Presented by the Securities and Investment Professional Liability Practice Group

Legal Update for Securities

Recent Litigation Victories

In a recent FINRA arbitration, Stanley Abel v. Janney Montgomery Scott, FINRA Arbitration No. 14-00018, Sam Cohen (Philadelphia, PA) obtained a directed verdict on behalf of his clients, Janney Montgomery Scott LLC, and its registered representative. The claimant, a public customer, as well as a sophisticated owner of a broker-dealer, alleged that he was being charged an unreasonable and unfair mark-up on municipal bond sales. The claimant further alleged that he was the victim of elder abuse. In granting the motion to dismiss presented at the close of the claimant's case in chief, the arbitration panel found that the claimant failed to present a basis for his claim. The panel recommended expungement of all references to the arbitration from the registered representative's records maintained by FINRA on the grounds that the claim, allegation or information was factually impossible or clearly erroneous. The arbitration panel took the extra step of finding that the mark-ups on the municipal bonds sold to the claimant were not unfair or unreasonable and that the disclosure provided to the claimant was not inconsistent with industry regulations and law at the time of the alleged wrongdoing.


In the News

FINRA Presents Bond Disclosure Revisions for Public Comment

In an effort to increase transparency about potentially hidden markups in bond transactions, FINRA proposed potential rule revisions for public comment. The proposed rule changes, a companion to an almost identical proposal put forth by the MSRB covering municipal bonds, require bond dealers in retail-sized fixed income sales to disclose to customers the price of same-day principal trades in the same security, as well as the difference between that reference price and the customer’s bond purchase price.

Proposed amid growing concerns over non-disclosed markups in riskless principal transactions, the potential rule revisions are open to public comment until January 20, 2015. Riskless principal transactions are trades in securities that involve two identical orders, with one of them being dependent upon receipt, execution or completion of the other.

FINRA has stated that they are seeking public comments on the likely economic implications of the proposed rule changes as well as input on alternative regulatory approaches to the governance of riskless principal transactions. Included among the potential regulatory approaches are potential mark-up disclosure requirements that would be included on a customer’s trade confirmations. 


Wall Street and FINRA at Odds Over FINRA’S Comprehensive Automated Risk Data System

The Securities Industry and Financial Markets Association, a Wall Street lobbying group, has joined in the criticism of FINRA’s announced Comprehensive Automated Risk Data System (CARDS). In a 63-page letter, the group criticized the proposed CARDS program for the projected cost of implementation and the potential cyber security risks associated with the storage of private customer data.

Proposed by FINRA in 2013, CARDS is a data collection system based upon mandated reporting requirements. FINRA intends to introduce the CARDS program in two phases. Phase I will require firms that carry customer or non-customer accounts or clear transactions to periodically submit data in a standardized format relating to those accounts and transactions. Phase II will require brokerage firms to submit client information, including an individual’s investment time horizons, investment objectives, risk tolerance, client’s net worth, client’s birth year and advisor’s compensation.

FINRA hopes that by regularly collecting this data from across the industry, it will be able to perform market-wide risk assessment analytics to determine if securities laws violations are occurring. The Securities Industry and Financial Markets Association, as well as other critics of the CARDS system, argue that the program poses far too great a risk to customers due to the centralization of individual records and information. Despite reassurances from FINRA that the information sought will not include social security numbers or customer names, critics maintain that FINRA will collect sufficient information to recreate a customer’s identity in the case of a breach. Given the number of high-profile data breaches in 2013 and 2014, they further argue that FINRA has not taken adequate precautions to protect the CARDS program and the data it will collect.

Finally, FINRA and the proposal’s critics differ on their expectation of the costs that will be endured by market participants. According to FINRA, it will cost firms between $8 million and $12 million over a three-year period to develop the technology and systems behind the CARDS program. Certain brokers’ annual maintenance costs could range from $76,000 to $2.44 million. Critics of the system point to a study commissioned by the Securities Industry and Financial Markets Association which estimates that the cost to develop the system would be $680 million, while yearly maintenance would likely cost firms $360 million.

Close attention should be paid to this development as the Wall Street lobby has stated that it will not rule out litigation in an attempt to prevent the CARDS proposal from being implemented. 


SEC Poised to Clarify Standard of Care for Investment Brokers and Investment Advisors

The SEC has announced that it will be revisiting the question of whether to establish a uniform standard of care that would cover both investment brokers and investment advisors. Currently, investment brokers or registered representatives are governed by the suitability standard because they receive commissions. Investment advisors, who charge fees, are governed by a fiduciary standard of care as set forth in the Investment Advisors Act of 1940.

According to the National Association of Insurance and Financial Advisors (NAIFA), a uniform standard would result in increased liability, which would in turn result in additional cost to procure liability insurance. The NAIFA argues that this cost would then be passed onto the consumers seeking financial advice. The Securities Industry and Financial Markets Association, as well as notable groups such as the AARP, the Certified Financial Planner Board of Standards, the Financial Planning Association and the National Association of Personal Financial Advisors, are in favor of a uniform standard.

A provision in the Dodd-Frank Act provides the SEC with authority to write a standard-of-care regulation, but so far, the SEC has yet to take action. Many NAIFA members are dually registered as investment advisors and investment brokers. The NAIFA asserts that the nature of these overlapping services exposes its members to various levels of oversight from the SEC and FINRA, including the suitability standards that mandate the provision that investment advice must match an investor's objectives. According to the NAIFA, this overlapping oversight is sufficient enough to protect investors, and additional regulation would require those members who are dually registered to either limit their services or pass the compliance costs through to their customers.

The SEC’s position on a uniform standard bears monitoring. A new uniform standard for conduct would significantly affect the potential liabilities that broker-dealers and their affiliated representatives face. We will be sure to monitor and report on any developments as they occur.    


Recent Decisions

FINRA Arbitration Panel: Goldman Sachs Must Pay Former Brokers Deferred Commissions in Award for Wrongful Termination

A FINRA arbitration panel awarded two former Goldman Sachs’ investment brokers $7.6 million in wrongful termination damages. The two brokers alleged that Goldman Sachs forced them to forfeit deferred commissions to which they were entitled. During the brokers’ affiliation with Goldman Sachs, Goldman changed its compensation plan requiring that a percentage of their commissions be held as restricted stock units that would vest over time. Goldman terminated the brokers’ affiliation before the commissions vested. The panel also awarded $2 million in punitive damages.   


Florida Appeals Court Reaffirms Courts’ Authority to Examine Waiver of Securities Arbitration Claims Where Litigation Activity Has Taken Place

In 2009, the appellees sued the appellant in state court in a securities dispute. The appellant sought to compel arbitration based on the appellees’ brokerage account documents. The appellees opposed arbitration, asserting the pertinent provisions were unenforceable. Following a period of inactivity, the judicial case was withdrawn, and the appellees filed a Statement of Claim with FINRA. The appellant moved in state court to stop the arbitration, arguing that the appellees had waived their right to arbitration by their prior conduct. The trial court ruled in favor of the appellees, ruling that the arbitration panel should hear the challenge, not the court. On appeal, the Florida state appeals court remanded and decided that courts, not arbitration panels, have authority to examine a claim that there was a waiver of the right to arbitrate based on prior litigation. Detailing persuasive Circuit Court decisions, the Florida appeals court noted that courts are best suited to evaluate whether prior litigation activity constitutes a waiver, and this case should be distinguished from the Supreme Court’s ruling in Howsam v. Dean Witter Reynolds, Inc., which should be read to refer only to waiver, delay or defenses arising from non-compliance with contractual conditions precedent to arbitration, and not to claims of waiver based on active litigation in court.




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