Monday, April 17, 2017


It wouldn’t seem likely that elders and athletes would have much, if anything, in common.  But they do.  They are frequently blessed with substantial semi-liquid assets, and are therefore the targets of fraudulent or reckless investment schemes.

Much has been written about why professional athletes are frequent victims.  And the last professional athlete I represented possessed many of the following common attributes:

·         Young and inexperienced with finances;
·         Rapidly accumulating substantial wealth;
·         Easily identified as a person with substantial wealth subject to potential investment;
·         Highly focused on meeting the demands of a career requiring singular attention, frequent travel, and unplanned relocations.

As a result, the media is littered with accounts of massive investment losses suffered by current and former athletes.  Some of the statistics are shocking.  For example, from 1999-2002 78 NFL players lost over $40 million to fraud.  According to a Sports Illustrated article, approximately 60% of NBA players are “broke” within five years of their retirement from the league.  And in 2014 former Yankee star Jose Pasada sued two financial advisers that allegedly bilked him of $11 million through real estate and hedge-fund investments.

The National Football League Players’ Association took action in 2002 and created a Financial Advisors Program. The Program required advisers to apply and be screened for approval for inclusion in the program.  But it was not sufficiently robust.  For example, just a few years after the program was initiated, an approved financial adviser lured several active players in to a hedge fund.  The players lost almost $20 million and the adviser was convicted of securities fraud and money laundering.  Moreover, some approved advisers use their NFLPA registration as a marketing tool.  One even suggests that their athlete clients can be free of financial distractions while the adviser constructs a “bulletproof” financial retirement plan.  That type of pitch seems to encourage the very characteristics that lead to the financial victimization of athletes.  Laurence Landsman wrote an excellent article that was published in the National Sports Law Institute’s Journal in 2010.  He called for reforms to the NFLPA program.  And the NFLPA made them in 2012.  Now when will the NBA, NHL, and MLB get on board?

There are strong parallels between the methodology and prevalence of financial exploitation of athletes and elders.  Our firm has represented several elder investors over the years.  And all of us are former securities regulators that witnessed the pace and pattern of financial elder abuse.  Elders frequently have a large accumulation of wealth available for investments, and they are prone to over-trust and over-rely on their financial advisers.

In 2012 Stephen Dunn published in Forbes a list of do’s and don’ts for professional athletes.  They are, however, equally applicable to our elders.  Just a few of them are:

·         An adviser’s trustworthiness is paramount;
·         Invest with advisers associated with a well-established firm;
·         Don’t pretend you are a business mogul.  Kurt Schilling’s saga may be a good tale of caution, and;
·         Avoid complex investment schemes.

And I have one final self-serving but sound piece of advice:  retain an attorney that is independent of your financial adviser and who is also sophisticated in investment matters.  That attorney should be called upon to interface with your adviser and help you evaluate the wisdom and risk of your adviser’s proposals, background, etc.  Food for thought.

2.  ESPN's "Broke" :

Friday, March 24, 2017

Kokesh v. SEC: Implications for the Statute of Limitations for Missouri Securities Enforcement Actions

 Kokesh v. SEC, Docket No. 16-529 (oral argument date April 18, 2017) – Implications for the Statute of Limitations for Missouri State Securities Enforcement Actions.

By John R. Phillips, Counsel for Cosgrove Law Group, LLC and former Director of Enforcement for the Missouri Securities Division, Office of the Secretary of State. 

Kokesh v. SEC is an appeal to the U.S. Supreme Court from the 10th Circuit Court of Appeals, in which the Court will be asked to decide whether a disgorgement award in favor of the SEC constitutes a penalty or forfeiture within the meaning of 28 U.S.C. § 2462, which therefore must be brought within that section’s five year statute of limitations.  This verdict from New Mexico, affirmed on appeal by the 10th Circuit, awarded the Securities and Exchange Commission (“SEC”) a disgorgement award of $34.9 million, plus $18.1 million in prejudgment interest, and a penalty of $2.4 million for Charles R. Kokesh’s (“Kokesh”) misappropriation of funds from four SEC-registered business development companies (“BDC”).   The BDCs raised money from investors through public securities offering and invested in private start-up companies that focused on technology, biotechnology, and medical diagnostics.  From 1995 through 2006, Kokesh directed the BDCs to take $23.8 million to pay salaries and bonuses to BDC Advisers, including Kokesh himself, and to take $5 million to cover office rent.  In 2000, Kokesh also had the BDCs distribute $6.1 million in payments described as “tax distributions.”  See SEC v. Kokesh, 834 F.3d 1158, 1160-61 (10th Cir. 2016).  The jury found “(1) that Defendant knowingly and willfully converted the Funds’ assets to his own use or to the use of another and (2) that he knowingly and substantially assisted the Advisers in defrauding the [BDCs], in filing false and misleading reports with the SEC, and in soliciting proxies using false and misleading proxy statements.”  Id. at 1161.  The trial court held that disgorgement of $34.9 million “reasonably approximates the ill-gotten gains causally connected to Defendant’s violations.”  Id

The Tenth Circuit: Disgorgement Is Remedial, Not a Penalty or Forfeiture

The 10th Circuit held that disgorgement is not “a penalty or forfeiture within the meaning of § 2462.”  Id. at 1167.  First the 10th Circuit held that “disgorgement is not a penalty under 2462 because” it “does not inflict punishment” but rather “is remedial.” Id. at 1164.  “[I]t does so…by depriving the wrongdoer of the benefits of wrongdoing.”  Id. (citing SEC v. Contorinis, 743 F.3d 296, 301 (2d Cir. 2014)).  However, the 10th Circuit acknowledged that “in common English the words forfeit and disgorge…capture similar concepts,” and that the “definitions in the leading legal dictionary…also have similarities”: Black’s defines “disgorgement” as a “legal compulsion” to “giv[e] up something (such as profits illegally obtained),’” and “forfeiture” as the “’loss of…property because of a crime, breach of obligation, or neglect of duty.’”  The 10th Circuit believed that § 2462 used “forfeiture” in a narrow historical sense—as “an in rem procedure to take ‘tangible property used in criminal activity.’” Id. at 1165 (citing U.S. v. 92 Buena Vista Ave., 507 U.S. 111, 118 (1993)).  In end, the 10th Circuit affirmed the disgorgement award.     

Petitioner’s Argument: Circuit Split and Consequences of No Statute of Limitations for Disgorgement        

Kokesh appealed to the U.S. Supreme Court, presenting the question of whether: “[u]nder 28 U.S.C. § 2462, any ‘action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued.’  Does the five-year statute of limitations in 28 U.S.C. § 2462 apply to claims for “disgorgement?’”  Pet. Brief at i, Docket No. 16-529 (2016).  

28 U.S.C. § 2462 sets a five-year limitations period for claims seeking certain sanctions and states:

Except as otherwise provided by Act of Congress, an action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued if, within the same period, the offender or the property is found within the United States in order that proper service may be made thereon.

            Kokesh argues that Gabelli v. SEC, 133 S. Ct. 1216 (2013) mandates that § 2462 applies to disgorgement awards because disgorgement is a form of penalty or forfeiture.  Gabelli also rejected the SEC’s request for the application of the “discovery rule” to the § 2462 statute of limitations as that “would leave defendants exposed to Government enforcement action not only for five years after their misdeeds, but for an additional uncertain period into the future.”  Id. at 1223.  Gabelli expressly reserved the question of whether § 2462 applies to claims for disgorgement.  Id. at 1220 n. 1.

As an initial matter, all parties agreed that there is a circuit split on the question of whether § 2462 applies to claims for disgorgement.  The 11th Circuit has held that “§ 2462’s statute of limitations applies to disgorgement,” finding that disgorgement is a “forfeiture” within the meaning of the statute.  SEC v. Graham, 823 F.3d 1357, 1363 (11th Cir. 2016).  The underlying Graham district court held that “disgorgement…can truly be regarded as nothing other than a forfeiture…, which remedy is expressly covered by § 2462.”  21 F.Supp.3d at 1310-11.  By contrast, the 1st and D.C. Circuits (and the 10th Cir. in Kokesh) held that § 2462 does not apply to actions for disgorgement.  SEC v. Tambone, 550 F.3d 106, 148 (1st Cir. 2008); Riordan v. SEC, 627 F.3d 1230, 1234 (D.C. Cir. 2010)(“there is no statute of limitations for SEC disgorgement actions”). 

In Kokesh, the SEC did not bring its disgorgement claims against Petitioner until 2009, yet the district court entered a $34.9 million disgorgement order based on securities-law violations that occurred as far back as 1995.  Pet. Brief at 2.  “In the Eleventh Circuit, all the SEC’s claims that arose before 2004 would be untimely under § 2462, and the SEC has conceded that this rule would preclude all but $5 million of the disgorgement order against Petitioner.  Id. (citing Pet. App. 26a-27a).    

            According to Kokesh, if §2462 does not limit disgorgement actions, then sweeping disgorgement liability will be limitless in time.  Statutes of limitation aim to provide “security and stability to human affairs,” reflecting the settled wisdom that it would be “’utterly repugnant to the genius of our laws’” if actions “could ‘be brought at any distance of time.’”  Gabelli, 133 S. Ct. at 1223 (quoting Adams v. Woods, 6 U.S. (2 Cranch) 336, 342 (1805)).  Moreover, the difference it would make to recoveries in SEC actions is sizeable.  For Kokesh, it would mean at least $29 million in disgorgement liability would be erased.  And writ large, in 2015 alone, “the SEC extracted $3 billion in disgorgement payments.  That amount dwarfs the SEC’s money penalties, which were just $1.2 billion, and is also growing faster:  Disgorgement collections have jumped 60% since 2011, compared with just a quarter increase in penalties.”  Pet. Br. at 3. 
            SEC:  There Is No Statute of Limitations For Disgorgement Actions

The SEC’s argument is surprisingly simple: there is no statute of limitations for disgorgement and § 2462 does not apply to bar SEC disgorgement actions.  See generally, Res. Br.  The “equitable relief” power under 15 U.S.C. § 78u(d)(5) includes authority to order disgorgement.  Porter v. Warner Holding Co., 328 U.S. 395, 398-99 (1946); see, e.g., SEC v. Masson, Inc., 465 F.3d 1174, 1179 (10th Cir. 2006), cert. denied, 550 U.S. 905 (2007). 
Congress has not specified a statute of limitations for an SEC enforcement action alleging a violation of the Exchange Act, the Advisers Act, or the Investment Company Act.  Res. Br. at 2.  But Congress has enacted a statute of limitations (28 U.S.C. § 2462) that governs “penalty provisions throughout the U.S. Code.”  Gabelli, 133 S. Ct. at 1219.  The purpose of disgorgement is “not to inflict punishment but to prevent an unjust enrichment.”  Res. Br. at 8 (citing Sheldon v. Metro-Goldwyn Pictures Corp., 309 U.S. 390, 399 (1940)).  Disgorgement “differs greatly from…damages and penalties,” because it has a quintessential remedial nature.  Id., (citing Porter, 328 U.S. 402).  

Apart from that general recitation of the purpose of disgorgement and the implications of the Circuit split, the SEC’s argument was very simple, if only by implication:  there is no statute of limitations for the disgorgement remedy and the SEC should be able to reach back as far as disgorgement can be “reasonably approximate[d].”  SEC v. Kokesh, 834 F.3d at 1161.    

Reply and Amicus (Chamber of Commerce): Disgorgement to Injured Victims Is Distinguishable Because That is Remedial And “Forever Liability” Could Result in Potentially Crippling Monetary Awards

            Kokesh’s reply focuses primarily on the nature of disgorgement that the SEC routinely seeks, as it is “a legal obligation to pay money to the government, imposed as a consequence of wrongdoing—a classic form of punishment.”  Pet. Reply at 1.  Kokesh then also distinguishes Porter and Sheldon as cases where the disgorgement went to injured victims: rents to tenants in Porter and profits from copyright infringement in SheldonId. at 1-2.  “In those cases restitution order had the remedial effect of restoring property to its rightful owner,” whereas in Kokesh’s case the disgorgement money goes to the SEC.  Id. at 2. 

            The Chamber of Commerce’s amicus brief took head on the SEC’s argument that there was no statute of limitations for disgorgement: 

a defendant in an agency enforcement action is forever liable for potentially crippling monetary awards that may never be discharged.  This is an extraordinary position.   Statutes of limitation “promote justice by preventing surprises through the revival of claims that have been allowed to slumber until evidence has been lost, memories have faded, and witnesses have disappeared,” Order of Railroad Telegraphers v. Railway Express Agency, Inc., 321 U.S. 342, 348-349 (1944), and provide “certainty about…a defendant’s potential liabilities,” Rotella v. Wood, 528 U.S. 549, 555 (2000).

Amicus Br. at 3. 

The Chamber proceeded to argue that disgorgement is a penalty because it “goes beyond remedying the damage caused to the harmed parties by the defendant’s actions.”  Amicus Br. at 5 (quoting Johnson v. SEC, 87 F.3d 484, 488 (D.C. Cir. 1996)).  Disgorgement is animated by a deterrent purpose, which is a hallmark of punitive remedies.  Id. (citing SEC v. Rind, 991 F.2d 1486, 1490 (9th Cir. 1993)(“The theory behind the remedy is deterrence and not compensation.”)).  The SEC’s “public statements about its enforcement actions” confirm this deterrent purpose by highlighting the “deterrent and retributive effect of its disgorgement orders.”  Id. at 6 (citing SEC, Press Release No. 2005-93 (June 28, 2005)). 

The Chamber argued further that disgorgement is particularly punitive when the defendant has not retained the benefit of all the ill-gotten gains—where for instance those monies were expended on rent/salaries. Amicus Br. at 6-7.  Moreover, a disgorgement claim that cannot be ascertained with sufficient certainty “takes on the character of a plea for punitive relief.”  Id. at 7 (citing SEC v. Wills, 472 F.Supp. 1250, 1276 (D.D.C. 1978)).  The SEC is only required to provide a “reasonable approximation” for disgorgement.  Id. (citing SEC v. Teo, 746 F.3d 90, 107 (3d Cir. 2014).  Finally, the disgorgement awards go to the U.S., not victims, and therefore are by nature punitive.  Id. at 8 (citing SEC v. Cavanagh, 445 F.3d 105, 117 (2d Cir. 2006)). 

In a final piquant point, the Chamber points out that the SEC has taken the position that disgorgement orders are non-dischargeable in bankruptcy because they fit within the “fine, penalty, or forfeiture” language of the discharge exception.  Id. at 11-12 (citing In re Telsey, 144 B.R. 563 (Bankr. S.D. Fla. 1992); see also IRS, Office of Chief Counsel, Memorandum, No. 201619008, at p. 9 (May 6, 2016)).

Implications for Missouri and Other States Which Do Not Have an Express Statute of Limitations for Administrative or Civil Securities Enforcement Actions

Current Statute of Limitations for Missouri State Securities Enforcement Actions

The Missouri Securities Act of 2003 (“MSA”) was based on the Uniform Securities Act of 2002.  It contains provisions for administrative, civil, and criminal enforcement, as well as a private cause of action.  Section 409.5-509, RSMo. is the private cause of action under the MSA and has very clear statutes of limitation:  one year for the violation of the provision prohibiting the offer and/or sale of an unregistered security (§409.3-301, RSMo.); two years after discovery of the facts for any other violations of the Act, with a five year statute of repose.  See § 409.5-509(j), RSMo.  However, administrative, civil, and criminal actions do not carry specific statutes of limitation under the Act. 

            Clearly, a statute of limitation would apply to criminal actions under Section 409.5-508, RSMo., likely Mo. Rev. Stat. § 556.036.2 (three years for any felony).  However, without a specific provision, the statutes of limitations for civil and administrative enforcement actions are not clear.  Section 409.5-509(j), RSMo., does not apply, leaving a series of possible candidates in the general civil statutes of limitations.  And it is in this context that Kokesh may be relevant to interpreting civil and/or administrative enforcement actions under the Act.

             Sections 409.6-603 and 409.6-604, RSMo., address the SEC enforcement action corollary for the state of Missouri, allowing the Commissioner, through the Attorney General, or the Commissioner him/herself administratively, to pursue penalties and/or an order of rescission, restitution, or disgorgement for violations of the Act.  However, the Act is “remedial” in nature and court decisions interpreting the securities laws have construed these acts to achieve broad investor protection.  See Uniform Securities Act (Last Revised or Amended in 2005), § 608(b), and Official Comment 5 (citing SEC v. W.J. Howey Co., 328 U.S. 293, 299, 301 (1946). 

Hence, it is likely that the several Missouri statutes of limitation that apply to “penal statutes” would not apply to actions under Sections 409.6-603 and 409.6-604, RSMo.  See Mo. Rev. Stat. §§ 516.380 (1 year from violation), 516.390 (2 years from violation), and 516.400 (3 years from commission of offense).  Indeed, precedent suggests that those statutes of limitation are for actions where the primary focus is penalties, such as for clean water act violations, rather than for enforcement actions where a broad penumbra of remedies are available.  See State ex rel. Nixon v. Summit Inv. Co., LLC, 186 S.W.3d 428 (Mo. App. S.D. 2006). 

A better analog for assessing the proper statute of limitations would be the Missouri Merchandising Practices Act (“MMPA”), section 407 et seq., as it likewise is a remedial statute with multiple remedies in enforcement actions brought by the Missouri Attorney General, as well for private rights of action.  For the MMPA, courts have applied one of two statutes of limitation:
(1)       Mo. Rev. Stat. §516.120.2 (5 years) for “[a]n action upon a liability created by a statute other than a penalty or forfeiture;” or

(2)       Mo. Rev. Stat. §516.130.5 (3 years) for “[a]n action upon a statute for a penalty or forfeiture, where the action is given to the aggrieved, or to such party and the state…” 

            There is a general consensus in courts that section 516.120.2, RSMo., applies for all actions under the MMPA.  Huffman v. Credit Union of Texas, 758 F.3d 963, 967 (8th Cir. 2014)(citing Ullrich v. CADCO, Inc., 244 S.W.3d 772, 778 n. 3 (Mo. App. 2008); Owen v. Gen. Motors Corp., 533 F.3d 913, 921 n.6 (8th Cir. 2008)).  However, there has been discussion that section 516.130.5, RSMo., may apply.  Huffman, 758 F.3d at 966; Schuchmann v. Air Services Heating & Air Conditioning, Inc., 199 S.W.3d 228 (Mo. App. S.D. 2006).  The Missouri Securities Act carries similar remedies to the MMPA, and likewise would be an “action upon liability created by a statute other than a penalty or forfeiture.”  Thus it is reasonable to assume that whatever the statute of limitation is for a civil enforcement action by the Attorney General under the MMPA would also apply to civil and administrative enforcement actions under the Securities Act. 

Missouri Securities Enforcement Actions After Kokesh – Some Statute of Limitations Will Apply

Kokesh might have application for Missouri state securities enforcement actions by virtue of the debate between whether the MMPA (and by implication the MSA) has a 3 or 5 year statute of limitations under sections 516.120 or 516.130, RSMo.  If disgorgement is considered a “penalty” for federal securities enforcement actions, then the MSA itself, or actions for disgorgement under it, may very well also be considered actions on a “penal statute,” and therefore fall under the provisions of section 516.130(2), RSMo.[1]  The third, less likely scenario, is that “penalty” actions under the MSA, including for disgorgement if Kokesh find the remedy penal, would be limited to three years by section 516.130(2), RSMo., while restitution and other remedies could be brought up to five years after the violation under section 516.120(5), RSMo.   Obviously, the way in which the SEC makes use of “disgorgement” as a remedy makes that remedy look quite penal, particularly under the facts of Kokesh.  Thus the usage of disgorgement by the Attorney General or Commissioner in a Missouri enforcement action may be distinguishable from Kokesh on its facts.

What is clear irrespective of whether disgorgement is characterized as “penal” or “remedial,” is that Gabelli is persuasive authority that some statute of limitations applies to state enforcement actions for violations of the Missouri Securities Act, even if there is no such specific statutes of limitation and the existing general statutes of limitation are poor fits.   A holding by the Kokesh Court that disgorgement is “penal” in nature would be persuasive authority that, notwithstanding precedent labeling the MSA “remedial,” the MSA is a “penal” statute by virtue of providing equitable “penalties” such as disgorgement, and therefore subject to a 3 year SOL under section 516.130 (or the more restrictive limits under other statutes).  At the very least, it would be persuasive authority that where the Commissioner or Attorney General seeks disgorgement, he/she can reach back only 3 years, instead of the five contemplated under section 516.120, RSMo., which would be a hybrid approach essentially applying two different statutes of limitations to causes of actions under one statute. 

Conversely, if the Supreme Court finds that the SEC’s disgorgement remedy is not time barred by 28 U.S.C. §2462, then it is persuasive authority for the proposition that the equitable remedies under the Missouri Securities Act likewise are not time barred.  That seems an unlikely outcome.  Gabelli strongly infers that the Supreme Court would not countenance there being absolutely no statute of limitations for actions under sections 409.6-603 and 409.6-604, RSMo.  On the other hand, the variety of remedies under the MSA speak to labeling it as a “remedial statute,” even though the MSA also contains certain penal provisions.  Hence the five year statute of limitations under section 516.120, RSMo., would be most appropriate, even if Kokesh finds that disgorgement is subject to the statute of limitations for penalties under 28 U.S.C. §2462.    

[1] Because of the hybrid nature of the remedies, it seems unlikely that MSA enforcement actions would ever be “penal statutes” for the purposes of the statutes of limitation in sections 516.380, 516.390 and/or 516.400, RSMo.  But that also would remain an open question.  

Friday, February 24, 2017

Get Your Own Lawyer, Darn It!

Financial advisors facing an arbitration claim or regulatory inquiry often count on their broker-dealer or registered investment advisor for legal counsel. These “employers” will frequently provide them with an ostensibly independent “conflict counsel” after they retain their own counsel. Unfortunately, however, it is arguably little more than a charade when the “independent” attorney either has, or one day hopes to represent the broker-dealer or registered investment advisor.

Consider viewing the situation in the context of an attorney's ethical duty of loyalty, her fiduciary duty to put the client's interests first, and her obligation to avoid even the appearance of failing to do so. If you (the attorney) have been hired and paid by a large client that you covet to represent an individual financial advisor that you will never see again, would you not be hesitant to suggest the financial advisor save herself – even if it injures the interests of the large corporate client? Would you really warn the advisor if you caught wind of the broker-dealer's or registered investment advisor's intention to throw him or her under the bus, or even put their interests before your client's in just a small way? And these are not mere hypotheticals. I have seen these situations, and even been caught up in them.

Loyalty and independent judgment are essential elements in the lawyer's relationship to a client. Concurrent conflicts of interest can arise from the lawyer's responsibilities to another client, a former client, or a third person or from the lawyer's own interests. For specific Rules regarding certain concurrent conflicts of interest, see Rule 4-1.8. For former client conflicts of interest, see Rule 4-1.9. For conflicts of interest involving prospective clients, see Rule 4-1.181.

Many years ago, I was in a fairly “steady relationship” with a large broker-dealer. But my firm was more like a second fiddle to a larger law firm they had used for years. Upon the advent of a large regulatory action, the broker-dealer hired me to represent some of their former advisors and executives. I became uncomfortable with this arrangement when it became apparent to me that many of my clients had a strong defense to the allegations, in that the broker-dealer was in large part responsible for my clients' alleged omissions. But before that day of reckoning arrived, something happened. The broker-dealer's primary attorney decided to file what appeared to me to be a frivolous motion that would not be in the best interests of my individual clients. I informed the primary attorney that my clients would not be joining the motion as he had directed. I received a major ass-chewing from him, and an order to get in line. Long story short is that I did not comply with that demand, and the broker-dealer got sanctioned for the motion. My individual clients were relieved, and ultimately dismissed from the case for zero fines or sanctions. But the broker-dealer never hired me again.

In another case, a financial advisor hired me to file a breach of fiduciary duty action against his former broker-dealer's attorney. That attorney initially represented both the broker-dealer and the advisor during a regulatory investigation. That same attorney then proceeded to play an instrumental role in throwing that financial advisor under the bus. When the dust had settled, no pun intended, the broker-dealer and attorney paid almost $4,000,000 to my client for their respective roles in the subsequent U-5 defamation and breach of fiduciary duty.

Finally, in a more recent situation, the attorneys for a broker-dealer's employee never even broached the subject of a resolution between my client and her individual client. Her firm covets their relationship with the broker-dealer far more than I had even dared to imagine. Things went south fast in our previously cordial relationship when I had the audacity to raise the “appearance” issue with her. Nothing changed in terms of proper legal representation, other than the tenor of the relationship.

The moral of these stories is this: if you are in hot water together with your employer, avoid the temptation of having your employer pay your legal bills and pick your lawyer for you. And if you are representing a broker-dealer and they ask you to serve as an unbiased loyal counsel for an employee or independent contractor, “just say no." Food for thought.

Wednesday, February 8, 2017

In re Behrends: FINRA Arbitration Awards May Not Be Dischargeable In Bankruptcy But Make Sure To Register Them As Judgments.

11 U.S.C. §523(a)(19), which was part of the Sarbanes-Oxley Act of 2002, states that a discharge [in bankruptcy] does not discharge an individual debtor from any debt that
            (A) is for:

(i) the violation of any of the Federal securities laws…, any of the State securities laws, or any regulation or order issued under such Federal or State securities laws; or

(ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and

            (B) results before, on, or after the date on which the petition [in bankruptcy] was filed, from:
(i) any judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding;

                        (ii) any settlement agreement entered into by the debtor; or

(iii) any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor. 

In re: Behrends, No. 15-1420, (10th Cir. Nov. 14, 2016)(appeal from In re: Behrends, No. 14-cv-03247 (D. Colo. September 30, 2015), involved a proceeding in a Chapter 7 bankruptcy whereby a creditor had obtained a FINRA arbitration award against the debtor for selling “$623,560.53 worth of five highly speculative securities offerings which [they] represented as suitable for retirees like Claimants who were looking for safe income producing investments.”  Claimants also maintained in the arbitration that the offerings were “’non-exempt public securities offerings conducted in violation of state and federal securities laws’ which were ‘the subject of SEC enforcement actions for fraud in the sale of securities.”  Id.  Their FINRA statement of claim asserted breach of fiduciary duty, fraud, violation of the Colorado Securities Act, violation of the Texas Securities Act, and negligence.  Behrends filed an answer to the FINRA arbitration, but did not appear at the scheduled hearing even though he had notice.  The FINRA panel concluded that the claimants had proved both liability and damages and issued a written Award stating that there were “multiple violations of Colorado state and federal securities law…” and finding Behrends jointly and severally liable for compensatory damages, as well as solely liable for a portion of compensatory damages. 

            Behrends thereafter filed his Chapter 7 bankruptcy case.  The bankruptcy court granted claimants relief from the automatic stay, and plaintiffs confirmed the judgment in Colorado state district court.  Behrends did not oppose confirmation of the award.  Claimants then filed an adversary proceeding in the bankruptcy court seeking to have the debt declared non-dischargeable under 11 U.S.C. § 523(a)(19). 

            The bankruptcy court found both requirements of (a)(19) to be met, and that collateral estoppel barred it from reconsidering the merits of the plaintiffs’ FINRA claim.  Behrends appealed.  The Tenth Circuit affirmed that the debt was non-dischargeable in bankruptcy.   Among the Tenth Circuit’s findings was that (a)(19) does not require the securities violation to be “actually litigated,” as Congress departed from the common-law understanding of collateral estoppel and issue preclusion principles.  Section 523(a)(19) “permits a determination of nondischargability based on ‘any judgment,’ (emphasis added).”  Id.; See also, Tripodi v. Welch, 810 F.3d 761, 766-67 (10th Cir. 2016). 

            Behrends also challenged the finding because he claimed the FINRA arbitration award was not sufficient to show a securities law violation, including which securities law he violated, the acts or omissions on which the violations are based, which facts support the damages awarded, and what standard of proof the panel applied.  The Tenth Circuit again disagreed, holding “all that is required is a determination that the award satisfied the requirements for nondischargeability described in § 523(a)(19)." 

            Behrends also conceded that the Denver County District Court order confirming the award and entering judgment thereon “qualifies as a judicial order memorializing the debt.” 

            The implications herein are significant, but at this point largely unpublicized.  According to a PIABA report, as much as $62.1 million in customer awards issued in 2013 alone were unpaid, and an many as $1 of every $4 awarded is unpaid.,%202016).pdf.  

           To the extent these FINRA arbitration awards are unpaid because the Respondent declared bankruptcy, and the judgment is properly registered, In re Behrends indicates that pursuant to 11 U.S.C.  § 523(a)(19), such awards would not be discharged in bankruptcy.  

Monday, February 6, 2017

Sentinel Growth Fund Management and Mark Varacchi: Even Rich People Should Stick With Registered Financial Advisors.

On Thursday, February 2, 2017, the SEC filed a civil complaint in Connecticut federal court against Mark J. Varacchi and Sentinel Growth Fund Management, alleging that the defendants misappropriated at least $3.95 million of investor assets at two private funds the defendants advised/managed.  According to the complaint, the defendants used investor money for personal and business expenses, and to pay prior investors, which would be a Ponzi scheme.  This violated defendants’ fiduciary duty to their clients.

Sentinel’s purported business model was to provide a platform for investors to “invest with up-and-coming hedge fund managers.”  The defendants claimed to have a “master fund that included multiple series managed by the [designated hedge fund managers].  Investor funds either were never invested in the designated hedge funds, or redeemed without authorization. 

The SEC seeks disgorgement and penalties against Varacchi and Sentinel, and also named two hedge funds in an attempt to recover investor assets allegedly in those funds’ possession. 

Neither Sentinel Growth Fund Management, nor Mark Varacchi are registered representatives in the Central Registration Depository, which is the database FINRA maintains of all individuals who are financial advisors (either broker-dealer agents or investment adviser representatives).  As a result, neither appear when search on FINRA’s broker-check website:  Nor do either appear on SEC’s Investment Adviser Public Disclosure website:

It is easy to post a website claiming your firm as the “Best Emerging Manager Managed Account Platform 2016.”  It is much more difficult to take the FINRA Series tests required in order to become a registered financial advisor.  While investing with any given registered persons is no guarantee as to honesty or market returns, placing investor funds with unregistered persons is the single easiest way to lose money in investing.  This is true whether you are investing a modest nest egg, or chasing yield in a supposedly curated hedge fund strategy.  

Thursday, December 22, 2016

FINRA Statutory Disqualifications and the MC-400 Process

Under the Securities Exchange Commission’s authority FINRA promulgates rules of its own as a self regulatory organization (“SRO”). Pursuant to FINRA’s By-Laws (and the By-Laws of the NASD and the NYSE before it) a person may be disqualified from membership. A person disqualified from membership would be prohibited from participation in the securities industry. In July 2007 FINRA adopted a revised version of the NASD’s definition of disqualification contained in its By-Laws such that any person subject to a statutory disqualification under the Securities Exchange Act Section 3(a)(39) also is subject to disqualification under FINRA’s By-Laws.

Prior to the amendment, the NASD’s By-Laws listed some, but not all, of the grounds for statutory disqualification contained in Exchange Act Section 3(a)(39). However, after the amendment to the NASD’s then existing By-Laws, FINRA’s By-Laws provided that: “A person is subject to a ‘disqualification’ with respect to membership, or association with a member, if such person is subject to any ‘statutory disqualification’ as such term is defined in Section 3(a)(39) of the [Securities Exchange Act of 1934].”

The revised definition of disqualification incorporated three additional categories of statutory disqualification which previously did not exist. One of those additional categories of disqualification comes from the Sarbanes-Oxley Act. Section 604 of the Sarbanes-Oxley Act expanded the definition of statutory disqualification under the Securities Exchange Act of 1934 by creating Exchange Act Section 15(b)(4)(H) and then incorporating it into Exchange Act Section 3(a)(39). As a result of this change, statutory disqualification under Exchange Act Section 15(b)(4)(H) includes a person that:
is subject to any final order of a State securities commission (or any agency or officer performing like functions), State authority that supervises or examines banks, savings associations, or credit unions, State insurance commission (or any agency or office performing like functions), an appropriate Federal banking agency (as defined in section 3 of the Federal Deposit Insurance Act (12 U.S.C. 1813(q))), or the National Credit Union Administration, that --
1. bars such person from association with an entity regulated by such commission, authority, agency, or officer, or from engaging in the business of securities, insurance, banking, savings association activities, or credit union activities; or
2. constitutes a final order based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct.
This revised definition of statutory disqualification became effective as of July 2007. The effect of the revised definition would have been the immediate disqualification of a large number of individuals subject to the new categories of disqualification. In order to remain in the securities industry, these individuals would have had to utilize the then existing NASD eligibility proceedings for persons subject to disqualification; i.e. NASD Rule 9520.

In order to avoid this result, the NASD requested that the Securities Exchange Commission Staff not recommend enforcement action to the Commission under Exchange Act Section 15A(g)(2) or Rule 19h-1(a) for those persons subject to the new definition of disqualification until the NASD could update and improve its eligibility proceedings to address the changes to the definition of statutory disqualification. As a result, the SEC, by Chief Counsel Catherine McGuire, issued a No Action Letter on July 27, 2007, informing the NASD that it would not seek enforcement against the individuals subject to the new categories of statutory disqualification if NASD did not file notice with the Commission for enforcement between the time the amended By-Laws containing the revised definition of statutory disqualification became effective and the effective date of the revised eligibility procedures. This would mean that those persons subject to the revised definition could continue membership in FINRA without going through the application process for eligibility pending the adoption of the revised eligibility procedures.

In April 2009, FINRA released Regulatory Notice 09-19 which set forth the amendments to FINRA Rule 9520 Series to become effective June 15, 2009. The revised FINRA Rule 9520 Series established procedures applicable to firms and associated persons subject to the additional statutory disqualifications as a result of the adoption of the revised definition of disqualification. Under this new construct of the Rule 9520 Series, individuals subject to one of the additional categories of disqualification would need to seek FINRA’s approval to enter or remain in the securities industry by way of an application with FINRA’s Department of Registration and Disclosure (“RAD”) only under certain circumstances. The need to file an application depends on 1) the type of disqualification; 2) the date of the disqualification; and 3) whether the firm or individual was seeking admission, readmission or continuance in the securities industry.

There are likely four different ways that a member of FINRA would know that they are required to file an application with RAD as a result of the application of revised Rule 9520 Series to an order of a state securities commission. First, Regulatory Notice 09-19 states that as of June 15, 2009, FINRA began reviewing its records to identify persons that met any of the additional conditions that would require the filing of an application under the revised Rule 9520 Series. In what manner FINRA has undertaken this review is unknown. Second, an individual could identify on their own that they are subject to an existing order which would require an application with RAD.

Third, if someone is seeking to transfer their registration to a new broker-dealer, then any existing state orders which would require an application with RAD as a result of the revised Rule 9520 Series would be disclosed by the CRD (the central licensing and registration system for the U.S. securities industry and its regulators) when it is reviewed by FINRA. Fourth, if an individual is subject to a new order of a state regulator, then an alert is sent out to all other state regulators as well as FINRA through the CRD. Whether FINRA reviews each alert it receives in order to decide to take action against an individual subject to an order of a state securities commission is unknown.

For those subject to a statutory disqualification arising from orders specified in Exchange Act Section 15(b)(4)(H)(i) and Exchange Act Section 15(b)(4)(H)(ii), find below an outline of the circumstances under which the person must file an application with RAD under FINRA’s revised Rule 9520 Series:

A. If the person is seeking admission or re-admission to the industry; and
1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i), then the person must file an application unless the order imposing a bar on the person is time-limited and the time period is expired. However, if the bar is related to Fraudulent, Manipulative or Deceptive (“FMD”) conduct, then the person must submit an application under the circumstances described in section I.B.
2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then the person must submit an application unless:
i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions) and the sanctions are no longer in effect; or

ii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), the sanctions are no longer in effect, and the order was entered 10 or more years ago.

B. If the person was, as of March 17, 2009, a member of, or an associated person of a member of FINRA or another SRO, and was subject to a statutory disqualification as of that same date and is seeking to continue in the industry; and

1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i); and
i. the bar is no longer in effect and is not related to FMD conduct, then no application is required.

ii. the bar is still in effect and is not related to FMD conduct then no application is required unless there is a “triggering event” - which occurs when the person subject to the statutory disqualification either changes employers or the member firm makes an application for the registration of such person as a principal pursuant to FINRA rules.

iii. the bar is still in effect and is related to FMD conduct, then an application is required.

2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then an application is required unless:

i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are no longer in effect; or

ii. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are still in effect, in which event an application is required only if there is a triggering event; or

iii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), and the sanctions are no longer in effect, and the order was entered 10 or more years ago. However, if the order was issued less than 10 years ago, then an application is required if there is a triggering event.

C. If the person was, as of March 17, 2009, a member of, or an associated person of a member of FINRA or another SRO, and is subject to a statutory disqualification that arose after March 17, 2009, and is seeking to continue in the industry; and

1. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(i), then the person must file an application unless the order imposing a bar on the person is time-limited and the time period is expired. However, if the bar is related to FMD conduct, then the person must submit an application under the circumstances described in section III.B.

2. the person is subject to an order under Exchange Act Section 15(b)(4)(H)(ii), then an application is required unless:

i. the sanctions do not involve licensing or registration revocation or suspension (or analogous sanctions) and the sanctions are no longer in effect; or

ii. the sanctions do involve licensing or registration revocation or suspension (or analogous sanctions), the sanctions are no longer in effect, and the order was entered 10 or more years ago.
Some more recent articles touching upon this process include: “Stockbroker's DUI Puts Career in the FINRA Ditch” by Bill Singer, “Bankrupt Stockbroker Winds Up Statutorily Disqualified” by Bill Singer, “U-4 Omissions and Statutory Disqualification:Much Ado About Nothing” by Alan Wolper. Do not hesitate to call us if you or your broker-dealer need assistance with a potential MC-400 application.

Wednesday, September 28, 2016

NASAA Releases Its 2016 Enforcement Report

The North American Securities Administrators Association (NASAA) recently released its Enforcement Report for 2016, an annual publication providing a general overview of the activities of the state securities agencies responsible for the protection of investors who purchase investment advice or securities. Admittedly, the information undercounts many statistics due to differences in fiscal year reporting and a lack of response or underreporting for each survey question posed. However, trends in the 52 U.S. jurisdictions are still apparent in the report.[i]

For the first time since NASAA began tracking enforcement statistics, more registered than unregistered individuals and firms were subject to respondent status.[ii] During 2015, state securities regulators conducted 5,000 investigations and brought 2,000 enforcement actions against 2,700 respondents, which often involved more than one individual or company.[iii]

Sanctions imposed upon those who were found in violation of securities law ranged from incarceration to monetary relief and bans on trading. The year witnessed a combined 849 years of imprisonment, 410 years of probation, and 23 years of deferred prosecution, as well as $538m paid in restitution and $238m in fines/penalties.[iv] In addition to criminal and monetary repercussions, revocation and disbarment from the industry occurred for more than 250 individuals, while another 475 licenses/registrations were denied, suspended or conditioned.[v]   

The five most common violations prompting these actions were, in order of frequency: Ponzi Schemes, Real Estate Investment Program Fraud, Oil & Gas Investment Program Fraud, Internet Fraud, and Affinity Fraud.[vi]

The NASAA report found that Ponzi scheme victims were often targeted through the internet or for identifiable attributes, such as race or religion. The report also found that vulnerable seniors were disproportionately victims; jurisdictions that reported on seniors found one-third of all investigations related to their victimization.[vii]

Prison terms have become more common for those conducting such schemes, such as Derek Nelson, found guilty of selling about $37m in promissory notes for property purchases that never took place. As a consequence, Mr. Nelson received 19 years in prison.[viii]

Real estate and oil and gas investment fraud was also a major concern for reporting NASAA members. Some states, such as Colorado, have sought judicial remedy and have secured investor protection by winning the right to have oil and gas interests subject to securities law.[ix]

The report clearly states that all fraud has been made easier to accomplish due to the internet, where only basic computer skills allow an individual from anywhere in the world to “enter” the homes of investors. Scott Campbell was sentenced to 20 years in prison for conducting a Ponzi scheme over the internet from Florida. Alabama garnered 18 convictions in an international bank scheme conducted through Craigslist.[x] Affinity frauds, in which an individual purports to be a member of a certain group, are much easier to accomplish given the anonymity of the internet.

The industry’s heightened attention to elder abuse has not shielded those responsible for supervision or oversight. Wells Fargo Advisors, LLC and Fulcrum Securities, LLC were ordered to pay $470,000 to investors for their failure to oversee Christopher Cunningham of Virginia, who defrauded elderly clients in a Ponzi scheme. For his part, Cunningham was disbarred and sentenced to 57 months in federal prison.[xi]

Attorneys are not immune to abusing their positions in order to perpetrate fraud. According to the report, Michael Kwasnik, an estate planning attorney, used his position of trust to perpetrate a $10m Ponzi scheme against elderly victims in New Jersey. The Court found that he had taken advantage of the attorney-client trust. Earlier in the year, Kwasnik also pled guilty to securities fraud in Delaware, utilizing the client trust account of his law firm to commingle monies from both frauds. Though Mr. Kwasnik received no jail time, he was ordered to repay millions in lost monies, amongst other judgments.[xii]

What may be the single worst case of elder victimization presented in NASAA’s annual report was perpetrated by Sean Meadows, owner of a financial planning and asset management firm, Meadows Financial Group LLC (MFG). Meadows perpetrated a $13m Ponzi scheme against 100 individuals, some disabled, poor, or terminally ill. He took the life savings of most, luring them into draining their retirement accounts. Many lost their homes, ability to care for their families, and even pay for cancer treatments.[xiii]

Meadows convinced his victims to pull money out of tax-deferred accounts to invest with MFG, promising these transactions would be tax-free rollovers. He then convinced these same individuals to allow him to do their taxes, in order to cover up the scheme. He either filed fraudulent tax returns or filed nothing at all. As a result, in addition to losing retirement savings, many incurred significant tax liabilities. For his crimes, Meadows received 25 years in prison.[xiv]

As the NASAA report makes clear, positive steps are being taken by its members to address the fraudulent and criminal activities of some individuals and firms. Laura Posner, NASAA Enforcement Section Chair, believes enhanced regulatory scrutiny is responsible for the increase in action documented by the report.[xv] However, it is still necessary to be on alert for promises that seem too good to be true. If you feel you may have fallen victim, please seek consultation from an attorney immediately.   

[i] North American Securities Administrators Association (2016) NASAA 2016 Enforcement Report (Based on 2015 Data) [Electronic Format]. Retrieved from: (pp. 11)
[ii] Ibid. pp. 5
[iii] Ibid. pp. 2
[iv] Ibid. pp. 3
[v] Ibid. pp. 4
[vi] Ibid. pp. 4
[vii] Ibid. pp. 5
[viii] Ibid. pp. 6-7
[ix] Ibid. pp. 4-5
[x] Ibid. pp. 7
[xi] Ibid. pp. 7
[xii] Ibid. pp. 9
[xiii] Ibid. pp. 9-10
[xiv]Ibid. pp.  9-10
[xv] NASAA Releases Annual Enforcement Report (9.13.2006) [Electronic Format]. Retrieved from: