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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.

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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.

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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.

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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.

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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.