Securities Industry Commentator by Bill Singer Esq

August 15, 2019

Have You Met One Alhaji the Big Cattle and Dairy Farmer?
In the 1949 film classic "The Third Man," we come across one Harry Lime (played by Orson Welles), who dilutes penicillin he has stolen from hospitals in occupied Vienna and sells the useless medicine on the black market. As the police close in on him, Lime launches into a monologue belittling the fate of his victims and extolling the virtues of immorality. That was then. Now . . . we have an online world of Harry Lime hustlers. Okay, look, I get these idiot spam emails multiple times a day. You do too, right? Every so often, a particular bit of jackassery catches my eye. Here is such a bit of crapola from my email inbox:

Contract Supply

David Pascal via 


I wish to introduce you to a very lucrative business. I worked as a product sourcing manager with an import and export company here in Cote d'Ivoire.In a business seminar I attended sometimes in 2014, I met one Alhaji, who is the president & CEO of a big cattle and dairy farm here in my country. Alhaji informed me that he needed a particular vaccine which he usually buys at USD2,000 per carton and he buys up wards of 3000 cartons every three months. Back in my office, I carried out a market research and discovered that we could purchase this medicine cheaper somewhere in Europe for US$575.00 per carton.

I discussed this proposal with my boss and he decided to handle the supply by himself.We moved a proposal to Alhaji to supply him with this vaccine at US$1,500.00 per carton which he accepted.My boss has supplied this vaccine to Alhaji for more than four times now, making a very huge profit.My problem now is that my boss has vehemently refused to pay me my share of the profit as we agreed.As a result of this, I decided to arrange with Alhaji to link him to the real producers of the vaccine who will give him the vaccine at a cheaper rate. After my discussion with Alhaji, I offered to supply him the vaccine at a cheaper rate of USD1,250 per carton of 12 bottles. Alhaji accepted my offer and now wants to place order for more than 3650 cartons of the vaccine. Right now, Alhaji has stopped all communications with my boss.

I therefore wish to present you as my foreign contact so that you can handle the supplies to Alhaji. If you can handle the contract, kindly contact me immediately for details and negotiations on what is going to be my commission.We will get the medicine from the producers at US$575 and supply to Alhaji at US$1250 per carton of 12 bottles(500ml).Alhaji also agreed to make a down payment of 70% of his total order to your company for the procurement of the vaccine.

Thanks and God bless you.

David Pascal
In today's blog we consider two nearly identical FINRA public-customer arbitrations. In both cases, the FINRA member firms were left holding the bag when the customers left debits in their accounts. The brokerage firms appeared at the arbitration hearings. The customers didn't. You'd expect the same result in each case. Ahhh . . . life is filled with surprises! Sometimes you have a wide-open slam dunk and you jam it through; other times, you choke and the ball clangs off the rim.

Effex Capital, LLC, et al., Plaintiffs/Appellants, v. National Futures Association, (Opinion, United States Court of Appeals for the Seventh Circuit, No. 18-1914)
As set forth in the "Syllabus" to the 7Cir Opinion [Ed: footnotes omitted]:

RIPPLE, Circuit Judge. Effex Capital, LLC ("Effex"), brought this action alleging that the National Futures Association (the "NFA") had defamed it in documents related to a settlement between the NFA and one of its members, Forex Capital Markets, LLC ("FXCM"). It sought injunctive relief and damages. The district court dismissed the action, holding that Effex had failed to exhaust its administrative remedies. Effex timely appealed the district court's dismissal.   

For the reasons set forth more fully in the following opinion, we now affirm the judgment of the district court. In the Commodity Exchange Act, 7 U.S.C. § 1 et seq., Congress has regulated comprehensively all matters relating to NFA discipline. As such, a federal Bivens remedy is unavailable.Further, the Commodity Exchange Act preempts Effex's state law claims. Any remedy available to Effex must be based on the provisions of that statute. 

By way of brief background, Effex is a closely held, foreign‐currency trading firm managed and controlled by John Dittami, and the firmt is not an NFA member and is not subject to NFA regulation. Following an NFA investigation of its member firm FXCM, the firm settled charges and, accordingly, NFA released various documents attendant to that settlement including a press release. As set forth in the 7Cir Opinion [Ed: footnotes omitted]:

The NFA's complaint against FXCM alleged that FXCM failed to comply with a litany of NFA rules. More pertinent‐ ly, the NFA claimed that Effex was involved in the miscon‐ duct allegedly committed by FXCM. The resulting decision outlined the allegations in the complaint, including those involving Effex, and accepted them as true. The accompanying narrative summarized the decision, including its statements about Effex. The press release, although it did not specifical‐ ly reference Effex, noted that FXCM committed numerous deceptive and abusive actions and directed the public to the narrative on the NFA's website. Effex alleges that the NFA's findings in the FXCM Settlement Documents are false and that their publication is defamatory. 

Although its investigation into FXCM implicated Effex, the NFA did not contact Effex or provide Effex with notice of the investigation. The CFTC, on the other hand, conducted its own investigation into FXCM. As part of its investigation, the Commission subpoenaed documents from Effex and took the deposition of Mr. Dittami and other Effex employees. Effex alleges that the NFA obtained documents necessary for its investigation from the CFTC despite Effex's re‐ quest that its responses as a third party be kept confidential.   

On the same day that the NFA announced its settlement with FXCM, the CFTC issued its own decision about FXCM and its business practices. It determined that FXCM had concealed an improper trading relationship with a "high‐ frequency trader" and a company the trader formed (which the Commission termed "HFT Co").15 Although not explicitly named, the HFT Co is Effex. The CFTC found materially the same facts as the NFA did regarding Effex. 

Effex did not seek review of either the NFA's decision or the Commission's decision regarding FXCM. Rather, four months after the decisions were released, Effex filed this ac‐ tion against the NFA in the district court.

Pages 9 - 10 of the 7Cir Opinion

On July 31, 2017, Effex sued NFA in the United States District Court for the Northern District of Illinois ("NDIL") alleging, in part, that the self-regulator had violated the company's due process rights by failing to provide notice of its investigation or an opportunity for a hearing -- and Effex further alleged that the NFA published defamatory materials about it.  In rejecting Effex's claims, the district court noted that [Ed: footnotes omitted]:

[T]he CFTC had the ability to adjudicate due process claims. Moreover, the court acknowledged that even though the Commission rarely re‐ views NFA settlements, it previously had reviewed settle‐ ments. Finally, observing that Effex's claims "touch on the contents of the NFA Publications-documents generated as a result of the NFA investigation relating to a disciplinary action,"21 the district court rejected Effex's contention that it was not seeking review of an NFA disciplinary action but rather merely was seeking a court order regarding the publication of the FXCM Settlement Documents containing the alleged defamatory statements.   

Pages 13 - 14 of the 7Cir Opinion

In affirming NDIL's judgment, 7Cir characterizes key aspects of the appeal as follows [Ed: footnotes omitted]:

[E]ffex does not maintain that there is a specific federal cause of action to redress harm inflicted by an SRO upon one of its members. Rather, it asks that we imply a cause of action to remedy harm to a nonmember (such as Effex) resulting from an SRO proceeding. It casts this cause of action as one to remedy a due process violation under Bivens v. Six Unknown Named Agents of Federal Bureau of Narcotics, 403 U.S. 388 (1971). Bivens recognized a damages remedy to compensate persons injured by the federal officers who violated the Fourth Amendment even though the Amendment does not provide for money damages "in so many words." Id. at 395- 97. In doing so, the Court noted that Congress had not explicitly foreclosed a damages remedy and that there were no "special factors" counseling against authorizing such a remedy to effectuate the statute's purpose. . . . 

Pages 14 - 15 of the 7Cir Opinion

The Court then notes that the United States Supreme Court has consistently refused to extend Bivens and deemed such excess a "disfavored judicial activity." Expressing a rationale that I have difficulty understanding or reconciling, the 7Cir finds in pertinent part as follows [Ed: footnotes omitted]:

An entity that was not a party to the SRO proceeding is no doubt in a somewhat different position than a party to the proceeding. We do not believe, however, that the difference is so significant that such an entity can maintain a judicially created cause of action against the SRO for harms that the nonparty claims to have suffered as a result of disciplinary proceedings. Such a view presupposes a very narrow, and in our view too narrow, understanding of the scope of the Commodity Exchange Act. Effex offers no explanation or support for why Congress, having established a comprehensive mechanism for the governance of the commodities industry, would permit disruption of that mechanism through a judicially created cause of action. 

Indeed, as the CFTC points out in its brief as amicus curiae, Congress has decided that a "person aggrieved" by the SRO's action may seek redress before the Commission. See 7 U.S.C. § 21(h)(2). To determine who falls within the scope of the provision, the CFTC submits that, like other statutorily created causes of action, there must be an inquiry into the zone‐of‐interests sought to be protected by the Commodity Exchange Act. See Lexmark Int'l, Inc. v. Static Control Components, Inc., 134 S. Ct. 1377, 1388 (2014). This inquiry utilizes "traditional tools of statutory interpretation," id. at 1387, and "the breadth of the zone‐of‐interests varies according to the provisions of the law at issue," id. at 1389 (internal quotation marks omitted). The statutory analysis involves "discern[ing] the interests ‘arguably . . . to be protected' by the statutory provision at issue" and then asking "whether the plaintiff's interests affected by the agency action in question are among them." Nat'l Credit Union Admin. v. First Nat'l Bank & Trust Co., 522 U.S. 479, 492 (1998) (quoting Ass'n of Data Processing Serv. Orgs., Inc. v. Camp, 397 U.S. 150, 153 (1970)). Undoubtedly, a "person aggrieved" by an SRO's action always includes a party to the proceedings. And there may be circumstances where a nonparty may fall within the zone‐of‐interests of the statute and therefore have the right to seek redress before the CFTC. Whether a particular entity falls within the zone‐of‐interests protected by the statute is a determination left to the Commission through case‐by‐case administration of the statute.

Pages 17 - 19 of the 7Cir Opinion

In rebuffing Effex's various state-law claims, in part 7Cir finds that:

[A]t bottom, Effex's challenge remains a challenge to the settlement of a disciplinary proceeding before the NFA that was within the NFA's jurisdiction. Effex claims, in essence, that the NFA improperly conducted its disciplinary proceedings. It does not matter whether Effex is a member or nonmember of the NFA or a party or nonparty to the proceedings. Permitting a collateral attack on those proceedings based on Effex's tort claims would impair the NFA's ability to enforce its rules and carry out its regulatory role.  Preemption does not necessarily mean that Effex has no remedy; it means that it must look to the federally mandated review scheme established by Congress. The fact that these remedies may be different from those afforded by state law, or inadequate by comparison, is not of consequence. Congress has the right to determine the remedies available and the individuals who are eligible for those remedies. . .
Pages 25 - 26 of the 7Cir Opinion

Bill Singer's Comment: In my life there are many things that I do not understand. This 7Cir Opinion is one of those incomprehensible facts. When all is said and done, Effex is NOT an NFA member. Effex is NOT subject to NFA jurisdiction. Nonetheless, the federal courts seem to entertain arguments that, to my sensibilities, amount to little more than if-my-aunt-were-a-man-she'd-be-my-uncle. I have reported the Opinion as best I can. I do not agree with its rationale or findings. I suspect the judges could care less as to my concurrence or dissent. About all that I can think of after reading the Opinion is that famous line (which may or may not have been uttered): Eppur si muove

SEC Charges Orange County, California Investment Advisers with Fraud (SEC Release)
In a Complaint filed in the United States District Court for the Central District of California, the SEC charged Stuart Frost and Frost Management Company, LLC with violating the antifraud provisions of Sections 206(1), 206(2), and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-8 thereunder. As set forth in part in the SEC Complaint:

[F]rost and Frost Management Company, investment advisers to five private venture capital funds, raised nearly $63 million for the funds between 2012 and 2016. Frost and Frost Management Company then invested those funds in a portfolio of start-up companies. The start-ups were incubated by Frost Data Capital, LLC, another Frost-owned company, using the so-called "Frost incubator model" and, as such, they paid incubator fees to Frost Data Capital for the purported purpose of providing operational support and other services in anticipation of the companies maturing and ultimately being sold. In reality, as alleged in the SEC's complaint, a significant portion of the incubator fees were used to cover Frost Data Capital's overhead and to pay Frost's exorbitant salary and extravagant personal expenses. When Frost needed more cash to fund his lavish lifestyle, including a personal chef and housekeeper, an archery range, beach club membership, a boat, and luxury cars, he created new start-up companies, invested more fund capital in them, and then used Frost Data Capital to extract additional incubator fees.

As the SEC's complaint alleges, Frost and Frost Management Company violated their fiduciary duties as investment advisers by failing to disclose the existence of the incubator fees or misleadingly representing that the incubator fees would be charged on a case-by-case basis and the charges were at or below market rate for the services. As further alleged, the excessive payment by the start-up companies of over $14 million in fees weakened their financial condition and prospects for success, which, in turn, harmed the funds' investments in those companies. The SEC's complaint also alleges that Frost and Frost Management Company charged two of the funds undisclosed management fees and charged another fund unearned management fees.

SEC Charges Broker-Dealer with Violations of Gatekeeping Provisions Aimed at Protecting Investors (SEC Release)
Without admitting or denying the SEC's findings, broker-dealer Canaccord Genuity LLC consented to an SEC Order that it cease and desist from committing or causing any violations and any future violations of Section 15(c)(2) of the Exchange Act and Rule 15c2-11, imposing a censure and ordering that it pay a $250,000 penalty. As set forth in part in the SEC Release:

[C]anaccord published quotes and made markets in dozens of over-the-counter (OTC) securities without performing the review required by Exchange Act Rule 15c2-11, which requires that broker-dealers have a reasonable basis for believing the prospectus and other information made available by the issuer of the securities was accurate. The order finds that Canaccord delegated to a compliance associate the responsibility to obtain and review the information required by Rule 15c2-11 and to fill out and sign the necessary forms demonstrating compliance with the rule. The compliance associate had no trading experience and no formal training on conducting the requisite review, such as training related to the analysis of financial statements and other information. As a result of the deficient review performed by the compliance associate, Canaccord allowed dozens of OTC securities to be traded in U.S. markets without conducting the review required to protect investors.  Canaccord has since revised and improved its policies and procedures with respect to Rule 15c2-11.

Outside Business Activities Lead to FINRA Fine and Suspension. In the Matter of Leonard J. Kuczynski, Respondent (FINRA AWC 2018059177601)
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, Leonard J. Kuczynski submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In accordance with the terms of the AWC, FINRA found that Kuczynski had violated FINRA Rules 3270 and 2010, and imposed upon Kuczynski a $10,000 fine and a four-month suspension from association with any FINRA member in any capacity. As set forth in part in the AWC:

While associated with Innovation, Kuczynski engaged in three separate outside business activities ("OBAs") for compensation without providing required, prior written notice to the Firm. The undisclosed OBAs were as follows: 

    • Between February 2013 and sometime in 2014, he mentored a colleague and partnered with him to write insurance despite representing in writing to the Firm in 2014 that he would not do so without advance approval. 
    • Between 2014 and August 2017, he sold fixed annuities. 
    • Finally, between 2015 and 2016, he worked for another company through which he sold alternative income products to non-Firm customers. 

Each of the above activities were outside the scope of the relationship with his Firm. Moreover, two of the OBAs were contrary to certifications on his 2015 and 2016 annual compliance questionnaires that he was not engaged in such activity. 

‘Shocking' FINRA elections to feature rarely contested race for large-firm rep (Financial Planning by Kenneth Corbin)
As noted in part in the Financial Planning article:

Brokerage shops will have a rare opportunity to weigh in on who will represent large firms at FINRA as they cast ballots for two members of the regulator's board of governors later this month.

Chris Flint, president and CEO of ProEquities, is vying to upset former Piper Jaffray chairman and CEO Andrew Duff to take one of the large-firm slots, a rarity in what has tended to be an amicable nominating process among representatives of the heavy hitters on Wall Street.

FINRA Small Firm Member Board of Governors Election
Voting Ends August 19, 2019

The FINRA Small Firm community is once again up in arms over the ongoing election for the open 2019 Small Firm Member Board of Governors' seat. "UPDATE: 2019 FINRA Contested Small Firm Election: Vote for Linde Murphy" ( Blog /  July 26, 2019). In this latest dust-up, FINRA's National Nominating & Governance Committee nominated sitting Small Firm Governor Robert A. Muh for re-election and, thereafter, transmitted an email on July 25, 2019, urging eligible voters to support their nominee's candidacy despite the existence of Small Firm Member Petition Candidate Linde Murphy. Murphy needed to obtain the requisite 3%-plus petitions in support of her candidacy, whereas Muh, who previously ran for his first term as a petition candidate, avoided that inconvenient qualifying step by accepting the Nominating Committee's nod. 

Why does any of this matter? 

A Board of 24

The FINRA Board of Governors consists of 24 members: 

  • Chief Executive Officer of FINRA; 
  • 13 Public Governors; 
  • 1 Floor Member Governor; 
  • 1 Independent Dealer/Insurance Affiliate Governor; 
  • 1 Investment Company Affiliate Governor; 
  • 3 Small Firm Governors (1 to 150 registered representatives);
  • 1 Mid-Size Firm Governor (151 to  registered representatives); and 
  • 3 Large Firm Governors (500 or more registered representatives) 

A Powerful Committee

According to FINRA's website:


The Nominating and Governance Committee is responsible for nominating persons for appointment or election to the FINRA Board, as well as nominating persons to fill vacancies in appointed or elected governor seats on the Board. The Committee also nominates Industry and Public members for positions on FINRA's National Adjudicatory Council.

The Committee is responsible for periodically reviewing and recommending changes to standing committee charters and, in consultation with the CEO, nominates the members and chairs of each standing committee of the Board. Also in consultation with the CEO, the Committee develops and recommends to the Board guidelines for effective corporate governance. In addition, the Committee reviews and approves appointments to each of FINRA's advisory committees and changes to the advisory committee enabling resolutions.

3,261 FINRA Small Member Firms

In "Upcoming FINRA Board of Governors Election" (FINRA Election Notice / May 24, 2019), we are informed that:

As of the close of business on Thursday, May 23, 2019, the number of FINRA large firms was 174, and small firms was 3,261.

According to FINRA's online "Statistics", as of June 2019 there were 3,589 Member Firms. As such, FINRA's 3,261 Small Firms account for 91% of the self-regulatory-organization's membership; however, that 91% majority has been allocated only 3 out of 24 FINRA Board of Governors seats -- which amounts to 12.5% of the Board seats for 91% of the organization's member firms! 

The Power to Appoint. The Power to Nominate.

Somewhat lost in all the verbiage of the FINRA Election Notice is this nugget:

Of the 24 Board members, the following seats are appointed by the FINRA Board from candidates recommended by the Nominating Committee: the Public Governors, Floor Member Governor, Independent Dealer/Insurance Affiliate Governor and Investment Company Affiliate Governor (Appointed Governors).

The Nominating Committee also may nominate individuals to run for election for the seven elected governor seats that comprise the three Small Firm Governors, one Mid-Size Firm Governor and three Large Firm Governors (Elected Governors). . . . 

FINRA's Nominating Committee of three industry and four public governors appoints 16 of the Board's 24 Governors (which works out to 67% of the Board): 13 Public Governors and the 1 Floor Member Governor and the 1 Independent Dealer/Insurance Affiliate Governor and the 1 Investment Company Affiliate Governor. In addition, the Nominating Committee "may nominate" the 7 industry governors. Apparently, FINRA's CEO gets a free pass and is neither appointed nor nominated. We should all be so lucky!

91% With Little Proportionate Power -- FINRA's Dirty Little Governance Secret

Consider these extracts from the FINRA Nominating Committee's July 25th email in support of Muh's nomination:

[O]ur committee is comprised of three industry governors and four public governors. . .

The role of the small firm representatives on the Board, representing over 3,200 such institutions, is a crucial one that demands significant industry experience. . . 

The majority of the FINRA board are not from the industry and they have all looked to Bob to get an understanding of the impact of rule proposals on the small firm. . . .

Given how the small firms' Board representatives roles are "crucial" since the majority of FINRA's Board "are not from the industry," it's no small wonder that such non-industry folks would look to Bob Muh in order to "get an understanding," Thankfully Bob sits on the all-power FINRA Nominating Committee. Having been unfairly restricted to disproportionate representation on the Board, at least the Small Firm community has 1 of 7 seats on the all-powerful Nominating Committee, which is about 14% of the Committee's seat and a modest bump-up from the 12.5% of the Board seats. 

Ummm . . . hold on a sec. What???

I see from the 2019 roster of the FINRA Nominating Committee that, in fact, Robert Muh is not a member of the Nominating Committee

So . . . which Small Firm Member Governor is a member of the Nominating Committee? 

I don't see the name of Small Firm Member Governor Stephen A. Kohn. 

I don't see the name of Small Firm Member Governor Page W. Pierce. 

That's all there is. There ain't no more Small Firm Governors. 

Omigod, FINRA engineered its Small Firm Member community out of any Nominating Committee seats! There are three "industry" seats set aside on the Nominating Committee. There are three "industry" categories of Large, Mid-Sized, and Small. Shamefully, there is not a single set-aside for a Small Firm Member Governor to sit on the Nominating Committee.  91% of FINRA's member firms have 0% representation on FINRA's Nominating Committee.

As to the so-called independence of the National Nominating Committee, consider this from "Upcoming FINRA Board of Governors Election" (FINRA Election Notice / May 25, 2018)

FINRA Nominating Committee Nominee

FINRA's Nominating Committee has nominated the following individuals: 

Large Firm Governor Candidate: Timothy C. Scheve, Janney Montgomery Scott LLC 

Mid-Size Firm Governor Candidate: Brian J. Kovack, Kovack Securities, Inc. 

Small Firm Governor Candidate: The Nominating Committee determined it would not nominate a candidate for election in 2018. Instead, any eligible candidates who obtain the requisite number of petitions will be included on the ballot. 

Similarly, as to the Nominating Committee's Chair, consider this from "FINRA Announces Governor Elections and Appointments" (FINRA News Release / August 22, 2017)

At the July 2017 meetings, the Nominating Committee nominated and the Board made a number of appointments to the Board that became effective at the Annual Meeting. Governor Kathleen A. Murphy, President of Fidelity Personal Investing, was appointed to succeed Governor John J. Brennan as the Investment Company Affiliate on the Board. . . 

All three of the industry member firm governors sitting on FINRA's Nominating Committee were appointed or nominated by that same committee, and not one of those appointed/nominated industry governors is designated as a Small Firm Member Governor. 

So those who do the appointing are appointed to appoint those who do the appointing -- and that's a conflict-free, democratic process? 

And that's not designed to marginalize and silence the voice of 91% of the organization's member firms? 

Just imagine how one of the many public companies traded by FINRA's member firms would fare if they proposed to restrict 91% of their public shareholders to 12.5% of their Board seats and shut them out of any role on the Nominating and Governance Committee!

And FINRA wonders why its Small Firm Member community feels isolated?  Why some 3,261 firms feel marginalized? Why the Small Firm community looks upon the Nominating Committee's email as an unwanted interference in a contested election? 

The Protest Vote for Candidate Linde Murphy

Before this whole mess blew up on July 25th, Petition Candidate Linde Murphy submitted a public statement to the Blog by a July 24, 2019, 5 p.m. EDT deadline, (as did Nominee Robert Muh). In her prescient statement, Murphy assured the Small Firm Member community that:


As you know, my name is on the ballot this year because I went through the petition process to get it there.  Let's not forget the efforts of a small group of dissidents that first contested the FINRA nominee years ago.  They fought for the rights of small firms and against what they felt was a nominee handpicked by FINRA. 

At no point in the future would I accept the FINRA nomination for the Small Firm Seat for the Board of Governors.  The person who represents small firms at the board level should go to the members and ask for their support by signing a petition.

The FINRA Small Firm community must send a clear and unequivocal message to FINRA to "remain strictly neutral" when it comes to Small Firm politics.