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The Securities and Exchange Commission (“SEC”) announced this month that four investment advisory firms—Merrill Lynch, RBC Capital Markets, Eagle Strategies, and Cozad Asset Management—agreed to pay $4.72 million to settle charges that they recommended and sold mutual share classes to its customers when cheaper shares were available to those investors.  The majority of that sum, namely, $3.88 million, is attributable to RBC Capital Markets.  The mutual fund fee disgorgements resulting from the settlements with the SEC are part of the SEC’s initiative, launched in February 2018, wherein the SEC agreed to waive civil penalties against investment advisers who self-reported and admitted that they had been putting investors into high-fee mutual fund classes and agreed to reimburse those customers.  These settlements are the last ones the SEC will accept as it concludes the mutual fund amnesty program.

A mutual fund share class represents an interest in the same portfolio of securities with the same investment objective, with the primary difference being the fee structures.  For example, some mutual fund share classes charge what are called “12b-1 fees” to cover fund distribution and sometimes shareholder service expenses.  Many mutual funds, however, also offer share classes that do not charge 12b-1 fees, and investors who hold these shares will almost always earn higher returns because the annual fund operating expenses tend to be lower over time.

In the various cease and desist orders, the SEC found that Merrill Lynch, RBC Capital Markets, Eagle Strategies, and Cozad Asset Management purchased, recommended or held for their clients mutual fund share classes that paid the firms or the advisors 12b-1 fees instead of lower cost share classes of the same funds for which their customers are also eligible.  The firms also failed to disclose these conflicts of interest, either in its Forms ADV or otherwise, related to their receipt of 12b-1 fees and/or the selection of mutual fund share classes that pay higher fees and result in higher commissions to the investment advisors.  Investment advisors owe a fiduciary duty to their customers to act in their best interest, including disclosing conflicts of interest.  The SEC found that the investment advisory firms’ failures to adequately disclose that the advisors were actually incentivized to recommend funds with higher fees when the same mutual funds without those fees were available violated the firms and advisors’ fiduciary duty to their customers.

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On September 18, 2017, Lax & Neville LLP was appointed special securities litigation counsel for court-appointed Receiver, Richard W. Barry, in an action commenced by the Attorney General of New Jersey on behalf of the Chief of the New Jersey Bureau of Securities. The action alleged securities fraud in the sale of securities, as well as other violations of the New Jersey Uniform Securities Laws, by defendants Osiris Fund Limited Partnership (a hedge fund), Peter Zuck, and others.  State of New Jersey, et al. v. Peter Zuck, et al., Docket No.: HDU-C-125-12.

The Receiver—who was empowered to pursue actions on behalf of the receivership estate to recover assets for the benefit of defrauded investors, victims, and creditors—filed a motion to approve the retention of Lax & Neville LLP as special securities counsel to assist the Receiver in his duties and seek relief on behalf of those defrauded.  Given the sophisticated nature of the securities-related issues, the Receiver sought to retain a law firm with specialized skill, knowledge and experience in securities law and arbitration.  Lax & Neville LLP’s retention as special securities counsel was approved by court order on September 18, 2017.

On December 30, 2017, Lax & Neville LLP commenced a Financial Industry Regulatory Authority (“FINRA”) arbitration claim on the Receiver’s behalf against Interactive Brokers and Kevin Michael Fischer, who is the head of Interactive Brokers LLC’s block trading desk.  The FINRA arbitration concerned the collapse of Osiris Fund, a fraudulent Ponzi scheme orchestrated by Peter Zuck, a convicted felon who was banned from the securities industry (specifically, the National Futures Association (“NFA”)) fifteen years before he opened accounts with Fischer at Interactive Brokers.  The Receiver’s Statement of Claim alleged that, from April 2009 through December 2011, Interactive Brokers ignored numerous red flags, including obviously fraudulent account opening documents, suspicious fund transfers, ludicrously high “management fees,” and hundreds of e-mails and hours of recorded phone calls between Osiris Fund’s employees and Fischer.  The Receiver further alleged that Interactive Brokers and Fisher became instrumental to the scheme, with Interactive Brokers providing substantial participation in the form of what was apparently a completely unsupervised platform that gave Osiris Fund credibility with Investors, and with Fischer participating substantially in marketing and solicitating new investors, recommending securities, directing Osiris Fund’s employees, and at times managing Osiris Fund’s investments himself.  The Receiver alleged that Interactive Brokers, Fisher, and Osiris Fund defrauded approximately 72 investors out of approximately $6.5 million.

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On May 7, 2019, two former Credit Suisse investment advisers represented by Lax & Neville LLP won a $6.68 million FINRA arbitration award against Credit Suisse Securities (USA) LLC for unpaid deferred compensation and violations of the New York Labor Law (“NYLL”).  This is the fourth FINRA Award against Credit Suisse for unpaid deferred compensation.

The claimants, Joseph Todd Lerner and Anna Sarai Winderbaum, 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 Ms. Winderbaum and Mr. Lerner voluntarily resigned and forfeited their deferred compensation.  A three member FINRA Arbitration Panel determined that Credit Suisse terminated Ms. Winderbaum and Mr. Lerner without cause, breached their employment agreements by cancelling their deferred compensation and violated the NYLL.    The FINRA Panel was chaired by a law professor and expert in labor and employment law.

The FINRA Panel awarded Ms. Winderbaum and Mr. Lerner compensatory damages totaling $2,787,344, which included 100% of their deferred compensation awards, 2015 deferred compensation, and severance.  Having concluded that the cancellation of deferred compensation violated the NYLL, the FINRA Panel awarded statutorily mandated interest, attorneys’ fees and liquidated damages equal to 100% of the unpaid compensation.  See NYLL § 198(1-a).  The FINRA Panel ordered Credit Suisse to pay 100% of the FINRA forum fees, totaling $50,250.00, and recommended expungement of Mr. Lerner and Ms. Winderbaum’s Form 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. Lerner and Ms. Winderbaum’s “Reason for Termination” was “Voluntary,” i.e. that they voluntarily resigned.  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 17-00057.

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On November 6, 2018, Nicolas Finn, a former Credit Suisse investment adviser represented by Lax & Neville LLP, won a FINRA arbitration award against Credit Suisse Securities (USA) LLC for unpaid deferred compensation. On November 27, 2018, Credit Suisse petitioned the New York Supreme Court (Commercial Division) to vacate the Finn Award on grounds of arbitrator misconduct and manifest disregard of the law. See Credit Suisse Securities (USA) LLC v. Nicholas B. Finn, CV 655870/2018. The Honorable Judge Jennifer Schecter, by order dated April 24, 2019, denied the Petition to Vacate in its entirety and entered judgment for Mr. Finn.

Credit Suisse is currently being sued by dozens of its former investment advisers in connection with the 2015 closure of its US private bank. Four FINRA Panels have issued awards thus far, all of them finding Credit Suisse terminated its advisers without cause and ordering it to pay deferred compensation. This is the first time a court has heard Credit Suisse’s defenses to the Credit Suisse Deferred Compensation Arbitrations.

Credit Suisse contended that the Finn Panel acted in manifest disregard of the law on two issues. First, Credit Suisse argued that Mr. Finn resigned as a matter of law when he left Credit Suisse on November 23, 2015, a month after Credit Suisse announced it was closing its private bank. Under the terms of Credit Suisse’s contracts with its investment advisers, deferred compensation is cancelled immediately upon voluntary resignation but vests immediately upon termination without cause. The evidence at arbitration overwhelmingly established that Credit Suisse both structured the closure of the private bank and deliberately concealed and misrepresented material information in order to mischaracterize its advisers as having “resigned” after they were given no option but to leave Credit Suisse. It then cancelled more than 95% of its advisers’ deferred compensation, amounting to almost $200 million. The Finn Panel rejected Credit Suisse’s argument that Mr. Finn resigned voluntarily and ordered expungement of “Voluntary” termination from his Form U-5. The Panel recommended that the Form U-5 be amended to state that the reason for termination was “Termination Without Cause.”

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On November 6, 2018, a former Credit Suisse investment adviser represented by Lax & Neville LLP, a leading securities and employment law firm, won a FINRA arbitration award against Credit Suisse Securities (USA) LLC for unpaid deferred compensation.  This is the second FINRA Award against Credit Suisse for unpaid deferred compensation. 

The claimant, Nicholas Finn, was an adviser in Credit Suisse’s New York US private banking division (“PBUSA”) and was terminated when Credit Suisse closed PBUSA.  Credit Suisse took the position, as it has with hundreds of other former investment advisers, that Mr. Finn voluntarily resigned and forfeited his deferred compensation.  A three arbitrator panel determined that Credit Suisse terminated Mr. Finn without cause and awarded him all of his compensatory damages in the amount of $975,530, which included all of his deferred compensation awards valued as of November 23, 2015, the day he left Credit Suisse, and his 2015 deferred compensation.  The Panel ordered Credit Suisse to pay 100% of the FINRA forum fees, totaling $27,300, and recommended expungement of Mr. Finn’s Form U-5, the termination notice a broker-dealer is required to file with FINRA.  As with Mr. Finn’s colleagues, Credit Suisse falsely reported that Mr. Finn’s “Reason for Termination” was “Voluntary,” i.e. that Mr. Finn resigned.  The Panel recommended that the “Reason for Termination” be changed to “terminated without cause.”   The Panel also denied Credit Suisse’s counterclaims.  To view this Award, Nicholas Finn v. Credit Suisse Securities (USA) LLC, FINRA Case No. 17-01277 

Credit Suisse raised a mitigation defense based upon compensation Mr. Finn received or may receive from his current employer, UBS Financial Services Inc.  Like the Panel in Brian Chilton v. Credit Suisse Securities (USA) LLC, FINRA Case No. 16-03065, the Finn Panel  rejected Credit Suisse’s mitigation defense when it awarded Mr. Finn all of his Credit Suisse deferred compensation.

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On October 10, 2018, a former Credit Suisse investment adviser represented by Lax & Neville LLP, a leading securities and employment law firm, won a FINRA arbitration award against Credit Suisse Securities (USA) LLC for unpaid deferred compensation.  The claimant, Brian Chilton, was an adviser in Credit Suisse’s US private banking division (“PBUSA”) and was terminated when Credit Suisse closed PBUSA.  As it did with hundreds of his colleagues, Credit Suisse took the position that Mr. Chilton voluntarily resigned and forfeited his deferred compensation.  A highly sophisticated and experienced three arbitrator panel determined that Credit Suisse terminated Mr. Chilton without cause and awarded him all of his deferred compensation, consisting of 39,980 shares of Credit Suisse AG valued as of the date of his termination at $585,307.20.  The Panel ordered Credit Suisse to pay interest of $131,694.12, attorneys’ fees of $146,326.80, and 100% of the FINRA forum fees, totaling $69,750.00.  The Panel also recommended expungement of Mr. Chilton’s Form U-5, the termination notice a broker-dealer is required to file with FINRA.  Credit Suisse had falsely reported that Mr. Chilton’s “Reason for Termination” was “Voluntary,” i.e. that Mr. Chilton resigned.  The Panel recommended that the “Reason for Termination” be changed to “terminated without cause.”  To view this Award, Brian Chilton v. Credit Suisse Securities (USA) LLC, FINRA Case No. 16-03065.

Credit Suisse announced it was closing PBUSA on October 20, 2015.  Dozens of its former advisers have subsequently filed FINRA Arbitration claims for their unpaid deferred compensation.  The claims are based upon unambiguous language in Credit Suisse’s contracts providing that deferred compensation awards vest immediately upon termination without cause.  In a transparent attempt to evade its deferred compensation liabilities, which amounted to hundreds of millions of dollars, Credit Suisse deliberately mischaracterized its advisers’ terminations as voluntary resignations, notwithstanding that it had announced it was closing PBUSA, told its employees, including the advisers, to find someplace else to work and told its clients to close their accounts.  In its Form U-5 filings, Credit Suisse misrepresented to its regulator that the advisers had voluntarily resigned.

The Chilton Panel was the first to reach a decision on this issue and found that Mr. Chilton’s Form U-5 filing was false and should be changed to termination without cause.  Under the unambiguous terms of Credit Suisse’s contracts, Mr. Chilton was therefore entitled to his deferred compensation.

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On April 6, 2016, the Department of Labor (“DOL”) issued its final rule expanding the “investment advice fiduciary” definition under the Employee Retirement Income Security Act of 1974 (“ERISA”).  The rule, which is effective April 10, 2017, has already had significant impact on the wealth management business and advisers should be particularly aware of changes to recruitment and compensation.

The rule modifies the Best Interest Contract Exemption (“BIC”), under which the DOL permits financial advisers and their firms to engage in otherwise prohibited transactions.  When the rule was issued last year, many firms were concerned that the revised BIC would create unacceptable liability risk on commission-based retirement accounts and prohibit back-end performance-based incentives altogether.  The DOL has now confirmed that the back-end incentives, such as bonuses for meeting asset or sales targets, will no longer be exempted under the BIC.

On October 27, the Department issued a FAQ regarding the new rule.  Question 12 addressed recruitment incentives:

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On March 7, 2016, Lax & Neville LLP, together with a number of other concerned law firms, submitted a letter to Financial Industry Regulatory Authority (“FINRA”) urging it to take action in light of Credit Suisse’s repeated violations.  In particular, the letter sought to address Credit Suisse’s current Employment Dispute Resolution Program (EDRP), which prevents employees from exercising their right to resolve disputes through FINRA arbitrations.  A second letter was sent to FINRA on July 19, 2016.

On July 22, 2016, FINRA released a Regulatory Notice addressing “Forum Selection Provisions Involving Customers, Associated Persons and Member Firms.”  Therein, FINRA stated that it “considers actions by member firms that require associated persons to waive their right under the Industry Code to arbitration of disputes at FINRA in a predispute agreement as a violation of FINRA Rule 13200 and as conduct inconsistent with just and equitable principles of trade and a violation of FINRA Rule 2010 (Standards of Commercial Honor and Principles of Trade).”  FINRA further noted, “a member firm cannot use an existing non-compliant agreement as a basis to deny an associated person the right to FINRA arbitration as specified in FINRA rules, without violating FINRA rules.”   Accordingly, FINRA has determined that the EDRP, which Credit Suisse has insisted its employees follow, violates FINRA rules and cannot be relied upon in resolving disputes with Credit Suisse.

The Regulatory Notice further noted that FINRA has a statutory obligation to enforce compliance by member firms and warned that “[m]ember firms with provisions in predispute agreements that do not comply with FINRA rules may be subject to disciplinary action.” Specifically, “FINRA may sanction its members or associated persons for violating any of its rules by ‘expulsion, suspension, limitation of activities, functions, and operations, fine,  ensure, being suspended or barred from being associated with a member, or any other fitting sanction.’”  In light of this, FINRA recommends that member firms review their predispute agreements to ensure compliance.

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On April 29, 2016, the Securities and Exchange Commission (“SEC”) filed an Order Instituting Administrative and Cease-and-Desist Proceedings Pursuant to Section 4C of The Securities Exchange Act of 1934, Section 203(k) of The Investment Advisers Act of 1940, and Rule 102(e) of The Commission’s Rules of Practice, Making Findings, and Imposing Remedial Sanctions and A Cease-and-Desist Order (the “Order”) against Santos, Postal & Company, P.C. (“Santos, Postal & Co.”), an accounting firm, and Joseph A. Scolaro, CPA (“Scolaro”), a Santos, Postal & Co. partner since 2004 (collectively the “Respondents”).  The Order involves improper examinations by Santos, Postal & Co. of its clients’ funds, of which it had custody.  Further, Santos, Postal & Co. and Scolaro filed two (2) Forms ADV-E with materially false statements relating to the examinations.  Santos, Postal & Co. has been registered with the SEC’s Public Company Accounting Oversight Board since 2010, and Scolaro regularly conducted public accounting services before the SEC.

The Respondents’ improper examinations relate to the misappropriation of client funds by SFX Financial Advisory Management Enterprises, Inc.’s (“SFX”) Vice President, Brian J. Ourand (“Ourand”).  SFX first engaged Santos, Postal & Co. to perform its examinations in 2004 and continued to engage them until 2012 when SFX withdrew its registration with the SEC.

Santos, Postal & Co. is a certified public accounting and management consulting firm based in Rockville, Maryland, that provides accounting, tax, and auditing services.  Scolaro was one of five partners and owned 25% of Santos, Postal & Co.  He was the only engagement partner for services for SFX.

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On June 29, 2015, Mark F. Leone (“Leone”) submitted a Letter of Acceptance, Waiver, and Consent (“AWC”) to settle allegations made by the Financial Industry Regulatory Authority, Inc. (“FINRA”).  Currently, Leone is registered with Cambridge Investment Research, Inc.; however, FINRA alleged that while Leone was registered with Morgan Stanley, he exercised discretion in customer accounts without written authorization to do so.  To settle the FINRA allegations, Leone submitted to censure, a fine of $5,000 and suspension for fifteen (15) business days.  A copy of the FINRA AWC is available here.

Specifically, FINRA alleged that on March 10, 2014, Leone, effected five (5) discretionary transactions on customer accounts without first obtaining written authorization from the customers, or having the accounts accepted as discretionary at Morgan Stanley.  According to Leone’s BrokerCheck Report, on April 3, 2014, Morgan Stanley terminated Leone for allegations regarding discretionary trading without written authorization.  In response to those allegations, Leone stated, “five clients owned a stock and had a gain in the stock.  The market was about to close and I was going out of town.  I quickly entered sell orders to close the positions in the account. This generated a bunching report to Morgan Stanley.”

Bunching, or aggregating multiple executions into a single tape report, is prohibited under FINRA Rules Rules 6282(f), 6380A(f) and 6380B(h).  Similarly, NASD Conduct Rule 2510(b), FINRA Rule 2010, and Morgan Stanley firm policies all prohibit registered representatives from exercising discretionary control over customer accounts without written authorization from that customer and firm approval.  FINRA alleged that Leone lacked any authorization to make transactions in these customer accounts outside of one account where he was given insufficient verbal authorization.  As such, Leone violated NASD Conduct Rule 2510(b) and FINRA Rule 2010.

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