New York Securities Lawyer Blog

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.

On December 18, 2019, the SEC voted to propose amendments to the definition of accredited investor, potentially vastly changing suitability criteria for investors. This change could have a significant impact both on investors who may gain access to a now-expanded range of private placements and on the viability of damages claims for sales practices abuses related to private placements.

One of the main criteria that would be changed in the proposed amendments is net worth. The proposals would expand eligibility to individuals with professional knowledge, experience, or certifications. Expanded eligibility criteria was also proposed for institutional investors.

SEC Chairman Jay Clayton said the following with regard to the proposal:

On November 11, 2019, the Hong Kong Securities and Futures Commission (“SFC”) announced that UBS Financial Services (“UBS”) was fined $51.09 million for overcharging thousands of clients throughout the last decade. The SFC said in its statement that their investigation found that UBS overcharged up to 5,000 clients on “post-trade spread increases,” and that these charges were far in excess of standard firm fee disclosures and rates. UBS also agreed to pay approximately $25.5 million in restitution to affected clients.

According to the SFC, UBS stated that the investigation was triggered by a self-reported discovery of systemic internal control failures. Most firms have compliance software in place that prevents fees or spread markups in excess of certain ratios, with manual overrides required to circumvent these controls. Based on the SFC statement, it was unclear to the public which specific internal controls were breached and whether the breaches were caused by software or human error. UBS issued the following response to the SFC statement:

The relevant conduct predominately relates to limit orders of certain debt securities and structured note transactions, which account for a very small percentage of the bank’s order processing system.

According to a Complaint filed by Janney Montgomery Scott (“Janney”) in the Eastern District of Pennsylvania, financial advisor Jordan Braunstein (“Braunstein”) left with firm client data and violated the restrictive covenants in his contracts. The Complaint recited that when Braunstein departed Janney for Paradigm Wealth Management, he took not only his own client list, but also a list of all the clients serviced by the Lexington Avenue Wealth management team that he led, including many who were introduced and serviced by other advisors on the team.

Janney took the position that Braunstein violated both the Protocol for Broker Recruiting (“the Protocol”) and the Lexington Avenue Team Agreement, arguing that Braunstein was allowed to take only a limited list of legacy clients he brought over from Morgan Stanley and clients he introduced to the Lexington Avenue Team while at Janney. But, Janney reasoned, he could not take clients that other members of the team had originated. Pending a hearing on the matter, the Judge issued a temporary restraining order (“TRO”) barring Braunstein from soliciting any of Janney’s clients.  Firms can obtain TROs through any court of competent jurisdiction, pursuant to FINRA Rule 13804 upon a showing of three elements: (1) a likelihood of ultimate success on the merits; (2) the prospect of irreparable injury if the provisional relief is withheld; and (3) a balance of equities tipping in the moving party’s favor.  A party seeking a TRO from court is also required to submit to arbitration and at the same time file with the Director a statement of claim requesting permanent injunctive and all other relief relating to the same dispute.  A party will then need to prevail at an arbitration hearing in order to convert the TRO into a permanent injunction.

Whenever a financial professional exits a team, important legal questions arise surrounding the sourcing of client relationships, the servicing of clients, the existence of joint rep codes or client revenue sharing agreements, and ultimately the ownership of client relationships. While brokerage firms have the incentive to restrict departing brokers’ client contact to prevent customers and assets from leaving the firm, brokers clearly have the incentive to retain their books of business upon switching firms to the extent same does not violate any restrictive covenants in their employment agreements. Firms are required by FINRA Regulatory Notice 19-10 to provide customers with a departing broker’s new contact information if the firms have it, but only if the customers ask. Successfully navigating FINRA Rules, federal privacy laws and employment agreements can mean the difference between a smooth transition and receiving a TRO preventing the solicitation or servicing of clients at a new firm.

Lax & Neville has obtained a settlement for a managing director of a New York hedge fund in what the United Stated District Court for the Southern District of New York described as a “bitter employment dispute.”  The managing director was forced to bring a claim for breach of contract, unjust enrichment, and violation of the New York Labor Law (“NYLL”) after his former employer terminated him without cause and refused to pay him more than $3 million in earned compensation.

The parties reached a settlement after the District Court denied the hedge fund’s motion for summary judgment.  The hedge fund had sought to dismiss each of the managing director’s claims on various grounds, but primarily argued that the NYLL claim should be dismissed on the ground that carried interest and performance bonuses are not “wages” under the statute.  Relying upon clear precedent in the New York Court of Appeals and Second Circuit, the Court held that “although ‘incentive pay’ like the disputed bonus amounts in this case ‘does not constitute a wage until it is actually earned and vested,’ when it is ‘guaranteed under [a] formula to be a percentage of the revenues . . . generated’ and ‘not left to [the employer’s] discretion,’ it constitutes protected ‘wages’ under the Labor Law.” (quoting Reilly v. Natwest Markets Grp., 181 F.3d 253, 264-65 (2d Cir. 1999)).  The District Court allowed the managing director’s claims, including for liquidated damages, prejudgment interest, and attorneys’ fees under the NYLL, to proceed and ordered the parties to prepare for trial.  The parties settled shortly thereafter.

Courts and FINRA arbitration panels have considered the applicability of the New York Labor Law to brokers and other financial services professionals in several recent cases involving attempts by financial services firms to evade deferred compensation and bonus obligations to their former employees.  Lax & Neville has extensive experience helping professionals in the financial services industry enforce their rights under the New York Labor Law in FINRA, state and federal court, and AAA and JAMS arbitrations.  For a free consultation, please call (212) 696-1999.

On September 16, 2019 the Securities and Exchange Commission (“SEC”) announced that Stifel, Nicolaus & Co. (“Stifel”) and BMO Capital Markets Corp. (“BMO”), two large broker-dealers, agreed to pay fines of $2.7 million and $1.95 million, respectively, to settle charges for providing the SEC with inaccurate and incomplete securities trading information, known as “blue sheet data.”

The SEC’s investigation found that Stifel and BMO made frequent deficient blue sheet submissions, primarily due to undetected software coding errors. According to the SEC, Stifel failed to report data for approximately 9.8 million transactions and provided erroneous information for approximately 1.4 million.  According to the SEC, BMO’s deficiencies led to missing or incorrect data for 5.4 million transactions. Inaccurate reporting of blue sheet data impedes regulators ability to halt harmful or fraudulent activity, such as insider trading, which can potentially harm investors and the integrity of the markets.

The SEC found that both firms lacked adequate systems for catching these errors and did not have proper processes in place to validate the accuracy of submissions.  As such, the SEC determined that Stifel and BMO both willfully violated the broker-dealer books and records and reporting requirements of federal securities laws.

On September 16, 2019, the Financial Industry National Regulatory Authority (“FINRA”) reported that it had censured and fined J.P. Morgan Securities (“JPM”) $1.1 million for failing to timely disclose 89 internal investigations. Firms have a regulatory obligation to disclose to FINRA or the appropriate regulatory body all internal reviews and allegations of misconduct by registered individuals or associated persons.

Broker-dealers such as JPM are required to file with FINRA a Uniform Termination Notice for Securities Industry Registration (“Form U5”) within 30 days of terminating a registered representative. They are also required to file an amendment with FINRA within 30 days of learning that anything previously disclosed on the Form U5 is inaccurate or incomplete. Firms are required to disclose allegations involving fraud, wrongful taking of property, or violations of investment-related statutes, regulations, rules or industry standards of conduct.

FINRA uses the information filed in the Form U5 to help identify and investigate potential misconduct and sanction individuals as appropriate. The Form U5 is a critical source of information on a financial adviser, and informs regulators, future employers, and potential clients of the nature of the adviser’s misconduct.  State securities regulators and other regulators use the information to make informed regulatory and licensing decisions.

On August 14, 2019, the Securities and Exchange Commission (“SEC”) charged Canaccord Genuity LLC (“Canaccord”) with violating gatekeeping provisions aimed to protect investors. Small market cap, thinly traded securities, such as those that trade over-the-counter (“OTC”), are generally not subject to the same level of investor scrutiny and due diligence as stocks that trade on large established exchanges and are covered by assigned analysts. As such, broker-dealers such as Canaccord are expected to provide some “gatekeeping” functions, before listing the securities offerings of small cap companies.

The Exchange Act Rule 15c2-11 mandates that broker-dealers have a reasonable basis for believing that the prospectus and other information made available by the issuer of the securities are accurate. According to the SEC, Canaccord enabled dozens of OTC companies to list and trade, without making any proper effort to ensure prospectus information and offering figures were accurate or obtained from reliable sources. The SEC alleged that Canaccord assigned a compliance associate to review OTC listings; however, the compliance associate had no trading experience or training required by the rule. For example, the SEC noted that he did not have experience related to the analysis of financial statements. Simply assigning a compliance individual to a task does not waive firms of their obligations to ensure the task is done properly, adequately, and to full extent mandated by the SEC and/or the Financial Industry National Regulatory Authority. Compliance is a robust process of checks and balances so as to ensure fairness and transparency within the financial services industry.

Canaccord consented to the institution of cease and desist proceedings ordering that it cease and desist from committing or causing any violations relating to Exchange Act Rule 15c2-11, and it agreed to pay a $250,000 fine and censure.