Wednesday, July 8, 2015

Feds Take Aim at Investment Advisers

The SEC and DOJ brought a slew of cases against IAR's and RIA's in the first half of 2015. At least six cases were filed just last month alone. Here is a brief summary of a sampling of those cases.

On January 21, 2015, the SEC filed fraud charges and an asset freeze against a Fort Lauderdale, Florida-based investment advisory firm, its manager, and three related funds in a scheme that raised more than $17 million. The SEC’s complaint filed in federal court in the Southern District of Florida charged Elm Tree Investment Advisors LLC, its founder and manager, Frederic Elm, and Elm Tree Investment Fund LP, Elm Tree “e”Conomy Fund LP, and Elm Tree Motion Opportunity LP. According to the complaint, Elm, formerly known as Frederic Elmaleh, his unregistered investment advisory firm, and the three funds misled investors and used most of the money raised to make Ponzi-like payments to the investors. The complaint alleges that Elm used the funds to buy a $1.75 million home, luxury automobiles, and jewelry, and to cover daily living expenses.

On March 6, 2015, an investment adviser was hit with felony charges alleging that he defrauded clients of more than $1 million while running his own investment firm in Chicago. Philip E. Moriarty II is accused of six counts of wire fraud related to allegations that he defrauded investors of at least $1.1 million while he was the CEO of First Street Capital Partners in Chicago from 2008 to 2010. He’s accused of convincing four investors that they were investing in his businesses through the use of fraudulent documentation, and then spending the funds on personal expenses, including payments to a golf, hunting and fishing club, and $23,000 to a boarding school in New Hampshire.

Late that month, the SEC filed fraud charges against an investment adviser and her New York-based firms accusing them of hiding the poor performance of loan assets in three collateralized loan obligation (CLO) funds they managed. The SEC’s Enforcement Division alleged that Lynn Tilton and her Patriarch Partners firms breached their fiduciary duties and defrauded clients by failing to value assets using the methodology described to investors in offering documents for the CLO funds. Tilton and her firms allegedly have avoided significantly reduced management fees because the valuation methodology described in fund documents would have given investors greater fund management control and earlier principal repayments if collateral loans weren’t performing to a particular standard.

In April, 2015, a former JPMorgan Chase investment adviser was arrested on charges he stole $20 million from customers and spent the funds on unprofitable trading and other personal expenses. Michael Oppenheim allegedly took money from at least seven bank clients in a fraud scheme he operated from March 2011 to March 2015. Oppenheim worked as a JPMorgan investment adviser. He advised approximately 500 clients who collectively kept roughly $89 million in assets under his management, according to a criminal complaint filed by Manhattan federal prosecutors.

Later in April, a former Merrill Lynch and Smith Barney investment adviser already serving a federal prison term for investment fraud pleaded guilty to additional fraud charges in connection with a nearly two-decade-long scheme to defraud clients of hundreds of thousands of dollars. Jane E. O’Brien of Needham, MA, pleaded guilty to three counts of mail fraud, two counts of wire fraud, and two counts of investment adviser fraud. As alleged in the indictment, between 1995 and 2013, O’Brien defrauded several clients for whom she provided investment advisory services. As part of the scheme, O’Brien misappropriated funds entrusted to her through a variety of means, including persuading clients to withdraw money from their bank and brokerage accounts to invest. After gaining control of her clients’ money, however, O’Brien made no such investments. Instead, she used the misappropriated client funds for a variety of improper purposes, including paying personal expenses, paying purported investment returns, or repaying personal loans to other clients. Finally, in order to perpetuate her fraud and conceal it from her clients, O’Brien made false statements and misrepresentations to clients, including by making lulling payments to clients and otherwise providing them with false assurances of their financial security.

On May 15, 2015, Bryan Binkholder of St. Louis was sentenced to 108 months in prison on multiple fraud charges involving his financial planning and investment strategy businesses. In addition to the prison sentence, he was also ordered to pay $3,655,980 in restitution to the victims. According to court documents, Binkholder labeled himself “The Financial Coach” and provided investment and financial planning advice to the public through his affiliated websites and an investment related talk-radio show that aired on local radio stations. In 2008, he developed a real estate investment he termed “hard money lending.” Using his platform as an investment advisor and financial talk show host, Binkholder solicited his clients and others to invest in the hard money lending program. As part of his sales pitch he represented that he had relationships with developers who were not able to secure financing from traditional banks. As part of the hard money lending program, Binkholder told investors that they would invest money with him, and he would act as a bank and provide short term loans to these developers at a high rate of interest which would be shared with the investor. Instead of exclusively making hard money loans as promised, he took in millions of dollars of investor money, made only a small number of hard money loans and caused investors to lose more than $3,000,000.

On May 21, 2015, The Securities and Exchange Commission filed fraud charges against an Atlanta-based investment advisory firm and two executives accused of selling unsuitable investments to pension funds for the city’s police and firefighters and other employees. The SEC’s Enforcement Division alleged that Gray Financial Group, its founder and president Laurence O. Gray, and its co-CEO Robert C. Hubbard IV breached their fiduciary duty by steering these public pension fund clients to invest in an alternative investment fund offered by the firm despite knowing the investments did not comply with state law. Georgia law allows most public pension funds in the state to purchase alternative investment funds, but the investments are subject to certain restrictions that Gray Financial Group’s fund allegedly failed to meet. The SEC alleged that Gray Financial Group collected more than $1.7 million in fees from the pension fund clients as a result of the improper investments.

On June 3, 2015, the SEC filed two cases against purported investment advisers who falsified their credentials. In one case, the SEC charged that Todd M. Schoenberger of Delaware solicited at least a dozen people to invest in promissory notes issued by LandColt Capital, an unregistered advisory firm. According to the SEC, he said the notes would be repaid from management fees. Just a few days later, a Chicago investment adviser was arrested on federal charges that he defrauded his clients of at least $1 million, some of which he allegedly gambled away at local casinos. Alan Gold was charged in a criminal complaint that was unsealed following his arrest.

On June 11, 2015, the United States Attorney for the Western District of Wisconsin announced the unsealing of a 21-count indictment charging Pamela Hass with wire fraud and money laundering. The indictment also contains a forfeiture allegation seeking $460,831.27 in criminal proceeds. The indictment alleges that Hass engaged in a wire fraud scheme to defraud investors by promising returns from an investment in internet pop-up ads. According to the indictment, Hass falsely told investors they would obtain a return of anywhere from five to 20 times their original investment, and that if the investment failed, she would personally guarantee the return of the original investment plus 7 percent interest.

Also last month, The Securities and Exchange Commission announced fraud charges against a Washington D.C.-based investment advisory firm’s former president accused of stealing client funds. The firm and its chief compliance officer separately agreed to settle charges that they were responsible for compliance failures and other violations. SFX Financial Advisory Management Enterprises is wholly-owned by Live Nation Entertainment and specializes in providing advisory and financial management services to current and former professional athletes. The SEC alleged that SFX’s former president Brian J. Ourand misused his discretionary authority and control over the accounts of several clients to steal approximately $670,000 over a five-year period by writing checks to himself and initiating wires from client accounts for his own benefit.

Just a day later, Kenneth Graves, a former investment adviser representative in Corpus Christi whose license to sell securities was revoked last year by the Texas Securities Commissioner, was indicted on fraud charges related to the sale of investment contracts and excessive fees for his firm’s services. The indictment alleges that Graves defrauded six clients of his firm, Warren Financial Services LLC, through the sale of $420,720 in investment contracts. The indictment alleges that in a separate fraud in 2013 and 2014, Graves misapplied $128,918 in fees he had collected from clients of Warren Financial.

Finally, on June 17, 2015, the SEC announced fraud charges against a Massachusetts-based investment advisory firm and its owner for funneling more than $17 million in client assets into four financially troubled Canadian penny stock companies in which the owner had an undisclosed financial interest. The SEC alleged that clients at Interinvest Corporation may have lost as much as $12 million of their $17 million investment based on the recent trading history of shares in the penny stock companies, some of which were purportedly in the business of exploring for gold or other minerals. Interinvest’s owner and president Hans Black served on the board of directors of these companies, which have collectively paid an entity he controls approximately $1.7 million. Black’s involvement with these companies and his receipt of payments from them created a conflict of interest that he and Interinvest failed to disclose to their advisory clients.

On a final note--Investors and accountants should take the time to read Brian Carroll's article regarding investment advisory fraud in the Journal of Accounting.

In addition to founding the Investment Adviser Rep Syndicate, David Cosgrove, a former regulator and prosecutor, is the founding Member and Manager of Cosgrove Law Group, LLC. The law firm represents both investors and investment advisers across the nation. In doing so, the firm's members have a unique strategic advantage and insight when it comes to litigation or conflict resolution in the financial services and investment arena. 

Wednesday, July 1, 2015

Wells Fargo Takes One on the Chin

A St. Louis County jury recently awarded over $70 million to the beneficiary of two trusts against Wells Fargo (WF).

WF and its predecessors had served as the corporate trustee of one trust, and the custodian of the other. This firm previously prosecuted an arbitration against a WF predecessor on behalf of a trustee. The client prevailed, but not for $77 million! (Her damages were much lower!)

A review of the case facts set forth in Missouri Lawyer's Weekly's May 18th publication suggests that the case was anything but a slam dunk for the plaintiff. So—kudos to Jim, Megan, and Paul!

My law partner, Dan Conlisk, has over 25 years of fiduciary litigation experience to compliment my financial services industry practice. He too was amazed at the result.

The primary protagonist in the underlying drama was the plaintiff's own son, Doug Morris. WF's defense, in part, was that Mr. Morris, rather than WF ran the trusts. Further, WF argued that the elderly woman at plaintiff's table “said yes to everything her attorneys now complain about.” Notably, Mr. Morris wasn't suppose to be running the two trusts and there were 11 women on the jury.

At the end of the trial, the plaintiff prevailed almost entirely on her breach of fiduciary duty and Uniform Fiduciaries Law claims. The jury assessed 98% of the blame to WF. Food for thought if you are a trust beneficiary or “mere custodian.”  

Wednesday, March 11, 2015

The Arbitration System

The premise that underlies the justification for the loss of rights in arbitration is simple: both parties knowingly agreed to binding arbitration. This presumption is based upon the presumptions that 1) signators read contracts before signing, 2) they have the time and knowledge to understand the implications of the arbitration provision, and 3) they have a viable ability to opt-out of agreeing to the provision. Arbitration's entire legitimacy is based upon these fairly specious presumptions. And there has been much written about these presumptions and whether or not binding arbitration is actually the product of an informed voluntary decision by both parties. See “Whimsy Little Contracts' with Unexpected Consequences: An Emperical Analyss of Consumer Understanding of Arbitration Agreements,” Jeff Sovern, Elayne Greenberg, Paul Kirgis, and Yuxiang Liu, St. John's Legal Studies Research Paper No. 14-0009, October 29, 2014 and “Arbitration Clauses Trap Consumers with Fine Print,” Jeff Sovern,, December 2, 2014.

The position of the “Whimsy Little Contracts'...” study is that no one would voluntarily agree to have substantial rights resolved in a quasi-judicial system so blatantly contaminated by bias. Take a look at these charts and decide for yourself if the system is fair and free of improper influence:

Finally, there is another false assumption that bolsters the presumption favoring arbitration: it is more efficient than the courts: Cheaper and quicker! Unfortunately, I could rattle off twenty examples demonstrating just how bogus this presumption is when presented as a general truth. I recently received an arbitration award from JAMS 7 years after the claim was filed. I just paid AAA over $20,000 before the Panel has ever convened, and the Respondent is burying us in discovery. If I was in Federal Court, I would have a scheduling order protecting my client for approximately $200 in filing fees.

In sum, both the courts and the legislature need to take a hard and honest look at the jurisprudential legitimacy of binding arbitration. Food for thought.

Tuesday, February 10, 2015

Did the Eastern District Just Void Financial Adviser Independent Contractor Arbitration Clauses?

I think they may have done just that, at least in Missouri.  Us kids who work with or in the financial services industry know that brokers like Edward Jones frequently run to court when a broker leaves them.  They seek a TRO, ostensibly to prevent the broker from misusing confidential information or violating a non-complete agreement.  Fair enough. 

Now, ask yourself – When is the last time the financial adviser went to court to seek some kind of equitable relief?  Almost never, in part because the circumstances that would invite equitable relief for the adviser himself are much narrower.

According to the typical Investment Adviser Account Agreement between the financial adviser and the broker-dealer, both parties are required to resolve their disputes in a FINRA Arbitration.  Would that arbitration clause be binding in the Eastern District?  Or does it lack the requisite mutuality, since, in effect, only the broker-dealer can avail itself of the state and federal courts?

Last month, in the case of Jimenez v. Cintas Corp., No. ED 1011015 (2014), the Court of Appeals affirmed the trial court’s refusal to grant arbitration of Ms. Jimenez’ employment discrimination claim.  The Court’s affirmation rested upon its own conclusion that the parties’ “Employment Agreement” contained a binding arbitration clause that excluded claims for declaratory judgment or injunctive relief concerning the employees covenants only.  The covenants include confidentiality and competition obligations.  Id. at 3.[1]  Therefore, the agreement to arbitrate lacked uniformity.  As such, the employer’s “promise to arbitrate [was] devoid of mutuality of obligation.  Accordingly, [employer’s] professed promise to arbitrate [was] not valid consideration and does not support a determination that the parties formed a valid agreement.”  Id. at 14.

The Court of Appeals observed initially that the contract at issue was “bilateral”, and that valid consideration for a bilateral contract “rests solely on whether the parties promises to each other are mutually binding.”  Since, in effect, the employer could still side-step arbitration in non-compete matters, the promises to arbitrate were not equally binding.  Id. At 9.  More specifically, citing Frye v. Speedway Chevrolet Cadillac, 321 S.W.3d 429 (Mo. App. W.D. 2010), the Court stated: 

“A contract that purports to exchange mutual promises will be construed as lacking legal consideration if one party retains the right to unilaterally divest itself of an obligation to perform the promise initially made.”

The following analysis should bring a chill to the broker-dealer’s in-house counsel, or counsel for any party that blindly succeeds in divesting itself of a contractual obligation to perform a mutual promise, whether it be arbitration, confidentiality, or competition: 

Section 8 of the Agreement requires that Cintas and Jimenez arbitrate any unresolved “claims for damages, as well as reasonable costs and attorney’s fees, caused by [the other]’s violation of any provision of this Agreement or any law, regulation or public policy.”  However, it expressly exempts from arbitration:  “workers’ compensation claims, unemployment benefits claims, clams for a declaratory judgment or injunctive relief concerning any provision of Section 4 and claims not lawfully subject to arbitration. . . .” 

(Emphasis added). 

Defendants argue that the above terms in Section 8 plainly require both parties to arbitrate their disputes, with several exceptions, and these terms should be construed as “mutual in all relevant respects.”  On its face, we agree that the language in Section 8 plainly states that both parties must arbitrate all of their claims except:  workers’ compensation claims, unemployment benefits claims, claims not lawfully subject to arbitration, and “claims for a declaratory judgment or injunctive relief concerning any provision of Section 4 . . . .”

Jimenez, however, correctly points to additional language in Section 4, providing that only the: 

Employer[,] may apply to any court of competent jurisdiction for a temporary restraining order, preliminary injunction or other injunctive relief to enforce Employee’s compliance with the obligations, acknowledgments and covenants in this Section 4.  Employer may also include as part of such injunction action any claims for injunctive relief under any applicable law arising from the same facts or circumstances as any threatened or actual violations of Employee’s obligations, acknowledgments and covenants in this Section 4. 

The effect of the language in Section 4, Jimenez asserts, is that Cintas alone is exempted from arbitrating alleged violations of the Non-Compete Provisions.

Defendants reply that the plain terms of Section 8 do not specify which party may seek judicial relief for alleged violations of the Non-Compete Provisions of Section 4, and so we should construe Section 8 to mean that both parties are exempt from arbitrating alleged violations of the Non-Compete Provisions of Section 4.  But this interpretation would render meaningless the express language of Section 4, which provides that Cintas alone may apply “for a temporary restraining order, preliminary injunction or other injunctive relief to enforce [Jimenez]’s compliance with the obligations, acknowledgements and covenants in this Section 4.” 

We construe a contract as a whole so as not to render any terms meaningless.  See Chochorowski v. Home Depot U.S.A., 404 S.W.3d 220, 229 (Mo. banc 2013).  Furthermore, when construing the language of a contract, specific terms and provisions are given preference over general terms.  See General American Life Ins. Co. v. Barrett, 847 S.W.2d 125, 133 (Mo. App. W.D. 1993).  We, therefore, cannot ignore the specific language of Section 4.

We agree with Jimenez that Cintas alone is exempted from arbitrating disputes concerning Section 4’s Non-Compete Provisions, while Jimenez is bound to arbitrate those same claims.  We also agree that this exception allows Cintas to refrain from arbitrating those claims it is most likely to bring against Jimenez.  [Footnote excluded].  At the same time, Jimenez is bound to arbitrate all of those claims legally arbitrable.  [Footnote excluded].  Thus, the Agreement allows Cintas to seek redress through the court system for those claims it is most likely to have against Jimenez, while binding Jimenez to arbitrate all legally arbitrable claims she may have against Cintas. 

Equally critical to resolution of this issue is that the plain language of Section 4 allows Cintas to file “any claims for injunctive relief under any applicable law arising from the same facts or circumstances as any threatened or actual violation of Employee’s obligations . . . in this Section 4.”  (Emphasis added).  This expansive clause arguably renders illusory Cintas' promise to arbitrate, by permitting Cintas to seek redress in the courts based upon its bare allegation that such claims are tied to Section 4’s Non-Compete Provisions.  Cintas may litigate at its discretion, while Jimenez is bound to arbitrate all of her legally arbitrable claims. 

Where the practical effect of an arbitration agreement binds only one of the parties to arbitration, it lacks mutuality of promise and is devoid of consideration. 

Id. At 11-13.  Food for thought when evaluating the enforceability of an arbitration clause in Missouri.

[1] Notably, the trial court rested its conclusion upon lack of consideration, as well as unconsciousability.

Wednesday, January 7, 2015

Arbitration's Cancer – The Systemic Bias Created by the Co-existence of Paid Arbitrators, Arbitrator Strikes, and Award Histories

It has been said: “because bias is so subtle, it's extremely effective.” So it should come as no surprise that one of the cornerstones of the rules of judicial ethics is that bias is to be avoided or ferreted out.  Bias should be no more acceptable in an arbitration forum than it would be in a federal court.  But it seems to be just that, as a confluence of procedures in our private arbitration forums produce an "extremely effective" systemic bias. 

These facts are known to any reasonably informed arbitrator:

1)      The FINRA Member, or private party that inserted AAA or JAMS in to its commercial contract, has a procedural right to strike and rank potential arbitrators, without cause or explanation.
2)      The FINRA Member or private party will have access to the details and magnitude of the arbitrator's prior compensatory, punitive, cost and fee awards.
3)      A federal court has never vacated an arbitration award on the grounds that the compensatory award to the investor or broker wasn't big enough, or because the panel failed to award punitive damages, costs, or fees. 
4)      JAMS, FINRA, and AAA can, and have, removed an arbitrator from their roster without explanation after the arbitrator chaired over the issuance of a substantive award.

In order to combat this bias, arbitrators must first be able to identify and somehow neutralize the bias these indisputable facts generate.  But since they are subconsciously biased, neutralizing this bias is a very tall order. It is certainly an unrealistic expectation. FINRA, JAMS, and AAA arbitrators are human. And even though most, no doubt, are individuals of high integrity and intelligence, they want to serve as arbitrators, and they are compensated to do so.  Many of them are full-time arbitrators, at least partially dependent upon that compensation. 

In order to eradicate the insidious bias created by the system in favor of (statistically undeniable) depressed compensatory awards and rejected punitive, cost and fee claims, the system must be changed.  Until it is, the federal courts' rather convenient strict adherence to a purported congressional policy (lobby) in favor of arbitration will be perverted by a money-bias--the same bias the judiciary espouses to be intolerable and inconsistent within its own jurisprudence.       

How do you remove this “extremely effective” bias pressing upon compensated private arbitrators?  The solution is “simple, but not easy:”

1)      Drastically reduce or eliminate arbitrator compensation, and/or
2)      Eliminate the granting of strikes and rankings to FINRA Members and to volume-consumers of other private arbitration services (e.g. Fisher Investments).

Until arbitrators are wholly ambivalent to what FINRA Members and arbitration consumers[1] with strikes think about their past Awards, arbitrators will suffer from a subtle but highly potent bias against claimants.

[1]FINRA itself as well as the owners of for-profit arbitration services like JAMS and AAA could still, however, influence arbitrators.  For example, an arbitrator chairman that issued a multi-million dollar award to one of my clients was subsequently relieved of his duties by FINRA.  Probably just a coincidence, but... Do we need lifetime appointments for arbitrators?  Or minimum terms?

Sunday, November 30, 2014

What Will be on the SEC’s 2015 Exam Priorities for Investment Advisers?

Each January, The SEC’s National Exam Program (“NEP”) issues examination priorities for the year ahead.  The priorities are based upon the SEC’s evaluation of those areas in the financial markets that it believes will be presenting a risk of harm to investors, the markets, or capital formation.

The NEP has four program areas: 1) Investments advisers, 2) broker-dealers, 3) exchanges and SRO’s, and 4) clearing and transfer agents.  Recall that the SEC and State regulators split the regulatory oversight for investment advisers with the SEC retaining jurisdiction over the “larger AUM” RIA’s.

The 2014 NEP priorities for investment adviser agents and registered investment advisers included safety of assets and custody and conflicts of interest and marketing claims related to investment objective and performance.  In the opinion of this author, one would think Fisher Investments endured a substantial SEC exam in 2014 in light of these priorities. The SEC is already foreshadowing what will be included in the list for 2015.

Hearsay and rumors in our corner of the market indicate that the SEC is currently concerned about investment adviser sales practices related to 401(k) to IRA rollovers.  If it is indeed a 2015 priority, there will certainly be several large RIA’s under the microscope.  Of no surprise, word on the street is that the priority list will include cyber security and dual registrations.  As for the broker-dealer area: it looks like costly mutual funds and “bad brokers” will be an SEC priority for 2015.   But enough speculation – we should have the list in a matter of weeks.  In the meantime, let us know if we can help you with your compliance or litigation needs.  Food for thought.

Business Torts in the Financial Industry Arena

The attorneys at Cosgrove Law Group, LLC frequently handle business disputes on a contingent fee basis in arbitrations and the courts.  We are typically litigating in the financial industry arena where slashing, cross-checking and full-body blows are routine. Although they may be routine, they may also cross a generous line and sow the seeds for a future arbitration award or court judgment.

When an investor, broker-dealer agent or investment adviser representative comes to us for help, our first task is to gather all of the facts. This is, of course, a critical task. But the next step is just as critical – identifying the most applicable and powerful causes of action. The cause of action is your gateway from facts to recovery, and the evidentiary elements of and recovery available under different causes of action vary greatly. Luckily, you don’t have to choose just one. For example, an investor may have a claim for breach of fiduciary duty that does not provide for punitive damages in an arbitration forum, but he or she may also have a claim for a violation of a state’s model security act. That act explicitly provides for punitive damages, costs and/or attorney fees under certain provisions. As such, an arbitration panel would be empowered to grant those remedies.

Another example: a broker may have a U-5 defamation claim against his former broker-dealer.  If she signed a financial adviser agreement that has a Missouri choice-of-law provision (because that is where her broker-dealer is headquartered), but her broker-dealer defamed her to her clients in Georgia as well, the broker likely has a Missouri breach of contract cause of action and Georgia common law tort claims for defamation and tortious interference with a business relationship. So, if you are a member of the financial industry arena or an investor, and you just took an illegal cross-check, make sure you hire the right legal counsel, and do so as soon as possible.