; and, as such, I also hope to see a similar report prepared by advocates for the beleaguered associated person community. 
Finally, this is merely a situation where the chickens have come home to roost. For too long, FINRA, the self-styled Wall Street self-regulatory-organization, has adamantly and obstinately disenfranchised such critical marketplace stakeholders as the very public customers represented by PIABA and the hundreds of thousands of associated persons who work at the regulator's member firms. 
See, for example, "Bill Singer Submits Rare FINRA Comment" ( Blog / 
June 1, 2017)"
The lack of meaningful input and influence by customers and industry employees will continue to question FINRA's legitimacy and place it in the uncomfortable position of having to awkwardly defend policies and procedures such as the organization's disastrous expungement process.
In a FINRA Arbitration Statement of Claim filed in February 2019 associated  person Henningson sought the expungement of a customer complaint from his Central Registration Depository record ("CRD"). Respondent Cetera Advisor Networks did not oppose the requested relief.  The customer did not opposed the requested relief and did not participate in the hearing. By Order dated May 18, 2019, the sole FINRA Arbitrator confirmed a Joint Stipulation and Proposed Order pertaining to liability, damages, discovery, and confidentiality as submitted by the parties. In recommending expungement, the Arbitrator made a FINRA Rule 2080 finding that the customer's claim, allegation, or information is factually impossible or clearly erronoeous, and false. The Arbitrator offered this concise and compelling rationale:

The Customer was one of the joint beneficiaries of her father's estate which included an annuity from "The Hartford". The Customer and her sister were joint and equal beneficiaries of this annuity. The Customer's father died in 2008. The Customers' sister rolled her portion of the inherited annuity into a "beneficiary annuity" or IRA. The Customer elected to take a cash settlement for her share. Later in the year (October 10, 2008), the Customer filed a subject complaint with Respondent indicating that she was not informed that she "had 60 days after taking lump sum distribution on her father's annuity accounts . . . to reverse the decision." The statement placed on the Claimant's form U4 states the allegation as "client alleges that the rep failed to discuss transfer of deceased account to a tax favorable account in January 2008. 

Claimant met with the Customer and her sister twice after the passing of their father to discuss the distribution of their inherited assets. These meetings were held on January 10 and 15, 2008. Testimony indicates that Claimant discussed options for minimizing tax consequences that could occur by cashing out the inherited annuities, and he recommended options for reinvesting the assets to minimize tax consequences. Claimant provided the Customer and her sister documentation to transfer the annuities to beneficiary annuities with The Hartford. Claimant also advised both the Customer and her sister that they should consult with a CPA or Tax Attorney prior to making any decisions. 

The Customer's sister followed Claimant's recommendations, but the Customer decided to cash out her share of the inherited annuities with The Hartford. Claimant indicated during oral testimony that he was not involved with the Customer's filing the necessary application with The Hartford to receive a cash out payment. He further indicated he was not aware of any issues the Customer had until her complaint letter was filed in October 2008. 

The Customer was made aware when she completed The Hartford request for a lump sum payment that there could be tax consequences and that the decision to receive a lump sum payout was final and not reversible. The second sentence of the application form for lump sum payment indicates: "Please note that this will be reported as a death distribution to the IRS and may have a taxable portion". The Customer also elected to not have any federal taxes withheld as part of the payout that was an available option. The lump sum payment form also clearly states that once the payment has been made it is not reversible. 

Respondent investigated the Customer's complaint and concluded it was unmerited and denied the claim. The Customer did not file any further legal action after Respondent denied her claim. The Customer elected not to provide oral or written testimony at the hearing. 

Xiaosong Wang and Jiali Wang were charged in the United States District Court for the District of Massachusetts with one count of conspiracy to commit securities fraud. As alleged in part in the SEC Release, the Defendants and others: 

conspired and engaged in a coordinated stock manipulation scheme that artificially influenced the prices of publicly traded securities by making others in the market believe that there was trading interest and activity in particular stocks.  In reality, no such interest or trading activity existed, and the defendants profited from the price movements they caused. 

The alleged scheme targeted "thinly-traded" securities, which are securities with a low trading volume that are volatile and highly responsive to buying/selling activity.  The defendants are alleged to have placed (or coordinated the placement of) thousands of non-bona fide purchase/sell orders in order to move stock prices up or down.  After the prices moved and the defendants purchased/sold the securities at the artificially higher/lower prices, the initial orders were cancelled.  Defendants and their co-conspirators are alleged to have profited millions of dollars as a result of the stock price spoofing scheme.
In today's featured Wall Street legal drama, a former Ameriprise stockbroker was likely not a happy Ameriprise camper and broke up his partnership and left the firm. Likely, the former employer was not happy with the former employee's alleged use of confidential customer information as part of the launch of his new biz. Likely, the former employee's former partner wasn't all that happy a camper when his former partner moved on. What ensued was a fast-paced Texas Two-Step. Two FINRA arbitrations. Two state courts. Two federal courts. Wow . . . let's grab a beer and sit ourselves down.

SEC Charges Registered Investment Adviser and Broker-Dealer with Defrauding Advisory Clients (SEC Release)
In an Amended Complaint filed in the United States District Court for the District of Colorado, the SEC charged registered investment adviser/broker-dealer Cetera Advisor Networks LLC and Cetera Advisors, LLC with violating the antifraud, fiduciary, and conflicts of interest provisions of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder, and seeks permanent injunctions, disgorgement of ill-gotten gains and prejudgment interest, and penalties. As alleged in the SEC Press Release, the SEC is seeking to recover over $21 million alleged caused when: 

[C]etera Advisor Networks breached its fiduciary duty and defrauded retail advisory clients by, among other things, failing to disclose conflicts of interest related to the firm's receipt of undisclosed compensation in the form of 12b-1 fees, revenue sharing, administrative fees, and mark-ups. The SEC's initial complaint against Cetera Advisors LLC, filed in federal court in Colorado in August, charged Cetera Advisors LLC with similarly failing to adequately disclose to its advisory clients unlawful practices concerning undisclosed compensation and the conflicts of interest associated with them.
In a FINRA Arbitration Statement of Claim filed in October 2018, associated person Claimant Miramontes sought the expungement of a customer complaint from his Central Registration Depository records ("CRD").  Respondents Morgan Stanley and UBS did not oppose the requested relief; and Morgan Stanley participated in the hearing. Although notified of the hearing, the customer did not contest the requested relief and did not appear at the hearing. In recommending expungement, the sole FINRA Arbitrator made a FINRA Rule 2080 finding that the customer's claim, allegation, or information is false. The Arbitrator offered this rationale:

Claimant was employed by Morgan Stanley from 1995-2008 and thereafter with UBS. In 2000, Claimant recommended that the Customer consider purchasing various Morgan Stanley mutual funds in an attempt to appreciate the value of her portfolio while meeting her investment objectives. The Customer purchased several of the Morgan Stanley mutual funds. 

After being given the prospectuses, the Customer did not have any questions or concerns regarding the funds. In 2009, nine years after the initial investments, the Customer brought a complaint against Claimant alleging that he lost her money by not investing in safe investments. As a result, UBS reported the Underlying Complaint on Claimant's CRD records. Morgan Stanley completed its investigation and sent the Customer a letter rejecting the Underlying Complaint, to which the Customer did not respond and did not did pursue arbitration. 

The Customer complained about losses after watching market performance for years, including events such as the crash, the markets reaching all-time highs in 2007 and then the subsequent financial crisis. Claimant was employed by UBS in 2008 and ceased to be the Customer's financial advisor at such time. Claimant, as a financial advisor, is not a guarantor of performance of the market particularly when there no longer is a relationship with the customer.
In a FINRA Arbitration Statement of Claim filed in October 2018, public customer Claimant Siu asserted Arizona securities fraud; misrepresentation and omissions; negligence; breaches of fiduciary duty, trust, and agency; negligent supervision; control person liability; constructive fraud; and consumer fraud. Initially, Claimant Siu south at least $550,000 in damages, disgorgement of commissions/fees, interest, fees, and costs. Respondent Merrill Lynch generally denied the allegations and asserted various affirmative defenses. Claimant Siu and Respondent Merrill Lynch requested an Explained Decision. The FINRA Arbitration Panel found Respondent Merrill Lynch liable and ordered the firm to pay to Claimant Siu $330,000 in compensatory damages. Because of the jaw-dropping nature of the Explain Decision, I present it below in full:

During the period in question, Claimant worked with two financial advisors at Merrill Lynch. Claimant was advised that a conservative investment strategy to generate income would be to write covered call options using his extensive Intel stockholdings. Claimant made it clear to both financial advisors that he would only pursue this strategy if he could be assured that none of his Intel shares would end up being sold away. The advisor who was helping Claimant with his call option strategy in 2018 admitted that it was his understanding that he would receive advance notice of any potential assignment of Claimant's shares which would allow time for the options to be bought back prior to any exercise. Because this advisor knew Claimant wanted to make sure that his shares were not called away, he testified that he checked with someone at the Merrill Lynch options trading desk in order to confirm his understanding. On numerous occasions, Claimant was told by this advisor that he would get advance notice before any of his shares were assigned so that he could buy back the options before they were exercised. 

The financial advisor admitted during the hearing that the information he provided to Claimant related to advance notice was wrong. Even though Claimant received written disclosures stating that writing covered call options might result in his shares being called away without notice, it was not unreasonable for him to rely on the advice he received directly from the financial advisor he was working with and who knew Claimant's investment objectives. 

On May 4, 2018, two of Claimant's covered call option positions for Intel stock were exercised without advance notice resulting in the sale of 38,500 shares of Intel. 

The panel finds Respondent liable for negligent misrepresentation and negligence. The panel denies recovery to Claimant on the other legal theories alleged. 

Damages are awarded to Claimant in the amount of $330,000.00, which includes considerations related to tax liabilities Claimant incurred as a result of the shares being sold, and dividends Claimant has asserted he would otherwise have received had the shares not been sold. 

Bill Singer's Comment: And Merrill Lynch's defense against all of this was what exactly? Given that the FINRA Panel of Arbitrators found that the "financial advisor admitted during the hearing that the information he provided to Claimant related to advance notice was wrong," why didn't Merrill Lynch just write out a damn check to cover the out-of-pocket losses and submit any disputed tax consequences, costs, and fees to binding mediation? It may be that the customer was demanding no less that $550,000, which may well have be unreasonable given the Panel's $330,000 award. That being said, I'm not sure why Merrill Lynch thought it sensible to have this embarrassment wind up reported in a published FINRA Arbitration Decision and become the grist for so many articles such as this. To FINRA's credit, this case was litigated and decided within about one year. 

Supervisor Charged for Role in Brokerage Firm's Improper Handling of ADRs (SEC Release)
Without admitting or denying the findings in an SEC Order, Domenick Migliorato, former supervisor of the securities lending desk at Industrial and Commercial Bank of China Financial Services LLC (ICBCFS), settled charges for his supervisory failures involving the improper handling of transactions involving American Depositary Receipts (ADRs). Migliorato will pay a $150,000 penalty and is prohibited from acting in a supervisory capacity for at least three years. Earlier this year, ICBCFS agreed to pay over $42 million to settle the SEC's charges against the firm. The SEC Order alleges that Migliorato violated Section 15(b)(6) of the Securities Exchange Act when he failed reasonably to supervise members of ICBCFS's securities lending desk with a view to preventing and detecting violations of Section 17(a)(3) of the Securities Act. As alleged in part in the SEC Release:
[F]rom 2011 through 2014, Migliorato was responsible for the firm's compliance with these requirements of pre-release. Under Migliorato's watch, personnel on ICBCFS's securities lending desk failed to take reasonable steps to determine whether the proper number of foreign shares were owned and held by ICBCFS or its customers. This failure opened up the possibility that the ADRs could be used improperly for short selling or dividend arbitrage.

Dual-Class Shares: A Recipe for Disaster (Speech by Rick Fleming, SEC Investor Advocate)
In a speech at the International Corporate Governance Network ("ICGN") Miami Conference, SEC Investor Advocate Rick Fleming spoke about what he called the "troubling trend" of the "increased use of dual-class shares by companies that seek to go public." In part, Fleming admonished that [Ed; footnote omitted]:

In my view, what we now have in our public markets is a festering wound that, if left untreated, could metastasize unchecked and affect the entire system of our public markets. The question, then, is what can be done to avoid the inevitable reckoning.

We on the investor side need to start by being honest with ourselves. As much as we may want to talk about the stock exchanges and their race to the bottom with their listing standards-and trust me, I have talked about it -- we need to acknowledge that investors themselves have engaged in their own race to the bottom when it comes to corporate accountability to shareholders. Investors, and particularly late-stage venture capital investors with deep pockets, have been willing to pay astronomical sums while ceding astonishing amounts of control to founders. This means that other investors, in order to deploy their own capital, must agree to terms that were once unthinkable, including low-vote or no-vote shares. The end result is a wave of companies with weak corporate governance.
In an Amended Complaint filed in the United States District Court for the Central District of California, the SEC alleged that Eric J. "EJ" Dalius, Ryan M. Evans, Professional Realty Enterprises, Inc., Saivian LLC, Savings Network App LLC, Saving Network App Limited, Saivian International Limited, Saivian INT Limited, and Realty Share Network, LLC  violated the antifraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder, as well as the registration provisions of Sections 5(a) and (c) of the Securities Act. The SEC Release alleges in part that:

convicted felon Eric J. "EJ" Dalius and the companies he controlled under the umbrella name "Saivian" engaged in a scheme to defraud when they sold securities that entitled investors to receive 20% cash back on their shopping purchases in exchange for paying a fee of $125 every 28 days, and submission of receipts. In its amended complaint, the SEC charges Evans with taking actions and making material misstatements in furtherance of the scheme. The amended complaint alleges that defendants Dalius, Evans, and the Saivian companies falsely claimed that Saivian funded its cash back payments to investors by selling receipt data submitted by its members. Instead, the defendants operated a Ponzi scheme in which they paid returns to investors from the funds of later investors, rather than through legitimate business activity. The amended complaint also alleges that the defendants engaged in an illegal pyramid scheme when they promised a daily residual income stream for affiliates who sold Saivian memberships to downline recruits. The SEC also alleges Dalius concealed his control of the Saivian scheme and failed to disclose his prior criminal conviction in connection with an earlier multi-level marketing fraud.
Between 2015 and 2018, Kwamaine Ford, posing as an Apple customer service employee, emailed various celebrities to ask them to change or share their passwords.  Over 100 victims provided their passwords for their iCloud accounts, which included email and photos. Ford stole an estimated $325,000 by fraudulently using victims' credit card numbers that he accessed through phishing.