Financial Industry Regulatory Authority Archives - Stoll Berne | Attorneys | Class-Action, Securities, IP, Real Estate, Business Litigation

In Regulatory Notice 21-09, FINRA announced the adoption of new supervision and disclosure rules for brokers with a significant history of misconduct and the firms that employ them. Of particular interest to investors, FINRA amended BrokerCheck Disclosure requirements in Rule 8312 to improve disclosures relating to the Taping Rule, Rule 3170 (Tape Recording of Registered Persons by Certain Firms). The Taping Rule requires firms with a specified number of registered persons who previously worked for disciplined firms to have certain supervisory procedures intended to protect customers from fraud and improper sales practices. As the name of the rule suggests, a taping firm must have procedures to record phone calls between registered persons and potential customers or customers. The recordings must be maintained for at least three years.

Previously, FINRA would only release information about whether a firm was a taping firm in response to a phone inquiry to BrokerCheck. This limitation on disclosure meant that anyone searching a firm on BrokerCheck via the internet would not have access to information about whether a firm was a taping firm. Amended Rule 8312(b) now requires FINRA to make taping firm status available through a BrokerCheck web search. According to FINRA, that information will be displayed in the BrokerCheck summary section and will include, “This firm is subject to FINRA Rule 3170 (Taping Rule).”

Regulatory Notice 21-09 also announced other new rules and changes to existing rules. While an appeal of a disciplinary decision is pending, new Rule 9285 requires firms to adopt a heightened supervision plan for a broker found to have violated a statute or rule. The heightened supervision of the broker must address the violations found in the disciplinary proceeding.

FINRA also amended Rule 9522, a rule relating to a firm associating with a person who is disqualified from engaging in the securities business under the Securities Exchange Act of 1934. The amendments require a firm that applies to continue to associate with a disqualified person to have a heightened supervision plan that remains in place while FINRA reviews the application.

Bloomberg reported about a wealthy 93 year old who brought constructive fraud, abuse of fiduciary duty, and other claims before FINRA against J.P. Morgan Securities, LLC and previously registered brokers and investment advisers Evan Schottenstein and Avi Schottenstein. Evan and Avi had been registered through J.P. Morgan. They were also the claimant’s grandchildren. A FINRA panel awarded the claimant approximately $19 million against the bank and brokers.

According to the description of the dispute on Evan Schottenstein’s BrokerCheck report, the “causes of action relate to the allegedly unauthorized purchase and/or sale of various securities in Claimants’ account, including, but not limited to, multiple auto-callable structured notes and various other securities for which Respondent J.P. Morgan Securities, LLC was a market maker, as well as initial public offerings (IPOs) and follow-on offerings (FPOs).” This description leaves out, as reported by Bloomberg, that when Evan and Avi joined J.P. Morgan and brought their grandmother’s account with them, the account was so valuable to J.P. Morgan that it gave one of the brothers a $1.5 million signing bonus.

If you suspect someone you know is the victim of financial elder abuse, the National Council on Aging may be a good resource. According to the National Council, 1 in 10 adults aged 60 and over have experienced some form of elder abuse. As was true in the case in the Bloomberg article, the National Council says that in nearly 60% of elder abuse and neglect cases, the perpetrator is a family member.

The Oregon Department of Justice has free resources and instructions about how to report elder abuse here.

Investors are borrowing against their portfolios at record levels, according to FINRA data about debit balances in margin accounts. As of November 2020, investors borrowed more than $722 billion against the value of their accounts. This is an increase from $561 billion in January 2020. According to FINRA’s data, the previous high of nearly $669 billion was in May 2018. You can see several years of margin data from FINRA here.

Trading on margin means an investor uses assets in his or her portfolio as collateral to borrow money from a brokerage to make more trades. The borrowing is not free—the investor pays the brokerage interest on the borrowed money. Margin trading increases an investor’s purchasing power and at the same time increases the size of potential losses. Losses can even exceed the amount invested. If account assets fall below a threshold, the brokerage will make a margin call and require the investor to deposit more cash. If the investor does not, the brokerage will sell the shares purchased on margin and other assets in the account to try to meet the margin requirement.

For many investors and retirees, trading on margin adds unnecessary risk. Margin trading may be unsuitable and not in an investor’s best interest. For investors who depend on income from investments or do not have cash or other liquid assets to cover a margin call, trading on margin is especially risky.

In November 2018, FINRA published an article for investors titled, “Know What Triggers a Margin Call.” With margin borrowing at record levels, that article is worth revisiting.

In an October 29, 2020, regulatory notice, FINRA announced the adoption of a new rule that creates new requirements before any person associated with a firm regulated by FINRA obtains power of attorney or is named a beneficiary, executor, or trustee for or on behalf of a customer. Rule 3241 now requires firms regulated by FINRA to review and approve or disapprove any such status or role by a registered person associated with the firm.

The rule is intended to limit conflicts of interest that arise when a broker or registered representative is a customer’s beneficiary, executor, trustee, or has power of attorney. These conflicts are problematic and dangerous for any investor, but especially for elderly and unsophisticated investors. In explaining the new rule, FINRA said many member firms already address this potential conflict by prohibiting or imposing limitations on an associated person from being named as a beneficiary or to a position of trust when there is not a family relationship with the customer. FINRA added, “Nonetheless, FINRA observed situations where registered representatives tried to circumvent firm policies, such as resigning as a customer’s registered representative, transferring the customer to another registered representative, or having the customer name the registered representative’s spouse or child as the customer’s beneficiary.”

By requiring the registered person to provide written notice of such proposed status to the member firm and receive written approval from the firm, the new rule may provide limited additional protection for investors.

Mistakes made by even well-intentioned financial advisers, stock brokers, promoters, solicitors, and others who give investment advice or sell financial products sometimes come to light when markets are volatile or when a bull market ends. Volatility and bear markets can make it difficult to conceal fraud and other illegal acts. Lawyers who represent investors in Oregon, Washington, Alaska, and in other states, along with investors in FINRA arbitrations, often consider several potential claims when evaluating a case.

1. States Securities Laws

Investors sometimes have claims under state securities laws. State securities laws may provide protection to not only state residents but also when investors or investments have a connection to the state. State securities laws, sometimes called Blue Sky Laws, often have two broad categories of claims—technical claims and claims involving misrepresentation or omission.

Common technical claims include sales by an unregistered salesperson and sales of unregistered securities. For example, in general, it is a violation of Oregon law for an unregistered salesperson to sell a security. Unless an exemption applies, it is also generally a violation of the Oregon securities laws to sell an unregistered security. The Oregon securities laws can be found in the Oregon Revised Statutes at Chapter 59.

The second broad category of state securities law claims involve misrepresentation or omission. Common misrepresentations and omissions include inadequate risk disclosures, misleading projections or reports about financial performance, false statements about business operations, and incomplete or false information about fees.

The plaintiff or claimant should always consider who is potentially liable for any misrepresentation or omission. In securities fraud cases under Oregon law, for example, the seller is potentially liable as are officers, directors, managing members, control persons, and anyone who participates or materially aides in the sale of a security.

2. Breach of Contract

For some investors, the strongest claim is for breach of contract. When a promissory note or other contractual right to payment is at issue and the debtor does not pay, a breach of contract claim may be available. A missed payment or other breach may also give the creditor the right to accelerate payment on the entire debt.

Pay close attention to the language of the contract. Contracts sometimes include an arbitration provision, seek to limit the time period within which a person must bring a claim, apply the law of a particular jurisdiction, and include other provisions that determine the parties’ rights and obligations.

3. Elder Abuse

Many states have laws designed to protect people based on age or disability. In Oregon, a defrauded investor who was 65 years of age or older at the time they invested should consider a claim for financial elder abuse. In investor cases, these claims typically involve the wrongful taking of money. A plaintiff who prevails on a financial elder abuse claim under Oregon law is entitled to treble damages and attorney fees. Oregon’s elder abuse statute is available in the Oregon Revised Statutes at Chapter 124.

4. Suitability and Best Interest

Unsuitability and best interest claims arise when a broker makes an investment that is inconsistent with an investor’s goals or investment profile. The broker should consider the investor’s age, risk-tolerance, financial goals, net worth, and other factors when recommending an investment. When an investment recommendation is out of line with these factors, the investment might be unsuitable or not in the customer’s best interest. For example, it might be unsuitable for a retired investor who plans to live off interest from fixed income investments to have a significant percentage of their assets invested in a volatile, equity options fund.

For more on the best interest requirement, see our blog post from July 1, 2020, available here.

This is not a complete list of potential claims an investor who is the victim of fraud or other financial abuse should consider. Other common claims include negligence, breach of fiduciary duty, common law fraud, claims under a state’s unlawful trade practices act, churning, and unauthorized trading. Whether a claim is available—and whether it makes strategic sense to make any given claim—depends on the specific facts of the case and the law that applies.

Investors have access to free electronic search tools through self-regulatory organizations, federal, and state regulators to research investment firms and professionals. This post describes several free tools that give access to information beyond what you can learn using Google and other search engines.

FINRA’s BrokerCheck is a good starting place to learn about registration and reported discipline. BrokerCheck allows you to search for an investment firm or professional by name or CRD number. BrokerCheck will tell you whether a firm is a broker or an individual is a registered representative regulated by FINRA. If regulated by FINRA, a BrokerCheck search will include information about reported disclosures, such as arbitrations or customer disputes, and provide information about registration. Click on the “Detailed Report” link—as the name of the link implies—for more detailed information, including summaries of any complaints. Also, keep in mind that through expungement, a broker can ask FINRA to remove customer complaints and arbitrations from records available through BrokerCheck. This means that an expunged complaint will not show up in your BrokerCheck search. Further, customer complaints are not always timely reported and may be missing from BrokerCheck.

FINRA also provides a free search tool for certain disciplinary actions since 2005. This search tool is available at https://www.finra.org/rules-guidance/oversight-enforcement/finra-disciplinary-actions-online.

If a firm is registered as an investment adviser or an individual is registered as an investment adviser representative, searching for the firm or individual using BrokerCheck will provide you with a link to the SEC’s Investment Adviser Public Disclosure website. For investment adviser representatives, the SEC’s Investment Adviser Public Disclosure search provides information similar to what FINRA makes available about brokers and registered representatives using BrokerCheck. For investment adviser firms, the SEC’s search tool gives access to the firm’s Form ADV, brochure, and Form CRS. These documents include information about an investment adviser’s business, including information about fees.

You should also check with the division in your state that regulates investment advisers. Some state regulators make available free information about investment advisers licensed to conduct business in the state. For example, the State of Oregon provides a free search tool that gives access to limited license information here: https://www4.cbs.state.or.us/ex/dfcs/dfcslic/adviser/.

In Interactive Brokers LLC v. Saroop, No. 19-1077, 2020 WL 4668551 (4th Cir. 2020), the Fourth Circuit Court of Appeals recently confirmed that a violation of FINRA rules can be a breach of an agreement between an investor and a broker-dealer.

Three investors opened accounts with Interactive Brokers, an online broker-dealer. The investors’ agreements with Interactive Brokers had an arbitration clause. Trading on margin, a third-party investment manager invested the accounts in an exchange-traded note that moved based on the stability of the market and also sold naked call options. FINRA rules prohibit trades of some high risk securities on margin, including the exchange traded note. A large, one-day drop in the markets in August 2015 led to Interactive Brokers liquidating the accounts and a margin call.

The investors brought claims in FINRA arbitration against Interactive Brokers. The arbitration panel found for the investors. In dismissing a counterclaim brought by Interactive Brokers, the arbitrators referred to FINRA Rule 4210, which includes the prohibition against trading certain high risk securities on margin. Interactive Brokers challenged the award in federal district court.

The district court sent the case back to the arbitrators, seeking an explanation of the award. The arbitrators referred to FINRA rules in explaining the award and wrote, “To ignore a FINRA rule by the Panel would defeat the purpose of FINRA.” Interactive Brokers again moved to vacate the panel’s award. The district court did so, finding that by basing liability on FINRA Rule 4210, the arbitrators disregarded the law because there is no private right of action to enforce FINRA rules.

The investors appealed to the Fourth Circuit. The Fourth Circuit vacated the judgment of the district court and instructed the district court to confirm the arbitration award. In its opinion, Interactive Brokers LLC v. Saroop, No. 19-1077, 2020 WL 4668551 (4th Cir. 2020), the Fourth Circuit explained that the agreement between the investors and Interactive Brokers provided that all transactions were subject to rules and polices of relevant markets and clearinghouses, and applicable laws and regulation. The Court held, “[t]his, of course, includes the publicly available FINRA rules (citation omitted). As such, the clause could well be read as incorporation the FINRA rules, making a violation of the rules a breach of the parties’ contract.”

Beginning June 30, 2020, brokerage firms and their associated persons will have to comply with Regulation Best Interest (Reg BI), which sets a new standard of conduct when working with retail investors. The SEC adopted Reg BI, as the name suggests, to require firms and associated persons to work in the best interest of investor customers, not the firm’s own interest. Along with the overarching requirement that broker-dealers put the customer first, Reg BI includes four major obligations: 1) full disclosure of all material facts (such as of fees); 2) care, including exercise reasonable diligence, skill, as well as care, in making investment recommendations; 3) mitigation and control of conflicts of interest; and 4) compliance. Broker-dealers must implement policies and procedures to ensure these obligations are met. The Reg BI duties apply to investment recommendations, investment strategies, and account changes (such as rollovers).

Reg BI largely replaces FINRA’s suitability rule for many investors and is meant to be a heightened standard that firms must meet. The “care” obligation under Reg BI, however, aligns closely with the existing FINRA suitability rule and preserves suitability concepts. For institutional customers, in contrast to retail investors, the suitability rule is still in effect.

Reg BI also bars broker-dealers from using sales contests, sales quotas, bonuses, and other non-cash compensation based on a representative selling a specific investment or type of investment within a defined period of time.

Stoll Berne is investigating claims on behalf of individual investors who may have lost money with Spokane-based financial advisor, Ronald Hannes of Woodbury Financial. The Financial Industry Regulatory Authority (FINRA) also began investigating claims that Hannes allegedly misappropriated funds from a customer’s life insurance policy. FINRA has subsequently revoked his license. Stoll Berne believes other former customers of Hannes may have been targeted as well.

Hannes was a financial advisor with the Spokane-based Woodbury Financial Services from 1994 through 2019. Hannes also operated a business under the names Hannes Financial Services and Ronald W. Hannes & Associates.

If you were a client of Ronald Hannes or Woodbury Financial and you believe that you lost money, we are interested in speaking with you. Contact us for a free evaluation of your potential case using the form below or email attorney Josh Ross directly.