Showing posts with label Breach of Fiduciary Duty. Show all posts
Showing posts with label Breach of Fiduciary Duty. Show all posts

Thursday, December 12, 2013

Broker-Dealer Submits to State Consent Order

Early this month a Missouri based broker-dealer entered into a Consent Order with the Missouri Securities Division. In doing so, the broker-dealer consented to a finding that it failed to supervise one of its agents and failed to have in place sufficient policies and procedures to detect and identify violations of the securities laws by its agents.

The Cosgrove Law Group represented one of the clients victimized by the broker-dealer's agent. According to the Consent Order, the agent, now deceased, deposited at least eighty (80) checks from clients in his Gateway Financial Resources account, and used a portion of these funds for his personal expenses. The funds were generated in some instances pursuant to the agent's recommendation to client's that they liquidate their investments.

The broker-dealer paid at least $700,000 to the various victims and, pursuant to the Consent Order, over $100,000 to the State.  

Friday, December 23, 2011

New York's Highest Court Holds That Martin Act Does Not Preempt Claims for Breach of Fiduciary Duty and Gross Negligence

In Assured Guar. (UK) Ltd. v. J.P. Morgan Inv. Management Inc., 2011 N.Y. Slip Op. 09162, 2011 WL 6338898 (N.Y. Dec. 20, 2011), the plaintiff, Assured Guaranty (UK) Ltd., commenced an action against defendant, J.P. Morgan Investment Management Inc., asserting causes of action for breach of fiduciary duty, gross negligence and breach of contract. The gravamen of the complaint was that J.P. Morgan mismanaged the investment portfolio of an entity whose obligations plaintiff guaranteed.

J.P. Morgan moved to dismiss the complaint, arguing that the breach of fiduciary and gross negligence claims were preempted by the Martin Act (New York's "blue sky" law). The Supreme Court granted the motion and dismissed the complaint. The Appellate Division modified by reinstating the breach of fiduciary duty and gross negligence causes of action and part of the contract claim. The Appellate Division granted J.P. Morgan leave to appeal.

J.P. Morgan's position was that plaintiff's common-law breach of fiduciary duty and gross negligence claims must be dismissed because they are preempted by the Martin Act. The Martin Act, argued J.P. Morgan, vests the Attorney General with exclusive authority over fraudulent securities and investment practices addressed by the statute. Therefore, J.P. Morgan contended, it would be inconsistent to allow private investors to bring overlapping common-law claims.

After reviewing the legislative history of the Martin Act, the court found that the plain text of the Act, while granting the Attorney General investigatory and enforcement powers and prescribing various penalties, did not expressly mention or otherwise contemplate the elimination of common-law claims. (citing ABN AMRO Bank, N.V. v. MBIA Inc., 17 N.Y.3d 208, 224 (2011) (stating that, if the Legislature intended to extinguish common-law remedies, “we would expect to see evidence of such intent within the statute”)). The court could find nothing in the legislative history that demonstrated a “clear and specific” legislative mandate to abolish preexisting common-law claims that private parties would otherwise possess.

The court acknowledged that New York courts had previously held that the Martin Act did not “create” a private right of action to enforce its provisions (citing CPC Intl. v. McKesson Corp., 70 N.Y.2d 268, 276-277 (1987)). However, the court found that the fact that “no new per se action was contemplated by the Legislature does not ... require us to conclude that the traditional ... forms of action are no longer available to redress injury” (citing Burns Jackson Miller Summit & Spitzer v. Lindner, 59 N.Y.2d 314, 331 (1983)). Hence, the court agreed with plaintiff that the Martin Act does not preclude a private litigant from bringing a nonfraud common-law cause of action.

J.P. Morgan pointed to past precedent which established that there was no common-law cause of action where the claim is predicated solely on a violation of the Martin Act or its implementing regulations. However, the court distinguished these cases by noting that an injured investor may bring a common-law claim (for fraud or otherwise) that is not entirely dependent on the Martin Act for its viability. In other words, the mere overlap between the common law and the Martin Act was not enough to extinguish common-law remedies.

Finally, the court found that policy concerns militated in favor of allowing plaintiff's common-law claims to proceed. The court agreed with the New York Attorney General that the purpose of the Martin Act is not impaired by private common-law actions that have a legal basis independent of the statute because proceedings by the Attorney General and private actions further the same goal—combating fraud and deception in securities transactions.

For all of these reasons, the court concluded that plaintiff's breach of fiduciary duty and gross negligence claims were not barred by the Martin Act. Accordingly, the court found that the order of the Appellate Division reinstating the breach of fiduciary duty and gross negligence causes of action and part of the contract claim should be affirmed.

Friday, June 17, 2011

Second Circuit Weighs in on Scope of Broker Fiduciary Duty

On June 7, 2011, the Second Circuit rendered a decision in United States v. Allen Wolfson, Docket Nos. 10-2786-cr(L) and 10-2878-cr(CON), which weighs in on the scope of the fiduciary duty in the broker-customer context. In the case, the defendant appealed from two judgments of conviction entered on a number of different grounds, including securities fraud, relating to the defendant's involvement in a "pump and dump" stock scheme. The evidence at trial showed that the defendant artificially inflated the prices of certain thinly-traded securities in which he had amassed a substantial interest, and then unloaded those holdings on unsuspecting investors. The scheme relied on corrupt stock brokers who sold the securities for prices far above their actual value. In exchange, the defendant rewarded the brokers with exorbitant commissions. Some of the brokers failed to disclose the fact of the commissions to their customers. Others made affirmative misrepresentations about the size of these commissions.

On appeal, the defendant argued that the brokers had no duty to disclose their commissions, and that his fraud convictions, which relied on the breach of that duty to establish a scheme to defraud, must therefore be overturned. The defendant also argued that, even if a duty to disclose might arise in some contexts, the district court gave an improper fiduciary duty instruction.

The court noted that although it had long held that "there is no general fiduciary duty inherent in an ordinary broker/customer relationship," it had also recognized that "a relationship of trust and confidence does exist between a broker and a customer with respect to those matters that have been entrusted to the broker. United States v. Szur, 289 F.3d 200(2d Cir. 2002). The court noted that the fiduciary duty most commonly arises in the broker-customer relationship in situations in which a broker has discretionary authority over a customer's account. However, the court recognized that "particular factual circumstances may serve to create a fiduciary duty between a broker and his customer even in the absence of a discretionary account." United States v. Skelly, 442 F.3d 94 (2d Cir. 2006).

For example, the court noted that in Szur the owner and president of J.S. Securities had convinced brokers to market stock in exchange for unusually large commissions, sometimes as much as 50 percent of the proceeds of the sale. 289 F.3d at 212. The brokers failed to disclose the size of the commissions to their customers. The court held that, although the brokers owed no general fiduciary duty arising from discretionary authority, they were under a duty to disclose the exorbitant commissions because the information would have been relevant to a customer's decision to purchase the stock. Id. This holding was an outgrowth the court's pronouncement in SEC v. First Jersey Securities, Inc., 101 F.3d 1450, 1469 (2d Cir. 1996), where the court explained that "[s]ales of securities by broker-dealers to their customers carry with them an implied representation that the prices charged in those transactions are reasonably related to the prices charged in an open and competitive market."

In other words, the presence of a discretionary account automatically implies a general fiduciary duty, but the absence of a discretionary account does not mean that no fiduciary duty exists. For that reason, the controlling question in the case before the court was whether the jury was properly instructed on the fiduciary duty. The instructions were as follows:

Whether a fiduciary relationship exists is a matter of fact for you, the jury, to determine. At the heart of the fiduciary relationship lies reliance and de facto control and dominance. The relationship exists when confidence is reposed on one side and there is resulting superiority and influence on the other. One acts in a fiduciary capacity when the business which he or she transacts or the money or property which he or she handles is not his own or for his or her own benefit but for the benefit of another person, as to whom he or she stands in a relation implying and necessitating great confidence and trust on the one part and a high degree of good faith on the other part.

If you find that the government has shown beyond a reasonable doubt that a fiduciary relationship existed, such as between any one of the brokers and the customers you next consider whether there was a breach of the duties incumbent upon the fiduciary in the fiduciary relationship and specifically whether the defendant caused the broker or brokers to breach their fiduciary duties to customers. I instruct you that a fiduciary owes a duty of honest services to his customer, including a duty to disclose all material facts concerning the transaction entrusted to him or her. The concealment by a fiduciary of material information which he or she is under a duty to disclose to another, under circumstances where the nondisclosure can or does result in harm to the other is a [b]reach of the fiduciary duty and can be a violation of the federal securities laws, if the government has proven beyond a reasonable doubt the other elements of this offense, as I explained them to you.

The court concluded that the instruction given was identical in all material respects to the charge given in Szur, 289 F.3d at 210. Because the court found no principled basis on which to distinguish the case before it from Szur, the court concluded that there was no error in the charge.

A complete copy of the Second Circuit's decision can be found here.

Wednesday, June 9, 2010

Got Fraud? Delaware’s Corporate Paradise

It’s no secret why most corporations are incorporated in the state of Delaware or require claims against them to be brought in a Delaware court. Delaware is known for having notoriously lax standards for corporate behavior making the state courts very tolerant of corporate misconduct. In fact, the standards are so favorable to corporations, the directors and officers who played an integral role in the demise of Lehman Brothers may not be liable for their conduct because it is protected by the business judgment rule.

The business judgment rule affords limited judicial review of decisions made by the directors of a corporation under the presumption that they are acting on an informed basis, in good faith, and with an honest belief that the decisions made were in the best interest of the company. However, this presumption generally can be overcome by a showing that a director breached his fiduciary duty or a decision was a result of an irrational process. Therefore, the business judgment rule does not protect director decisions made in bad faith. In Delaware, however, the rule protects directors unless there is a showing that their actions rose to the level of gross negligence. Essentially, there is no remedy under Delaware law for nefarious conduct that is not so outrageous so as to be classified as grossly negligent.

Historically, and in most states, the business judgment rule applied only to directors of a corporation because they are held to certain fiduciary standards, unlike corporate officers. However, in a recent Delaware Supreme Court decision, Gantler v. Stephens, the state’s Supreme Court held that corporate officers and directors are bound by the same standard of fiduciary duties. Presumably, this extends the protection of the business judgment rule beyond directors to corporate officers. This conclusion is consistent with the findings of Anton Valukas, the court-appointed examiner of the Lehman Brothers bankruptcy.

Mr. Valukas penned a nine-volume, 2,200-page report on the company’s ruin. In his report, he notes the expansion of officer fiduciary duties and discusses the ramifications of Gantler, most notably, the larger umbrella of the business judgment rule in Delaware. As such, the conduct of Lehman Brothers’ directors and officers is likely insulated from liability because it does not rise to the level of gross negligence, despite alleged fraudulent transactions involving $50-billion in assets moving on and off its financial statements and the failure to heed to warnings from the company’s risk managers.

The business judgment rule and other protections from litigation for directors are necessary, but Delaware’s exceedingly lenient stance on corporate conduct may leave claimants without any recourse and provide even more incentive for companies to incorporate in Delaware.

Thursday, April 22, 2010

Supreme Court Decides Mutual Fund Fees Case, Rejects Test Adopted By 8th Circuit

Last April, the issue of mutual fund adviser’s fiduciary duties concerning fees was before the United States Court of Appeals for the 8th Circuit in the case Gallus v. Ameriprise. Gallus considered the scope of a mutual fund adviser’s fiduciary duties under Section 36(b) of the Investment Company Act of 1940 (“1940 Act”) codified as 15 U. S. C. §80a–35(b).

The Court of Appeals reversed the decision of the United States District Court for the District of Minnesota holding that an inquiry into Section 36(b) does not rely solely on the Gartenberg factors laid out by the Second Circuit in Gartenberg v. Merrill Lynch Asset Management, Inc. The Gartenberg test looks at whether the “fee is so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm’s-length bargaining.”

The Court explained that while Gartenberg provides a “useful framework for resolving the claims of excessive fees”, the size of the fee should be considered alongside the mutual fund adviser’s conduct. Thus, the Eighth Circuit read the plain language of Section 36(b) to impose a “duty to be honest and transparent throughout the negotiation process.” In its decision, the Court heavily relied on the decision reached by the 7th Circuit in Jones v. Harris Associates L.P. In Jones, Chief Judge Easterbrook also rejected the proposition that Gartenberg should be the sole test applied to determine the reasonableness of an adviser’s fee. Instead, the Seventh Circuit declared that the focus should be on the fairness and transparency of the process for approving mutual fund adviser fees.

On March 30, 2010, the U.S. Supreme Court rejected the test proposed in the 7th Circuit (and subsequently adopted by the 8th Circuit). The Supreme Court unanimously agreed that Section 36(b) does not extend a duty to the negotiation process between mutual fund advisers and their clients. In addition to reinforcing the Gartenberg test as the appropriate approach in resolving Section 36(b) claims, the Court also clarified several points to create uniform application amongst the Circuits. Namely, the Court explicitly stated:

§ The weight given to comparison of fee size will depend on the circumstances surrounding the parties.

§ It is appropriate for a court to look at the fees an investment adviser charges a captive mutual fund versus the fees charged to independent clients.

§ Courts should give deference to the fee size because pursuant to the ’40 Act, fees must be approved by a “fully informed mutual fund board.” However, the level of deference may vary depending on the approval procedure of the board.

To read the Supreme Court’s full opinion, please click here.

Saturday, October 31, 2009


Cosgrove Law, LLC has locked horns with nationally known investment adviser Fisher Investments, Inc. on behalf of one of its clients. The matter is currently being litigated in the JAMS arbitration forum. Cosgrove Law, LLC has brought claims alleging, among other things, that Fisher Investments failed to satisfy its fiduciary duty to its clients by funneling their clients in to inappropriately aggressive portfolios comprised almost entirely of equities. Needless to say, these portfolios got destroyed by excess market exposure in 2008. Cosgrove Law, LLC has also asserted claims for unlawful merchandising, unregistered investment advice, negligent representations and an unlawfully fraudulent investment advice scheme. Fisher Investments Inc' CEO is best-selling author and Forbes columnist Ken Fisher. Mr. Fisher was recently deposed by Mr. Cosgrove in San Francisco. The case should go to hearing or trial in the first half of 2010. Stay tuned.