Arbitrating in the FINRA Forum - sifma
←
→
Page content transcription
If your browser does not render page correctly, please read the page content below
Arbitrating in the FINRA Forum
SIFMA COMPLIANCE & LEGAL SOCIETY
ANNUAL MEETING
March 16, 2020
Moderator
Patricia Cowart
Panelists
Richard W. Berry, FINRA
Linda Drucker, Bank of the West
Cheryl L. Haas, McGuireWoods LLP
Bentley Stansbury, Keesal, Young & LoganI. CLAIMS BY ELDER INVESTORS
A. Background
1. Financial exploitation of the elderly is one of the most frequently reported
forms of elder abuse.
2. The National Center on Elder Abuse estimates that such abuse costs older
adults around $2.9 billion annually.
3. By 2030, people aged 65 and older will constitute 20% of the total U.S.
population with those aged 85 and older ranking as one of the fastest
growing populations in the country. (National Center on Elder Abuse
(“NCEA”).
4. Many states have enacted laws protecting against elder financial abuse
exist at the state level. For example, California prohibits anyone from
taking, or assisting in taking, the real or personal property of seniors for
wrongful purposes or with the intent to defraud. California law also
provides treble damages in some instances of elder financial abuse.
5. In the last few years, the Claimants’ bar as well as NASAA, FINRA and
other regulators) have focused on seniors.
B. Industry and regulatory reactions
1. Regulators are expecting financial institutions to have written supervisory
and compliance procedures and training platforms directed specifically to
seniors.
2. FINRA Rule 2165 and Rule 4512 (amended) –provide firms with
additional tools to protect these individuals.
a. FINRA Rule 2165 (Temporary Account Holds) (effective February
5, 2018) permits member firms to place temporary holds on
disbursements of funds or securities from the accounts of specified
customers when there is a reasonable belief these customers are the
subject of financial exploitation.
(i) The Rule provides a safe harbor for firms to place a hold on
the account if they think their client could be harmed,
rather than an obligation to withhold disbursement of
funds/securities.
(ii) The Rule applies to “specified adults”: (1) 65 or older, or
(2) reasonably believed to have mental or physical
impairment that renders the individual unable to protect his
or her own interests.
–1–(iii) The Rule permits an initial hold of 15 business days, with
an extension to a total of 25 business days if an
investigation supports a reasonable belief that exploitation
is occurring (and a further extension if directed by a state
regulator or court).
(iv) The Rule includes detailed recordkeeping, compliance and
training requirements.
(v) Note: about half the states (generally coupled with the hold
provisions) mandate reporting to state securities regulators
and/or APS agencies if there is a reasonable belief of elder
financial exploitation, with some variation around
reporting/notice requirements and timing.
b. Amended FINRA Rule 4512 (Customer Account Information)
requires member firms to make reasonable efforts to obtain the
name and contact information for a “trusted contact person” for a
non-institutional customer’s account.
(i) Note firm’s will need to figure out what to do when one
identified as “trusted contract person” is the one accused or
suspected of abusive conduct towards the customer.
c. NASAA Model Act to Protect Vulnerable Adults from Financial
Exploitation
(i) At least 19 states adopted the NASAA Model Act in whole
or in part
(ii) Similar to FINRA Rule 2165.
(iii) Model Act requires reporting suspected financial
exploitation to state regulators or APS agencies.
II. COMMON CLAIMS AND DEFENSES RELATED TO SENIORS IN ARBITRATIONS
A. Overall Challenges:
1. Sympathy to elder investor, especially in this state of heightened
awareness of elder abuse and FINRA and state rules about elder
exploitation
2. 20/20 hindsight – how to recognize diminished capacity or even abusive
situations is an art not a science, but the claim occurs often years later
when other facts play out and the capacity or abuse is obvious
–2–3. Frequently no one left standing but firm to reimburse the elder’s losses,
and no way to rebuild that wealth
B. Suitability – the products sold to the senior were unsuitable
1. Claims:
a. Recommended investments unsuitable for elder customer
b. Firm should have stepped in to curtail elder’s self-directed risky
trading
c. Diminished capacity challenges (see below)
2. Defenses:
a. Age not sole factor in suitability – also investment objective, time
horizon, risk tolerance, assets/income
b. Age does not negate knowledge/sophistication/ability to make own
informed decisions
C. Diminished Capacity – the senior was not capable of making the investment
decision
1. Claim
a. Firm missed “red flags” of diminished capacity and allowed
trading to occur, contrary to FINRA 2165
2. Defenses
a. Adhered to the firm’s robust policies and procedures
b. Registered representative and supervisors were trained on these
rules
c. Clear documentation of considerations in making these decisions
D. Inappropriate account restriction – FINRA 2165 used against the firm. The senior
was capable of making the investment decision and was harmed by not allowing it
1. Claim
a. Conversion claims
b. Lost opportunity claims
c. Firm “made the wrong call”
–3–d. Firm keeping elder from own money allegedly causing dire
consequences
2. Defenses
a. Trying to do the right thing in a difficult situation
b. Adhered to the firm’s robust policies and procedures
c. Registered representative and supervisors were trained on these
rules
d. Clear documentation of considerations in making these decisions
E. Firm/Registered Representative actually engaged in “elder abuse.”
1. This is often a suitability claim with a reference to state statute on elder
abuse (and treble damages)
F. Third Party Fraud/Exploitation – Firm should have identified and
stopped/prevented the activity
1. Claim
a. Third party access and/or undue influence
b. Distributions legitimately requested by the elder, but scam victim
and firm allegedly missed red flags
c. Diminished capacity
See Ryan Peter Trottier, Executor of the Estate of Mary Anne
Trottier v. Morgan Stanley Smith Barney et al, FINRA Arb No. 15-
02910 (finding financial advisor and broker-dealer respondents
jointly and severally liable for failing to protect 72-year-old
decedent-client, who was later diagnosed with cognitive
impairment, from third-party exploitation by enabling client’s
purchase of $300,000 home security system).
2. Defenses
a. Robust policies and procedures and compliance with them
See Estate of Ward G. Dexel and Cynthia Marovich v. Raymond
James Financial Services, Inc. et al, FINRA Arb No. 17-02600
(Respondents prevailing on defense that the financial advisor
followed company protocols and not finding evidence of
exploitation).
–4–b. Dispute alleged red flag evidence
See Ryan Peter Trottier, Executor of the Estate of Mary Anne
Trottier v. Morgan Stanley Smith Barney et al, FINRA Arb No. 15-
02910 (dissent finding “a classic example of no good deed goes
unpunished” when the majority panel found the financial advisor
and broker-dealer liable for third-party elder exploitation)
c. Carefully and respectfully advocate that the elder’s actions that
contributed to the continuance of the fraud (statement review,
access provided to wrongdoer, etc.)
G. Claims frequently brought on elder’s behalf by POA or beneficiaries
1. Often the same person(s) now inheriting less funds
See Estate of Addie Belle Jones v. American Portfolio Financial Services,
Inc. et al, FINRA Arb No. 17-01414 (The Estate alleging, among other
things, that the financial advisor respondent breached his fiduciary duty, as
the decedent-client was incompetent when he executed a Transfer on
Death and annuity beneficiary form, designating the financial advisor one
of four beneficiaries).
2. Often involve family disputes
a. Dueling POAs/trustees
b. Post-death beneficiary disputes
c. Undue influence claims
See Estate of Ward, FINRA Arb No. 17-02600 (Estate alleging financial
advisor and broker-dealer failed to protect the decedent-client from
exploitation by family members, the daughter and husband).
3. Defenses:
a. Clear policies and procedures on who firm can speak with, take
direction from
b. Clear documentation in file of who POA/Trustee is
–5–H. LIKELY NEW CLAIMS BASED ON REGULATION BEST INTEREST /
STATE FIDUCIARY RULES
1. Best Interest Obligation: Expect each new obligation to be a cause of
action in an arbitration.
a. Broker shall act in the best interest of the customer at the time a
recommendation involving investment products, strategies or
account changes (i.e. rollovers) is made, without placing the
interests of the firm ahead of the customer. The best interest
obligation is satisfied by meeting the following four obligations:
(i) Disclosure Obligation: Prior to or at time of
recommendation, the broker shall provide “full and fair
disclosure” of all material facts including: that s/he is
acting as broker or broker-dealer; the fees and costs that
apply to customer’s transactions, holdings and accounts;
the type and scope of services provided; and the conflicts of
interest associated with the recommendation.
(ii) Care Obligation: Broker exercises “reasonable diligence,
care, and skill” in making the recommendation, including:
understanding the potential risks, rewards and costs, and a
reasonable basis to believe that the recommendation
(a) could be in the best interest of at least some
customers;
(b) is in the best interest of a particular retail customer
based on their investment profile;
(iii) Conflict of Interest Obligation: Firm establishes, maintains
and enforces policies and procedures that:
(a) identify and disclose or eliminate all conflicts of
interest related to the recommendation;
(b) Identify and mitigate conflicts that create an
incentive for the broker to make recommendations
that place the firm’s interests ahead of the customer;
(c) Identify and disclose material limitations placed on
the investment product or strategy;
(d) Identify and eliminate sales contests, sales quotas,
bonuses, etc. that are based on a specific product or
type of securities within a limited time
–6–(iv) Compliance Obligation: the firm establishes and maintains
compliance policies and procedures to achieve compliance
with Reg BI.
I. Expect cases brought due to an “implicit hold recommendation.”
1. Reg. BI applies to “any recommendations that result from the account
monitoring services that a broker-dealer agrees to provide.” Regulation
Best Interest: The Broker-Dealer Standard of Conduct, Exchange Act
Release No. 86031 (June 5, 2019), at 102 (“Reg. BI Adopting Release”).
2. Reg. BI introduces the concept of implicit hold recommendations where a
broker-dealer agrees—in writing or orally—to provide ongoing account
monitoring.
a. “By agreeing to perform account monitoring services, the broker-
dealer is taking on an obligation to review and make
recommendations with respect to that account (e.g., to buy, sell or
hold) on that specified, periodic basis,” and “the quarterly review
and each resulting recommendation to purchase, sell, or hold, will
be a recommendation subject to Regulation Best Interest . . . even
in instances where the broker-dealer does not communicate any
recommendation to the retail customer.” Reg. BI Adopting
Release, at 103.
b. The SEC stated that where there is such an agreement, “silence is
tantamount to an explicit recommendation to hold, and should be
viewed as a recommendation to hold the securities for purposes of
Regulation Best Interest.” Reg. BI Adopting Release, at 104-05.
J. FINRA’s 2020 Risk Monitoring and Examination Priorities Letter includes a list
of factors FINRA may consider when reviewing firms for compliance with Reg
BI. FINRA includes another question that could be used by Claimant’s counsel in
arbitrations: “Do your firm and your associated persons consider reasonably
available alternatives to the recommendation?” Claimant’s counsel will be
looking at what alternatives were available to firms to offer their customers.
K. Many States are proposing their own fiduciary and similar standards, including
Massachusetts, Nevada, New Jersey, New York and others. Expect that
Claimants’ counsel will bring claims under the respective state statutes as well.
–7–III. SELECTION AND USE OF EXPERT WITNESSES IN FINRA ARBITRATION
A. Background
1. Given many arbitrators now have limited securities experience, an expert
is important to educate the panel.
2. No specific standard – FINRA Code of Arbitration Procedure Rule 12604
(Customer); 13604 (Industry) “The panel will decide what evidence to
admit. The panel is not required to follow state or federal rules of
evidence.”
a. Nevertheless, applying Daubert standards makes sense – consider:
(1) whether the theory or technique in question can be and has
been tested; (2) whether it has been subjected to peer review and
publication; (3) its known or potential error rate; (4) the existence
and maintenance of standards controlling its operation and (5)
whether it has attracted widespread acceptance within a relevant
scientific community
B. Selection
1. Timing: early retention allows expert to assist with discovery requests and
shape theory of the case.
2. Qualifications: industry knowledge, product knowledge, prior testimony,
publications
C. Use
1. Disclose Expert with 20 day exchange material
2. Expert needs to review your case documents as well as the claimant’s
documents.
a. Documentation provided to the expert is discoverable, however not
all panels order the information to be produced.
3. Experts can prepare reports and/or demonstrative exhibits
a. Clear demonstrative exhibits showing your position are invaluable
4. Experts should attend the entire hearing. FINRA Code of Arb. Procedure,
Rule 13602/12602 allows for such attendance: “Absent persuasive reasons
to the contrary, expert witnesses should be permitted to attend the
hearing.”
–8–IV. EVOLUTION AND CURRENT TRENDS IN DAMAGES THEORIES
A. What are they?
1. Cherry-picking
a. Focuses claim solely on the “losers”
b. Allows for damages in a rising market
2. Market adjusted damages
a. Seeks to compensate claimants for the delta between how their
account performed and how a hypothetical “well managed”
account would have performed – traditionally in reference to an
index (e.g., S&P 500) or blend of indices (e.g., 60% bond
fund/40% S&P 500).
b. Statistical overview of the increase in this type of damages claim
over the last five years [slide]
3. Reg. BI/FINRA Rule 2111 – Failure to warn/holder damages
a. Rule 2111 applies to explicit “hold” recommendations. FINRA
Rule 2111 (Suitability) FAQ No. 1.2.
b. In contrast, Reg. BI introduces concept of implicit hold
recommendations where a broker-dealer agrees – in writing or
orally – to provide ongoing account monitoring.
B. Why topical?
1. Historic Bull Market
a. Dow closed at 7,552.29 on Nov. 20, 2008
b. Today over 29,000.
2. Claimant’s bar advocating novel theories, including specifically market-
adjusted damages
a. PIABA – encouraging a change from “well managed” to “market
adjusted”
b. Articles and online advertising
(i) Claimants’ Well-Managed or Market-Adjusted Damages
Theories (See Market Adjusted Damages in the FINRA
Forum, PIABA Bar Journal, Vol. 21, No. 2 at 135–150
–9–(2014), by Philip M. Aidikoff, Robert A. Uhl, Ryan K.
Bakhtiari, and Katrina M. Boice),
(ii) Republished in Advocate Magazine as “Winning Market-
Adjusted Damages For Investors Using the FINRA Forum”
in April 2016.
(iii) Claimants’ attorneys are posting their own bases for
market-adjusted damages on their respective websites (e.g.,
Guiliano Group).
C. Support for Novel Damages Theories
1. FINRA Arbitrator’s Guide at pp. 66–69 (Nov. 2019 ed.)
a. Cherry-picking
(i) Definition of Net Out-of-Pocket Loss (at p. 66): “The
calculation of Claimant’s net out-of-pocket losses varies
depending on whether the wrongful conduct involves one
or more specific trades or the management of an entire
account.”
(ii) Arbitrators should look to the parties for instructions on
these issues – presumably meaning whether Claimants
should be allowed to cherry-pick individual investments or
in reference to the entire portfolio.
(a) Defending these claims requires the defendant to
establish reasons for looking at the portfolio as a
whole.
(iii) Market Adjusted Damages
(iv) In Arbitrator’s Guide as “Benefit of Bargain” and “Well-
Managed Account Damages” (p. 66)
(v) Seeks to give the claimant the expected value of the
investment but for respondent’s wrongdoing.
(vi) The Guide recognizes difficulty in determining, with some
specificity, the profits that claimant would have reasonably
received
2. Support for novel damages in case law
a. Cherry-picking
– 10 –(i) Kane v. Shearson Lehman Hutton, Inc., 916 F. Supp. 643,
646 (11th Cir. 1990): analyzing statutory, negligence and
breach of fiduciary duty claims under Florida law, the court
rejected a “netting” approach to the investment portfolio,
saying there is nothing in the law that would “force victims
of fraud to aggregate their profits and losses from separate
transactions that happened to involve the same defendant
and thus reduce recoveries.”
b. Market Adjusted Damages
(i) Originally developed to prevent awards that would provide
a windfall to the plaintiff in a declining market. Rolf v.
Blyth, Eastman, Dillon & Co., Inc., 570 F.2d 38, 49 (2d
Cir. 1978)
(ii) Applied most frequently in churning cases.
(a) Miley v. Oppenheimer & Co., 637 F.2d 318 (5th
Cir. 1981), abrogated by Dean Witter Reynolds, Inc.
v. Byrd, 470 U.S. 213 (1985).
(b) Hatrock v. Edward D. Jones & Co., 750 F.2d 767,
773–74 (9th Cir. 1984)
(c) Winer v. Patterson, 644 F. Supp. 898, 900-01
(D.N.H. 1986), order vacated in part on
reconsideration, 663 F. Supp. 723 (D.N.H. 1987)
(d) Davis v. Merrill Lynch, Pierce, Fenner & Smith,
Inc., 906 F.2d 1206, 1218 n.13 (8th Cir. 1990)
(e) Nesbit v. McNeil, 896 F.2d 380, 385 (9th Cir.1990)
(f) Laney v. American Equity Inv. Life Ins. Co., 243 F.
Supp. 2d 1347, 1354 (M.D. Fla. 2003)
(iii) A few district courts have applied outside of churning.
(a) Levine v. Furtansky, 636 F. Supp. 899, 900 (N.D.
Ill. 1986)
(b) Medical Assoc. of Hamburg, P.C. v. Advest, Inc.,
No. CIV-85-837E, 1989 WL 75142 at *1
(W.D.N.Y. July 5, 1989): District Court noted that
the Rolf analysis was not limited to adjust damages
downward when the market declined but also could
– 11 –be applied to adjust damages upward where the
market went up.
D. Defending novel damages claims
1. Arguing the law
a. NOP is the traditional measure of damages (in securities fraud
cases).
(i) Randall v. Loftsgaarden, 478 U.S. 647, 668 (1986).
“Normally, however, the proper measure of damages in a
[securities fraud] case is an investor's out-of-pocket
loss. . . .”
(ii) In re Eugenia Vi Venture Holdings, Ltd., 649 F. Supp. 2d
105, 121 (2d Cir. 2008). “In New York, damages for
claims of fraud and fraudulent inducement are subject to
the “out-of-pocket rule,” which confines plaintiffs to
recovering actual losses sustained as the direct result of the
wrong alleged, and excludes expected profits.”
(iii) Henry v. Lehman Commer. Paper, Inc., 471 F.3d 977, 1001
(9th Cir. 2006). “The proper measure of damages in fraud
actions under California law . . . is ‘out-of-pocket’
damages.”
(iv) Estate Counseling Service, Inc. v. Merrill Lynch, 303 F.2d
527, 532 (10th Cir. 1962). “In Federal courts the measure
of damages recoverable by one who through fraud or
misrepresentation has been induced to purchase bonds or
corporate stock, is the difference between the contract
price, or the price paid, and the real or actual value at the
date of sale, together with such outlays as are attributable to
the defendant’s conduct.”
b. Market adjusted damages are speculative and uncertain. While the
actual performance of an index is based on historical data, the
selection of that index or allocation as an alternative or suitable
portfolio for Claimant is based on speculation and/or hindsight.
(i) Uncertain: [U]ncertainty as to the fact of damage, that is, as
to the nature, existence or cause of the damage, is fatal.
Brown v. Critchfield, 100 Cal. App. 3d 858, 871 (1980)
(quoting Griffith Co. v. San Diego Col. for Women, 45 Cal.
2d 501, 516 (1955)). Damages must be established with
such certainty as satisfies the mind of a prudent and
– 12 –impartial person. Resolution Trust Corp., 853 F. Supp. at
1426 (citations omitted).
(a) Causal connection: Resolution Trust Corp., 853 F.
Supp. at 1426, noting that even if the problem of
measuring damages could be overcome, the level of
uncertainty as to causation would prevent recovery
under Florida law.
(b) Timing: Time-sensitivity of transactions can inject
enough uncertainty into the measure of damages to
render lost profits unrecoverable. Id. at 1426.
(c) Alternative Portfolio: uncertainty is compounded
where the alternative investment choice is not
known. Id.
(d) Speculative: [D]amages cannot be based on
speculation or guesswork. PSG Co. v. Merrill
Lynch, Pierce, Fenner & Smith, Inc., 417 F.2d 659,
663 (9th Cir. 1969).
(e) Kane v. Shearson Lehman Hutton, Inc., 916 F.2d
643, 647 (11th Cir. 1990), rejecting plaintiff’s
claims that he would have sold stock at the optimal
time absent misrepresentations because it was too
speculative.
(f) Himes v. Brown & Co. Securities, 518 So. 2d 937,
939 (Fla. 3d DCA 1987), rejecting claims for lost
profits as too speculative in case where plaintiff had
not suffered out-of-pocket losses and could not
offer proof that he would have sold at optimal time
but for defendant’s misrepresentation.
(g) Resolution Trust Corp., 853 F. Supp. at 1429: [T]he
Court thinks that it’s anyone’s guess what (and
when) [plaintiff] would have done had it not
invested in junk bonds. . . . [t]he variables do not
stop there when would it have bought, when would
it have sold, what particular security or real estate
deal would it have invested in, would it have tolled
proceeds over, etc. Regardless of which guess is
best, any guess would be the type of conjecture and
speculation which cannot support recovery of
damages under Florida law.)
– 13 –(h) Messer v. E.F. Hutton & Co., 833 F.2d 909, 923
(11th Cir. 1987): rejecting damages for lost profits
because plaintiff failed to establish with reasonable
certainty that he would have followed the
alternative investment plan.
(ii) Damages should be established by unemotional,
mathematical evidence elicited throughout the trial as to
what actually took place in the plaintiff’s account. Stevens
v. Abbott, Proctor & Paine, 288 F. Supp. 836, 849 (E.D.
Va. 1968).
(iii) Claimant’s counsel often presents alternative portfolios to
afford them more flexibility in seeking damages as case
progresses. This supports speculative nature of the
proposed alternative.
(iv) Arbitrator Guide recognizes this – “The difficulty with
applying benefit of the bargain measure of damages is
determining, with some specificity, the profits claimant
would have reasonably received. (p. 67.)
2. Arbitrator selection
a. Lawyers – case law generally views these novel theories as
extraordinary damages
b. Experienced arbitrators who have seen market cycles
c. Review awards
3. Discovery
a. Evidence tending to show that the index proposed by Claimant’s
counsel is inappropriate for investor’s stated goals (e.g., how
claimant invested before/after; notes that investor did not want to
invest in equities; etc.).
4. Expert
a. If it is unfair for claimant to focus on a single investment or
investments in isolation, explain why it is necessary to look at the
portfolio as a whole. (See Arbitrator’s Guide, p. 66.)
b. If claimant is seeking an index which is not consistent with their
stated goals, have expert explain why that index is not appropriate
(e.g., S&P 500 or Russell 2000 isn’t appropriate for an investor
who said they wanted to limit market exposure).
– 14 –You can also read
