COVID-19 Update: How we are serving and protecting our clients.

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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.

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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.

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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.

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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

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.

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Direxion has announced that on March 31, 2020, the leverage of 10 daily ETF’s will be changed from 300% to 200%. Direxion released the following presser:

NEW YORK — March 27, 2020—The investment objective and strategy of each Fund in the table below is currently to seek daily leveraged, or daily inverse leveraged, investment results, before fees and expenses, of 300% or -300%, as applicable, of the performance of its underlying index. Effective after market close on March 31, 2020 each Fund’s investment objective and strategy will change to seek daily leveraged, or daily inverse leveraged, investment results, before fees and expenses, of 200% or -200%, as applicable, of the performance of its underlying index, as shown below:

Ticker Fund Underlying Index New Daily Leveraged Investment Objective (before fees and expenses)
BRZU Direxion Daily MSCI Brazil Bull 3X Shares MSCI Brazil 25/50 Index 200%
RUSL Direxion Daily Russia Bull 3X Shares MVIS Russia Index 200%
NUGT Direxion Daily Gold Miners Index Bull 3X Shares NYSE Arca Gold Miners Index 200%
DUST Direxion Daily Gold Miners Index Bear 3X Shares -200%
JNUG Direxion Daily Junior Gold Miners Index Bull 3X Shares MVIS Global Junior Gold Miners Index 200%
JDST Direxion Daily Junior Gold Miners Index Bear 3X Shares -200%
ERX Direxion Daily Energy Bull 3X Shares Energy Select Sector Index 200%
ERY Direxion Daily Energy Bear 3X Shares -200%
GUSH Direxion Daily S&P Oil & Gas Exp. & Prod. Bull 3X Shares S&P Oil & Gas Exploration & Production Select Industry Index 200%
DRIP Direxion Daily S&P Oil & Gas Exp. & Prod. Bear 3X Shares -200%


Since inception, these 10 Direxion funds have been used by traders, funds and investors as trading or hedging vehicles. Collectively, these funds hold billions of dollars of total assets. Direxion’s changing the leverage ratio of its funds may have been prompted by the extreme market volatility seen across capital markets throughout March 2020. However, this change could lead to immediate and significant losses by both Direxion fund investors and those who purchased options on Direxion funds.

Lax & Neville has significant experience with complex securities cases involving ETFs, ETNs and options. If you have suffered investment losses from Direxion funds or options, or your broker’s or investment advisor’s purchase of ETFs or ETNs in your investment account, contact Lax & Neville LLP today at (212) 696-1999 and schedule a consultation.


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On February 14, 2020, four former Credit Suisse investment advisers represented by Lax & Neville LLP won a $2.2 million FINRA arbitration award against Credit Suisse Securities (USA) LLC for failure to pay their earned deferred compensation when it exited the U.S. wealth management business in October 2015.  See Galli, et al. v. Credit Suisse Securities (USA) LLC, FINRA No. 17-01489.  This is one of numerous FINRA arbitrations against Credit Suisse arising from its calculated decision to withhold more than $200 million in deferred compensation from nearly 300 former advisers in breach of their employment agreements and its own deferred compensation plans.   Seven have gone to award thus far, including five brought by  Lax & Neville LLP.  See Galli, et al. v. Credit Suisse Securities (USA) LLC, FINRA No. 17-01489; DellaRusso and Sullivan v. Credit Suisse Securities (USA) LLC, FINRA No. 17-01406; Lerner and Winderbaum v. Credit Suisse Securities (USA) LLC, FINRA No. 17-00057; Finn v. Credit Suisse Securities (USA) LLC, FINRA No. 17-01277; and Chilton v. Credit Suisse Securities (USA) LLC, FINRA No. 16-03065.  All seven FINRA arbitration panels and a New York State Judge (Credit Suisse Securities (USA) LLC v. Finn, Index No. 655870/2018 (N.Y. Sup. Ct. 2019)) have found for the advisers and ordered Credit Suisse to pay the deferred compensation it owes them.

Lax & Neville LLP has won more than $13 million in compensatory damages, liquidated damages, interest, costs and attorneys’ fees on behalf of former Credit Suisse investment advisers.  To discuss these FINRA arbitration Awards, please contact Barry R. Lax, Brian J. Neville, Sandra P. Lahens or Robert R. Miller at (212) 696-1999.

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On January 28, 2020, the SEC charged Edward E. Matthes, a former registered representative and investment adviser in Wisconsin, with defrauding 26 of his majority elderly clients out of approximately $2.4 million.

According to the SEC’s complaint, between April 2013 and March 2019, Matthes made misrepresentations to his clients, claiming that a new investment opportunity would generate a higher return for them and earn a guaranteed minimum yield of 4% per year. The claimed investment opportunity did not exist and Matthes simply stole approximately $1.4 million from his clients. Matthes allegedly used the money to renovate his home, pay child support and purchase various luxury items.

Matthes further misappropriated an additional $1 million of his clients’ money by allegedly making unauthorized sales and withdrawals from his clients’ variable annuities and depositing the money directly into his personal bank account instead of clients’ accounts. Matthes used all of the funds he raised for his own personal use and to operate a Ponzi-like payment scheme, paying $170,000 to certain, select customers.

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On January 14, 2020, the SEC informed the public that they had filed an enforcement action and obtained a temporary restraining order and asset freeze against Kenneth D. Courtright, III, an Illinois resident, and his company, Todays Growth Consultants Inc. (TGC) in connection with an alleged Ponzi-like scheme that raised at least $75 million from over 500 investors.

The SEC’s complaint, initially filed in federal court in Chicago on December 27, 2019, and unsealed on January 14, 2020, charges Courtright and his company with antifraud and registration violations and seeks emergency relief, as well as permanent injunctions, return of ill-gotten gains with prejudgment interest, and civil penalties. On Dec. 30, 2019, the Court issued a temporary restraining order, ordered an asset freeze and other emergency relief.

Between 2017 and 2019, Courtright and TGC operated under the alleged false promise that they could provide a minimum guaranteed rate of return on revenues, generated by websites, to their investors. TGC claimed it would use investor funds to buy or build a website and develop, market, and maintain the website for investors. However, TGC’s sales were conducted through unregistered securities offerings. In reality, as alleged, Courtright and TGC were operating a Ponzi-like scheme, using investor funds to pay investor returns, in addition to paying for Courtright’s personal expenses, including his mortgage and private school tuitions for his family.

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On November 14, 2019, two former Credit Suisse investment advisers represented by Lax & Neville LLP won a $1.6 million FINRA arbitration award against Credit Suisse Securities (USA) LLC for unpaid deferred compensation. This is the sixth FINRA panel to rule on claims arising from Credit Suisse’s refusal to pay its advisers more than $200 million in earned deferred compensation when it closed its US private bank. All six FINRA panels have found for the advisers and ordered Credit Suisse to pay the deferred compensation it owes.

The claimants, Richard J. DellaRusso and Mark L. Sullivan, were advisers in the New York branch of Credit Suisse’s US private banking division (“PBUSA”) and were terminated when Credit Suisse closed PBUSA. Credit Suisse took the position, as it has with hundreds of its former investment advisers, that Mr. DellaRusso and Mr. Sullivan voluntarily resigned and forfeited their deferred compensation. A three member FINRA Arbitration Panel determined that Credit Suisse terminated Mr. DellaRusso and Mr. Sullivan without cause and breached their employment agreements by cancelling their deferred compensation.

The FINRA Panel awarded Mr. DellaRusso and Mr. Sullivan compensatory damages totaling $1,235,817, which included 100% of their deferred compensation awards, 2015 deferred compensation, and severance. The FINRA Panel also awarded interest and, having concluded that the cancellation of deferred compensation violated the New York Labor Law, attorneys’ fees. See NYLL § 198(1-a). The FINRA Panel recommended expungement of Mr. DellaRusso’s and Mr. Sullivan’s Forms U-5, the termination notice a broker-dealer is required to file with FINRA. As with hundreds of their colleagues, Credit Suisse falsely reported that Mr. DellaRusso’s and Mr. Sullivan’s “Reason for Termination” was “Voluntary.” The FINRA Panel recommended that the “Reason for Termination” be changed to “terminated without cause.” The FINRA Panel also denied Credit Suisse’s counterclaims. To view this Award, visit 17-01406.

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On December 26, 2019, FINRA sanctioned five firms, LPL Financial LLC, J.P. Morgan Securities LLC, Morgan Stanley Smith Barney LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Citigroup Global Markets Inc., for failing to ensure asset transfers on legally mandated dates for at least 80,585 accounts. 53,384 of the accounts came from Morgan Stanley and 15,366 accounts came from Merrill Lynch; while, 5,666 accounts were at J.P. Morgan Securities, 5,249 accounts were at LPL, and 920 accounts were at Citigroup.

Accounts operating under the Uniform Transfers to Minors Act (UTMA) and the Uniform Gifts to Minors Act (UGMA), allow customers to transfer funds to a minor beneficiary without creating a formal trust. In these accounts, a custodian conducts investments on behalf of the beneficiary, until the beneficiary reaches the age of majority, at which point the account is transferred from the custodian to the beneficiary. The five firms failed to follow the rules governing these wealth transfers, by allowing the custodians to conduct transactions in the accounts after the accounts were transferred to the beneficiaries.

FINRA requires firms to “know your customer,” by verifying the authority of any person acting on behalf of a customer. Following the “Know Your Customer” (KYC) rule requires firms to implement supervisory systems to verify custodian authority to make investment decisions in the accounts. The five firms failed to adequately supervise the accounts and therefore failed to follow FINRA’s KYC rule.

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