Wells Fargo Advisors, LLC wins FINRA Award sum of $15,300,000.00+ in Damage

     On February 2, 2023, a FINRA arbitration panel awarded the Claimant, Wells Fargo Advisors, LLC a sum of 15,300,000.00 in Compensatory Damages and over $4,000,000.00 in additional costs and attorney fees.

Case Summary:

            In October 2018, Kent Jackson Rhoades left his job at Wells Fargo Advisors, LLC in Mountain Home, Arkansas to start an independent financial consulting firm with Raymond James Financial Services, Inc. Rhoades not only left the corporate company to venture out on his own but also hired on a 12- person team, all of which worked under Rhoades at Wells Fargo, and named them the Financial Services and Investment Strategies Group. It is important to note that the Wells Fargo branch is no longer in business. 

            In August of 2020, Wells Fargo filed a complaint alleging Raymond James Financial Services and Kent Jackson Rhoades led a “coordinated raid.” What is a raid you might ask? A raid is poaching another financial advisor’s team or clients with the intent of harming that firm’s business. One might not see a case regarding “coordinated raids’ because they don’t happen frequently and are difficult to prove. FINRA rule 2010 states, “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” While a little vague, under this rule, a financial firm cannot ethically poach a significant portion of another firm’s team and/or clients, and in October 2018, Raymond James Financial Services did just that. 

Wells Fargo claimed Raymond James took the entire financial advisor team, as well as clients that Rhoades had been working with over the 20 years he worked at Wells Fargo. Wells Fargo sought damages, costs and fees against Raymond James Financial Services, Kent Jackson Rhoades and the 12-person team that collectively moved from Wells Fargo to Raymond James Financial Services. Rhoades claimed that the clients at Wells Fargo moved to his firm due to the “untruths and/or deception [which] caused clients to sever their relationships.” Rhoades and the 12 pursued a counterclaim award against Wells Fargo as well. However, on August 25,2022, Wells Fargo dropped the claim against the 12, and the 12 dropped the counterclaim against Wells Fargo, leaving just Rhoades and Raymond James Financial. 

After multiple hearings, FINRA awarded Wells Fargo Inc. $15.3M in compensatory damages (with a 6% annual interest rate), $3.5M in attorneys’ fee, $847,000 in costs, $1M in punitive damages, a $500 non-refundable claim filing fee, and $53,775 in hearing session fees totalling over $20M. The counterclaim was completely dismissed and all claims for relief for Raymond James Financial Services were denied. 

 

+ Awards are rendered by independent arbitrators who are chosen by the parties to issue final, binding decisions. FINRA makes available an arbitration forum—pursuant to rules approved by the SEC—but has no part in deciding the award.

Additional sources:

https://www.advisorhub.com/wells-fargo-advisors-wins-nearly-20m-in-raiding-claim-against-raymond-james/

https://www.advisorhub.com/wp-content/uploads/2019/08/Good-Moves-Bad-Moves-Bad-Move-Being-part-of-a-raid-1.pdf

Missouri Legislature Proposes Investment Adviser Disclosure of Social Objectives

On January 8, 2023, Representative O’Donnell introduced a bill to the 102^nd General Assembly that adds to the disclosure obligations of Missouri-registered investment advisers. If enacted, Missouri House Bill No. 824 will amend Chapter 409 (Regulation of Securities) of the Missouri Revised Statutes to require these investment advisers and investment adviser representatives to disclose any socially responsible criteria included in any recommendation to a client or solicitation of a prospective client. Then, before acting on any such social objective, the proposed law would require client written consent, such as:

“I, (NAME OF CLIENT), consent to my adviser or adviser’s representative incorporating a social objective or nonfinancial objective into any discretionary investment decision my adviser or adviser’s representative makes for my account; any recommendation or advice my adviser or adviser’s representative makes to me for the purchase or sale of a security or commodity; or the selection my adviser or my adviser’s representative makes, or recommendation or advice my adviser or my adviser’s representative makes to me regarding the selection, of a third-party manager or subadvisor to manage the investments in my account.  Also, I acknowledge and understand that incorporating a social objective or nonfinancial objective into investment decisions, recommendations, advice, and/or the selection of third-party manager or subadvisor to manage the investments in my account will result in investments and recommendations/advice that are not solely focused on maximizing a financial return on my account.”

This bill’s proposed effective date is August 28, 2023, which is very timely considering the U.S. Securities and Exchange Commission’s similar recently proposed amendments to rules and reporting forms that would establish disclosure requirements for funds and investment advisers that market themselves as having environmental, social, and governance (ESG) strategies.

Since matters such as investment adviser client disclosures are complicated, it can be helpful to hire an attorney that specializes in such areas. Cosgrove Law Group has experience dealing with these questions. If you are a client or a prospective client of a Missouri-registered investment adviser that has questions about these or other investment adviser disclosure obligations and would like to speak with one of our Missouri-licensed attorneys, call 314-563-2490.

Jury Trials in Missouri Securities Division Administrative Enforcement Actions

 The Enforcement Section of the Missouri Secretary of State Securities Division (the “Enforcement Section”) brought 35 administrative enforcement actions between 2020 and 2021 pursuant to Section 409.6-604, RSMo.,[1] which assessed $7.5 million in civil penalties.[2] Some of these administrative actions alleged securities fraud in violations of Section 409.5-501(1), Section 509.5-501(2), and Section 509.501(3). The administrative procedures allow the Missouri Secretary of State appointed Commissioner of Securities (the “Commissioner”) to issue an interim order finding that the respondent has committed securities fraud, which order becomes final unless the respondent requests a hearing. The administrative procedures also authorize the Commissioner to conduct the hearing, in effect serving as both the prosecution and the judge, which may be why only 5 hearings were requested in these 35 enforcement actions.[3]

Section 409.6-603 also authorizes the Missouri Securities Division to file civil actions to enforce alleged securities fraud violations to be tried by a neutral judge in the Circuit Court of Cole County, Missouri. But the Division does not.[4] And why would it when the Commissioner whose job it is to enforce the Missouri securities laws also gets to determine whether those laws have been violated?

But administrative enforcement proceedings for alleged securities fraud cases are not the only play here in Missouri. The case can certainly be made that the Missouri Constitution, art. I, section 22(a) applies to securities fraud enforcement claims, which states: “the right of trial by jury as heretofore enjoyed shall remain inviolate; …”[5] “Quite simply, the words of the provision are intended to guarantee a right, not restrict a right. The choice of words, particularly the use of the words ‘remain inviolate,’ is a more emphatic statement of the right than the simply stated guarantee written some 30 years earlier as the 7th Amendment of the United States Constitution that ‘…the right of trial by jury shall be preserved…’” State ex rel. Diehl v. O’Malley, 95 S.W. 3rd 82, 84 (Mo. Ct. App. 2002). 

Credit the U.S. Court of Appeals for the Fifth Circuit for first coming up with this idea in the context of securities fraud administrative enforcement actions in Jarkesy v. Securities and Exchange Commission, 34 F. 4^th 446 (5^th Cir. 2022), which ruled on May 18, 2022, in a 2-1 decision, that the U.S. Securities and Exchange Commission (“SEC”) may no longer use its own administrative proceedings framework to enforce SEC securities fraud cases. Instead, the SEC must bring such actions in federal district courts where respondents may exercise their rights to civil jury pursuant to the 7^th Amendment. The same principle applies to Missouri’s administrative proceedings framework to enforce Missouri securities fraud cases, even though there is also gratuitous language in Diehl and Goodrum v. Asplundh Tree Expert Co., 824 S.W. 2d 6, 11 (Mo. banc 1992), which appears to state otherwise. We disagree.  The key is that the rights the Enforcement Section seeks to vindicate in securities fraud administrative enforcement actions are analogous to fraud causes of action at common law brought at the time of Missouri’s 1820 Constitution. 

Cosgrove Law Group has experience dealing with these questions. If you are served with a securities fraud administrative enforcement action by Missouri Securities Division and would like to speak with one of our licensed attorneys, call 314-563-2490.   

Author: Brian St. James

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[1] All statutory references are to the 2020 Revised Statutes of the State of Missouri. 

[2] Committee Meeting Materials, “Administrative Practice Before the Missouri Commissioner of Securities,” 2022 MoBar Fall Conference, Office of the Missouri Secretary of State Securities Division. 

[3] Id.

[4] Id.

[5] Article, I, Section 22(a), the Missouri Constitution.

ARE YOU A FINANCIAL ADVISOR WITH A WRONGFUL TERMINATION OR DEFAMATION CLAIM?

            Advisors terminated by their broker-dealer should immediately retain experienced legal counsel.

The broker-dealer has 30 days after termination to file the mandatory U-5.  Legal counsel can help you negotiate fair and accurate language for this critical and potentially public disclosure.  Moreover, how the U-5 is completed above and beyond the narrative “reason for termination” can be pivotal.

          Many advisors fail to appreciate that, for the most part, their broker-dealer can terminate them without cause.  But there are contractual and public policy exceptions to this general rule that must be evaluated.  Cosgrove Law Group has extensive experience working with financial advisors who have been terminated, including not just U-5 issues, but also issues such as promissory notes and other compensation matters.

Two New Arbitration Cases

            April 26, 2022, brought us two new arbitration rulings to sink our teeth into. One ruling was issued by the Supreme Court and the other by the Court of Appeals. I think the court of Appeals decision might get reversed.

            In Car Credit, Inc v. Pitts, the Supreme Court considered a challenge to a judgment confirming an arbitration award. The appellant claimed that the award should be vacated because the arbitration forum designated in the arbitration clause was not utilized because it was unavailable. In my opinion, the Supreme Court (and Federal courts) go out of their way to confirm arbitration awards. This case was no different, but it relied upon a rule that the Supreme Court has repeatedly articulated. It is highly technical but lawyers in this field need to know it. The Court found that the arbitration agreement contained an enforceable delegation clause and the appellant failed to challenge the validity and enforceability of that clause.

         The appellant did challenge the AAA arbitrator’s authority to hear the case on jurisdictional grounds. The arbitrator denied that challenge. But the appellant failed to challenge the arbitrator’s jurisdiction to make that ruling. Regardless, the Court of Appeals ruled in her favor. But the Supreme Court reversed, noting in part that “the delegation provision is an agreement to arbitrate threshold issues concerning the arbitration agreement”, citing the Seminal case of Rent-A-Center, W., Inc. v. Jackson.

            In what may be the next arbitration ruling to be reversed by the Supreme Court, the Court of Appeals ruled in favor of the appellant in Wind v. McClure. In that case, the Court of Appeals held that the Circuit Court was correct in refusing to enforce an arbitration agreement because its language and format failed to comply with state law mandates. To be specific, the arbitration agreement failed to include certain large font warnings, regarding the existence of an arbitration clause.  The requirement in question, however, is not included in the Federal Arbitration Act, the supremacy of which the Supreme Court strictly enforces. Perhaps the appellate will not appeal. Food for thought.

5th Circuit Strikes Down SEC Administrative Proceedings Framework for Securities Fraud cases

          In Jarkesy v. Securities and Exchange Commission, Case No. 3-15255, a panel of the U.S. Court of Appeals for the Fifth Circuit ruled on May 18, 2022, in a 2-1 decision that the U.S. Securities and Exchange Commission (“SEC”) may no longer use its own administrative proceedings framework to enforce SEC securities fraud cases. Instead, the SEC must bring such actions in federal district courts where respondents may exercise their rights to civil jury. This is a stunning development for the SEC because the case finally recognizes that the SEC should not be acting as both prosecutor and jury in securities fraud cases nor require respondents to exhaust their administrative remedies before having their day in court.

In Jarkesy, the SEC brought administrative enforcement proceedings against the respondents alleging securities fraud. From the inception of the matter, however, respondents challenged the SEC’s right to bring such a matter administratively because it deprived them of their rights to civil jury. The administrative law judge ruled against respondents as did the SEC upon review and ordered respondents to cease and desist from committing further violations, pay a civil penalty of $300,000, and to disgorge nearly $685,000 in alleged ill-gotten gains.

“The case finally recognizes that the SEC should not be acting as both prosecutor and jury in securities fraud cases nor require respondents to exhaust their administrative remedies before having their day in court.”

On appeal, the 5th Circuit vacated the SEC’s judgment and held that the SEC’s administrative proceedings were unconstitutional for at least two reasons: (1) respondents were deprived of their Seventh Amendment right to civil jury; and (2) Congress unconstitutionally delegated legislative power to the SEC by failing to give the SEC an intelligible principle by which it could determine what matters it could use its administrative proceedings framework and what matters it was required to file suit in federal district courts. It remains to be seen whether the SEC will request a rehearing before the entire panel of the Fifth Circuit or seek redress from the U.S. Supreme Court, and whether other circuits of the U.S. Court of Appeals will follow suit. But as of now, the SEC should no longer use its own administrative enforcement proceedings in securities fraud cases.

For further guidance on Jarkesy or SEC enforcement proceedings in general, feel free to give us a call at (314)-563-2490.

Author: Brian St. James

Self-Directed IRA Custodian Liability under State Securities Acts

It should come as no surprise to anyone that if purchasers of securities or a state’s securities commission bring an  enforcement action for the unlawful sale or contract for sale of unregistered securities, then they will seek recourse against anyone involved in the transaction because the proceeds of such sales have often been spent by unscrupulous issuers in many of these circumstances. Self-directed IRA custodians are no exception. 

Such was the case in Boyd v. Kingdom Trust Company, et al.,[1] where two Ohio residents opened self-directed IRA accounts to invest in promissory notes as alternative investments. As practice dictates, the promissory notes were purchased by the self-directed IRA custodians for the benefit of the Ohio residents and the physical promissory notes held by the custodians in the self-directed IRA accounts. 

The residents argued that the self-directed IRA custodians and the issuer were jointly and severally liable pursuant to Ohio Securities Act provision that states: 

“The person making such sale or contract for sale, and every person that has participated in or aided the seller in any way in making such sale or contract for sale, are jointly and severally liable to the purchaser … for the full amount paid by the purchaser and for all taxable costs.”[2]

The Ohio Supreme Court in this case took a narrow view of this enactment by distinguishing the self-directed IRA custodians’ role as purchasers of the promissory notes as opposed to either participating in the sale or aiding the issuer in the sale and vindicated them, finding that “a financial institution’s mere participation in a transaction, absent any aid or participation in the sale of illegal securities, does not give rise to liability under R.C. 1707.43(A).”[3]

 But every self-directed IRA custodian should also note that this Court also stated that: 

“Nothing in our holding today would insulate from liability a self-directed IRA custodian who colludes with the seller in an unlawful sale of securities or actively participates or aids in the sale of illegal securities. But the certified question before us is limited to the liability of a self-directed IRA custodian whose only alleged participatory conduct was the purchase of illegal securities on behalf and at the direction of the owner of a self-directed IRA.”[4]

Consequently, the self-directed IRA custodians escaped liability in this case merely because the two Ohio residents failed to allege any other participatory activity in the sale of the promissory notes, such as providing the templates for the promissory notes, drafting them, being included in the issuer’s pitch materials, etc.[5] And in a regulatory environment such as the present one in which plaintiffs and enforcement sections of  state securities commissions seek restitution for defrauded investors by all means available to them, self-directed IRA custodians should be extremely mindful of their participation in these transactions. 

Consequently, if faced with such potential liability, you may wish to consult with experienced securities enforcement counsel at Cosgrove Law Group, LLC.

Author: Brian St. James

Please follow us on Twitter @CosLawGroup, on LinkedIn at Cosgrove Law Group, LLC, and on Facebook at Cosgrove Law Group, LLC. 

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[1] 150 Ohio St. 3d 196, 2018-Ohio-3156, 113 N.E. 3d 470 (2018).

[2] R.C. 1707.43(A). Note this provision has been enacted by each state that has adopted the Model Securities Act.

[3] 150 Ohio St. 3d at 199, 113 N.E. 3d at 473.

[4] Id. Emphasis added.  

[5] Situations where the custodian issues a finder’s fee or commission to the seller could also be “participatory activity.”