Published on:

On February 12, 2018, the Securities and Exchange Commission (“SEC”) instituted an enforcement action against Deutsche Bank Securities Inc. (“Deutsche Bank”) (the “Order”).  At the conclusion of this Deutsche Bank was ordered to pay $3.7 million back to customers, with $1.48 million as disgorgement penalties.

According to the Order, during the course of its investigation, the SEC found that traders and salespeople at Deutsche Bank made false statements surrounding the sale of commercial mortgage-backed securities (CMBS).  The investigation found that Deutsche Bank employees would tell costumers that they had on a certain date purchased a bundle of CMBS for a certain price – when in fact that bundle of CMBS may have been purchased at a far earlier date for an entirely different price.

There have been several lawsuits, arbitrations, investigations, and enforcement actions surrounding the obligations of traders and salespeople to customers in regards to revealing or accurately disclosing previous purchase prices of securities.  Most of these cases hinge on the question of whether or not a sales person revealing their purchase price of a security is a materially relevant fact.  Defendants in these matters have taken the position that accurate representations of securities previous purchase prices are not materially relevant, because buyers have their own valuation methods, and can analyze the market themselves – and they would not be buying large blocks of securities if they did not think they were worth the asking price.  They also argue that most buyers of large blocks of securities, who interact with investment banking salespeople, are institutional buyers, and therefore have their own teams of analysts to perform valuation. Regulators and Plaintiffs attorneys take the position that traders should never be able to lie to their customers, and that the actual prices paid are not simply proprietary information, but materially relevant facts that must also be disclosed to a prospective purchaser.

Published on:

In November, the Financial Industry Regulatory Authority (“FINRA”) ordered Stephen Todd Walker (“Walker”), a former Morgan Stanley (“MSSB”) Advisor, to pay approximately $2 million to cover remaining promissory note balances and arbitration costs (the “Award”).  Promissory note cases can be difficult to win, as the contractual language stipulating terms of repayment is typically very explicit as to the obligations of the promissory note holder.

MSSB terminated Walker in 2010, and he left for Oppenheimer with a large book of business and a small team of Financial Advisors and Assistants.  MSSB promptly sued Walker for breach of his promissory note agreements, with MSSB seeking repayment of the $1.67 million balance.  Walker filed counterclaims against MSSB for “tortious interference” with his client relationships, unfair competition, improper conversion of property, and defamation, that sought damages of $52 million.  The suit culminated in 160 pre-hearing and hearing sessions between 2011 and September 2017.

After a protracted 7-year arbitration battle, a three-person FINRA Arbitration Panel (the “panel”) ruled that Walker must pay $1.67 million in promissory note balances back to the firm, and pay $301,000 in attorneys’ fees (prevailing party attorneys’ fees can be contractually stipulated in promissory note agreements).  The Panel did however grant Walker $525,000 in compensatory damages from MSSB, making his total outstanding liability from the Award $1,446,000.

Published on:

On December 13, 2017, an Arbitrator from the American Arbitration Association rendered an award totaling approximately $1,000,000 against Allegis Investment Advisors, LLC (“Allegis”).  The Arbitrator found that Allegis breached its fiduciary duty by investing clients’ funds into entirely unsuitable, and high risk option strategies.  There will likely be more claims brought against Allegis, as the total amount of potential damages to its clients exceeds $33,000,000.  Allegis is a SEC registered investment advisory firm headquartered in Idaho Falls, ID.  It has approximately $654 million in assets under management, and caters primarily to high net worth individuals.

Selling very large numbers of Put options on indexes is an incredibly risky investment strategy. Specifically, the strategy Allegis implemented entailed the collection of a small premium on the Russell 2000 index (“RUT”) – from the option sale – however risked the possibility of complete and total loss of capital supporting the trade.  Allegis employed this RUT option strategy with certain clients’ life and retirement savings.

Allegis neglected to inform their clients that this RUT option strategy involved a massive asymmetrical risk reward ratio with potential for complete and total loss of capital.  With a derivative strategy such as this, approximately 97% of the time the options will expire Out of the Money, and the small premiums collected from the RUT option sale can be kept.  However, approximately 3% of the time the price of the RUT Index could move far enough from its expected volatility, leading to complete loss of capital.

Published on:

Lax & Neville is currently investigating the activities of Sica Wealth Management, a Securities and Exchange Commission (“SEC”) Registered Investment Advisory (“RIA”) based out of New Jersey, founded and run by Jeffrey Sica (“Jeff”). Despite TV appearances on CNBC, Fox Business, Bloomberg, and various other financial outlets, and the credentialization and authority that comes with having a voice on financial news networks, Jeff has 15 disclosable events on his FINRA BrokerCheck report. Many of these customer complaints allege millions of dollars in losses, and Jeff has settled the majority of them.

Lax & Neville is specifically investigating unsuitable sales practices at Sica Wealth Management relating to account churning, and private placement investments in Aequitas Capital — a billion-dollar Ponzi scheme.

On March 11, 2016, the Securities and Exchange Commission (“SEC”) charged Aequitas Management LLC (“Aequitas Management”), its founder Robert J. Jesenik, fundraiser Brain A. Oliver, and former Chief Financial Officer N. Scott Gillis (collectively the “Defendants”) with defrauding investors. The Complaint alleges that Defendants violated antifraud provisions of the Securities Act of 1933 (“Securities Act”), the Securities Exchange Act of 1934 (“Exchange Act”), and the Investment Advisors Act of 1940 (“Advisors Act”) in connection with security offerings by Aequitas and its entities.

Published on:

On October 30, 2017 Morgan Stanley announced that it would exit the Protocol for Broker Recruiting (the “Protocol”), effective on Friday, November 3rd.  Firms such as Morgan Stanley and Merrill Lynch signed on to the Protocol in 2004, in an effort to limit costly litigation or arbitration claims that can arise when brokers transition to new firms, or set up arrangements such as a Registered Investment Advisor (“RIA”). The Protocol is intended to outline an orderly system for transitions, by limiting the client information brokers can bring with them during job changes to the following: names; addresses; phone numbers; email addresses; and account title. Other client information and documents are not permitted to be taken. The Protocol additionally restricts brokers from telling clients they are planning to move, or from committing any other forms of pre-solicitation.

While the Protocol is advantageous to firms in terms of reducing litigation and compliance costs, these benefits are offset by the downside of increased volume of broker transitions. The frictional costs and risks associated with a broker moving his or her book of business are reduced by the Protocol —thereby giving brokers more bargaining power in recruitment deals, and instigating recruitment package bidding wars between banks.

Morgan Stanley released a statement, titled “Morgan Stanley Announces a New Talent Investment Strategy to Deliver Added Value to Clients.” The statement mentions technology solutions for strengthening investment objectives for clients, a focus on building client relationships, and other marketing tactics, all used as a prelude to justify leaving the Protocol, under the auspices of protecting client interests. Morgan Stanley emphasized that they will focus on building existing talent: “[t]hese investments further the Firm’s previously stated commitment to reducing recruiting efforts in order to refocus those resources on existing talent,” a strategy intended to reduce costs.

Published on:

Lax & Neville is currently investigating the activities of Michael D. Mathias, a broker associated with Summit Brokerage Services, Inc. (“Summit”).  Mr. Mathias, who has been in the industry for three decades, has a long history of sales practice abuses, including making unsuitable recommendations to his clients.  He has over twenty customer complaints or arbitrations listed on his record (CRD No. 1349406).  The vast majority of these complaints or arbitrations were resolved in the customer’s favor and roughly half required a personal contribution from Mr. Mathias.  Almost all involve the recommendation of high commission products, including limited partnerships and variable annuities.

In particular, Lax & Neville is focusing its investigation on the unsuitable recommendation and sale of variable annuities.  The recommendation and sale of variable annuities has long been a concern within the securities industry.  NASD and FINRA have released a number of investor alerts and notices to members on the subject, emphasizing that certain suitability requirements must be met to recommend variable annuities (NASD Notice 96-86), highlighting the importance of supervisory procedures to ensure that the suitability requirements are met (NASD Notice 07-06), and warning potential investors of the liquidity issues, high fees, and market risks associated with variable annuities (FINRA Investor Alert 12-00045).

In June 2004, the SEC and NASD released the joint report “On Examination Findings Regarding Broker-Dealer Sales of Variable Insurance Products.”  The report recognized that high commissions helped drive the sale of variable annuities but that the high fees and surrender charges associated with the product made them inappropriate for a wide variety of investors.  The report then identified a number of factors that could assist in “identifying abusive sales practices and violations,” including

Published on:

On October 16, 2017, The Financial Industry National Regulatory Authority (“FINRA”) announced a $3.4 million dollar fine against Wells Fargo, in connection to Wells Fargo brokers improperly placing retail clients in volatility linked products. Many of these volatility linked exchange-traded products (“ETPs”) such as the VXX, XIV, TVIX, and other variations of volatility indexes, that attempt to match, inverse, or leverage Chicago Board of Exchange volatility metrics, are highly complex products that are not suitable for all investors.  FINRA found in its investigation that Wells Fargo registered representatives recommended these ETPs to customers without fully understanding the risks they entail.

ETPs are uniquely volatile products that degrade in value significantly over time and are designed primarily for short term holds when part of a comprehensive hedging strategy or in anticipation of a binary event or large market move. ETPs are not designed to be bought and held in customer accounts for any significant time period, which is a practice Wells Fargo registered representatives were recommending to their customers. As a reminder to financial industry professionals of the obligations they have to customers when recommending volatility ETPs, FINRA released a new Regulatory Notice 17-32 reiterating and reminding firms of their obligations surrounding ETPs.

FINRA found that Wells Fargo failed to implement a sufficient or credible supervisory system to oversee solicited sales of volatility linked ETPs. Broker soliciting sales of volatility linked ETPs should already be cognizant of the significant risks they entail, the limited hold time, and the potential for significant losses.

Published on:

There is an enormous amount of speculation currently occurring in the initial coin offering (“ICO”) sphere, fueled by the rapid increase in the value of bitcoin and other cryptocurrencies. Cryptocurrency is a digital asset that uses cryptology to make transactions secure, and is decentralized in that its creation of new units of currency is fixed via an algorithm, and outside the control of central banks. As such, cryptocurrency currently acts as a derivative to world money supply and debt, with its value increasing in tandem with money supply, demand, and increased pressure from the no-arbitrage rule of functional equivalence. This exchange applies as long as a counterparty accepts the given cryptocurrency as a store of value and medium of exchange.

Cryptocurrencies have appreciated rapidly largely due to the worldwide low interest rate environment created by central banking policy. Many safe fixed income investments offer negative real rates of return after taxes and inflation are accounted for, generating a massive “search for yield” into alternative investment classes. This search includes hard assets such as commodities and real estate, and increasingly exotic assets such as ICOs. With the growth of ICOs, there is a tangent proliferation of fraudulent or risky investment schemes that seek to capitalize on increased ICO demand through complex capital structures and equity issuance. Given the limited regulation and inherent difficulties in insuring or protecting risk in this sphere, it is important investors be wary.

Apple Pay, and PayPal are sophisticated versions of digital assets, however the technical innovation with cryptocurrency is the use of a decentralized ledger distributed among network nodes, as opposed to a centralized ledger used by banks. As such, Apple Pay and Paypal are simply digital versions of a specific fiat currency such as USD, and are not a separate asset class. Each node in a cryptocurrency network has a full copy of the entire distributed network, meaning corruption of the system would necessitate corruption of all nodes simultaneously, which according to experts is nearly mathematically impossible from a code breaking standpoint. The key innovation difference between digital fiat and algorithmically derived cryptocurrencies is that cryptocurrencies can be created with a fixed supply set by the algorithm, as with Bitcoin which is capped at 21 million coins. There are currently approximately 16,519,00 coins in circulation, and with supply fixed and demand growing, some speculators think the price will continue to rise dramatically.

Published on:

On August 22, 2017, the Securities and Exchange Commission (“SEC”) charged Jeremy Drake (“Drake”), a former financial advisor of HCR Wealth Advisors (“HCR”), with defrauding two clients – a professional athlete and his wife—of more than $1.2 million in undisclosed fees from their accounts. The SEC is seeking a return of the ill-gotten monies, plus interest and disgorgement penalties, and is additionally seeking an injunction against Drakes’ future activities in the capital markets. The SEC Complaint (the “Complaint”) found that Drake’s actions constituted a violation of Sections 206(1) and 206(2) of the Advisers Act, 15 U.S.C. §§ 80b-6(1) & 80b-6(2), or, alternatively, the aiding and abetting of HCR’s uncharged violations of those same provisions.

Drake deceived his clients as to his fee structure, by misrepresenting that they had been given a special discounted rate of 0.2% due to their high net worth and status, when in fact they were charged a 1% fee. Drake personally received $900,000 of these fees, through his performance based compensation. Drake’s clients, who were victim to this fraud, were led to believe they had paid only $300,000 in fees, rather than $1.2 million.

Drake worked as a registered investment advisor for HCR from 2009 through July 2016, until he was terminated for misconduct regarding fraudulent fee misrepresentation. Drake personally managed over $50 million dollars for approximately 20 clients. HCR itself has over $900 million in assets under management, with approximately 500 clients in its book. The Complaint’s findings of Drake’s misconduct at HCR should caution investors to look closely at their asset holdings, and insure they are not being charged excessive fees. Compliance screening procedures at HCR may be inadequate at properly protecting investors from predatory sales practice abuses.

Published on:

New York State, among other states, has a “shield law” that gives journalists the right to keep their sources confidential. This law may prove problematic for cases of insider trading. Consider the following recent scenario: Reorg Research Inc (“Reorg”), a subscriber newsletter that covers bankruptcy and distressed debt, published an article about Murray Energy Corporation (“Murray”), one of the largest coal mining companies in the US. Given the confidential nature of the information published, Murray assessed that the information had to have come from some of its private investors, and as such the disclosure of this information to Reorg constituted a breach of Murray confidentiality covenants.

Murray proceeded to sue Reorg, (Murray Energy Corporation v. Reorg Research Inc. 55 Misc.3d 669, 47 N.Y.S.3d 871, 45 Media L. Rep. 1301, 2017 N.Y. Slip Op. 27036) demanding that the source who disclosed information on Murray financials be revealed. The court ordered Reorg to reveal the sources. Reorg appealed, and on July 13, 2017 won the appeal, with the Supreme Court Appellate Division First Department of New York ruling: “we find that the Respondent is except from having to disclose names of its confidential sources from New York’s Shield Law, because it is a professional medium or agency which has one of its main functions the dissemination of news to the public.”

The court made the determination that despite the fact Reorg has only 375 subscriber firms who each pay tens of thousands of dollars a year for access to the publication, Reorg covers a niche market—distressed debt—that is of vital public interest. According to the court, Respondents argued persuasively that the public benefits secondarily from the information Reorg provides to its high paying subscribers, because that audience is comprised of “people most interested in this information and most able to benefit from it” and from this network distributes the information and its pricing effects to the wider public.