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On March 11, 2021, a FINRA arbitrator awarded expungement relief to George D. Ewins Jr. and Richard J. Kowalski, former Merrill Lynch financial advisors.  Ewins and Kowalski were represented by Robert J. Moses of Lax & Neville LLP.  Ewins and Kowalski sought expungement of a customer complaint from their registration records maintained by the Central Registration Depository (“CRD”).  CRD is the central licensing and registration system for the securities industry and its regulators, which contains information made available to the public via FINRA’s BrokerCheck. Pursuant to FINRA Rules 2080 and 13805, an arbitrator may grant an expungement of customer dispute information from a registered representative’s CRD record.  In the underlying arbitration filed by the customers, the customers alleged that Ewins, Kowalski, Merrill Lynch and Bank of America (“BOA”) sold Merrill Lynch proprietary volatility indices linked to structured notes known as Strategic Return Notes which were unsuitable in light of their investment objectives.  Merrill Lynch and Bank of America settled with the customers which resulted in the customers’ not having any out-of-pocket losses.  Ewins and Kowalski did not contribute to the settlement.

Pursuant to FINRA Rule 13805 of the FINRA Code of Arbitration Procedure (“Code”), the FINRA arbitrator in the expungement proceeding made the following FINRA Rule 2080 affirmative finding of fact: “[t]he claim, allegation, or information is false.”  According to the Award, the arbitrator reached this conclusion “based upon the fact that neither Ewins nor Kowalski was responsible for the failure of Merrill Lynch and BOA to make the requisite disclosures concerning the fixed costs associated with the Strategic Return Notes. Both Ewins and Kowalski testified credibly that they performed necessary due diligence before they recommended the Strategic Return Notes for the customers. There is no reason to conclude that either Ewins or Kowalski could have reasonably questioned the validity, accuracy and completeness of the Strategic Return Notes offering materials prior to the SEC and FINRA actions. One of the customers who filed the underlying arbitration submitted a detailed written response to Ewins and Kowalski’s request for expungement and testified at the expungement hearing that he “personally do[es] not have a problem with a potential expungement of the petitioner[s’] record[s] if they have met the burden for their record to be cleared,” and that he did not want Ewins and Kowalski to have adverse consequences from having the disclosures on their CRDs.

As noted by the arbitrator in the Award, Merrill Lynch agreed to pay a $10 million penalty to settle charges by the SEC that Merrill Lynch violated securities laws and was responsible for misleading statements in offering materials provided to retail investors for structured notes linked to a proprietary volatility index.  Merrill Lynch also agreed to a Letter of Acceptance, Waiver and Consent (“AWC”) with FINRA in connection with the same disclosure violations.

On September 9, 2020, the U.S. District Court for the District of Colorado entered a final judgment by consent against ex-Stifel investment adviser Steven D. Rodemer for allegedly defrauding an elderly widowed client, according to the U.S. Securities and Exchange Commission (“SEC”).

Rodemer, who was registered with the brokerage and investment banking firm Stifel as a general securities representative from November 2011 until his termination by the firm on January 21, 2020, is alleged to have misappropriated $451,889 of his long-time client’s funds from March 2012 through 2019, including $136,098 after May 2015. According to a Financial Industry Regulatory Authority (“FINRA”) letter of acceptance, waiver and consent Rodemer signed on March 23, 2020, Stifel terminated him for taking “money from a client account for his personal use without authorization.” The SEC, which did not name the client in its complaint, alleged that the client had “developed a relationship of trust and confidence” in Rodemer and “relied upon Rodemer for information regarding the balances and transactions in her accounts.” Beginning in March 2012, shortly after he became the client’s power of attorney, Rodemer started misappropriating funds from her and her late husband, using the power of attorney authority to withdraw funds from her brokerage and bank accounts “for a variety of personal expenses, including to cover construction and maintenance costs on his vacation home in Breckenridge, Colorado, to pay insurance premiums, and to fund an undisclosed brokerage account in his wife’s name at another broker-dealer.” Beginning in July 2018, Rodemer then also started using the client’s funds to pay his own personal expenses at gas stations, grocery stores, and hardware stores, as well as to pay his own personal credit card bills.

While Rodemer had initially cooperated in FINRA’s investigation, he ceased doing so in March 2020, and his counsel informed FINRA on March 20, 2020 that he would not appear for on-the-record testimony at any time, in direct violation of FINRA Rules 8210 and 2010. As a result, and upon Rodemer’s signing the previously mentioned letter of acceptance, waiver and consent, FINRA barred Rodemer from the industry, prohibiting him from associating in any capacity with any FINRA member. Subsequently, and immediately after the SEC filed its complaint on September 3, 2020, Rodemer agreed to pay $385,536 to settle the SEC’s claim against him. The final judgment that was entered in the federal district court in Colorado ordered Rodemer to pay this amount as a civil penalty, and according to the SEC’s complaint, he has already returned the misappropriated funds to the client’s account.

On June 4, 2020, the Financial Industry Regulatory Authority (“FINRA”) announced that it ordered Merrill Lynch, Pierce, Fenner & Smith Inc. to pay its customers more than $7.2 million in restitution and interest  resulting from unnecessary sales charges and excess fees incurred by more than 13,000 Merrill Lynch accounts in connection with mutual fund transactions from 2011 to 2017.  FINRA found that Merrill Lynch’s ’s supervisory systems and procedures failed to ensure that certain customers received sales charge waivers and fee rebates that were available to them.

Typically, mutual fund issuers will offer their customers a right of reinstatement, allowing the investors to purchase shares of a mutual fund after previously selling shares of that fund or another fund in the same fund family, without incurring a front-end sales charge, or allowing the investors to recoup some to all of contingent deferred sales charges.

Rather than ensuring that  proper supervisory systems and procedures were in place to identify waivers and fee rebates that were available through rights of reinstatement, Merrill Lynch instead relied on its brokers and investment advisors to manually recognize and apply waivers and rebates for investors and for the financial advisors to manually identify which customers are eligible  for reinstatement rights.  According to FINRA, the manual system was “unreasonably designed… given the number of customers involved, the complexity of determining which customers were due sales charge waivers or fee rebates, and difficulty in calculating the amount of the waiver and rebate.”

On March 12, 2020, the Securities and Exchange Commission (“SEC”) charged Morgan Stanley with providing misleading information to customers regarding the costs of “wrap fee” programs. Wrap fee programs offer accounts in which customers pay asset-based fees meant to cover investment advice and brokerage services, including the execution of trades. The SEC alleged that nowhere in Morgan Stanley’s retail wrap fee programs was it disclosed to customers that additional fees were charged for certain wrap fee trades that were directed to third-party broker-dealers for execution.

The SEC alleged that Morgan Stanley’s wrap fee practices involved extra costs that were not visible to customers, limiting the customers’ ability to assess the true costs and value of the services for which they were paying.  Morgan Stanley, without admitting or denying the wrongdoing, agreed to pay $5 million to settle the SEC charges. Morgan Stanley’s alleged wrongdoing occurred from October 2012 to June 2017, and the $5 million will be distributed to harmed investors.

Customers of brokerage firms or registered investment advisors are often unaware of all the fees they are charged for the investment advice and services they are receiving. As Melissa Hodgman, associate director in the SEC’s enforcement division, noted, “[i]nvestment advisers are obligated to fully inform their clients about the fees that clients will pay in exchange for services.” If an investment advisor fails to disclose all the fees to his or her customer or charges excessive fees to the customer, the customer may have a claim against the investment advisor, the advisory firm or the brokerage firm where the customer held his or her investments and accounts.

Oil and gas investments have experienced extreme volatility throughout 2020, as the underlying price of oil has plummeted. Oil prices briefly dropped below $0 for the first time in history, with contracts for West Texas Intermediate (WTI)—a grade of crude oil used as North America’s main benchmark for oil pricing—trading at approximately -$37.00 a barrel on April 20, 2020.

Oil companies in the United States have been saddled with debt and operating at a loss year after year, well before the COVID-19 pandemic caused further declines in oil prices. Many of these companies have been kept solvent only by the continual flow of investor dollars, as investors or financial advisors speculate that the price of oil will eventually rise and the investments will be profitable in the future. Investments in oil and natural gas companies, such as Chesapeake Energy, Diamondback Energy, and Whiting Petroleum Corp., have all declined precipitously this year as oil prices plunged. Complex exchange traded funds (ETFs), such as ProShares Ultra Bloomberg Crude Oil (UCO), United Stated Oil Fund LP (USO) and United States 12 Month Oil Fund LP (USL), collectively holding billions of dollars of investor assets, have also dropped over 70% in the last three months.

Given the high levels of debt and volatility in the industry, investments in the United States oil and gas industry are very risky and not suitable for all investors. Financial advisors or brokers who recommend and purchase oil and gas investments to investors have a duty to disclose all the risks associated with these types of investments, including that they are speculative bets in debt-laden and often unprofitable companies and can be high commission investment vehicles. If the financial advisors or brokers failed to do so, they and their advisory or brokerage firms could be liable for the losses incurred from recommending these investments.

Due in large part to the current COVID-19 pandemic, March of 2020 was one of the most volatile months for financial markets since the market crash of 1929 and the financial crisis of 2008. During periods of extreme market volatility, securities prices can fluctuate wildly, triggering margin calls and the liquidation of securities in investor’s investment margin accounts, at substantial and unrecoverable losses to investors. Margin accounts can be very risky and are not suitable for everyone.

In margin accounts, investors borrow money to purchase securities and that loan is collateralized with the cash and securities in the account. As with all loans, when an investor buys security on margin he or she will have to pay back the money borrowed plus interest and commissions. An investment strategy or portfolio that includes trading on margin exposes an investor to increased risks, added costs, and losses greater than the amount of the investor’s initial investment.

The use of securities to collateralize margin loans in a margin account exposes investors to leverage, which increases the risks in an account. One of the biggest risks from buying on margin and leveraging your portfolio is that the investor can lose significantly more money that he or she initially invested. For instance, a loss of 50% or more from securities purchased on margin is equivalent to a loss 100% or even more to an investor. An investor stands to lose all of the money he or she invested, plus interest for borrowing money, plus the commissions paid to the brokerage firm for the purchase or sale of the underlying securities. Trading on margin exposes an investor to significant risk when the brokerage firm or financial advisor forces a sellout of a stock in the account (without notice to or approval by the investor) to meet a margin call after the price of the stock has plummeted. In that scenario, the investor has lost out on the chance to recoup his or her losses if or when the market bounces back.

In January 2020, J.P. Morgan Chase & Co. announced that it would be placing one of its senior credit traders, Edward Koo, on administrative leave pending its investigation into his use of WhatsApp Messenger for “market chatter” with other J.P. Morgan Chase & Co. employees. This month, J.P. Morgan Chase & Co. fired Mr. Koo and cut the bonus payments for more than a dozen other J.P. Morgan Chase & Co. employees who used WhatsApp Messenger during the course of their business. On February 4, 2020, Paul Falcon, a broker with Aegis Capital Corp., signed a Financial Industry Regulatory Authority (“FINRA”) Letter of Acceptance, Waiver and Consent, agreeing to a fine of $5,000 and 30 day suspension for using WhatsApp Messenger to “conduct securities-related business with three Firm customers.” FINRA found that “Aegis was not able to capture the communications Falcon sent and received through WhatsApp Messenger” and that “[b]y virtue of the foregoing, Falcon violated FINRA Rules 4511 and 2010.”

FINRA Rule 4511 states: “(a) Members shall make and preserve books and records as required under the FINRA rules, the Exchange Act and the applicable Exchange Act rules; (b) Members shall preserve for a period of at least six years those FINRA books and records for which there is no specified period under the FINRA rules or applicable Exchange Act rules; and (c) All books and records required to be made pursuant to the FINRA rules shall be preserved in a format and media that complies with SEA Rule 17a-4.” FINRA Rule 2010 states: “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.”

Member firms typically include provisions in their written supervisory procedures that require electronic communications between employees and customers be conducted on firm-systems using firm-issued electronic devices in an effort to comply with these rules. These policies have allowed firms to monitor employees’ phone calls, emails and instant messages for potential violations of securities laws, including insider trading and money laundering, and retain this information for their records. However, WhatsApp Messenger’s encryption of its platform has made traditional monitoring and retention methods more difficult. Its prevalence among both employees and customers for social purposes has also made complete prohibition challenging.

Chinese coffee chain Luckin Coffee’s stock plunged more than 80% on April 2, 2020 after it revealed in an SEC filing that it was internally investigating an alleged fraud on the part of its former COO, Jian Liu. The allegations surround fraudulently fabricated transactions that involved a substantial part of Luckin Coffee’s revenue during the last three quarters of 2019. The embattled company stunned investors by disclosing that as much as 2.2 billion yuan ($310 million) in sales had been fabricated by the COO and some of the employees who worked under him. The falsified sales represented close to half of Luckin Coffee’s reported or projected revenue for the nine-month period.

In a few short years, Luckin Coffee displaced Starbucks as the coffee retail and delivery leader in China. But its stock is down another 18% (approximately) as investors continue appreciate the ramifications of the disclosure in the SEC filing and the re-positioning of the competitive Chinese coffee market. Immediately before its initial public offering (IPO) in May 2019, Luckin Coffee was valued at roughly $4 billion. Now, the company’s market cap is approximately $1.1 billion.

The steep dive in valuation is putting enormous pressure on the banks that extended loans to buy Luckin Coffee’s stock on margin. Buying on margin is the act of borrowing money to buy securities, which includes buying an asset where the buyer pays only a percentage of the asset’s value and borrows the rest from the bank or broker. The broker acts as a lender and the securities in the investor’s account act as collateral. Many investors who bought Luckin Coffee’s stock on margin are facing margin calls, which occur when the value of an investor’s margin account falls below the broker’s required amount. A margin call is the broker’s demand that an investor deposit additional money or securities so that the account is brought up to the minimum value.

Redwood Trust, Inc. (“RWT”), a publicly traded real estate investment trust (“REIT”), filed a Form 8-K on April 2, 2020 revealing that its book value fell as much 56% in the first quarter, resulting in the decline of RTW shares of approximately 31% in a single day. See RWT SEC filing http://www.snl.com/Cache/IRCache/c7e6c9bfb-d506-663b-3b5d-328e2398755c.html.

The Form 8-K reported as follows:

Preliminary Estimate of Book Value – Excluding any potential decline in the value of our intangible assets since December 31, 2019, as of March 27, 2020, we estimate that on a preliminary basis GAAP book value per common share is between $7.03 and $7.67, an estimated year-to-date decline of approximately 52% to 56% from our GAAP book per common share at December 31, 2019.