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The Georgia Court of Appeals has held that the Protocol for Broker Recruiting (“the Protocol”) does not preclude Financial Advisors from informing their employers of their intentions to leave. Some firms have Notice of Termination provisions in their employment contracts, which require brokers to give notice of their intentions to resign, prior to terminating their employment.

The Protocol is an agreement that was made in 2004. It was designed to allow financial advisors and brokers to transition from one firm to another while taking client information with them. At its peak, the Protocol included the vast majority of brokerage firms, leading to a significant decrease in litigation costs, which had reached staggering levels prior to the institution of the protocol. However, with the withdrawal of firms such as Morgan Stanley, which effectively withdrew from the Protocol on November 3, 2017, the Protocol has lost some of its influence. A recent Georgia court decision has further weakened the Protocol.

The June 2018 decision concerns a 2014 case where several brokers departed from Aprio Wealth Management LLC. Without waiting the obligatory 60 to 90 days outlined in their contracts, the brokers encouraged their clients to transfer their accounts over to Morgan Stanley. Morgan Stanley had recruited the brokers, telling them that the Protocol would override their advanced notice agreements. The Georgia court-of-appeals was tasked with determining what influence the Protocol plays on advanced notice agreements. The presiding judge of the Georgia Court of Appeals ruled that the Protocol does not override the advance notice provisions present in brokers’ contracts. Aprio claims that this decision is beneficial to its purposes, as it protects smaller and mid-sized firms from being poached by larger firms with more resources.

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On June 21, 2018 U.S. District Judge William Orrick (“Orrick”) in San Francisco granted a Motion to Dismiss (“MTD”) in the case Christopher M. Laver v Credit Suisse Securities (USA), LLC. Orrick ruled that the plaintiff Christopher Laver was bound by an agreement to arbitrate employment-related disputes and could not pursue his proposed class action on behalf of roughly 200 brokers.

In the Order Granting the Motion to Dismiss, Orrick wrote the following:

As Laver notes, Regulatory Notice 16-25 characterized as dicta a discussion in a FINRA Board of Governors 2014 enforcement action decision. Regulatory Notice 16-25 at fns. 17, 23 (discussing Board of Governor decision in Dept of Enforcement v. Charles Schwab & Co., 2014 FINRA Discipl. LEXIS 5 (April 24, 2014)). The Cohen court relied on that now-FINRA-disapproved-of-dicta from the Schwab decision suggesting firms could contract around employee rights to a FINRA arbitration (but not consumer rights to FINRA arbitration). However, the fundamental point remains; nothing in Regulatory Notice 16-25 indicates that member firms cannot contract around other, less fundamental provisions of the FINRA Code. Rule 13204 itself provides that its subparagraphs “do not otherwise affect the enforceability of any rights under the Code or any other agreement” indicating that the provisions of this specific rule are subject to waiver by private agreement. See Rule 13204

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On June 19, 2018 the Securities and Exchange Commission filed charges against multiple individuals and associated companies that defrauded investors out of $102 million. The individuals charged are Perry Santillo, Christopher Parris, Paul LaRocco, John Piccarreto, and Thomas Brenner (collectively “Defendants”).

These individuals accrued client assets largely through buying the books of business of retiring brokers. This method of raising funds allowed the brokers to gain clients trust, by ingratiating themselves with older brokers who were retiring and inserting themselves into the relationship. The Defendants would then convince clients to liquidate safe investments and move funds into companies controlled by Defendants. These companies were represented as real estate development trusts, financial services entities, oil and gas operations, etc. and double-digit investment returns combined with high dividends were promised.

In reality, these companies were simply shell entities controlled by Defendants, and once funds were transferred into the entities, they were transferred to feeder accounts, comingled, and withdrawn and misappropriated by Defendants for personal use. Defendants preyed on elderly victims with Alzheimer’s and deteriorating health, and while building trust and promising the safekeeping of funds, brazenly stole them for personal use.

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On May 30, 2018 the Securities and Exchange Commission (“SEC”) charged Steven Pagartanis (“Mr. Pagartanis”) with an $8 million fraud. Mr. Pagartanis was a registered representative of Lombard Securities Incorporated (“Lombard Securities”), an SEC registered broker-dealer. The SEC alleges Mr. Pagartanis had clients, including elderly retirees, write checks to an entity that he controlled that was similarly named to Lombard Securities.

Mr. Pagartanis promised the funds would be safe, and represented guaranteed monthly payments to his clients, while in fact he used the funds to pay personal expenses, or to make interest payments to earlier investors. Mr. Pagartanis hid this fraudulent, illicit activity from investors by creating fictitious account statements showing real estate holdings and interests in private development companies that did not in fact exist. Marc P. Berger, Director of the SEC’s New York Regional Office, said of the fraud: “[A]s part of the alleged scam, Pagartanis preyed on his customers’ trust, duping them to write checks payable to his own entity…regardless of how long investors have worked with their brokers, they should always confirm that recommended investments are approved for sale by their brokerage firm before transferring funds.”

When Financial Advisors engage in fraud and criminal behavior and steal victim’s funds, often times the funds have been spent and are difficult to recover. In some instances, the broker-dealer, custodian, or clearing firm that was involved in holding client accounts for the Financial Advisor that defrauded clients can be held liable for losses caused by the criminal activities of the Financial Advisor.

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Paul James Marshall (“Marshall”), a former Bear Stearns manager with over two decades in the wealth management industry, perpetrated a brazen fraud against clients through his registered investment advisory (“RIA”) firm Bridge Securities. Marshall had clients wire funds to JP Morgan, and make checks payable to JP Morgan, and then deposited those funds directly into Bridge Securities’ accounts. From there, he transferred the funds directly to checking accounts without ever even buying any securities with client funds.

Marshall went so far as to steal funds from a client dying of colon cancer who was in desperate financial condition. After the client passed away, Marshall pursued the insurance money, representing that he would manage it, while in fact using it for his own personal benefit. Marshall additionally charged the deceased’s relatives $5,000 in fees for tax-related work on the deceased clients account that he had never in fact performed.

Marshall falsified account statements by creating phony securities positions and investment returns. When clients attempted to redeem funds or seek information on their investments, Marshall either ignored them or lied to them. Federal prosecutors stated in the sentencing memorandum: “This case is not about mismanagement, poor investment decisions or bad luck, this is a case about outright theft from victims, many of whom were elderly, and the profound losses they suffered as a result.”

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On Friday, April 20, 2018, regulators announced a $1 billion fine against Wells Fargo over claims of misconduct and poor oversight in the auto lending and mortgage lending channels of Wells Fargo’s business. This $1 billion settlement with the Consumer Financial Protection Bureau (“CFPB”) and Office of the Comptroller of the Currency was in response to investigations that found Wells Fargo failed to catch or prevent improper charges to consumers.

Experts have posited that the myriad regulatory issues that have afflicted Wells Fargo are the result of poor internal controls and incentive structures – employees were given aggressive sales and account opening targets to achieve, and were bonused based on hitting specific hurdles. This aggressive payout system, while common in the industry, appears to have had particularly negative consequences at Wells Fargo, where some employees essentially defrauded both consumers and Wells Fargo itself by receiving performance bonuses based on fraudulently opened accounts or fees charged.

Wells Fargo has faced continual and mounting regulatory pressure, with a $185 million penalty in September 2016 for the fraudulent opening of 3.5 million accounts.  In February 2018, the Federal Reserve took the unprecedented enforcement action of issuing a cap on Wells Fargo’s assets, citing regulatory oversight issues.

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On April 6, 2018, the Securities and Exchange Commission (“SEC”) announced that three investment advisors, PNC Investments LLC, Securities America Advisors Inc., and Geneos Wealth Management (the “Advisors”) have settled charges with the SEC. The Advisors paid $12 million in restitution to clients harmed by the Advisor’s breach of their fiduciary duties.

The SEC found that these Advisors “violated their duty to seek best execution” by investing client assets in high cost mutual funds, when lower cost shares of the exact same funds were readily available. The SEC determined that the Advisors made these investment decisions simply for the purposes of self-enrichment.

Under the “Share Class Selection Disclosure Initiative,” the SEC is granting eligible Financial Advisors until June 2, 2018 to disclose and self-report any misconduct surrounding mutual fund purchases. The SEC’s Enforcement Division is willing to extend leniance to financial advisors, including recommending favorable settlement terms and waiving civil penalties, during this grace period granted under this Initiative.

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On March 27, 2018 the Securities and Exchange Commission (“SEC”) announced charges against Wedbush Securities Inc. (“Wedbush”) for failing to supervise employee Timary Delorme (“Delorme”).  The SEC Complaint alleges that Wedbush repeatedly failed to monitor or prevent Delorme’s activities, despite numerous red flags that Delorme was engaging in illicit activities.

The SEC complaint further alleges that Delorme was working in concert with Izak Engelbrecht — who was previously charged by the Commission and criminal authorities in separate actions – and received kickbacks and undisclosed benefits from Engelbrecht in exchange for buying penny stocks in customer accounts.  Wedbush failed to flag these high risk, unsuitable penny stock transactions, and failed to halt this fraudulent kickback scheme despite multiple FINRA inquiries regarding Delorme’s penny stock trading activity, and a customer complaint email to Wedbush detailing the specific scheme Delorme was engaged in.

A separate order against Delorme found that she had violated federal securities laws.  Without admitting or denying the findings, Delorme agreed to pay a $50,000 fine, and to a lifetime ban from the securities industry.  SEC Officer Marc P. Berger, Director of the New York Regional Office, issued a statement in regards to this investigation, saying “Brokerage firms play an important role in protecting retail investors from abusive conduct by brokers like Delorme; this case sends a clear message that we will not tolerate broker-dealers that fail to exercise appropriate supervision over employees, as alleged here.”

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On March 19, 2018, the Securities and Exchange Commission (“SEC”) announced its highest-ever whistleblower award, with the three recipients of the award receiving a total of approximately $83 million.  The award involved three whistleblowers, two of whom split $50 million, and one of whom provided greater assistance in the process, thereby receiving $33 million.  The $83 million award represents 20% of the $415 million fine levied against Merrill Lynch (“Merrill”) by the SEC.

This fine was the result of Merrill gaming SEC Rule 15c3-3 – a regulation that mandates broker-dealers keep customer cash separate from firm cash, so that in the event of a bankruptcy, customer funds would not be jeopardized.  Merrill circumvented this rule by writing derivative contracts that would allow customer cash to be held in Merrill accounts.  Merrill customers suffered no actual loss from these derivative contract trades that they were entered into, as the sole purpose of the contracts was not market exposure, but a way to account customer assets as being on Merrill books, so that for example the firm could have more cash with which to leverage.

This bespoke derivative contract that Merrill designed, called a “leveraged conversion” had no real economic substance, however it impacted the way “customer cash” was calculated. These contracts made it appear customers owed Merrill money that they did not, because the debt was simply notional.  Merrill actually sought SEC approval on these leveraged conversions, and was granted it.  The SEC likely granted this approval because they thought the intent of the trades was to help Merrill clients finance inventory, or had some other tangible benefit – they would not have approved the leveraged conversions had they known Merrill designed these contracts purely to skirt SEC Rule 15c3-3.

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In late 2017, the Justice Department ordered Wells Fargo & Co. (“Wells Fargo”) to conduct an investigation of its Wealth Management Division (“WFA”), after whistleblowers at the bank alleged sales practice abuses.  Wells Fargo released a statement saying that their board was investigating “whether there have been inappropriate referrals or recommendations, including with respect to rollovers for 401(k) plan participants, certain alternative investments, or referrals of brokerage customers to the company’s investment and fiduciary services business.”

Wells Fargo has faced continual and mounting regulatory pressure, with a $185 million penalty in September 2016 for the fraudulent opening of 3.5 million accounts.  In February 2018, the Federal Reserve took the unprecedented enforcement action of issuing a cap on Wells Fargo’s assets, citing oversight issues.  This investigation, initiated by the Justice Department, may only uncover more unsuitable or fraudulent practices at the troubled bank. Wells Fargo also found that it had improperly over-charged 800,000 auto loan customers, and 110,000 mortgage customers – Wells Fargo is now refunding approximately $100 million to these improperly charged customers.

As the investigation into WFA continues, more improper sales practice abuses may be uncovered.  If clients are pushed into high fee accounts, encouraged to buy products on margin (while paying margin interest), overly concentrated in specific sectors, or paying over 300 basis points in fees, there may be regulatory enforcement actions that demand arbitration.  In addition to the customers who may have suffered from Wells Fargo’s unsuitable/and or fraudulent actions, Financial Advisors who transitioned to WFA unaware of the problems they were transitioning into, may also have suffered damages.