Posts by David Cosgrove

There seems to be a new trend in town: broker-dealers unleashing compliance or “reputation managers” upon rich-target independent branch operators.  Perhaps it isn’t really that new of a trend.  Indeed, after handling several such matters over the years, I am able to at least describe the modus operandi for these “internal raids”.

First, the broker-dealer’s “business side” identifies a branch with a substantial AUM.  As it stands, the broker-dealer is sharing in a small fraction of the revenue the branch is generating.  Coupled with an external factor, such as a desire to satiate regulators or even a mere personality conflict, executives at the highest level of the organization decide to raid the branch.  But they do it under the pretense of a newly born compliance concern, and they respond to old concerns with an utterly disproportionate sanction – termination without notice.  No Letter of Caution or fine, of course, as this would merely give the target rich financial adviser the opportunity to escape the WMD.

Upon termination the broker-dealer is oddly well prepared to immediately file a devastating U-5, send a highly prejudicial warning/solicitation letter to the adviser’s clients, and/or offer immediate home-office supervision or new OSJ opportunities to all of the branch’s financial advisers.  The impact upon the financial adviser is massive, as he is unable to become registered with a new broker-dealer until a naïve state regulator slowly plods through its investigation of the opportunistic and frequently defamatory U-5 disclosure.  The raiding broker-dealer will be slow but “cooperative” in responding to the regulator’s requests for documents.  In terms of private legal counsel, the financial adviser’s source of revenue will dry up at the very moment he or she needs to retain an army of lawyers.  The non-terminated financial advisers will cherry-pick their old boss’ clients.  (They will be ripe for the picking after the nasty letter they received about their now-terminated broker.)  By the time the adviser is registered with a new broker-dealer, his or her book is all but gone.

I have previously written a blog about the causes of action available to a financial adviser who has been raided in such a fashion.  But until FINRA panels start fully compensating the victims of these internal raiding schemes and awarding substantial punitive damage awards – the bombings will continue.  Moreover, state regulators need to issue provisional registration states to such financial advisors while they conduct their investigation.  Food for thought.

See alsohttp://securitiesandinvestmentblog.blogspot.com/2015/12/how-to-terminate-discredit-and.html

The Massachusetts Securities Division – one of the most active and sophisticated in the nation – recently issued a Policy Statement “to provide its state-registered investment advisers who establish concurrent or sub-advisory relationships with third-party robo-advisers with guidelines on how to best comply with the Massachusetts Uniform Securities act and meet the fiduciary duties owed to their clients.” That may be the longest sentence I have ever written.

So let’s start with the basics: what is a robo-adviser? Generally speaking, a robo-adviser is an online wealth management service that provides automated algorithm-based portfolio advice. Of course, a traditional adviser may also utilize software based data but they typically employ that data in the context of more personalized advice and wealth management or retirement planning. A few examples of robo-advisers in the marketplace today are Covestor, Market Riders, Asset Builder and Flex Score.

The problem, at least as I see it, is robo-advisers dressed up as fiduciaries. Some, and in particular one ubiquitous SEC registered RIA, actually promotes itself as a premium fiduciary with unparalleled individualized portfolio construction. In my opinion, it is not. Not even close. Unfortunately, the SEC has failed to take action against such cynical charades, but the Massachusetts Securities Division is doing what it can do within its jurisdictional constraints.

According to the new Massachusetts policy, any investment adviser registered pursuant to the Massachusetts Uniform Securities act must:

  • Must clearly identify any third-party robo-advisers with which it contracts; must use phraseology that clearly indicates that the third party is a robo-adviser or otherwise utilizes algorithms or equivalent methods in the course of providing automated portfolio management services; and must detail the services provided by each third-party robo-adivser;
  • If applicable, must inform clients that investment advisory services could be obtained directly from the third-party robo-adviser;
  • Must detail the ways in which it provides value to the client for its fees, in light of the fiduciary duty it owes to the client;
  • Must detail the services that it cannot provide to the client, in light of the fiduciary duty it owes to the client;
  • If applicable, must clarify that the third-party robo-adviser may limit the investment products available to the client (such as exchange-traded funds, for example); and
  • Must use unique, distinguishable, and plain-English language to describe its and the third-party robo-adviser’s services, whether drafted by the state-registered investment adviser or by a compliance consultant.

If you want to review the flesh on these bones, click here. Now, if only the SEC, California, Missouri, Florida and… would follow Lantagne’s lead.

The Internet is awash with articles about “bad brokers” with clean U-4s, and “rouge brokers” obtaining expungements of valid customer complaints.  Indeed, studies have been published ostensibly demonstrating that state regulators poses more valuable information on their system than what appears on FINRA’s public Broker-Check data base.  In sum, there is a consensus that too many complaints are being expunged.  But whether that consensus is based on fact is subject to debate.

Regardless, FINRA has repeatedly responded to the hue and cry by making it increasingly difficult for a financial adviser to obtain an expungement of a customer complaint published on his or her professional record.  But amidst all of this anguish and gnashing of teeth, a politically incorrect truth has been left in the shadows.  I feel compelled to share it with you.  Here it is:  some customer complaints are baseless.  There; I said it.

Another often-overlooked fact is that FA’s are able to go straight to a court of law, rather than a FINRA arbitration, to obtain an expungement.  Almost exactly one year ago, FINRA issued new guidance to its arbitrators raising ever higher the procedural bars for a panel to recommend expungement[1].  Should a FA surmount the procedural hurdles and slim avenues to success, the FA still has to go to court to get the Award confirmed.  And, in that state court action, he or she still needs to name FINRA as a party so that they can show up and oppose the FINRA arbitrator’s recommendation.

But FINRA Rule 2080 actually reads as follows:

2080. Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD) System

(a) Members or associated persons seeking to expunge information from the CRD system arising from disputes with customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.

(b) Members or associated persons petitioning a court for expungement relief or seeking judicial confirmation of an arbitration award containing expungement relief must name FINRA as an additional party and serve FINRA with all appropriate documents unless this requirement is waived pursuant to subparagraph (1) or (2) below.

(1) Upon request, FINRA may waive the obligation to name FINRA as a party if FINRA determines that the expungement relief is based on affirmative judicial or arbitral findings that:

(A) the claim, allegation or information is factually impossible or clearly erroneous;

(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or

(C) the claim, allegation or information is false.

(2) If the expungement relief is based on judicial or arbitral findings other than those described above, FINRA, in its sole discretion and under extraordinary circumstances, also may waive the obligation to name FINRA as a party if it determines that:

(A) the expungement relief and accompanying findings on which it is based are meritorious; and

(B) the expungement would have no material adverse effect on investor protection, the integrity of the CRD system or regulatory requirements.

(c) For purposes of this Rule, the terms “sales practice violation,” “investment-related,” and “involved” shall have the meanings set forth in the Uniform Application for Securities Industry Registration or Transfer (“Form U4″) in effect at the time of issuance of the subject expungement order.

It seems as if very few have read the actual rule.  I recently read an attorney blog that makes no mention of the direct-to-court avenue whatsoever!  Well, our attorneys are very familiar with both the state court and arbitration options and procedures.

There is actually some case law out there on a financial adviser’s right to go to court to seek an expungement.  In Lickiss v. FINRA, 208 Cal.App. 4th 1125 (2012), the California Court of Appeals reversed a lower court’s dismissal of the FA’s petition.  In fact, it held that the trial court abused its discretion by limiting itself to the criteria set forth in Rule 2080(b), rather than employing the court’s broad equitable power and discretion.  The Court of Appeals stated in part:

FINRA has established BrokerCheck, an online application through which the public may obtain information on the background, business practices and conduct of FINRA member firms and their representatives.   Through BrokerCheck, FINRA releases to the public certain information maintained on the CRD, thereby enabling investors to make informed decisions about individuals and firms with which they may wish to conduct business.   This data includes historic customer complaints and information about investment-related, consumer-initiated litigation or arbitration….

The issues surrounding Lickiss’s sale of CET stock occurred more than 20 years ago, and the one regulatory matter against him resolved 15 years ago in 1997.   Since then, his record has been clear, yet Lickiss attested that he suffers professional and financial hardship relating to the prior sale of CET stock because current and potential clients increasingly use the Internet to obtain his BrokerCheck history.

Lickiss petitioned for expungement of his CRD records, asserting that the superior court had jurisdiction “pursuant to (1) FINRA Rule 2080(a);  [and] (2) the Court’s equitable and inherent powers to effectuate expungements.”…

FINRA removed the action to federal court.  Upon Lickiss’s motion, the federal district court remanded the matter back to the state superior court, ruling that it did not have subject matter jurisdiction over the case because there is no statute, rule or regulation imposing a duty on FINRA to expunge….

Had Lickiss merely petitioned the court for expungement relief under rule 2080, without also invoking the court’s equitable powers, that might be the end of the matter.   However, Lickiss explicitly invoked those powers….

Equity aims to do right and accomplish justice.  (Hirshfield v. Schwartz (2001) 91 Cal.App.4th 749, 770.)…

The equitable powers of a court are not curbed by rigid rules of law, and thus wide play is reserved to the court’s conscience in formulating its decrees…

This basic principle of equity jurisprudence means that in any given context in which the court is prevailed upon to exercise its equitable powers, it should weigh the competing equities bearing on the issue at hand and then grant or deny relief based on the overall balance of these equities…

The choice of a very narrow, rigid legal rule to assess the legal sufficiency of Lickiss’s petition—a choice that closed off all avenues to the court’s conscience in formulating a decree and disregarded basic principles of equity—was nothing short of an end run around equity…

This is not, as FINRA contends, merely a request for a remedy.   Rule 2080(a) essentially recognizes the right of members and associated persons to seek expungement of information from the CRD system by obtaining an order from a court of competent jurisdiction directing such expungement.

See also Lickiss v. FINRA, Fed.Sec. L. Rep. P.96, 345 (2011). Compare Updegrove v. Betancourt, 2016 WL 3442762 (2016).

If you are a FA who has a U-4 scarred by one or more clearly erroneous customer complaints, we would be happy to evaluate your prospects for success in seeking an expungement in state court or arbitration.  Your chances of erasing an unfair or unfounded complaint in a court of law at a reasonable cost might be better than you think.

 

[1] http://www.fa-mag.com/news/finra-continues-to-tighten-lid-on-expungements-with-newly-enhanced-arbitrator-guidance-23443.html

http://finra.complinet.com/en/display/display.html?rbid=2403&record_id=15841&element_id=11616&highlight=2081#r15841

 

In 1378, the Statute of Scandalum Magnatum granted judges and church officials in England a legal right to compensation if they had been insulted or defamed. The first Common Law defamation action on record was filed in England in 1507. Back then, however, the cause of action only applied to false utterances regarding criminality, incompetence, and disease. The law evolved dramatically in the United States. Indeed, Supreme Court Justice Stewart once wrote that the tort of defamation “reflects no more than our basic concept of the essential dignity and worth of every human being.1

Defamation law has been somewhat static since the seminal Supreme Court case of New York Times Co. v. Sullivan in 1964. But consider what has changed in the 50 years since that ruling. Let me cite just a few examples of developments that have completely transformed the impactof damages caused by defamatory conduct:

  1. An erosion of society’s perception of what is a private matter;
  2. 24-hour news cycles;
  3. The relative decline of more thorough print media; and
  4. The internet (and the explosion of linked high-speed outlets for the dissemination of falsehoods.)

As the old saying goes, “A lie makes its way around the world before the truth has time to get its pants on.”

I will blog again shortly about the intersection of defamation and U-5 FINRA defamation claims. The lesson for now is as follows: brokers that have suffered from U-5 defamation need to do much more than simply file an arbitration claim. Reputation management is critical.

________________________________________

1  If you want to dig deeper in to the legal history of defamation law, start with David Hudson’s excellent piece by clicking here.

Most of us know by now to have a plan for our eventual exit from this life. The centerpieces of the plan typically are insurance, a will and a trust, and beneficiary designations properly completed on all applicable accounts. On the other end of the scale, most of us have an emergency fund for a sudden precipitous financial hit caused by an unexpected decline in revenue or a spike in expenses. Some of us even plan ahead for the unfortunate possibility of the demise of our marriage with a “pre-nup” or other financial arrangements.

But how many of you have made contingency plans for your current position in the industry? If you are a decent producer associated with a large wire-house, are you blinded to the fact that your relative contentment might not be the only determining factor for your continued tenure? That is a fancy way of asking if you have a plan if you get shit-canned.

Many investment advisers and dually registered folks conjugate about what it would be like to have their own RIA. The American dream of being one’s own boss and the shining promise of independence and profits can almost make one giddy. But, I am trying to impress upon you the importance of realizing that one day circumstances beyond your control might push you from dreaming to scrambling.

Whether you would prefer to experience practicing your honed fiduciary skills with an independent broker/dealer, a large SEC registered RIA, or a small state-registered RIA, the amount of preparation for the transition will depend upon your current model. The more detailed your plan, the more likely you will survive the transition, particularly if sudden, with less (rather than no) financial or cardiovascular hardship. The amount of regulations pertaining to everything from the type of files you must keep, regulatory filing deadlines, and certain policy packets that must be in place can be overwhelming without the assistance of a valued and knowledgeable advocate.

The market is filled with attorneys and consultants that can assist you with your transition. You will need one of each and this is not the time for you to employ penny wise and pound foolish measures. Once you have a specific confidential plan in place, you can decide whether or not to use it, or simply put it in the drawer with your insurance policy and estate planning documents.

My law firm has assisted individuals that have needed to migrate at the drop of a hat for employment or regulatory reasons. While it is doable, it certainly isn’t optimal. And the more independent you want to be, the more details there are to identify, evaluate, and address. Where you want your office to be located will suddenly be as important as why you want to rely upon us for back-office support.

In addition to reviewing this blog and joining The SyndicateI would recommend to you a recent article by Jill Cornfield entitled “Independent Advisers: Is striking out on your own all it’s cracked up to be?Start planning for your dreams in case they arrive sooner than you planned!

 

Troy Kennedy (Kennedy”) left his position as director and executive officer of a trust and investment company when that company was bought by Central Trust & Investment Company (“CTI”). Kennedy left to found a competing firm. Both companies provided financial advice and investment management services. Within six months, Kennedy had successfully solicited 85 former clients. 

Before the sale and departure in question, Kennedy had placed a detailed list of 200 clients in a safe deposit box upon the advice of legal counsel. Kennedy did not register his new company, ITI, with the SEC as an investment adviser. Instead, Kennedy affiliated himself as an investment adviser representative of an RIA called SignalPoint Asset Management, LLC (“SignalPoint”), the defendant in this case. The agreement between Kennedy and SignalPoint allowed Kennedy to offer investment services through SignalPoint in exchange for various fees on an independent contractor basis.

CTI filed suit against Kennedy and his new company, ITI. At the time it filed suit, it didn’t even know about the client list in the safe deposit box. The suit included causes of action for conspiracy, misappropriation of trade secrets (MUTSA) and tortious interference with business relations. CTI then added SignalPoint as a third defendant. All three defendants filed motions for summary judgment. The trial court granted SignalPoint’s only. The Supreme Court ordered the matter transferred to it from the Court of Appeals. The Supreme Court’s analysis of the three different claims begins on page 7 of the 2014 Opinion [Click HERE]. The Opinion is a must read for attorneys representing agents or representatives that are about to “change ships” or broker-dealers or RIAs that are taking on a competitor’s producer.

The Supreme Court sustained the dismissal of the statutory trade secret claim because CTI could not establish that SignalPoint had access to the client list. In doing so, it side-stepped the issue of whether the client list qualified as a trade secret. Ironically, the most valuable portion of the opinion for practitioners might be the two extensive footnotes (8 and 9) about client lists that prove that lawyers and judges can render obscure what should be obvious. Regardless, the Supreme Court concluded that because there was no access, there was no misappropriation, so there was no MUTSA violation.

The first 10 pages of the opinion fail to pin the law to the reality of the situation—that Kennedy had access to the list and was using it to benefit himself and SignalPoint. Ironically, the plaintiff’s attorney couldn’t pin that tail on the donkey either—he or she somehow failed to plead any theory of vicarious liability. The theory of respondent superior was not available either—Kennedy’s IAR Agreement clearly established him as a non-employee. CTI needed but failed to plead that Kennedy was an agent over whom SignalPoint had a sufficient degree of control.

The Court proceeded to set forth the elements of a claim for tortious interference:

  “To prove a claim for tortious interference with a contract or a business expectancy, the plaintiff must prove the following five elements: “(1) a contract or a valid business expectancy; (2) defendant’s knowledge of the contract or relationship; (3) intentional interference by the defendant inducing or causing a breach of the contract or relationship; (4) absence of justification; and (5) damages resulting from defendant’s conduct.”

The Court concluded that the fourth element requires a showing of “improper means” and the plaintiff could not establish any because there was no misappropriation of a trade secret. The civil conspiracy claim died from the same wound. Food for thought.

The Cosgrove Law Group represents individual agents and reps both before and after they make a move to a new B/D or RIA. Retaining counsel before the litigation starts just might help you prevail and prosper.

A broker-dealer agent, whether dually registered or a straight-up 7, is obviously subject to FINRA’s enforcement apparatus. Sometimes agents/reps make serious mistakes that prompt a FINRA enforcement investigation. Many such investigations or actions are resolved through an agreed upon resolution commonly referred to as an “AWC.” An AWC is a FINRA Rule 9216 letter of Acceptance, Waiver, and Consent.

The pursuit of an AWC may be a reflexive response for many industry members and their attorneys. A couple of critical issues should, however, be considered. For example, if FINRA has not yet, but wishes to take an on-the-record (“OTR”) exam of you, will an AWC still be available at the end of the exam? Or will you be forced to choose between a lack of candor or making matters worse for yourself in the OTR? Some agents—perhaps retired—are in the envious position of just not really needing to be bothered with the cost and stress of an OTR.

A second issue you should consider before hitting the AWC button is publicity. The AWC will include a substantial statement of facts and FINRA will issue a rather thorough non-negotiated public summary of the AWC terms, factual basis, and sanction. If you are dually registered as an IAR, consider whether the AWC route will destroy the fee-based side of your book. Is it worth retaining your association with a FINRA member in light of the nature and composition of your book? Has your attorney communicated with the states and/or SEC regarding their position on your ticket on the 65 side?

If you firmly believe that an OTR would put you in greater jeopardy than you are already in, or would simply be a waste of your time and money, or that an AWC would throw out the baby with the bathwater—consider a fairly quiet FINRA Rule 9552 exit.

Rule 9552 addresses a regulated person’s failure to provide information to FINRA. The Rule provides for expedited automatic procedures that will allow for a gradual letter-notice transition from warning to suspension to revocation. Unless one decides to challenge one of the automatic stages, there are no pleadings or hearings or press releases. Refusing to sit for an OTR is a violation of Rule 9552.

It is possible your current counsel has only laid out two options for you: an expensive prolonged legal battle with FINRA or an AWC suicide pact. At least consider your third option, Rule 9552. But remember—the 9552 disposition is probably not an option once you sit for an OTR.