Securities Industry Commentator by Bill Singer Esq

December 29, 2020

SEC Obtains Emergency Asset Freeze, Charges Crypto Fund Manager with Fraud (SEC Release)
As set forth in the 8Cir's Syllabus [Ed: footnote omitted]:

Gary Luis, Caryl Luis, Gary A. Mentz, Michael J. Vitse, and Merri L. Vitse are former clients of RBC Capital Markets, LLC. Through RBC, the clients invested in reverse convertible notes (RCNs). The clients, individually and for a purported class, sued RBC for breach of contract. The clients alleged that RBC breached its duties to comply with Financial Industry Regulatory Authority (FINRA) rules and to know the clients' investment profiles. RBC moved for summary judgment, asserting that the plain language of the Client Account Agreement did not create either duty. The district court granted summary judgment to RBC. The clients appeal. Having jurisdiction under 28 U.S.C. § 1291, this court affirms.

By way of background concerning the nature of the RCNs at issue, consider this excellent summary:

RBC purchased RCNs on behalf of the clients. RCNs are "a complex 'structured financial product,' that combine the consistent interest rate payments of a bond with the inherent riskiness of a stock." Id. at 820. "[W]hen an investor buys an RCN, they are not buying a traditional bond-they are betting that a reference stock (or basket of stocks) will stay at a certain price level, and are then receiving above-market 'interest rate payments' in exchange for taking one side of that bet." Id. (emphasis in original). Because of a substantial risk of loss of the principal, RCNs are "perhaps the riskiest" structured financial product available to retail investors. Id. 

at Page 3 of the 8Cir Opinion

By way of context, the 8Cir notes that:

In an earlier case against RBC, the clients asserted claims of common law fraud, fraudulent concealment, violations of the Minnesota Securities Act, common law negligence, breach of fiduciary duty, and breach of contract. See Luis v. RBC Capital Markets, LLC, 2016 WL 6022909, at *2 (D. Minn. 2016). The clients' claims centered around the allegation that "RBC engaged in a series of actions designed to hide the true risk of [RCNs] from investors, while pushing them on individuals who had expressly indicated an unwillingness to partake in options trading." Id. The district court dismissed the clients' claims because they were precluded by the Securities Litigation Uniform Standards Act of 1998. See id. at *7. 

The clients again sued RBC for breach of contract, alleging that RBC failed to comply with FINRA rules and guidance by not following internal guidelines on RCNs and by pushing RCNs on ineligible clients. Luis, 401 F. Supp. 3d at 827. They argued that Paragraph 16 of the Agreement created a contractual duty that RBC comply with FINRA rules. The clients also argued that the Agreement and Client Account Information form together created an implied duty that RBC "know your customer." The district court granted summary judgment to RBC, ruling that the Agreement did not create a duty that RBC comply with FINRA rules and that the clients did not have a cause of action to enforce them. Id. at 832.

at Pages 5 - 6 of the 8Cir Opinion

In ultimately affirming the District Court's judgment, 8Cir found that:

Any duty that RBC know its customers is based in FINRA Rules, not the Agreement. See FINRA Rule 2090 (the rule, titled "Know Your Customer," states: "Every member shall use reasonable diligence, in regard to the opening and maintenance of every account, to know (and retain) the essential facts concerning every customer and concerning the authority of each person acting on behalf of such customer."). As discussed, RBC does not have the contractual duty to comply with FINRA rules. RBC did not breach a contractual duty to know its customers.

at Page 13 of the 8Cir Opinion

Bill Singer's Comment: I'm struck by one puzzling and actually troubling assertion by the federal appellate court:

FINRA enforces its rules through administrative proceedings and arbitration. See FINRA Rule 8310 (giving FINRA the authority to impose sanctions on broker-members for violations of FINRA rules); FINRA Rule 12200 (giving a client the authority to compel arbitration for disputes between the client and the broker-member). In 2015, after investigating the sale of RCNs to clients, FINRA entered into a consent decree with RBC. Between 2008 and 2012, RBC approved "approximately 364 [RCN] transactions in approximately 218 customer accounts" that were unsuitable for those customers under RBC's internal guidelines on suitability. Luis, 401 F. Supp. 3d at 824 (citation omitted). RBC paid a $1,000,000 fine to FINRA and $433,898.10 in restitution to harmed clients. Id.

at Page 5 of the 8Cir Opinion

FINRA may well enforce its rules through its own administrative proceedings but I would pointedly and vociferously disagree with the 8Cir's assertion that the self-regulatory-organization "enforces its rules through . . . arbitration." Not only is FINRA NEVER, EVER a party in its own arbitration forum but FINRA Code of Arbitration Procedure for Customer Disputes Rule 12200 provides for the mandatory arbitration of a customer dispute per a written agreement, or, in the absence of same, if requested by a customer invoking a "dispute" with a member or associated person and in connection with said member's/associated person's business activities. That's hardly a mechanism by which a Wall Street regulator enforces its regulatory rulesFinally, I have pointedly criticized the disclaimer below, which FINRA has forcibly inserted atop each and every Arbitration Award of recent vintage:

Awards are rendered by independent arbitrators who are chosen by the parties to issue final, binding decisions. FINRA makes available an arbitration forum -- pursuant to rules approved by the SEC -- but has no part in deciding the award

If FINRA "has no part in deciding the award" rendered by independent arbitrators at its FINRA Dispute Resolution Services, then I'm not quite sure how or why the 8Cir asserts that FINRA enforces its regulatory rules through its arbitration forum. More to the point, the 8Cir's bizarre statement about FINRA's regulatory role via its arbitration forum is all the more puzzling because the Class Action at issue is not being contested before FINRA's Dispute Resolution Services and the substantive issue before the federal district and appellate courts is, in part, dependent upon the applicability of a substantive FINRA regulatory rule (the "Suitability Rule").

SEC Obtains Emergency Asset Freeze, Charges Crypto Fund Manager with Fraud (SEC Release)
In a Complaint filed in the United States District Court for the Southern District of New York, the SEC charged charges Stefan Qin, Virgil Technologies LLC, Montgomery Technologies LLC, Virgil Quantitative Research LLC, Virgil Capital LLC, and VQR Partners LLC with violations of the antifraud provisions of the federal securities laws.  As alleged in part in the SEC Release:

[Q]in and his entities have been defrauding investors in the Sigma Fund since at least 2018 by making material misrepresentations about the fund's strategy, assets, and financial condition.  The complaint alleges that the defendants misled investors to believe their money was being used solely for cryptocurrency trading based on a proprietary algorithm, while Qin and the entities used investment proceeds for personal purposes or for other undisclosed high-risk investments. Since at least July 2020, Qin and Virgil Capital have told investors who requested redemptions from the Sigma Fund that their interests would be transferred instead to another fund under the ultimate control of Qin but with separate management and operations, the VQR Multistrategy Fund LP. The complaint alleges that no funds were transferred and the redemption requests remain outstanding. The SEC's complaint further alleges that Qin is actively attempting to misappropriate assets from the VQR Fund and to raise new investments in the Sigma Fund.
President Trump has  Elad L. Roisman as Acting Chairman of the SEC. Since September 2018, Roisman has served as an SEC Commissioner.
Today's blog is less a legal analysis of a case than it is a somewhat pathetic rendering of all that is wrong with Wall Street regulation. Unfolded before us is a tortured tale of miscues and missteps by regulators involving what truly appears to be a record of misconduct by the respondents. So, no . . . it's not as if FINRA's Complaints lacked justification. Frankly, it seems that there was misconduct, some of which was, indeed, serious. On the other hand, the more you read about this mess, you wonder how much of what drove the prosecutions and appeals was fueled by institutional bias against small firms and their management: Would FINRA and the SEC have gone after a large member firm or one of its C-suiters with the same hammer-and-tong approach? I'd like to think that the answer is "yes." On the other hand, history tends to offer us too many examples where the regulation of Wall Street is one of disparate treatment that comes down in a heavy-handed fashion against the industry's small fry. Looking down on the proceedings, and looking back over time, FINRA seems to be pulling wings off of flies, and doing so with disproportionate zeal and joy.