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Can a Broker-Dealer Firm be Sued for Failure to Supervise a Broker?

Broker-dealers, also known as brokerage firms, are routinely sued for “failure to supervise” claims.  The Financial Industry Regulatory Authority (FINRA), the organization which regulates broker-dealers and their employees, has a series of rules requiring broker-dealers to establish and maintain a supervisory system to supervise its brokers and other employees, as well as to monitor all trading activity to ensure compliance with applicable securities laws and regulations.  In many of our clients’ cases, the brokerage firm’s lack of supervision and failure to properly supervise a broker’s misconduct has directly and indirectly impacted our clients’ accounts, causing losses.  Malecki Law’s FINRA arbitration attorneys have handled many cases against brokerage firms in New York (and across the country) for failure to supervise and have received favorable monetary awards and settlements for our clients.

A supervisory system that cannot reasonably surveil and detect trades that violate securities laws and deceptive trade practices does not meet FINRA’s minimum requirement of proper supervision.  Moreover, proper supervision also requires a firm supervisor to approve a broker’s daily trades, as well as to systematically review clients’ accounts for wrongful trading activity such as recommending unsuitable investments, trading without proper authority from the customer, or charging high commissions that make it virtually impossible for the customer to make any sort of profit.

Investors often ask whether a clearing firm can be liable for losses sustained in their accounts.  The answer is “yes.”  Traditionally, clearing firms, also known as clearing houses, are financial institutions established to handle the confirmation, settlement, and delivery of transactions.  To ensure its clients’ transactions are made in a prompt and efficient manner, the clearing firm acts as a middle-man and is essentially the buyer and seller in the transactions.  To attract business and compete with other clearing firms, clearing firms offer an ever-expanding suite of services that go beyond mere routine clearing functions, which often brings them to be actively and directly involved in the actions of brokerage firms and their brokers.  Courts have held that clearing firms that extend services beyond “mere ministerial or routine functions” can be liable to an investor for a broker-dealer or broker’s misdeeds.

On behalf of several investor clients, Malecki Law’s FINRA arbitration attorneys are currently investigating cases involving claims against Pershing, LLC, a clearing house, and its introducing brokerage firm client, Insight Securities, Inc.  The claims involve an SEC-censured entity, Biscayne Capital.  Our clients sustained losses in their accounts due, in part, to Pershing’s alleged negligent supervision of transactions through its shared platform with Insight.

In relationships like this, the introducing firm and clearing firm have a clearing agreement, usually giving the clearing firm discretion to terminate any account, the responsibility to notify the introducing broker of suspicious activity, and to provide training or trained employees to look out for misconduct.  Usually the clearing firm has the responsibility to conduct regulatory monitoring of SEC Financial Responsibility Rules and to be directly involved in Anti-Money Laundering oversight.  Thus, with these heightened responsibilities, a clearing firm can move beyond its ministerial and routine clearing functions.

Many clients are asking, “can my arbitration hearing be done online by video?” The answer is yes.  FINRA allows for remote hearing services, via Zoom and teleconference, to parties in all cases.  In arbitration, all parties can agree as to almost anything and FINRA will allow it – such as who the arbitrators are, methods of picking arbitrators and/or how the hearing will happen.  The trick is to get your adversary to agree to alternative hearing methods or to get a sitting arbitration panel to order (force) your adversary to do it. A hearing can happen a number of ways with FINRA’s blessing, so long as it can be recorded.  Next week, we expect that FINRA will set out more formal guidelines and we will update this blog in a new post.

Zoom is a user-friendly video platform that provides high-quality and secure options for conducting remote hearings.  The platform allows parties, arbitrators, counsel, and witnesses to share documents and their screens with other participants.  Zoom is a viable option for parties unable to attend an in-person hearing. Malecki Law’s FINRA arbitration attorneys have experience and systems in place, ready to use this method for hearings in investor arbitrations, as well as industry employment and regulatory matters.  For many years, remote witnesses have participated and testified via video and telephonic methods.  It is really not a completely new concept.

Whether the hearing is remote or in-person, the prehearing process will not be hindered.  In customer dispute cases, where customers bring claims against their broker and/or broker-dealer, all aspects, except for an in-person hearing, are done remotely (such as filing the claims, resolving discovery disputes, and interviewing witnesses).  As a matter of fact, most claims against a broker and/or broker-dealer will settle before the hearing is scheduled to begin.

U.S. oil prices have been on a roller coaster ride over the last few weeks, at one point dropping below $0 for the first time in history to -$37.63 a barrel.  Oil has since rebounded from its subzero levels, but it remains questionable as to whether it can stay there.  It begs the question, what does this mean for investors and the U.S. oil market generally?

When prices cratered below zero, there were those that weighed in that it was nothing to worry about.  After all, the subzero price drop really had more to do with the expiration of contracts for oil futures.  It was explained that the current demand for oil is so low that producers would rather put their oil in storage and then sell it at some point in the future.  Placing additional strain on the market, the U.S. is running out of places to store it, with backlogs of oil tankers from Saudi Arabia out at sea and being turned away from U.S. shipping ports.

The U.S. has traditionally been a net importer of oil, but with the emergence of oil fracking, the U.S. at one point in 2019 surpassed Saudi Arabia as the world’s top oil exporter.  This trend towards parity gave many observers of the U.S. oil market a feeling of confidence that the U.S. was a rising oil power, with President Trump going so far as describing the U.S. level of participation as “energy dominance.”  But as pointed out by professionals, increased participation in the market has little to do with control over the market.  For instance, the price of U.S. oil recently began to spiral down when Russia and Saudi Arabia started to increase their production levels.  U.S. oil prices teetered even further, and then below zero, when the global and U.S. economic response to the spread of Covid-19 began to take shape – every state being under some level of a stay-at-home order, with fewer cars on the road, fewer people travelling by air, and U.S. oil workers in Texas and elsewhere being laid off in the tens of thousands.  The pumps have stopped and oil companies are already declaring bankruptcy, with likely more to follow.

Retirees and other retail investors who lose money in the stock market often don’t know where to turn to.  In fact, many people are often surprised to learn that they can recover their investment losses, but this realization is often delayed or completely obscured by our understanding of the markets being informed by two competing views.  On the one hand, the daily news feed of a fluctuating market conditions us to believe that putting our hard-earned savings in the stock market has its risks, no different from a casino, so “buyer beware.”  On the other hand, investment banks and brokerage firms pump out a steady diet of ads that lead us to believe that their financial advisers can guide us with our investment choices to help manage the risks, and safely plan for our retirement years.

For the average investor, it is difficult to know whether one is truly receiving sound investment advice.  A booming market can often hide the flaws in a poorly constructed investment portfolio.  Flaws in investment strategy usually don’t reveal themselves until the markets show some extreme volatility.  We are seeing this of late in the wake of the Coronavirus fallout — the market goes down by a thousand points one morning, only to swing up by a thousand points the same afternoon.  This leads many investors to ask a logical question:  If the market went down by a certain amount and then recovered by the same amount or more, how come my portfolio did not rebound in kind?  Diagnosing what went wrong with your portfolio can be a challenge for the average person, and financial advisers and firms will be quick to distance themselves from any responsibility, often blaming the market and then encouraging you to just hold on.

It is our human instinct to trust the financial professionals whom we have built a relationship with over the years.  In a bull market, that relationship and bond of trust likely only grew stronger.  So we are reluctant to burn a bridge and walk away from a bad adviser, who in some cases may have given you tickets for a sporting event or improperly befriended you (it is a business relationship and your broker should not rely on your friendship).

Getting a Rule 8210 Notice from FINRA can be a jarring event.  If you have received an 8210 notice, you should take it seriously, as well as immediate steps to develop your best course of action to comply with the request. An 8210 Notice is a subpoena from FINRA that is typically sent to registered representatives in connection with an informal inquiry that does not have to be reported on your form U4. When you first receive an 8210 notice, FINRA is likely trying to determine if there have been any violations of securities and/or industry rules and/or regulations.  You should notify your compliance officer, as they will likely have already received a copy from FINRA, but being transparent is important.

It is important to meet with an attorney as soon as possible to determine the best ways in which to protect your interests during the process.  All involved parties will not necessarily share the same interests, i.e., your firm and/or supervisor may have their own self-preservation interests.   As part of the 8210 notice, you will be required to answer a list of questions (interrogatories) and produce sometimes a wide range of documents, both business and personal.  The attorneys at Malecki Law are experienced in defending FINRA registered representatives and firms in FINRA disciplinary matters and can work with you in responding to interrogatories and assist you with your document production using state of the art electronic discovery tools.

In working with your attorney to respond to interrogatories and produce documents you should also start to prepare for a potential “on the record” interview (or “OTR” for short).  OTRs before FINRA involve sitting in a conference room with investigators and answering their questions under oath.  You should have your attorney prepare and accompany you to an OTR. While not all cases involve an OTR, many do.  Experienced counsel will know the best way to couch what happened with the right language and explanation.  Furthermore, it is important to identify and explain mitigating circumstances as soon as possible before enforcement decisions are made.

In March 2020 Oil prices had their worst day since 1991, plunging to multi-year lows. Tensions between Russia and Saudi Arabia and OPEC’s failure to strike a deal were escalated by the global economic slowdown spurred by COVID-19 resulting in oil’s worst day since 1991. With oil’s and the energy markets substantial price plunge the investment fraud attorneys at Malecki Law announce the firm’s investigation into potential securities law claims against broker-dealers relating to the improper concentration or oil and gas in portfolios, as well as the sale of energy related structured notes, Exchange Traded Funds (ETFs), and Master Limited Partnerships (MLPs).  Malecki Law has successfully prosecuted a number of these cases, including obtaining awards of attorneys’ fees and costs for investors.

Malecki Law is interested in hearing from investors who were recommended concentrated positions in oil and gas, as well as those recommended futures in Oil and Gas, MLPs or energy sector ETFs. Investors have lost millions in these products as the energy markets dropped.  As prices have continued to slide, losses have compounded. The energy market plunge is terrible for those whose financial advisors recommended that investors stay in and “ride it out.”

Unfortunately, many energy sector investments are risky investments that can be inappropriate for typical “mom and pop” investors, as well as those heading to or in retirement.  Unfortunately, there are some financial advisors and brokers that sell them to their clients anyway, without fully disclosing the potentially devastating risks.

Predicated on fear of a global slowdown and the uncertainty around coronavirus, the stock has experienced extreme volatility as it heads into bear territory. While it may be expected for even the bluest of blue-chip stocks to experience volatility,  investors should pay particular attention to their entire investment portfolios as it is in violate market climates that broker misconduct may reveal itself, especially as it relates to your investment objectives and suitability.

When the market suddenly drops, investment portfolios will reflect not only the fluctuations, but also the risks inherent inparticular strategies and investments. All securities carry risk, but some investment products have more than others. Risk tolerance refers to the level of uncertainty in investment performance that is acceptable to the investor. An investor’s risk tolerance is reflective of their financial situation, needs, age, objectives, time requirements, and other considerations. Generally, investors can be categorized within varying levels of conservative, moderate, or aggressive. The types of investments in an investor’s portfolio should reflect their risk tolerance. The changes that investors noticed in their portfolio during market shifts could be indicative of where their portfolio falls on this spectrum.

Investors with the lower risk tolerances should have a conservative investment strategy in place that shields their portfolio from significant declines in market downturns. The goal of conservative investors is to prioritize principal protection and liquidity over risky appreciation. A conservative investment portfolio will be mainly comprised of safer, low-risk fixed-income investments, such as bonds and certificates of deposits. While low-risk investments do not generate the highest returns, the chances of losing principal are much lower. Older individuals closer to retirement should have investment profiles that reflect a more conservative investment portfolio. It is a huge red flag for any conservative investors to have noticed a complete decline in their portfolio from the market downturn.

Today, Malecki Law, won a court appeal to allow an international investor to proceed in his securities lawsuit against Lek Securities Corporation and its principals (Samuel Lek and Charles Lek), allowing the case to go forward and be decided by a panel of arbitrators in the dispute resolution forum provided by the Financial Industry Authority (FINRA).  Today’s court order, which was issued by New York’s Appellate Division, First Department, reversed the July 19, 2019 order of the lower court (Supreme Court, New York County), which improperly granted Lek Securities a permanent stay (i.e., a halt) from arbitrating the dispute in FINRA.  The outcome of today’s decision is important because it adds color to the legal definition of who is a “customer” and, thus, who is eligible to bring their claims in FINRA arbitration.

Lek Securities is a U.S. brokerage firm regulated by the enforcement arm of FINRA – the largest independent regulatory body for securities trading and securities firms operating in the United States.  Within the fine print of their new account forms, all investors who open retail brokerage accounts with U.S. brokerage firms waive their rights to court and are, instead, required to arbitrate any disputes in FINRA.  However, FINRA provides a cost-effective arbitration forum that allows retail customers of brokerage securities firms to recover their lost investments much faster, and for far less money, than they would typically be able to in court.  This is due in part to arbitrations generally not being subject to appeal and arbitration having far less onerous discovery requirements, including not allowing depositions, generally speaking.   Arbitration in FINRA is also advantageous to investors because firms that lose in arbitration are incentivized to pay awards to customers within 30 days or otherwise have their brokerage licenses revoked.  While the firm is still operational, and while this case was waiting for the appeal to be decided, the owner of Lek Securities, Samuel Lek, who is also named in the instant lawsuit, was barred from the securities industry by FINRA and the Securities and Exchange Commission (SEC) in December of 2019.

In reversing the lower court’s decision, today’s order by the First Department holds that there was a customer relationship established between the investor and Lek Securities under the FINRA rules and in accordance with the law established in Global Mkts. Inc. v. Abbar, 761 F.3d 268 (2d. Cir. 2014) – a seminal case in which Malecki Law’s founder, Jenice Malecki, was instrumental in shaping and arguing before the Second Circuit.  The law in Abbar requires that to be a customer (and to therefore be eligible to arbitrate against a firm in FINRA), the investor must have either had an account or purchased a good or service from the firm.   In its court papers, Lek Securities claimed that the international investor had an account with the firm’s UK operations (LekUK), which is not subject to regulatory oversight in the United States, and that LekUK, in carrying out brokerage services for the investor, transferred the investor’s assets to the subject U.S. affiliate, and that any payment received by the Lek entity in the United States was incidental, and not received directly from the investor, but paid internally by LekUK.

Receiving a subpoena from the Securities and Exchange Commission (SEC) is a serious matter as is the associated document production most SEC subpoenas call for. Not only do most all SEC subpoenas require the production of vast amounts of documents, electronic files and data, the manner in which the SEC strictly requires production (see here for SEC data delivery standards) can be confusing for most, especially those not familiar with electronic discovery. Our securities regulatory attorneys frequently assist clients with examining, gathering and producing responsive documents and data for production in a format accepted by the SEC. Our securities regulatory attorneys utilize state of the art electronic discovery software and tools that reduce both the amount of time required of you and the billable hour.

All the documents and electronic data called for by the subpoena may seem overwhelming, however, ensuring that your production is both completely responsive and delivered in compliance with the SEC data delivery standards is one of the only ways in which you will be able to help the investigation proceed quicker to a final resolution. Often an issue for clients is the seemingly broad wording of SEC subpoenas, our securities regulatory attorneys are practiced in helping clients better understand what items are being sought by the SEC.  Thus, allowing you to limit your time spent searching for documents and data. A responsive and compliant production also limits the amount times that you and/or your attorney will need to spend in working with the SEC.  It is important to turn off any auto-delete functions that you may have in place to preserve your data and documents and DO NOT destroy anything. Not only will the destruction of any documents complicate your matter you may also face an obstruction charge.

It is imperative that you carefully comply in a timely manner with an SEC subpoena. The SEC can enforce a subpoena if you fail to comply with what the subpoena calls for and a failure to comply with court orders could result in contempt charges. Our securities regulatory attorneys are often able to negotiate the scope and timing of productions, including an extension of time for clients document production and testimony (if called for).It is also important that your response to the subpoena includes any legal objections that you may be entitled to. Remember, your response does not end the process.  The SEC may consider your Subpoena response for weeks or months before they decide whether further investigation is necessary.

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