Securities Industry Commentator by Bill Singer Esq

October 25, 2019

featured in today's Securities Industry Commentator:
Today's featured FINRA Arbitration reminds me of the famous Monty Python's Flying Circus "Cheese Shop" sketch. As the SEC finds on appeal, FINRA doesn't actually offer any arbitration services, well, at least to the extent that FINRA doesn't actually review an arbitrator's award to ensure that the document complied with the self-regulatory organization's rules. As the SEC writes this sketch, FINRA doesn't actually run an arbitration forum by its rules. As the SEC sees it, FINRA is merely a minister at its own arbitration forum -- it merely prepares and serves the awards of its arbitrators, and, moreover, does this service without ensuring that its done by the FINRA rulebook. The SEC insists that this FINRA cheese shop can't be sued for not providing a service that it doesn't offer. Do you have arbitrations? Yes? Can I have one that is adjudicated according to your rules? Ummm . . . no. 

In a FINRA Statement of Claim filed in July 2018, associated person Claimant Mittal asserted breach of contract and tortious interference with business relationship. Claimant sought $64,747,201 in compensatory damages and up to double said damages as punitive damages; and $1,549,230 in attorneys' fees, and $310,694.96 in costs. Respondent ITG Inc. generally denied the allegations, asserted various affirmative defenses, and filed a Counterclaim, which the FINRA Arbitration Decision characterized as asserting "breach of contract, attorneys' fees and costs, clawback of compensation, and setoff." In June 2019, Respondent withdrew all of its causes of action with the exception of attorneys' fees, for which the firm sought $4 million. In July 2019, Respondent filed a Motion to Preclude, which Claimant opposed. Although the FINRA Arbitration Decision does not fully present the parameters of the Motion, the Decision states in part that:

[T]he Panel decided: (1) to grant Respondent's motion to the extent of precluding the admission of evidence for the purpose of challenging the veracity of the SEC Order on Claimant's direct case, but would rule on the admissibility of evidence to rebut any defenses raised by Respondent, and; (2) to deny Respondent's motion to preclude the testimony of a witness, and rule on the admissibility of relevant evidence.

The FINRA Arbitration Panel found Respondent ITG liable and ordered it to pay to Claimant Mittal $3 million in compensatory damages for breach of contract plus interest; $1,549,230 in attorneys' fees; and $310,694.96 in costs. The Decision then offers the following post-Award commentary:


The Panel erred in granting Respondent's motion to preclude the introduction of evidence challenging the veracity of the SEC Consent Order. The fact that Claimant was not allowed to present evidence to rebut the factual contentions of the Order prevented Claimant from making a full presentation of his case. There was a sufficient number of demonstrably false statements in the Consent Order to call into serious question the main contention of the Consent Order, that is, that Claimant Mittal was culpable in the manner described in the Order. Based on the evidence presented, the compensatory damages awarded under the breach of contract claim are inadequate. Furthermore, Claimant stated a valid claim for tortious interference with business relationship with regard to both AQR and other potential employers. Compensatory damages should have been awarded under that claim. In addition, ITG's willful and malicious conduct toward Mr. Mittal indicates that punitive damages in an amount at least equal to compensatory damages should have been awarded. 


The following is but a brief response to the dissenting arbitrator's statement regarding the Panel's July 15, 2019 ruling on Respondent's motion to preclude. That ruling provided, in relevant part, that Claimant was precluded from challenging the veracity of the SEC Order on its direct case, but expressly provided that the Panel would rule on the admissibility of evidence offered to rebut the defenses asserted by the Respondent in connection with the Order. In fact, as the record in this case amply demonstrates, under the liberal application of this ruling at the hearing, Claimant was afforded a fair and full opportunity to present evidence in support of each of his claims and to rebut Respondent's defenses, including evidence challenging the factual underpinnings of the SEC Order - both on his direct case and on rebuttal. The intention and effect of the ruling was to limit the introduction of evidence regarding the SEC Order to the claims at issue in this arbitration, rather than conducting an unbridled re-evaluation by the Panel of the SEC's investigation into ITG and the ensuing Consent Order

Bill Singer's Comment: Yet another in a long line of FINRA intra-industry Arbitration Decisions that tease us with the underlying facts in dispute. If you go back and read -- and re-read -- the FINRA Arbitration Decision, you will learn NOTHING whatsoever as to what constituted the specifics of the parties' dispute. Why did Mittal sue? What did he allege that ITG had done to him? What was involved in the referenced SEC Order? Who was named in that SEC Order? I fully understand that there are those who will continue to argue that mandatory FINRA arbitration affords privacy and confidentiality to disputes. I will continue to argue that FINRA's enforced, mandatory intra-industry arbitration wrongly hides the industry's dirty laundry from similarly situated associated persons and from public customers seeking to do due diligence on registered persons and member firms. 
Online FINRA BrokerCheck records as of October 25, 2019, disclose that Mitttal was registered with ITG from June 2004 through August 2011. As set forth in part in "ITG Paying $24 Million for Improper Handling of ADRs" (SEC Release / January 12, 2017)

The SEC's order finds that ITG facilitated transactions known as "pre-releases" of ADRs to its counterparties without owning the foreign shares or taking the necessary steps to ensure they were custodied by the counterparty on whose behalf they were being obtained.  Many of the ADRs obtained by ITG through pre-release transactions were ultimately used to engage in short selling and dividend arbitrage even though they may not have been backed by foreign shares.  ITG's improper handling of ADRs lasted from 2011 to 2014.
. . .

The SEC's order finds that ITG violated Section 17(a)(3) of the Securities Act of 1933 and failed reasonably to supervise its employees on its securities lending desk.  Without admitting or denying the findings, ITG agreed to be censured and pay more than $15 million in disgorgement plus more than $1.8 million in interest and a penalty of more than $7.5 million.  The SEC's order acknowledges ITG's cooperation in the investigation and its remedial acts. 

Is the SEC's $24 million settlement with ITG the matter referenced in the Order at issue in Mittal v ITG? I dunno. The FINRA Arbitration doesn't deign to inform us of that nugget. As to what prompted Mittal's lawsuit against ITG and what, if anything, it had to do with the SEC settlement noted above -- alas, that too is not referenced in the FINRA Arbitration Decision. 

For some sense of what prompted the lawsuit, you might consider:

Hedge Fund AQR Fires Trading Head Linked to ITG Probe / The SEC brought an enforcement action against a former employer (The Wall Street Journal / August 12, 2015)

AQR's Ex-Head of Trading Sues Broker He Says Derailed His Career ( / July 31, 2018)

Ex-tech honcho claims firm ran ‘smear campaign' against him (New York Post / July 31, 2018)

FINRA Fines BNP Paribas Securities Corp. and BNP Paribas Prime Brokerage, Inc. $15 Million for AML Program and Supervisory Failures (FINRA Release)  
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, BNP Paribas Securities Corp. and BNP Paribas Prime Brokerage, Inc  submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In accordance with the terms of the AWC, FINRA imposed upon the Respondents a $15 million fine for anti-money laundering program and supervisory failures involving penny stock deposits and resales, and wire transfers, that spanned four years; and the firms are required to certify within 90 days that their procedures are reasonably designed to achieve compliance in these areas. As alleged in part in the FINRA Release:

[F]rom February 2013 to March 2017, despite its penny stock activity, BNP did not develop and implement a written AML program that could reasonably be expected to detect and cause the reporting of potentially suspicious transactions. Until 2016, BNP's AML program did not include any surveillance targeting potential suspicious transactions involving penny stocks, even though BNP accepted the deposit of nearly 31 billion shares of penny stocks, worth hundreds of millions of dollars, from its clients, including from so-called "toxic debt financiers." BNP also did not implement any supervisory systems or written procedures to determine whether resales of securities, including the penny stocks deposited by its customers, complied with the registration requirements of Section 5 of the Securities Act of 1933. As a result, BNP facilitated the removal of restrictive legends from approximately $12.5 million worth of penny stocks without any review to evaluate the transactions for compliance with Section 5.

During the same period, BNP processed more than 70,000 wire transfers with a total value of over $230 billion, including more than $2.5 billion sent in foreign currencies. BNP's AML program did not include any review of wire transfers conducted in foreign currencies, and did not review wires conducted in U.S. dollars to determine whether they involved high-risk entities or jurisdictions.

BNP's AML program also was understaffed. For example, although BNP effected more than 70,000 wire transfers during a two-year period, with a total value of $233 billion, during a majority of that period, only one investigator was tasked with reviewing alerts relating to wires originating from BNP's brokerage accounts. Although BNP identified many of these deficiencies as early as January 2014, BNP did not fully revise its AML program until March 2017. As a result, BNP did not identify "red flags" indicative of-or review-potentially suspicious activity involving the deposit and sales of penny stocks or foreign wire transfers that may have required the filing of a suspicious activity report.
In an Indictment filed in the United States District Court for the District of New Jersey, Gene Levoff, 45, was charged six counts of securities fraud and six counts of wire fraud. Previously, the SEC filed a civil Complaint against Levoff. As alleged in part in the DOJ Release:

Between February 2011 and April 2016, Levoff - the top corporate attorney at "Company-1," who also served as the company's assistant secretary and corporate secretary -allegedly misappropriated material, nonpublic information about Company-1's financial results and then executed trades involving the company's stock. This scheme to defraud Company-1 and its shareholders allowed Levoff to realize profits of approximately $227,000 on certain trades and to avoid losses of approximately $377,000 on others.

Levoff used his position as a member and co-chairman of Company-1's Disclosure Committee - which reviewed and discussed the company's draft quarterly and yearly earnings materials and periodic U.S. Securities and Exchange Commission (SEC) filings before they were disclosed to the public - to obtain material, nonpublic financial information about Company-1. Levoff used this confidential information to buy and sell stock in Company-1 ahead of its quarterly earnings announcements. When Levoff discovered that Company-1 had posted strong revenue and net profit for a given financial quarter, he purchased large quantities of stock, which he later sold for a profit once the market reacted to the news. When he learned that Company-1 had posted lower-than-anticipated revenue and net profit, he sold large quantities of Company-1 stock, avoiding significant losses.

Levoff was subject to Company-1's regular quarterly "blackout periods," which prohibited individuals who had access to material nonpublic information from engaging in trades until a certain period after the company disclosed its financial results to the public. Levoff ignored this restriction, as well as the company's broader Insider Trading Policy - which he was responsible for enforcing - and instead repeatedly executed trades based on material, nonpublic information without Company-1's knowledge or authorization. On several occasions, Levoff executed trades within a blackout period after notifying other individuals subject to the restriction that they were prohibited from buying or selling Company-1 stock until the blackout period terminated.

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Bruce K. Lee submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. Lee entered the industry in 1984, andby 2011, he was registered with FINRA member firm Merrill Lynch, Pierce, Fenner & Smith Incorporated, where he remained until April 2018. In accordance with the terms of the AWC, FINRA imposed upon the Lee a $15,000 fine; an 18-month suspension from association with any FINRA member firm in any capacity; and a requirement that within 60 days of his re-association, he will complete 10 hours of CE.  As alleged in part in the FINRA AWC, during the relevant period between June 2014 and March 2018:

[L]ee was a Managing Director in the Firm's Private Banking and Investment Group. As a registered representative, Lee was required to personally complete his assigned Firm Element CE modules and other assigned training throughout the year by certain deadlines set by the Firm. For 29 CE modules assigned to him by the Firm during the Relevant Period, Lee instructed two members of his staff, a financial analyst and a client associate, to complete the CE modules on his behalf, rather than completing the modules himself. 

Specifically, Lee instructed his staff to complete the following seven Firm Element CE modules on his behalf: 2016 "Annual Compliance Discussion Video and Acknowledgment" module; 2016 and 2017 "Key Policy Review" modules; 2017 "Regulation GG: Unlawful Internet Gambling Enforcement Act" module; 2017 "Deceased Customer Notification" module; and 2016 and 2017 "Product and Sales Practices" modules. In addition, Lee instructed his staff to complete eight CE modules required by laws and regulations apart from FINRA Rule 1250(b). For example, these modules covered topics including: United States Federal Reserve Regulation W; the 2016 Fair Credit Reporting Act; financial crimes compliance; and the Department of Labor  Fiduciary Rule. In addition, Lee instructed his staff to complete 14 CE modules required by the Firm. These modules covered topics including: the Merrill Lynch Code of Conduct; market-linked investments; risk appetite; business continuity awareness; and information protection. 

At Lee's direction, these individuals ensured that the above-referenced training was completed on Lee's behalf, and Lee did not complete this training himself. As a result of the foregoing, Lee violated FINRA Rule 2010.