Securities Arbitration

Omnibus Accounts Create an Increased Risk of Fraud

November 2, 2020 | By Christopher Keogh

Over the past several years, there has be an increasing number of registered investment advisors and financial advisors using omnibus accounts. In short, an omnibus account allows an advisor to trade the same securities on behalf of multiple clients, while typically identifying in advance which trades are intended for which client accounts. However, in some cases, trades are allocated after they are made. This creates an increased risk of fraud since some firms’ supervisory failures have allowed advisors to “cherry-pick” which accounts get the winning trades, and which accounts suffer losses. The securities fraud lawyers at Rich, Intelisano & Katz, LLP (RIK) won multiple claims against broker-dealers for allowing third parties to engage in this misconduct.

An omnibus account is intended to facilitate large purchase blocks of securities for multiple client accounts. The idea of aggregating or bunching purchases in a single transaction is to obtain more favorable prices, lower brokerage commissions, and create more efficient execution. After the trades are made, the advisor is supposed to allocate the trades to client accounts in accordance with the previously approved allocations. The allocations of trades then should be reviewed by compliance and/or risk management periodically to ensure that accounts are not systematically disadvantaged by this policy.

Unfortunately, some advisors use this policy to scam their clients. Sometimes allocation instructions are submitted after trades are executed, when the adviser has had the opportunity to view the performance of the trade over the course of the day. By reviewing trade performance first, the advisor knows which trades are profitable and which are unprofitable, then can “cherry-pick” – that is to allocate the profitable trades to favored accounts and allocate losing trades to other disfavored accounts.

RIK Files $3 Million Claim Related to the UBS Yield Enhancement Strategy (“YES”)

September 29, 2020 | By Christopher Keogh

Rich, Intelisano & Katz, LLP (RIK) filed a $3 million FINRA arbitration this month on behalf of clients that invested in UBS Financial Services, Inc.’s Yield Enhancement Strategy (YES). UBS claimed the YES Program had minimal risk, but unbeknownst to its customers, the risks of this options trading strategy significantly outweighed any potential gain. Unfortunately, investors around the world lost hundreds of millions of dollars investing in YES.

Although UBS and its brokers claimed the YES Program had limited risk of loss, in actuality, this was a high-risk strategy. UBS implemented the YES Program beginning in 2016 after it recruited a high-profile team of brokers from Credit Suisse with massive up front bonuses. To entice customers to invest, UBS represented that the YES Program was a low-risk way to generate incremental income of 3% to 6% annually (before the deduction of fees). UBS further stated that the Program used protective options trading combinations to create a market-neutral strategy, meaning the Program’s performance would have little correlation to the markets, thereby protecting investors from significant losses. These low-risk and loss protection statements made by UBS contradict the actual risks associated with the Program.

The fact is that the YES Program was a high-risk, complex options strategy that subjected UBS customers to significant market exposure and risk of loss. This complex options strategy involved hundreds of combinations of puts and calls. The complexity of the program and the lack of adequate risk controls exposed YES investors to significant risk of loss – loss that was far beyond the alleged risk protection. Specifically, YES investors were exposed to 15% to 40% of losses depending on their holding period, even though their expected annual income was only 3% to 6%. In sum, YES was not the low-risk, market neutral, downside protection strategy that UBS had stressed to its customers.

FINRA Arbitrations During the COVID-19 Pandemic

April 28, 2020 | By Diane Mall Sammarco

Arbitration at FINRA has long been known as a quicker, more efficient alternative to court litigation of disputes eligible for submission to FINRA’s Dispute Resolution forum. This continues to be true, to an even greater extent, during the COVID-19 pandemic.

Many courts at the federal and state levels, both in New York and across the US, have indefinitely suspended the filing of new nonessential cases during this time. Courts have also frozen the commencement of trials and the perfection of appeals in pending cases. And conferences, depositions and other in-person court appearances cannot take place where social distancing and large-group gathering guidelines are in effect. Thus, both new and pending court cases are in large part on hold until further notice, to protect the safety of parties, court personnel and the public.

At FINRA, however, the processing and handling of arbitration cases is primarily done electronically, with very little need for in-person contact until the final hearings on the merits. Even during the current unprecedented situation, parties can still file new cases at FINRA using the Dispute Resolution Portal, and can choose arbitrators and engage in discovery. Because FINRA arbitration does not allow for depositions except in extraordinary circumstances, the discovery process and exchange of documents and information can be done completely remotely and electronically, and without delay. Parties or potential parties should be reassured that their new or already-pending cases will continue to be administered as they were before the current pandemic.

Beware of Indirection at “Self Directed” Investment Firms

April 15, 2020 | By John G. Rich

We are increasingly hearing from investors who say that their investment representative at their “self directed” broker dealer—such as T.D. Ameritrade—recommended an outside investment advisor who was not formally affiliated with the firm and incurred investment losses as a result.

There could be many reasons why this may happen: the investment representative may have a financial arrangement with the advisor, or a personal relationship, or even just trying to be helpful. However, this is a problem that is obviously foreseeable for such firms, and sometimes lands an unwitting investor with a fraudster. In fact, such firms discourage their investment representatives from giving any investment advice because that can expose them bring to potential liability if the advisor or advice is unsuitable or fraudulent. Nevertheless, investment representatives sometimes make recommendations of outside unaffiliated advisors to their customers. The question is can the firm be legally responsible if the recommended advisor’s strategy is not suitable or fraudulent. The general rule is that if an investment representative recommends that a customer use an outside advisor, or even brings such an advisor or her strategy to the attention of the customer, the firm may be liable in FINRA arbitration to the customer if the advisor/strategy is unsuitable or fraudulent and losses are incurred as a result.

Brokerage firms that use the self directed business model try to protect themselves by inserting language in their client agreements that purports to absolve them of such liability. However, FINRA frowns on brokerage firm attempts to insulate themselves contractually for liability resulting from breach by their registered representatives of industry rules, such as the suitability rule. In addition, at least one FINRA panel has awarded damages against T.D. Ameritrade in just such a case. https://www.finra.org/sites/default/files/aao_documents/18-01404.pdf

Margin Call Disputes Primer

March 19, 2020 | By Ross B. Intelisano

Margin call disputes often arise during times of market turmoil such as now. Knowing what to do and whom to speak to when a margin call is issued is vitally important to an investor’s financial well-being. Here is a little primer on what to do.

A margin call often occurs when the value of an investor’s margin account falls below the broker dealer’s required amount. A margin call is the broker dealer’s demand that an investor deposit additional money or securities so that the value of the account is brought up to the minimum value, which is known as the maintenance margin. Some margin calls are small and an investor simply has to move securities in from another account or write a check to the broker. However, in other situations, the acts by the broker dealer prior to the margin call being issued may have played a role in the margin call itself.

For example, a conservative investor often should not be holding any securities on margin at a brokerage firm. If the firm recommended an unsuitable investment strategy that contained a significant amount of margin, and the market turned bad, and the investor sustained losses, said investor may have a potential FINRA arbitration claim against the broker. In these situations, when a margin call is issued on the account, we highly recommend that the investor call a law firm such as ours who regularly represents investors in disputes with the financial industry. It is paramount that the investor receives legal advice as soon as possible. Most broker dealers have very broad powers in how to handle margin calls pursuant to onerous margin agreements. The brokers sometimes even blow out investors’ portfolios without providing any notice (though they are supposed to exercise good faith in any decision they implement). Time is usually of the essence. It is important to have counsel engage with the broker dealer as soon as possible to potentially work out any issues.

Beware of Investment Advisor “Recommendations” from Securities Firms that Specialize in “Self Directed” Trading Accounts.

January 29, 2020 | By John G. Rich

Many firms, such as TD Ameritrade, Charles Schwab and Fidelity, whose business model includes or is tailored primarily to investors who want the benefits of a self-directed account also offer to introduce investors who wish independent investment advice to professional investment advisors who are technically “unaffiliated” with the firm. Such investment advisors are often small SEC Registered Investment Advisors (“RIA”s) who are thinly capitalized and have supervisory systems that are well below FINRA broker dealer standards. The brokerage firms contract with such RIAs to be on their platforms and available to provide advice to customers that the firm introduces them to. Those contracts are often designed to, among other things, insulate the brokerage firm from liability for investment advice given to the investor. This is so even though the brokerage firms vet such advisors, who become part of a “platform” they market to investors. Investors who are “introduced” by their firm to an RIA who will provide them investment advice may not realize that the firm’s position is that if the advice is inappropriate the RIA and not the firm is legally responsible. Indeed, the firms structure their contracts with the customer as well as the RIA to give them this protection. Customers can be easily misled by such “introductions” into believing that the firm stands behind the RIA. Although the legal documents, couched in legalese, may so specify, the customer, who often does not read all the legalese in these documents, can be forgiven for believing that the firm that recommended the advisor and investment plan should have some responsibility if that advisor acts improperly. Investors at such firms need to know that they are taking a risk that if their firm recommended RIA gives them unsuitable advice they may be stuck suing a potentially judgment proof RIA in court (rather than the more cost effective FINRA arbitration).

Split Decision on Arbitration in Bank of America Case

June 19, 2015 | By Jessica A. Murzyn

This week, a Florida appeals court partially reversed a ruling denying Bank of America’s efforts to arbitrate various claims related to the Scott Rothstein Ponzi scheme. Bank of America, N.A. v. Beverly, Nos. 4D14-3167, 4D14-3168 (Fla. Dist. Ct. App. June 10, 2015). The appellate court ordered arbitration in a case brought by Douglas Von Allmen, a long-time customer of Bank of America, who alleged that the bank’s improper advice led him to invest in a feeder fund to the Rothstein Ponzi scheme. Von Allmen had entered into a loan agreement with the bank that had a broad arbitration clause, which the court found to be enforceable.

In a second case consolidated for purposes of appeal, the Florida court refused to order arbitration in a case against Bank of America brought by plaintiffs who had no relationship to Bank of America, but who alleged that the bank’s advice to Von Allmen propped up Rothstein’s Ponzi scheme. The court found that these plaintiffs, who were non-signatories to any agreement with Bank of America, could not be forced into arbitration.

For a potential plaintiff, knowing whether your dispute arises from an agreement and whether that agreement has an enforceable arbitration clause can save not only time but also legal costs.

Broker Dealers Try to Avoid FINRA Arbitration: Heads I Win, Tails You Lose

April 10, 2015 | By Rich, Intelisano & Katz

There has been a spate of litigation in recent years over whether broker dealers can contract out of FINRA arbitration and litigate in court instead. Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, 764 F.3d 210 (2d Cir. 2014) is a recent example in the Second Circuit. Since 1989 the courts have blessed industry mandated FINRA arbitration as contained in the industry’s standard form customer agreement. Thus, investors effectively have no choice but to resolve investment disputes through arbitration. The industry has benefited from less costly and efficient arbitration and the avoidance of jury verdicts, and until recently, the FINRA rule requiring an industry representative on every panel. The trade off to enforcement of mandatory arbitration in favor of the industry was supposedly a fair and more efficient dispute resolution process for the investor.

Now, however, as FINRA reforms over the years have made arbitration more fair for investors, and as the cases brought against broker dealers have become larger and more complex, the industry is shifting strategy and attempting to have large and complex cases litigated in court. The means of choice for the industry to accomplish this are court forum selection clauses in contracts brokers obtain from the investor in an effort to trump any FINRA arbitration requirement.

Why would the industry like to be able to escape FINRA arbitration in a large and complex case? The answer lies in the nature of the investment documents usually associated with these cases which investors are required to sign as part of complex investment purchases. These investments typically have standard form risk disclosures which investors must acknowledge before investing. Such disclosures can sometimes be fatal to a court claim where they often form the basis for a motion to dismiss the case before discovery or trial, based on the more stringent pleading requirements of court litigation. In FINRA arbitration, on the other hand, absent rare circumstances, the investor is guaranteed a hearing on her case and motions to dismiss are not allowed.

Morgan Stanley Likely Will Face Lawsuit by New York Attorney General Related to its Mortgage Bonds; Reaches Agreement to Settle Federal Mortgage Claims

March 5, 2015 | By Jessica A. Murzyn

Reuters reports that Morgan Stanley’s annual 10-K, filed March 2, 2015, indicates that the New York Attorney General intends to file a lawsuit related to 30 subprime securitizations sponsored by the company. This follows lawsuits and similar allegations by attorneys general in California, Virginia and Illinois. The New York Attorney General indicated that the lawsuit would allege that Morgan Stanley misrepresented or omitted material information related to the due diligence, underwriting and valuation of loans and properties. In the 10-K, Morgan Stanley stated that it does not agree with the allegations.

Morgan Stanley also reached a $2.6 billion agreement in principle last month with the U.S. Department of Justice and the U.S. Attorney’s Office for the Northern District of California to resolve claims related to what it called “residential mortgage matters.”

It remains to be seen whether investors will reap any of the benefits of these government actions seeking to mend the damage done by the subprime mortgage crisis and the proliferation of mortgage-backed securities (MBS), residential mortgage backed securities (RMBS), and collateralized debt obligations (CDOs).

Securities Arbitration Award Against Merrill Lynch Upheld

February 19, 2015 | By Ross B. Intelisano

This week, the New Jersey Supreme Court denied the appeal of an arbitration award against Merrill Lynch by the Associated Humane Societies Inc. of Tinton Falls, N.J. In the original FINRA arbitration, the society alleged that certain of its investments were improper, it improperly sustained penalties and other charges when the investments were liquidated, its accounts were improperly managed and churned, and it was overcharged for management of its accounts. The society sought $10 million in punitive damages, $872,171 in compensatory damages and $544,299 in attorneys’ fees. After an 18-day hearing, the FINRA panel found in favor of the society, but awarded it only $168,103 in compensatory damages and $126,077 in punitives.

The society appealed. A 3-judge appellate division panel upheld the award in October, finding that the FINRA panel did not abuse its discretion. Associated Humane Societies, Inc. v. Merrill Lynch, Pierce, Fenner & Smith, Inc., No. L-4376-13 (Oct. 29, 2014). The New Jersey Supreme Court denied any further appeal on Feb. 17, 2015.

Though the society was ultimately disappointed with the size of the award, the decision shows the reluctance of courts to disturb FINRA arbitration awards.