September 2011 Archives

Casting a Wider Net: Deconstructing the Supposed "Winners" and "Losers" of Investment Fraud

September 16, 2011,

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There's an old pun making a comeback among New York securities lawyers: "Don't count your check-ins before they're cashed." The divide between so called "net winners" and "net losers" is a hot topic, particularly with regard to the defrauded victims of vilified Ponzi schemer Bernard Madoff. A thorough explanation of affinity fraud can be found in our Investors section, with a set of Ponzi scheme red flags available here from

In August, the U.S. Second Circuit Court of Appeals upheld Madoff trustee Irving Picard's decision to award upfront recovery payments of as much as $500,000 solely to the scheme's "net losers": investors whose withdrawals from Madoff's fund did not match their initial investment. "Net winners" - those who withdrew more than their initial entry into the fund - seek the same recovery, but have been denied by Picard in a motion that has now held up in court.

Branding either party winners or losers is problematic, and discredits the fact that all of these investors suffered and were betrayed by the same scheme. Moreover, a precedent was set favoring "net winner" restitution in the case of Randall v. Loftsgaarden 478 U.S. 647 (1986), in which the Supreme Court ruled that "[t]his deterrent purpose is ill-served by a too rigid insistence on limiting plaintiffs to recovery of their 'net economic loss'". A 2001 ruling in California Ironworkers Field Pension Trust v. Loomis Sayles, 259 F.3d 1036, (9th Cir. 2001) binds respondents to an "Anti-Netting Rule", concluding that gains in one investment do not offset losses in another. Why then might Picard's whims prove to be, as one Wall Street Journal headline wonders, "the Final Word on This Issue?"

Encouraging trends in recent rulings and arbitration have favored the "Well Managed Account Theory", a method of calculating damages by taking the initial value of the investor's portfolio, adjusting by a percentage change in an appropriate index during the relevant period, then subtracting the value of the portfolio at the end of that period. The theory is better suited for today than the prevailing wisdom of old, commonly known as the "Net Out of Pocket Theory", in which claimants receive only the amount they originally invested less their subsequent withdrawals.

This latest Madoff ruling thus seems outdated (albeit still the industry norm), lacking both fair compensation for investors and accountability from the brokerage industry. Consider but one example, Leigh v. Engle, 858 F.2d 368, (7th Cir. 1988), where the court "undertook the straightforward approach of comparing the return on the improper investments with that of a reasonably prudent alternative investment" and "adopted the 'most generous' of the reasonable damage calculations submitted".

In March 2010, the SIPC (Securites Investor Protection Corporation) determined that Madoff's net losers were entitled to up to $500,000 in up-front recovery payments, while net winners were not. Picard totals losses at $17.8 billion, while a recent figure from investor representatives cites as much as $64.8 billion squandered. Picard and federal prosecutors have recovered $11 billion, about 60% of their loss estimation. The appeals court's criticism of compensating both parties equally is that to do so would give the same merit to presumptions of profit as it does to quantifiable cash investment.

In fact, what these "winners" seek is a reasonable estimate of net worth had their money been invested with genuine, sensible regard. Not a "best-of-all-worlds" fantasy complete with mountains of Apple and Facebook stock, but a fair sum in step with how their investments would have performed in the hands of any legitimate professional. The Net Out of Pocket theory discourages investment altogether, offering these supposed "winners" less than they would have made by putting their money into a savings account, and the same amount made by placing it under their mattresses. Yet Picard's lawsuit against one high profile client, the owners of the New York Mets, continues to move forward on the grounds that these fleeced investors should have better investigated their broker, or risk accusations of "willful blindness" and "conscious avoidance". Validating such baseless claims not only allows broker-dealers to regulate their own fraud, but offers impunity to those who defraud investors up to the point at which losses would equal prior gains.

While there is logic to insuring the worst hit victims get compensated, a view of "net winners" is flawed. Someone who invested in 1980, then received only their net sum back by 2010 is in a far worse predicament than someone who invested in 2008 and received their investment alone. Through litigation, Madoff's supposed "Net winners" are seeking adjustment for inflation on their claimed earnings and losses, arguing that a sum invested in Madoff in previous decades was worth more in the past than it is today, required greater investment and commitment, and would have benefitted from subsequent boom periods. One million dollars invested in 1980, they argue, would be worth much more than the same sum invested shortly before the '08 collapse. Presently, the SIPC does not permit inflation or interest adjustments in the dispensing of investor compensation.

This leads us to a lynchpin of SIPC claims: that investors must prove that their loss was a result of insolvency - the inability to pay debts - and not of fraud, misrepresentation, or poor stock selection. A high profile case such as Madoff's brings conscious deceit to light as the very cause of such insolvency. Thus, if Wall Street seeks to rebuilds its contract with Main Street, it seems imperative for the SIPC and like-minded organizations to enforce the responsibilities that the professional securities market has towards victims of fraud.

The Incredible 9/11/01 Story

September 11, 2011,

In-cred-i-ble: Adjective 1. too improbable to be believed; 2. amazing, extraordinary; Merriam-Webster Dictionary I was a student downtown at New York Law School, I lived on Maiden Lane at Broadway, a street that leads to where the Twin Towers stood, just one block away. I always considered myself a "maiden of Maiden Lane" and the Twin Towers were like the big protective brothers I never had. Let's face it, the Twin Towers were incredible.

I would see the Twin Towers from a distance and know exactly where I lived and where we were going.

I would go to the Twin Towers from time to time, which had a shopping plaza, when I lived there. After I graduated law school and moved away, I frequently returned to the Twin Towers, as I had become a securities lawyer and the SEC, NYSE and Commodities Exchange were all housed there. All but about three years of my schooling and practice as a lawyer were spent in the financial district, my work home for sure.

At the time of the first attack in 1993, I was both a lawyer and an actress. At night, for fun, I would act in a troupe which had a member that also worked at the Commodities Exchange. I heard my red-haired friend's story about his evacuation and the crumbling (but standing) brick and mortar. Although I was frequently in the building, It would have been incredible to me if you would have told me that I would have been caught up in another attack there, or that there would even be another attack.

By the second attack, September 11, 2001, I had started my own private practice a few years prior (after working for others in the neighborhood). At the time, I had a smaller office on the 4th floor at 11 Broadway (where I still incredibly have my office today) and, in 2001, my back windows faced the direction of the Twin Towers.

On September 11, 2001, I was scheduled for a hearing at the National Association of Securities Dealers, Inc., now named the Financial Regulatory Authority. My adversary, from Texas, was staying at the Millennium Hotel just across from the Twin Towers. I was representing a woman who was in her 60s and in my office very early. I wore a black and white suit and the black shoes pictured here.

I felt something like the earthquake we had just a few weeks ago and in my old building with large old windows, the windows bowed in just slightly, but significantly in and of itself. I (stupidly) rushed to the window and saw people running towards the water. In the past, I had a dream about a plane going into the water off the tip of the city, so that's what I thought had happened.

Within minutes, my sister and my mother phoned. We had a conference call and one told me not to leave the building, the other told me to get out as soon as I could. In true fashion, I did a little of each. I stayed until my older client got there, tried to call the NASD at her request - but all lines were down. The client insisted that we go to the NASD and see if the hearing was going forward. I agreed to walk with her to the building.

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FINRA Fines Three New York Based Broker-Dealers For Mischaracterizing Customer Fees

September 8, 2011,

1210301_euro_coins.jpgNew York securities law saw quite the news day, as the Financial Industry Regulatory Authority (FINRA) issued a news release on September 7, 2011 announcing fines against five Broker-Dealers, three of them based in New York, for mischaracterizing fees charged to customers. The three New York based firms were John Thomas Financial of New York, NY, A&F Financial Securities, Inc. of Syosset, NY and Salomon Whitney, LLC of Babylon Village, NY. FINRA alleged that the firms understated commissions but charged additional handling fees to make up transaction based income for the firm. FINRA found that by structuring their fees this way, the firms ended up charging fees significantly higher than the actual cost of the services the firms provided.

In making their findings, FINRA reiterated that broker-dealers must accurately disclose commissions earned. By settling these charges with FINRA, the firms did not admit or deny wrongdoing, but they did consent to the entry of FINRA's findings and also agreed to implement actions sufficient to remedy the handling-fees violations.

Such mischaracterization of handling-fees is one example of how broker-dealers can put their own interests ahead of the interests of their clients, and represent what is essentially securities fraud. If you held an account with one of these firms or you think your broker-dealer may have charged fees in excess of what they disclosed to you, your entire portfolio may need a thorough review for suitability.

FINRA's September 7, 2011 News Release can be found here.

Is my account down because of the market, or is it something else?

September 2, 2011,

In rough economic times such as these, many investors have seen their accounts suffer large losses. As New York securities lawyers, we've seen some investors' accounts lose 25-50% over the course of a few months or years, while others have seen their accounts lose such large amounts seemingly overnight. A large drop in account value is unsettling for every investor, but for those nearing retirement or senior citizens living off their savings, large losses are extremely alarming and can be devestating. Regardless of their age or situation, investors who have suffered large losses often find themselves asking the same questions, "Is my account down because of the market, or is it something else?"

stock down.jpgInvestors who are approaching retirement or who are already retired are typically risk-averse - i.e. willing to accept lower returns to avoid the possibility of devastating losses. However, many of these investors find themselves being sold on "sure thing," "big winner," "can't lose," and "have your cake and eat it too" investment strategies that seem, and in fact are, too good to be true. Those who buy into these false promises can find themselves unknowingly invested in products and strategies that are much riskier than what they wanted, and most importantly, what they should have been invested in. Unfortunately, good times in the market can hide these risks from the average investor. It is not until a downswing in the market that these risks come to light, often taking the form of large, unexpected and crippling losses.

Many people who want to invest seek out professional guidance in handling their savings and their investments because they feel safer in the hands of professionals whom they trust and whom they believe are looking out for their best interests. Unfortunately, this trust can be abused and investors often find themselves in accounts that are not suitable for their financial needs and the amount of risk they are willing to take with their investments.

Investors often place complete trust in their financial advisor and follow all recommendations made to them, believing that their financial advisor has their best interest at heart. Regrettably, this is not actually the case and all too often, these people can find themselves in a situation where they do not even know what products they are invested in, until it is too late and they are financially devastated.

When confronted about large losses many brokers will simply blame it on the market, telling clients that "there's nothing I can do," "we'll have to just ride it out," "it's just the way the market is sometimes," or "it will bounce back, I promise." However, this is not always true. Sometimes, investment losses can be simply due to unfortunate swings in the market, but a properly diversified portfolio with the appropriate risk level should not experience such huge, devastating losses. These sudden, large losses may actually be the result of unsuitable investments or broker misconduct, including violations of state and federal law and SEC and FINRA Rules.

Other factors, such as a lack of diversification and an over-concentration in one type of investment or in one industry can also lead to losses. Trading on margin is also a risky strategy that many advisors portray as "safe" and "common practice" to their clients. More advanced investments such as ETFs and derivate products, like structured notes and mortgage backed securities, are also a big problem since they are often sold to investors who do not understand them or in some cases, do not even know what they are.

These sorts of investments, when unsuitable or improper for a customer, are barred from being recommended in order to protect investors from self-interested brokers and financial advisors. Investors who have been misled and suffered losses as a result do have rights and may be entitled to be reimbursed for some or all of the losses they have suffered.

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