Tuesday, December 11, 2012

FINRA Discusses Expungement for Unnamed Persons in Arbitration Claims at December 2012 Board Meeting

The FINRA Board of Governors met last week to discuss a number of issues, including several rulemaking items. A summary of one of the more pertinent rulemaking items is included below:

Expungement for Unnamed Persons in Arbitration Claims
The Board authorized FINRA to file a proposal with the SEC that establishes three different procedures that would permit registered persons who are identified for alleged sales practice violations in an arbitration claim, but are not named as parties in that claim (unnamed persons), to seek expungement relief. The unnamed person could seek relief under Rule 12805 by asking a party to the customer-initiated arbitration in writing to seek expungement on his or her behalf. Alternatively, the registered person could initiate In re proceedings under new Rule 13807 at the conclusion of the underlying customer-initiated arbitration case. Finally, the unnamed person could seek expungement relief at the conclusion of the customer’s case by asking the panel for an expungement based on the record compiled in the underlying case. The proposal incorporates many of the comments and suggestions received on Regulatory Notice 12-18, as well as feedback from several FINRA committees. FINRA believes that these proposals provide unnamed persons with a remedy to seek redress concerning allegations that could impact their livelihoods, yet maintains the protections of FINRA’s expungement rules to ensure the integrity of the CRD records.

The authorization to file a proposal with the SEC is interesting and important news for associated persons who are mentioned in but not named as parties to an arbitration.  If ultimately approved, this will permit these individuals to seek expungement relief by the three methods mentioned above.  Currently, allegations mentioning an associated person must be reported in the same way that customer complaints are reported—to the Central Registration Depository system on Forms U4 or U5. The Code of Arbitration Procedure for Customer Disputes and the Code of Arbitration Procedure for Industry Disputes do not presently provide unnamed persons with express procedures to seek expungement of these types of allegations.

Friday, November 30, 2012

Federal District Court Denies Questar's Motion to Vacate 3.25 Million Dollar Arbitration Award

On November 12, 2012, Senior Judge Thomas B. Russell of The United States District Court, WesternDistrict of Kentucky, issued a 60-page Opinion denying a Petition to Vacate and a Motion to Vacate filed by Questar Capital Corporation. Questar is a fully owned subsidiary of U.A. Allianz. Questar filed in federal court after a 3-arbitrator FINRA panel sitting in Louisville issued a $3.25 million Award to a client of St. Louis' Cosgrove Law Group, LLC. The client is a former independent contractor, broker-dealer agent, and investment advisor representative of Questar.

The Court spent the first 1/3 of its Opinion addressing the broker's contention that Questar had waived its right to file a Motion to Vacate by failing to comply with the 30-day post-Award deadline set forth in FINRA Rule 13904. The broker had filed a Motion to Dismiss Questar's Petition to Vacate because, while it was filed within 30 days of the Panel's Award, Questar subsequently filed a Motion to Vacate about 75 days after the Award. The Court denied the Motion to Dismiss, concluding that, despite conflicting legal precedent, Rule 13904 “did not establish a 30-day time limit for filing a Motion to Vacate.” (Opinion at 23). Specifically, Judge Russell concluded that it is sufficient if a movant files within the 90-day time limit set forth in Section 12 of the Federal Arbitration Act (FAA).

Approximately half-way through his meticulous Opinion, Judge Russell initiated his analysis of “the heart of this proceeding”--the merits of Questar's application for vacatur. He began by noting the limited grounds upon which an arbitration award may be vacated under the FAA, noting that the Sixth Circuit recognizes an extra non-FAA judicial basis-- “manifest disregard of the law” by the arbitrator. Finally, rather than proceeding to evaluate sequentially each and every specific claim set forth by Questar, the Court divided Questar's allegations and the Court's analysis into the four FAA grounds of vacatur, as well as the Sixth Circuit's manifest disregard basis.

As to FAA Section 10(a)(2)-- “evident partiality” --the Court concluded that Questar's challenge to the sufficiency of pre-hearing disclosures the Panel Chairman made was without merit. (Opinion at 29-39). The Court's detailed analysis in this regard notes, among other things, that “...a party cannot remain silent as to perceived or actual partiality or bias and then later object after the panel reaches an unfavorable decision.” (Opinion at 37).

Judge Russell proceeded on to address Questar's multi-layered contention that the Panel violated FAA Section 10(a)(3) in that it allegedly refused to hear evidence pertinent and material to the controversy. In this regard the Court noted that “the standard for judicial review of arbitration procedures is merely whether a party to arbitration has been denied a fundamentally fair proceeding.” (Opinion at 40). The Court observed that only two of Questar's myriad of claims fell within this category: 1) that despite allowing the broker to introduce evidence through the testimony of his former attorney, the Panel improperly allowed him to assert the attorney-client privilege on Questar's cross-examination, and 2) that the Panel improperly excluded testimony from the broker's former clients. (Opinion at 41-42).

As to the first, the Court concluded that the claim was factually without merit. As to the latter, the Court concluded that the Panel's provision of 10 subpoenas in response to Questar's request for 55 subpoenas in the middle of the five-months of hearing sessions was more than adequate, noting that “arbitrators are not required to hear all of the evidence tendered by the parties; they need only afford each party a fair opportunity to present their arguments and evidence.” (Opinion at 42-49).

As to FAA Section 10(1)(4), the Court evaluated Questar's general challenge to the sufficiency of the evidence to support Claimant’s claims for defamation, negligence or tortious interference. At the outset of this analysis, the Court noted:

“...the award is devoid of any rationale or explanation as to the factual basis for the Panel's decision, the particular theory or cause of action upon which the award is based, and/or how the Panel calculated the award figure. But, Importantly, this is precisely the outcome contracted for between the parties. Cf. United Steelworkers v. Enter. Wheel & Car Co., 363 U.S. 593, 598 (1960) (“Arbitrators have no obligation to the court to give reasons for an award.”); Dawahare v. Spencer, 210 F.3d 666, 669 (6th Cir. 2000) (“Arbitrators are not required to explain their decisions.”). As the Sixth Circuit has stressed, where the arbitral agreement imposes no duty of explanation on the arbitrator, “remand for the purpose of having the arbitrator clarify his reasoning would be inappropriate.” Id. at 977 n.9.

(Opinion at 50-51).

Aptly enough, Judge Russell stated: “The Court will not be lured into reviewing the merits of the Panel's decision.” (Opinion at 51). The Court proceeded to rebuke Questar's sufficiency challenge after a careful review of the appropriate controlling precedent and standard of review for Motions to Vacate. Judge Russell cited a fundamental tenet on this point:

“The Supreme Court and this Circuit have both admonished courts that “as long as the arbitrator is even arguably construing or applying the contract [to arbitrate] and acting within the scope of his authority, that a court is convinced he committed a serious error does not suffice to overturn his decision”; accordingly, “courts must refrain from reversing an arbitrator simply because the court disagrees with the result or believes the arbitrator made a serious legal or factual error.” Misco, 484 U.S. At 38; Salvay, 442 F.3d at 476.

(Opinion at 56).

Finally, the Court evaluated Questar's Motion to Vacate under the Sixth Circuit's “manifest disregard of the law” standard. This analysis bore no fruit for Questar either. Judge Russell cited Coffee Beanery, Ltd. v. WW L.L.C., 300 F.App'x 415 (6th Cir. 2008) for the proposition that vacatur is only appropriate under this standard if “the decision [flies] in the face of clearly established precedent.” Id. at 418. (Opinion at 57). The Court also made the insightful distinction between a manifest disregard of the law, and the manifest disregard of fact that Questar was essentially peddling. (Opinion at 58-59).

The attorneys at Cosgrove Law Group, LLC spent approximately five (5) months briefing the various post-Award issues in this matter. In doing so, they reviewed dozens upon dozens of FAA and vacatur opinions. Judge Russell's Opinion in this matter may be the most thorough and instructive. You would be remiss not to digest it and save it if you practice in this area.

Friday, November 2, 2012

FINRA Panel Awards Expungement in Unlikely Case

 A FINRA hearing Panel in Pittsburgh, Pennsylvania recently made an uncommon move when it expunged an arbitration from a broker’s CRD records despite finding the broker jointly liable to the customer. 

In Bordas v. Wells Fargo, FINRA ID # 11-00484, the Claimants, James and Linda Bordas filed an arbitration claim against Wells Fargo Advisors, LLC and Ernest Coffindaffer for unsuitability, unauthorized trading, forgery, misrepresentation, fraud, negligence, breach of fiduciary duty, violations of the Securities and Exchange Act of 1934 and Rule 10b-5, respondeat superior, failure to supervise, and breach of contract.  The causes of action relate to the alleged recommendation and purchase of municipal bonds and variable annuities against the Claimants’ express wishes. 

The Respondents asserted counterclaims for defamation per se, tortious interference with business relationships, and tortious interference with prospective business relationships. 

At the close of hearing, Claimants’ requested a total award of $10 million: $754,765.00 in lost capital; $707,200.00 in lost gain; and the balance in non-economic and punitive damages.  Respondents’ requested $2,000,000.00 in compensatory damages, plus attorneys’ fees of $381,561.60 and $65,564.63 in disbursements. 

The Panel found Wells Fargo and Coffindaffer jointly and severally liable to the Claimants in the amount of $97,250.00.  Since arbitration awards rarely discuss findings of fact, it is unclear which claim(s) the award relates to.  James Bordas was found liable to Coffindaffer for defamation in the amount of $1,000.00.  All other claims against Claimants were dismissed with prejudice. 

Despite finding Coffindaffer jointly and severally liable with Wells Fargo, the Panel made a specific finding of fact that Coffindaffer was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of customer funds.  Even though it is uncertain what claim(s) the award was based on, one can assume that Coffindaffer was probably not found liable for fraud or any claims involving an element of willful intent especially since the Panel found that Coffindaffer’s conduct was “not so egregarious as to warrant a permanent stigma on his CRD.”  

The Central Registration Depository (CRD) is a database used by FINRA and NASAA to store and maintain information on registered securities and broker firms.  CRDs contain qualification, employment, and disclosure histories of registered individuals and can be used like a background check on brokers.  FINRA also pulls information from CRDs for its BrokerCheck program, which provides background information on brokers and firms to investors. 

When a broker is named as a respondent in a customer-initiated arbitration, the claim and any alleged wrongdoing are required to be reported on the borker’s Form U4, which will eventually get recorded in the CRD system and become available to the public through BrokerCheck. Therefore, some information that can be disclosed on one’s CRD could be damaging to a broker’s reputation.   

Brokers may seek to expunge any reference to the allegations or involvement in the arbitration from the CRD system.  However, FINRA provides rules that arbitrators must follow before awarding expungement to a broker. 

FINRA Rule 2080 requires that a court of competent jurisdiction confirm an arbitration award granting expungement.  FINRA must be named as an additional party to these court proceedings.  In most cases, FINRA generally opposes the confirmation of an award to expunge.  However, upon request, FINRA may waive the requirement to be named as an additional party in these proceedings if the award directing expungement contains one of the following findings: (1) the claim, allegation or information is factually impossible or clearly erroneous; (2) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or (3) the claim, allegation or information is false.

FINRA Rules 12805 and 13805 provide that in order to grant expungement, an arbitration panel must hold a recorded hearing session regarding the appropriateness of the expungement.  If the case involves a settlement, the panel must review the settlement documents and conditions of the settlement to determine whether concerns exist about the broker’s involvement in the alleged misconduct. The panel must also indicate which grounds exist under FINRA Rule 2080 to support expungement.  Finally, all hearing session fees must be assessed against the party requesting expungement for any hearings in which the sole topic is expungement. 

Therefore, although the panel awarded expungement, Coffindaffer will still have to obtain a confirmation of the expungement award by the courts.  While the Panel made a specific finding under FINRA Rule 2080, FINRA may still oppose the expungement since he was sheld jointly and severally liable to the customer.  The Panel’s finding that Coffindaffer’s conduct was “not so egregarious as to warrant a permanent stigma on his CRD” may not be enough.

If you are a broker named in a customer-initiated arbitration and would like to seek expungement of the allegations or involvement in the arbitration from your CRD, contact the experienced attorneys at Cosgrove Law Group, LLC.   

Wednesday, October 31, 2012

Eighth Circuit Finds Investors Are Not “Customer” of Managing Broker-Dealer of Securities Offering Under FINRA Rule 12200

In Berthel Fisher & Co. Financial Services, Inc. v. Larmon, No. 11-2877, 2012 WL 4477433 (8th Cir. Oct. 1, 2012), the controversy arose out of securities issued by a group of Minnesota limited liability companies (collectively, Geneva) and purchased by defendants-appellants (the Investors) in 2007 and 2008.  Berthel Fisher & Company Financial Services., Inc., et al. (collectively, Berthel), a licensed broker-dealer and member of FINRA, served as managing broker-dealer for the offering. As managing broker-dealer, Berthel assembled a group of FINRA-registered broker-dealers-Selling Group Members, or SGMs-who in turn offered the securities to their own customers, including the Investors.

Although Geneva prepared the private placement memoranda (PPMs) to be provided to prospective purchasers of the securities, Berthel reviewed at least two of the PPMs, suggesting changes that Geneva adopted.  Per the agreement between Berthel and the SGMs, Berthel collected investor payments from the SGMs and passed those payments along to Geneva. In addition, the contract between Berthel and Geneva obligated Berthel and the SGMs to determine each investor's eligibility to participate in the offering. Because of this, Berthel maintained a file on each investor that included the investors' names, dates of birth, and contact information.

The securities did not perform as anticipated, leading the Investors to file FINRA arbitration claims against Berthel. The Investors alleged that Berthel performed insufficient due diligence on the offering, leading to critical omissions in the PPMs. Berthel filed suit in the United States District Court for the District of Minnesota, seeking a declaratory judgment that the Investors were not Berthel's "customers" under the FINRA Code and that Berthel was therefore not obligated to arbitrate with the Investors. Further, Berthel moved for a preliminary injunction enjoining the arbitrations, and the Investors cross-moved to compel arbitration.

The district court held that the Investors did not qualify as Berthel's customers under the FINRA Code and that the Investors' claims against Berthel were therefore not arbitrable before FINRA. Accordingly, the court granted Berthel's motion to enjoin the pending arbitrations and denied the Investors' cross-motion to compel arbitration.

The Court noted that "the first task of a court asked to compel arbitration of a dispute is to determine whether the parties agreed to arbitrate that dispute." Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, Inc., 473 U.S. 614, 626, 105 S.Ct. 3346, 87 L.Ed.2d 444 (1985). The Investors did not allege that Berthel explicitly agreed to arbitrate; rather, they allege that they qualified as Berthel's "customers" under the FINRA Code. The Court found that the FINRA Code, which Berthel signed as a FINRA member, constituted an agreement to arbitrate disputes between Berthel and its customers.

The court noted that Rule 12200 of the FINRA Code states:

Parties must arbitrate a dispute under the Code if:

o Arbitration under the Code is either:

(1) Required by a written agreement, or

(2) Requested by the customer;

o The dispute is between a customer and a member or associated person of a member; and

o The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.

The Court of Appeals stated that the question of arbitrability turned on whether the Investors are Berthel's customers under the FINRA Code.

The FINRA Code defines "customer" in the negative, stating only that "[a] customer shall not include a broker or dealer." FINRA Rule 12100(i). In Fleet Boston Robertson Stephens, Inc. v. Innovex, Inc., 264 F.3d 770, 772 (8th Cir.2001), the Court of Appeals construed "customer" to "refer[ ] to one involved in a business relationship with [a FINRA] member that is related directly to investment or brokerage services."

The Court noted that in the present case it was uncontested that the Investors had no contact with Berthel in the course of investing in the securities at issue.  The Investors argued, however, that they qualified as Berthel's customers under Rule 12200 because Berthel

provided "investment or brokerage services" to the investors in three ways. First, Berthel Fisher was responsible for conducting due diligence on the TIC interests. Second, Berthel Fisher was obligated to conduct a reasonable-basis suitability analysis on the TIC interests. Third, Berthel Fisher maintained customer files on the investors and was responsible for protecting the investors' privacy.

The Court determined that the provision of these services in the case before it failed to transform the Investors into Berthel's customers, because Berthel provided those services not to the Investors but instead to the SGMs and Geneva. The Court noted that if the provision of these services formed any customer relationships at all, it formed them between Berthel, Geneva, and the SGMs, not between Berthel and the Investors.

The Investors argued that Fleet Boston requires only "investment or brokerage related services." But the Court found that the provision of "investment or brokerage related services" is only half of the picture-not only must the FINRA member firm provide those services, but also must it provide those services to the customer either directly or through its associated persons. In Fleet Boston, the Court of Appeals had observed that "[a]lthough other cases interpreting the term 'customer' have in some ways taken a broad view of the term, in all of these cases there existed some brokerage or investment relationship between the parties." Id. at 772 (emphasis added). The Court concluded that, simply put, in the case before it there was no "relationship" between Berthel and the Investors as required by Fleet Boston. Because Berthel did not provide "investment or brokerage related services" to the Investors, the Investors were not Berthel's customers under FINRA Rule 12200. Accordingly, the Court affirmed the judgment of the district court.

Sunday, August 26, 2012


There may be many documents that qualify for this blog entry, but I am writing specifically about your brokerage account statements. Sure, you may take a peek at the bottom line now and then, but actually reading the entire statement—who does that?! Let me suggest that next month it will be YOU! 

Brokerage statements hold information your brokerage firm is required to provide to you on a regular basis. They hold key information about your life investments and how they are being managed. The Financial Industry Regulatory Authority (“FINRA”) has provided helpful insight to consumers regarding understanding brokerage statements and the importance of the information contained in those statements. Additionally, most regulators are going to agree that staying on top of your brokerage accounts is extremely important in ensuring your accounts are being handled in an appropriate manner. 

This doesn’t mean you have to know a lot about investments, but, according to FINRA, “Not only do these documents help you stay on top of your investment holdings, but they also provide valuable information that can alert you to errors, or even misconduct by your broker or brokerage firm such as unauthorized trading or overcharging customers for handling transactions.” So, even if you don’t know everything a particular Mutual Fund holds, your statements can bring to light problems you might not otherwise notice in a timely manner. Some examples of “red flags” are: Information or transactions in the account summary that you did not authorize or expect, or income that appears on your statement, but has not been deposited in your account. 

FINRA has provided a helpful key information guide that breaks down sections of an account statement and provides information about why it is important and what activity might qualify as a red flag. 

Many consumers are overwhelmed by the thought of reviewing financial information on a regular basis. Either they lack confidence that they will understand the statements and their holdings, or they fear activity in the market may have decreased their balance so they just avoid opening the statement all together. If you start out slow, only focusing on certain portions of your statement until you feel like you have an understanding of what should be there and what it means, you can progress to fully reading the account statement. While it may be uncomfortable and time consuming, it is an important step in overseeing how your hard earned money is being managed. It is a way to protect yourself from fraud and other unsavory activity and, should you come across something on your statement you are concerned about, FINRA recommends that you “immediately call the firm that issued the statement or confirmation about any transaction or entry [you] do not understand or did not authorize, and re-confirm any oral communication in writing with the firm.” 

So the next time that statement comes in the mail, think positive—this is an opportunity to protect your assets and you can start out slow—just be sure to start!

Friday, August 24, 2012

SEC’s Whistleblower Rewards Program – Who are the Real Bounty Hunters?

The U.S. Securities and Exchange Commission (“SEC”) made its first payout of $50,000 to a whistleblower since a program was created last year to reward people who provide regulators with evidence of securities fraud. 

The SEC set up a whistleblower program in August 2011 to reward individuals who provide evidence of securities law violations which lead to SEC sanctions of more than $1 million. The program was authorized in the 2010 financial-regulation overhaul. Potential awards could range from 10 percent to 30 percent of the money collected. 

The unnamed whistleblower helped the SEC bring an enforcement action that resulted in more than $1 million in sanctions.  The SEC rewarded the anonymous whistleblower 30% of the recovery.  So far the SEC has only collected $150,000 but as more of the sanctions are recovered, the whistleblower’s reward will increase.  The SEC believes the announcement of its first reward payout will give the program a boost.  However a second person in the same matter was denied a whistleblower reward because the information provided by the person did not lead to or significantly contribute to the enforcement action. 

While the program is supposed to encourage individuals to come forward with information relating to securities fraud, Peter Sivere, a former compliance officer at JPMorgan Chase had a much different experience with his efforts to “do the right thing.”  To be clear, the story of Peter Sivere occurred from 2003 to 2005 before the whistleblower program was adopted by the SEC. 

During an SEC investigation of whether a New Jersey hedge fund, a big client of JPMorgan, was late trading mutual funds, Sivere was allegedly terminated from JPMorgan for turning over emails to the SEC and expressing concerns that JPMorgan was not fully cooperating with the investigation.  The emails indicated that JPMorgan had provided a $105 million line of credit to the hedge fund that it used to facilitate its late trading in mutual funds.  Late trading occurs when one buys shares at the day’s final price even though the market has closed. 

Before his termination, Sivere contacted SEC lawyer George Demos by email seeking to become a whistleblower and inquiring whether he would be able to collect a reward for his information.  Even though Demos informed him that a “bounty” would not be available, Sivere turned the emails over to the SEC anyways.  Sivere was later fired and JPMorgan reported on his U-5 that he was terminated for “accessing e-mails without authorization.”  JPMorgan later agreed in a settlement to amend his U-5 to state his employment ended as a result of a “disagreement regarding the scope of [Sivere’s] authority.” 

Sivere reported the alleged retaliation to the Occupational Safety and Health Administration (“OSHA”) and it was discovered during their investigation that Demos informed JPMorgan’s lawyers that Sivere had asked the SEC for a whistleblower bounty and Demos even encouraged JPMorgan to use this information in the lawsuit between Sivere and JPMorgan.  While Demos’ behavior violates SEC protocol, and the allegations were confirmed by the SEC’s inspector general, no disciplinary action was taken against Demos.  In fact, Demos held his position with the SEC until 2009.
More recently, a whistleblower’s identity was inadvertently revealed during an SEC investigation of Pipeline Trading Systems, LLC when an SEC lawyer shared the whistleblower's notebook with one of Pipeline’s executives.  The executive recognized the whistleblower's handwriting.  The whistleblower, Peter Earle, was a former employee of one of Pipeline’s trading affiliates and expressed his disappointment in the SEC’s failed efforts to keep his identify private.

The new whistleblower rewards program is supposed to guarantee anonymity, yet the SEC has scars from the past which might be counter intuitive for the program, especially since no action was taken against Demos for the confidentiality violation. 

If you think you have information that may lead to a recovery under the whistleblower program, contact the attorneys at Cosgrove Law Group, LLC to have your rights represented and your identity protected.

Thursday, August 23, 2012

Second Circuit Finds Existence of Indirect Contract and Tort Liability by Adviser to Investors Under Investment Management Contract

In Bayerische Landesbank v. Aladdin Capital Management LLC, 11-4306-cv (2nd Cir. August 6, 2012), Plaintiffs-Appellants Bayerische Landesbank (“Bayerische”) and Bayerische Landesbank New York Branch (collectively “Plaintiffs”) filed an action against Defendant-Appellee Aladdin Capital Management LLC (“Aladdin”) for breach of contract and gross negligence based on Aladdin’s alleged disregard of its obligation to manage a portfolio in favor of investors.

Aladdin was the manager of an investment portfolio containing collateralized debt obligations ("CDOs").  A CDO is a financial instrument that sells interests (in this case, in the form of “Notes”) to investors and pays the investors based on the performance of the underlying asset held by the CDO.  The CDO at issue in this case, called the Aladdin Synthetic CDO II (“Aladdin CDO”), was a “synthetic” CDO, meaning that the asset it held for its investors was not a traditional asset like a stock or bond, but was instead a derivative instrument, i.e., an instrument whose value was determined in reference to still other assets.  The derivative instrument the Aladdin CDO held was a “credit default swap” entered into between the Aladdin CDO and Goldman Sachs Capital Markets, L.P. based on the debt of approximately one hundred corporate entities that were referred to as the “Reference Entities” and comprised the “Reference Portfolio.”

Aladdin's formal responsibilities were spelled out in the Portfolio Management Agreement (“PMA”), an agreement between Aladdin and the "shell issuer" created by Aladdin and Goldman Sachs.  The PMA was not signed by the "Noteholders," such as Plaintiffs.   In fact, Plaintiffs did not enter into any direct contract with Aladdin.  Plaintiffs purchased $60 million of the total $100 million worth of notes from Goldman Sachs, which underwrote the CDO.  Plaintiffs alleged that, following the issuance of the Aladdin CDO, Aladdin managed the portfolio in a grossly negligent fashion, causing Plaintiffs’ Notes to default.

On the basis of the foregoing, the Amended Complaint assertd two claims: (1) a claim in contract alleging that Aladdin breached its obligations under the PMA; and (2) a claim in tort alleging that Aladdin’s conduct was grossly negligent, resulting in harm to the Noteholders.

The district court held that, because of a provision of the contract limiting intended third-party beneficiaries to those “specifically provided herein,” Plaintiffs could not bring a third-party beneficiary breach of contract claim, and held also that plaintiffs could not “recast” their failed contract claim in tort. The Second Circuit Court of Appeals disagreed.

With regard to the breach of contract claim, the court noted that under New York law "a third party may enforce a contract when 'recognition of a right to performance in the beneficiary is appropriate to effectuate the intention of the parties and . . . the circumstances indicate that the promisee intends to give the beneficiary the benefit of the promised performance.'” Levin v. Tiber Holding Corp., 277 F.3d 243, 248 (2d Cir. 2002) (quoting Restatement (Second) of Contracts § 302).   The court found that portions of the PMA plausibly demonstrated an intent to benefit the Noteholders by defining Aladdin’s obligations and delineating the scope of its liability to the Noteholders.  Therefore, the Plaintiffs' breach of contract claim survived the motion to dismiss.

The court next turned to Plaintiffs' second, alternative, claim: that Aladdin breached a duty of care, in tort, to the Noteholders, by engaging in acts that amounted to gross negligence in its management of the Reference Portfolio. The court noted that, under New York law, a breach of contract will not give rise to a tort claim unless a legal duty independent of the contract itself has been violated. See, e.g., Clark-Fitzpatrick v. Long Island R.R. Co., 70 N.Y.2d 4 382, 389 (1987).  Such a “legal duty must spring from circumstances extraneous to, and not constituting elements of, the contract, although it may be connected with and dependent on the contract.” Id.  Where an independent tort duty is present, a plaintiff may maintain both tort and contract claims arising out of the same allegedly wrongful conduct.  See Hargrave v. Oki Nursery, Inc., 636 F.2d 897, 898-99 (2d Cir. 1980) (citing Channel Master Corp. v. Aluminum Ltd. Sales, Inc., 4 N.Y.2d 403, 408 (1958)).

The court found that the allegations in the Amended Complaint were sufficient to withstand a Fed. R. Civ. P. 12(b)(6) motion to dismiss.  In light of Plaintiffs allegations that it detrimentally relied on Aladdin's representations of how it would select the Reference Portfolio and manage the portfolio for the life of the CDO, Plaintiffs sufficiently established that “[a] legal duty independent of contractual obligations may be imposed by law as an incident to the parties’ relationship” in this case. Sommer v. Fed. Signal Corp., 79 N.Y.2d 540, 551 (1992). This legal duty, though assessed largely on the standard of care and the other obligations set forth in the contract, would arise out of "the independent characteristics of the relationship between Bayerische and Aladdin, and the circumstances under which Bayerische purchased the notes linked to the Reference Portfolio that Aladdin, under the PMA, was to manage."

While Aladdin argued that the noteholders failed to allege facts that plausibly show Aladdin’s conduct amounted to gross negligence, the court disagreed.  Specifically, the court found that accepting below-market spreads on risky entities appeared to have been contrary to how Aladdin explicitly represented it would manage the portfolio on behalf of the Noteholders.  After discovery, the court noted that facts could come to light which may show a different story.  But at the preliminary motion-to-dismiss stage, drawing all inferences in Plaintiffs' favor, Plaintiffs plausibly alleged that Aladdin’s gross negligence exposed Plaintiffs to greater risk that they would lose their entire investment than would have otherwise been the case.

This case is important in that it demonstrates how a poorly drafted provision in an investment management agreement can open the door to third-party beneficiaries claiming a breach of contract and, in addition, how advisers may be exposed to indirect tort liability in a securitization.

Monday, July 9, 2012

Diamond Food Board Sued over Financial Problems and Botched Merger Plans

We previously reported on Diamond Food’s SEC investigation into certain crop payments the company made to walnut growers at the end of its 2010 fiscal year.  See Diamond Foods SEC Investigation. 

On Wednesday, shareholders filed a lawsuit against the board of Diamond Foods for costing it the chance to buy its rival Pringles from The Procter & Gamble Co.  In the midst of the accounting scandal in which crop payments allegedly were improperly reported to inflate the company’s 2010 earnings and shift costs into its 2011 fiscal year, Diamond’s stock price fell from last year's high of $96.13 to Wednesday's close of $17.49, a loss of about 80 percent.    

The lawsuit, being held in Delaware, is a derivative complaint, meaning the shareholders seek permission to step into the shoes of the company and hold directors and officers responsible for harm they caused.

Thursday, June 28, 2012

Class Arbitration: Are Investment Advisers Representatives Excluded?

Investment Adviser agreements typically contain provisions which require all disputes between the Registered Investment Adviser (“RIA”) and Investment Adviser Representative (“IAR”) to be determined in a final and binding arbitration.  These agreements also preclude class claims from being brought to arbitration.  In effect, RIAs have thereby evaded being the subject of class actions brought by IARs, at least for now. 

At the beginning of the year, the National Labor Relations Board (“NLRB”) decided a case which outlaws contract provisions in which the employer conditions employment upon signing an agreement that precludes employees from filing joint, class, or collective claims in any forum.  However, the claims must address issues such as wages, hours, or other working conditions. 

D.R. Horton v. Michael Cuda involved an employment contract where the employee was required to submit all claims to arbitration.  The agreement also prevented employees from consolidating or bringing class claims.  The NLRB determined that these agreements prohibit the exercise of substantive rights that are protected under Section 7 of the National Labor Relations Act (“NLRA”).  The NLRB’s decision specifically outlines certain limitations to its holding.  In particular, the decision is only applicable to “employees” as defined in the NLRA.  This definition specifically excludes independent contractors.

It should be noted that the US Supreme Court recently ruled in AT&T Mobility LLC v. Conception that the Federal Arbitrations Act (“FAA”) permits companies to require customers to arbitrate their complaints individually, precluding class action claims.  D.R. Horton differs in that it involved employee class actions, which is protected by statute, versus customer or consumer class actions.  However, since D.R. Horton has been appealed to the 5th Circuit Court of Appeals, it will be interesting to see the outcome, and whether or not the Supreme Court will grant certiorari.  My guess is that it will.   

That being said, the hurdle for IARs is that they are often classified as “independent contractors” rather than employees.  Not only is this usually set forth in their investment advisor agreements, but the type of relationship between the employer and the IAR has some characteristics of an independent contractor.  However, they also have employer-employee characteristics that could be crucial in determining the type of employment relationship. 

There are various factors that determine whether one is considered an employee versus an independent contractor.  These factors include but are not limited to the following: (1) the level of control the employer has over the work performed by the individual; (2) whether the employer or worker furnishes the tools, materials, supplies, or equipment needed to perform the job; (3) whether the worker provides services for more than one firm or company at a time; (4) whether the worker can realize a profit or loss as a result of his services; (5) whether the employer set the work schedule; and (6) whether the employer hires, supervises, or pays assistants of the worker.

Perhaps one of the more determinative factors in defining an employment relationship is the level of control and supervision the employer has over an individual.  By design, RIAs are required to supervise the conduct and activities of any IAR that represents it, whether the IAR is an employee or an individual that provides investment advice on behalf of the RIA.  An RIA’s legal duty to supervise its IARs emanates from a number of sources.  For instance, Section 203(e)(6) of the Investment Advisers Act of 1940 permits the SEC to take action against an RIA for failing to supervise its IARs.  Pursuant to SEC Rule 206(4)-7 under the Advisers Act, RIAs are required to adopt policies and procedures that are reasonably designed to prevent violations of securities laws by the adviser and its supervised persons.   Furthermore, SEC Rule 204A-1 requires RIAs to adopt a code of ethics which sets forth the standard of business conduct to be exhibited by IARs. 

Generally, investment advisory agreements authorize RIAs to monitor and evaluate the IAR and subject the IAR to the supervision of the adviser.  Moreover, the duty to supervise an IAR may also stem from the fiduciary duty the RIA owes to its clients.  This supervisory duty and level of control is often implemented with periodic or annual compliance audits of each IAR.  Despite this level of control, the IAR is often contractually defined as an independent contractor.   

Therefore, as it stands, IARs could face a substantial but perhaps surmountable hurdle in bringing class arbitration claims if the investment advisor agreement defines the representative as an independent contract and precludes class actions.  Since the NLRA definition of employee precludes traditional independent contractors, there may be no statutory protection granted to some IARs. 

Friday, May 25, 2012

The Privilege Defense to U-5 Defamation Claims

Cosgrove Law previously blogged on the topic of U-5 defamation. We noted that broker-dealers that are members of the FINRA are required to file a Form U-5 when terminating their relationship with a registered representative.  Broker-dealers must also describe the specific reason(s) that the rep was discharged or permitted to resign.  If the reasons disclosed on the U-5 were false, exaggerated or misleading, the firm can be subject to a claim for defamation.

One defense frequently raised by defendant broker-dealers is that the statements made on the form U-5 are subject to an "absolute privilege."  This means that a broker-dealer cannot be held liable for defamation for anything it puts on the U-5, even if it knows the statements were false or misleading.  If that defense is unavailable, a broker-dealer will argue that the statements are subject to a "qualified privilege."  A qualified privilege is usually revoked by proof of malice or by a showing of reckless disregard as to the truth of the statements.  Frequently, the falsity of the statements could arguably show the malice required to revoke whatever privilege the U5 might enjoy.

Unfortunately for the broker-dealers raising the absolute privilege defense, it is rarely available.  State law, not federal law, determines whether an absolute privilege applies.  So far, only the state of New York has adopted the absolute privilege standard.  Rosenberg v. MetLife, Inc., 866 N.E.2d 439, 445 (N.Y. 2007) (finding that statements made by employer on form U-5 are subject to absolute privilege in suit for defamation).

In fact, many states have explicitly rejected the absolute privilege defense or have found that only the qualified privilege applies. See Dawson v. New York Life Ins. Co., 135 F.3d 1158, 1163-64 (7th Cir. 1998) (holding that reports of customer complaints on Form U-5 are not protected by absolute privilege under Illinois law); Glennon v. Dean Witter Reynolds, Inc., 83 F.3d 132, 136-37 (6th Cir.1996) (holding that statements on Form U-5 are not entitled to absolute privilege under Tennessee law); Moreland v. Perkins, Smart & Boyd  240 P.3d 601, 609 (Kan.App. 2010) (rejecting absolute privilege and holding that the statements in the Form U–5 were entitled to a qualified privilege at most, both under case law and under Kansas statutory law); Dickinson v. Merrill Lynch, Pierce, Fenner & Smith, Inc.  431 F.Supp.2d 247, 261-62 (D.Conn. 2006) (finding that statements made on form U-5 were not subject to absolute privilege from defamation liability under Connecticut law, but were instead subject to qualified privilege); Boxdorfer v. Thrivent Financial for Lutherans, No. 1:09-cv-0109-DFH-JMS, 2009 WL 2448459, *4 (S.D.Ind. Aug. 10, 2009) (noting that statements on the Form U-5 are entitled to a qualified privilege under Indiana law); Wietecha v. Ameritas Life Ins. Corp., No. CIV 05-0324-PHX-SMM,  2006 WL 2772838, *11 (D.Ariz. Sept. 27, 2006) (finding that Arizona law comports with the application of a qualified privilege to statements published in the U-4 and U-5 Forms).

If you are a registered representative and feel you have been harmed by false or misleading statements published on your Form U-5 or to third parties, Cosgrove Law, LLC has substantive experience representing reps and advisers in such matters. 

Tuesday, May 15, 2012

SEC Takes a Closer Look at Real Estate Investment Trusts

A Real Estate Investment Trust (“REIT”) is generally a company that owns income producing real estate.  To qualify as a REIT, a company must have the majority of its assets and income connected to real estate investments and must annually distribute at least 90 percent of its taxable income to shareholders in the form of dividends.  To review additional qualifications of a REIT, See SEC - REIT Information

REITs have really come under intensifying scrutiny by securities regulators since many non-traded REITs have been forced to cut their estimated value and have ceased making distributions.  Furthermore, many of these REITs have attracted retirees as investors by promising steady and dependable distributions.  For example, the SEC has recently taken interest in the activities of Inland American Real Estate Trust to determine if it committed violations relating to management fees, the timing and amount of distributions paid to investors, determination of property impairments and transactions with affiliates.  The investigation was announced by Inland last week in its quarterly report.  Executives from Inland have stated that they intend to fully cooperate with any investigation and that they do not believe it has committed any violations. 

Inland holds around $11.2 billion in property, including retail hotels, offices, industrial buildings and apartment complexes.  It is the largest REIT in an industry of around 90 non-traded REITs.

FINRA has recently proposed new guidelines on adviser disclosure of REITs.  See FINRA Regulatory Notice.   Furthermore, the SEC has been pressing non-traded REITs to provide better disclosure on their share valuations because these valuations can vary due to some REITs relying on outside appraisals and others relying on their own management.  For instance, FINRA sued David Lerner Associates Inc., last year, alleging that the Apple REIT seller “unreasonably valued their shares at a constant price of $11, notwithstanding market fluctuations, performance declines and increased leverage.”  The case is still pending. 

In June, 2011, another REIT, Retail Properties of America Inc., estimated its value at $6.95 per share.  However, in its initial public offering last month, the shares were listed at $3.20 per share. 

REITs, however, may be appropriate for the savvy and experienced investor, particularly since many REITs have been investing in the global market.  Several U.S. REITs that have invested abroad believe the future is promising.  For instance, New York and Toronto based Brookfield Office Properties entered into its first London deal on a development site known as 100 Bishopgate.  Many of these investments are good for the patient investor because income is usually not realized until further down the road. 

If you have suffered losses as a result of purchasing non-traded REITs, contact us to discuss your legal rights.

Thursday, May 10, 2012

FINRA Bars Pinnacle Partner Financial Corp. and its President Over Allegedly Fraudulent Sales

On April 25, Financial Industry Regulatory Authority (“FINRA”) expelled broker-dealer Pinnacle Partners Financial Corp. and its president, Brian Alfaro, from membership after they failed to respond to allegations that they made fraudulent sales involving oil and gas private placements and unregistered securities in violation of Section 10(b) of the Securities Exchange Act of 1934.  In addition to expulsion, Pinnacle and Alfaro also were ordered to offer rescission to investors who were sold fraudulent offerings, and to refund all sales commissions to those who do not request rescission. See FINRA Order
According to FINRA, from August 2008 to March 2011, Alfaro and Pinnacle operated a “boiler room” from which approximately 11 brokers placed thousands of cold calls per week attempting to persuade investments in oil and gas drilling joint ventures that Alfaro owned or controlled.  FINRA claims the operation raised more than $10 million from more than 100 investors.  Alfaro allegedly misrepresented or omitted material facts regarding the offerings they sold to investors. 

FINRA also alleges that from around January 2009 through March 2011, Alfaro used customer funds: “(1) to meet obligations for previous offerings; (2) cover Alfaro’s personal expenses; and (3) make cash payments to Alfaro personally.”  See FINRA Order
The disciplinary proceedings began on November 23, 2010.  Alfaro and Pinnacle subsequently entered in Temporary Cease and Desist Consent Orders (“TCDO”).  Approximately two months after entering into the TCDO, Alfaro and Pinnacle allegedly violated the orders and were suspended from FINRA on March 8, 2011.  The hearing was scheduled for February 27, 2012 but Alfaro informed his counsel that he would not be attending the hearing and planned on defaulting.  As a result, Pinnacle and Alfaro were expelled from FINRA. 

Wednesday, April 25, 2012

Has the SEC Stepped Up to the Plate on Fraud Enforcement Actions?

The Securities and Exchange Commission’s (“SEC”) mission is “to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.”  The SEC believes that its “investor protection mission is more compelling than ever” since more first-time investors have turned to the market to invest in their future.  Therefore, it goes without saying that the SEC’s enforcement authority is crucial in maintaining investor protection.  But, has the SEC stepped up to the plate considering the negative impact the 2008 financial crisis has had on investors?

The 2008 financial crisis had devastating effects on our economy which caused massive job losses and a growing number of American families at risk of foreclosure and poverty.  However, some companies made substantial profits from the financial collapse and many top executives received considerable bonuses (some from government bailout money) after millions of families’ investments dwindled or even disappeared. 
Most recently, the SEC filed civil fraud charges in Texas against former Chief Executive Anthony Nocella and former Chief Financial Officer J. Russell McCann of Franklin Bank Corp. for concealing the deterioration of the bank’s finances during the mortgage crisis.  Specifically, the SEC alleged that in 2007, Nocella and Man used aggressive loan modification programs to hide the bank’s non-performing loans and artificially boost profits.  See SEC Complaint

Despite having charged over 100 people and firms with fraud tied to the financial crisis, critics of the SEC believe the agency hasn’t buckled down hard enough.  Yet SEC enforcement chief, Robert Khuzami, believe these numbers show the agencies effectiveness in “tackling financial-crisis wrong-doing.”  Of the 74 cases filed against individuals, 55 are chief executives, finance chiefs or other top officers.  Khuzami believes this “sends a strong deterrent message.”  

Many of the SEC critics note that about 24 of the people charged by the SEC have avoided trial by reaching “weak” settlements.  Senator Grassley from Iowa stated, “The lack of accountability from Wall Street encourages recidivism.” 

For instance, Angelo Mozilo, Chief Executive of Countrywide Financial Corp., agreed to a settlement of $67.5 million ($22.5 million penalty and $45 million disgorgement), while denying any wrongdoing.  These sanctions are supposed to compensate investors for their losses.   However, the repayment of illegal profits is tax-deductible and can be covered by some corporate insurance policies.  In Mozilo’s case, nearly half of the $45 million payment came from Countrywide's current owner, Bank of America Corp.  It can be difficult for the SEC to challenge indemnification rights in employment contracts or insurance policies.

According to The Wall Street Journal, in the 24 crisis-related cases where the SEC reached a settlement with an individual, the median sanction was $203,751.  These same defendants paid a combined $80.7 million in penalties.  Most of those penalties came from executives at collapsed mortgage lenders such Countrywide, American Home Mortgage Investment Corp. and New Century Financial Corp.; yet, their investors sustained losses of about $31 billion based on the three companies' peak stock-market value before the financial crisis began.  These penalties arguably pale in comparison to investor losses. 
Even some federal judges have criticized the large gaps between investor losses and the penalty.  For example, U.S. District Judge Frederic Block in New York, said $1.05 million in penalties paid by two former Bear Stearns Cos. hedge-fund managers, Ralph Cioffi and Matthew Tannin, in a proposed settlement of civil-fraud charges against them was “chump change” compared with the $1.8 billion lost by investors. The judge has not yet approved the proposed settlement.

While to some, the above penalties may seem like an inadequate punishment for the charges, Cioffi and Tannin have agreed to a temporary ban from the securities industry.  Khuzami believes the SEC’s power to expel people from the securities industry or from serving as directors of public companies is “probably one of the most powerful sanctions [it has].” 

Furthermore, when reaching settlements, the SEC has to weigh the likelihood of losing to a jury, along with the amount the agency can show was a direct result of the wrongdoing.  In some cases, it can be hard to say with certainty how much of investor losses were caused by fraud or illegal conduct, or if any fraud or illegal conduct actually took place.  Usually, defendants argue the financial losses were due to a failure to predict the meltdown, rather than any fraud on their part.  The answer is not always clear cut and pushing for stricter penalties across the board may not be appropriate for each case. 

Nevertheless, we can only hope that Americans’ trust in our banking and financial systems can once again be restored. 

Thursday, April 12, 2012

Finra Sends Out a Busy Signal to Telemarketing

The Financial Industry Regulatory Authority (“Finra”) recently  announced the approval of new Finra Rule 3230 by the U.S. Securitiesand Exchange Commission (“SEC”), thereby replacing NASD Rule 2212. Finra Rule 3230 speaks directly to the telemarketing activities of Finra member firms and their associated persons and has an effective date of June 29, 2012.

Finra Rule 3230

NASD Rule 2212, NYSE Rule 440A and NYSE Rule Interpretation 440A/01 were all invalidated by the SEC’s approval of Rule 3230. That said, however, the new rule does adopt certain provisions of NYSE Rule 440A and its Interpretation and is substantively similar in context to FTC rules and regulations dealing with telemarketing activities and other such deceptive and abusive practices.

FinraRule 3230 contains several components, each of which is highlighted below.

  1. General Telemarketing Requirements

Rule 3230 states that no Finra member firm or associated person of a member firm may initiate an outbound telephone call to any personal residence prior to 8:00am or after 9:00pm local time at the location of the called individual. However, such a call is permissible if the member firm meets one of the following exceptions:

  • The member has an established business relationship with the person being called;
  • The member has received the person’s prior permission or invitation; or,
  • The person phoned is a broker or dealer.

If one of the defined exceptions is not met, such a call would be deemed a rule violation.

In addition, no member firm or associated person may make an outbound telephone call to a person whom has previously requested to not be contacted by the member firm or who has registered his/her telephone number with the FTC national Do-Not-Call Registry.

  1. Do-Not-Call Registry

The rule states that a member firm telemarketing calls will not be held to have committed a violation of 3230(a)(3) by phoning a person on a phone number registered with the national Do-Not-Call Registry if:

  • The member has an established business relationship with the recipient of such a call (It should be noted, a request to be placed on the firm’s Do-Not-Call list ceases the business relationship, even if the person continues to conduct business with the firm.);
  • The member has obtained the prior express written consent of the recipient to receive such a call; or,
  • The associated person placing the call has a personal relationship with the recipient of the call.

  1. Safe Harbor Provision

A member firm or associated person of a member will be deemed to not be liable of violating 3230(a)(3) if the member can demonstrate that such violation is the result of an error and that the member meets the following benchmarks:

  • The member has established and implemented written procedures to comply will the rules and requirements of the national Do-Not-Call registry;
  • The member has trained its personnel and any 3rd parties assisting with the member’s compliance on the member’s procedures established pursuant to the national Do-Not-Call registry;
  • The member has maintained and recorded a listing of all telephone numbers which it may not contact; and,
  • The member utilizes a process or procedure whereby it seeks to prevent any outbound telephone call to any telephone number on any Do-Not-Call registry, using a version of the national Do-Not-Call registry obtained from the administrator of the registry not more than 31 days prior to the date any such call is made, and the member maintains records documenting such a process.

  1. Procedures

Prior to employing telemarketing activities, a member firm must first develop and establish procedures to comply with Rule 3230. Such procedures must, at a minimum, satisfy the following:

  • Members must have a written policy for the maintenance of a Do-Not-Call registry.
  • Personnel of a member that engage in telemarketing activities must be informed of and trained on the use of such a Do-Not-Call registry.
  • A member who receives a request from a person not to receive calls from that member must record the request and place the person's name, if provided, and telephone number on the firm's Do-Not-Call registry at the time the request received. Members must honor such a request within a reasonable time, not to exceed 30-days from the date the request is made. A member will be held liable for the failure to honor such a request, even if such requests are recorded or maintained by a 3rd party placing calls on behalf of a member.
  • A member or associated person of a member making an outbound telephone call must provide the call recipient with the name of the individual caller, the name of the member, an address or telephone number at which the member may be contacted, and inform the recipient that the purpose of the call is to solicit the purchase of securities or related services. In addition, the telephone number provided may not be a 900 number or any other number for which charges exceed local or long distance transmission charges.
  • Unless specifically requested to the contrary, a person's do-not-call request shall apply to the member making the call and will not apply to any affiliated entities unless the consumer reasonably would expect such affiliated entities to be included given the identification of the caller and the product being advertised.

  1. Wireless Communications

All provisions of the rule shall also apply to calls made by the member and its associated persons to wireless telephone numbers.

  1. Outsourcing Telemarketing

A member shall still remain accountable for certifying compliance with the provisions of the rule, even if it should outsource some or all of its telemarketing services to an outside party.

  1. Called ID Information

Any member that engages in telemarketing activities must ensure that the telephone numbers used and, where available, the name of the member is appropriately displayed on any caller ID devices utilized by the recipient of an outbound call. Such a telephone number provided must be available during normal business hours for a recipient of such a call to make a Do-Not-Call request.

  1. Unencrypted Consumer Account Numbers

No member or associated person shall disclose or receive, for consideration, unencrypted consumer account numbers for use in the member’s telemarketing activities. The term “unencrypted” shall mean not only complete, visible account numbers, but also encrypted information with a key to its decryption.

  1. Submission of Billing Information

For any telemarketing transaction, a member or its associated person must obtain the express consent of the person to be charged.
In any telemarketing transaction involving preacquired account information and a free-to-pay conversion feature, the member must:

  • Obtain from the customer, at a minimum, the last four digits of the account number to be charged;
  • Obtain from the customer an express agreement to be charged; and,
  • Make and maintain an audio recording of the entire telemarketing transaction.

In any other telemarketing transaction involving preacquired account information not described above, the member must:

  • Identify the account to be charged with sufficient specificity for the customer to understand what account will be charged; and,
  • Obtain from the customer an express agreement to be charged and to be charged using the account number identified.

  1. Abandoned Calls

No member shall “abandon” any outbound telemarketing call. An outbound call is considered to be “abandoned” if a person answers it and the call is not connected to a person associated with a member within two seconds of the person's completed greeting.

A member shall not be liable for violating this provision of the rule if:

  • The member employs technology that ensures abandonment of no more than three percent of all telemarketing calls answered by a person, measured over the duration of a single calling campaign, if less than 30 days, or separately over each successive 30-day period or portion thereof that the campaign continues;
  • The member allows the telephone to ring for at least 15 seconds or four rings before disconnecting an unanswered call;
  • Whenever a person associated with a member is not available to speak with the person answering the telemarketing call within two seconds after the person's completed greeting, the member plays a recorded message that states the name and telephone number of the member or person associated with the member on whose behalf the call was placed; and,
  • The member retains records establishing compliance with this provision of the rule.

  1. Pre-recorded Messages

No member shall initiate an outbound telemarketing call that delivers a prerecorded message other than a prerecorded message permitted for compliance with the call abandonment safe harbor unless:
  • The member has obtained from the recipient of the call an express written agreement that:
    • The member obtained only after a clear and conspicuous disclosure that the purpose of the agreement is to authorize the member to place prerecorded calls to such person;
    • The member obtained without requiring, directly or indirectly, that the agreement be executed as a condition of opening an account or purchasing any good or service;
    • Evidences the willingness of the recipient of the call to receive calls that deliver prerecorded messages by or on behalf of the member or its associated persons; and,
    • Includes such person's telephone number and signature (which may be obtained electronically under the E-Sign Act);
  • The member allows the telephone to ring for at least 15 seconds or four rings before disconnecting an unanswered call; and within two seconds after the completed greeting of the person called, plays a prerecorded message that promptly provides the disclosures above, followed immediately by a disclosure of one or both of the following:
  • For a call that could be answered by a person, that the person called can use an automated interactive voice and/or keypress-activated opt-out mechanism to assert a do-not-call request at any time during the message. Such a mechanism must:
    • automatically add the number called to the member's Do-Not-Call registry;
    • Once invoked, immediately disconnect the call; and,
    • Be available for use at any time during the message.
  • For a call that could be answered by an answering machine or voicemail service, that the person called can use a toll-free telephone number to assert a do-not-call request. The number provided must connect directly to an automated interactive voice or keypress-activated opt-out mechanism that:
    • Automatically adds the number called to the member's Do-Not-Call registry;
    • Immediately thereafter disconnects the call; and,
    • Is accessible at any time throughout the duration of the telemarketing campaign; and,
  • The member complies with all other requirements of Rule 3230 and other applicable federal and state laws.

  1. Credit Card Laundering

Except as expressly permitted by the applicable credit card system, no member or person associated with a member shall:

  • Present for payment, a credit card sales draft generated by a telemarketing transaction that is not the result of a telemarketing credit card transaction between the cardholder and the member;
  • Employ, solicit, or otherwise cause a merchant, or an employee, representative or agent of the merchant, to present for payment, a credit card sales draft generated by a telemarketing transaction that is not the result of a telemarketing credit card transaction between the cardholder and the merchant; or,
  • Obtain access to the credit card system through the use of a business relationship or an affiliation with a merchant, when such access is not authorized by the merchant agreement or the applicable credit card system.

  1. Definitions

Finra Rule 3230 adopts definitions that are substantially similar to the FTC’s

Supplementary Material

Rule 3230 also includes as Supplementary Material a provision that is similar to NYSE Rule Interpretation 440A/01 and which reminds members that the rule does not affect the obligation of any member or its associated person that engages in telemarketing to comply with relevant state and federal laws and rules.
Cosgrove Law, LLC welcomes guest blogger Jeffery Barton.  Mr. Barton is able to offer a variety of compliance consulting services which can be used as an extension of the compliance services offered by Cosgrove Law, LLC.