Friday, February 24, 2017

Get Your Own Lawyer, Darn It!

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

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

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

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

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

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

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

Wednesday, February 8, 2017

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Monday, February 6, 2017

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

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

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

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

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

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