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Articles Posted in Investment Fraud

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.

Last week, the Financial Industry Regulatory Authority (FINRA) censured and assessed a fine of $50,000 against a national investment firm, Paulson Investment Company LLC, in connection with its sale and solicitation of private placement offerings to investors, in violation of Rule 506 of Regulation D and Section 5 of the Securities Act of 1933.  Among other things, Regulation D (more commonly known as Reg D) provides a legal “safe harbor” for investment firms to sell and market private placements, which are restricted securities (i.e., not traded on a public market and therefore carry more risk), to no more than 35 non-accredited investors, provided the firm has a pre-existing relationship with that investor.  The law is intended to prevent advertising and marketing to non-accredited investors – a legal term for those who do not have the requisite financial means to bear risk or who are unsophisticated and cannot appreciate the risks of purchasing an investment that is typically illiquid and cannot readily be traded on a national exchange.  In violation of Reg D, as well as FINRA Rule 2010 (requiring all member firms to conduct their business with high standards of commercial honor), FINRA found that Paulson solicited 11 individuals and sold six separate private placement offerings, totaling approximately $4.5 million, prior to having a pre-existing and substantive relationship with these investors.

Perhaps this barely registers as a newsworthy event; brokerage firms are censured and fined all the time by regulators, and for much more than $50,000.  Paulson is considered a small to medium-sized firm and it is registered in 53 states and territories.  The firm has been licensed as a member brokerage firm with FINRA since 1971 and has carried its registration as an investment advisory firm with the Securities and Exchange Commission (SEC) since 1983.  However, there are other recent developments at Paulson, particularly at its 40 Wall Street office in New York City, which should give pause to any investor or prospective retiree.

While Paulson derives more than 50% of its revenue from underwriting activities, it also engages in general brokerage activities by buying and selling investments for retail investors.  Among the brokers or registered employees at its Wall Street address, there are currently seven individuals with at least 3 or more public disclosures in the Central Registration Depository (CRD) known as BrokerCheck, a national database that tracks the background and disciplinary history of stockbrokers and other financial professional concerning customer complaints, regulatory or criminal events, and other financial disclosures (such as personal bankruptcy or tax liens).  This is significant, because, according to FINRA, most brokers have a clean history, with approximately 4% having been subject to at least one customer complaint, but only less than 0.41% with 3 or more BrokerCheck complaints.   Paulson’s Wall Street office alone employs seven such individuals with 3 or more disclosures.  But this is only scratching the surface.

Last week, a New York City panel of arbitrators with the Financial Industry Regulatory Authority (FINRA) unanimously awarded an investor represented by Malecki Law over $200,000 in damages, plus attorneys’ fees of $67,000 and 5% interest dating back to May 2018.  The panel’s award found the New Jersey-based brokerage firm Network 1 Financial Securities Inc. to be liable in connection with the investor’s allegations of unsuitable investment recommendations, misrepresentations (NY General Business Law § 349), and failure to supervise its broker/financial adviser, Robert Ciaccio, who now has 7 disclosures on his public FINRA BrokerCheck disciplinary record (5 customer complaints and 2 regulatory censures).  The investment at issue was Proshares Ultra Bloomberg Crude Oil 2X (otherwise known by its stock symbol UCO), which Mr. Ciaccio recommended to the investor but failed to disclose the numerous risks associated with this product, which belongs to a group of products known as Non-Traditional Exchange Traded Funds (or Non-Traditional ETFs).

FINRA, the Securities and Exchange Commission (SEC), and other regulators have repeatedly warned firms against selling Non-Traditional ETFs because they are difficult to understand and carry risks that are not easily understood by the typical investor.  Unlike a simple investment like a stock or bond, Non-Traditional ETFs are fee-laden, structured products, built with derivatives and complex mathematical formulas, which, in “simplest” terms, offer leverage and are designed to perform inversely to an outside benchmark index (e.g., the S&P 500, VIX, etc.).  Noting the popularity of these high-risk, high-cost products, FINRA has issued numerous investor alerts and warnings to member brokerage firms about Non-Traditional ETFs, stating:

“While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets….  In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met.”

With the highly-publicized Bernie Madoff Ponzi scheme, which resulted in an ABC mini-series and the HBO original movie, Wizard of Lies, investors might tend to think that Ponzis are a thing of the past.  But Ponzi schemes are alive and well, and may even be on the rise.  According to a New York Times report from last week, the United States Securities and Exchange Commission (SEC) has prosecuted 50 percent more Ponzi cases in the last 10 years since the Madoff scheme was busted, affecting over 4 million investors in 291 Ponzi cases, ultimately costing investors more than $31 billion in losses.

This week, the SEC filed charges against yet another Ponzi fraudster, James T. Booth, who the SEC alleges to have conducted a multi-year scheme, defrauding approximately 40 investors out of up to $10 million.  The SEC complaint alleges that Mr. Booth fabricated elaborate account statements for his clients, many of whom were seniors and unsophisticated investors who utilized Mr. Booth to manage their retirement savings.  Mr. Booth is 74 years old and resides in Norwalk Connecticut, and he is the founder of Booth Financial Associates, a firm originally created by Booth to sell advisory services and insurance products.

Mr. Booth was also a financial advisor registered with the investment advisory and brokerage firm LPL Financial LLC, a firm that is registered with the SEC and the Financial Industry Regulatory Authority (FINRA).  Over time, Mr. Booth would solicit his customers from LPL to wire money away from LPL to invest in opportunities elsewhere, with promises of safer investments or higher returns.

FINRA-registered brokerage firm, Nomura Securities International, Inc., will pay over $25 million to settle the SEC’s allegations that its supervisory shortcomings permitted traders to defraud customers in transactions involving mortgage-backed securities. In two related enforcement actions, the SEC details how five former Nomura brokers allegedly made misrepresentations to customers while selling non-agency commercial real estate (CMBS) and residential mortgage-backed securities (RMBS) between 2010 and 2014. As part of the settlement, Nomura will pay $20.7 million to RMBS customers and $4.2 million to CMBS customers as reimbursement for profits obtained from the brokers’ misrepresentations along with a$1.5 million regulatory fine. Our investor fraud lawyers highlight this case as an example of the potential fraud that could occur in markets as opaque as that for mortgage-backed securities.

According to the SEC, Nomura traders allegedly mislead customers about the cost of the securities and the profit the firm would receive from transactions. Notably, the traders reportedly inflated the prices of securities by sometimes even doubling the actual cost. The SEC also alleges that the Nomura brokers would sometimes claim to still be in negotiations with a third party while already having the mortgage-backed securities in their possession. The traders were able to get away with their misrepresentations because the secondary trading market for mortgage-backed securities does not make trade prices public. Therefore, customers can only rely on the words of their financial professionals. The trust should have been safeguarded by proper oversight by the brokerage firm. However, Nomura’s alleged “weak” supervisory procedures enabled otherwise discernible and preventable fraud to go undetected.

Mortgage-backed securities are fixed-income investments collateralized by a pool of residential or commercial real estate loans. The creation process of these asset-backed securities entails banks selling mortgages to an entity that securitizes the pool for sale to investors. Entities that issue mortgage-backed securities could be a federal government agency, government-sponsored enterprise, or a securities firm. Investing in mortgage-backed securities entitles the investor to the interest payments and principal paid by the original burrower. Investors can expect a coupon rate, known as the yield, equivalent to the borrower’s payments to their mortgage. The amount of risk involved in mortgage-backed securities depends on the issuer. Mortgage-backed securities issued by the Government National Mortgage Association, a U.S government agency guarantee that investors receive timely payments. However, private institution-issued mortgage-backed securities do not have such protections.

A Ponzi Scheme is a type of investment fraud that pays purported “returns” to current investors from proceeds received from new investors, rather than through genuine investments. Once the fraudster stops receiving new money or investors request too much of their money back, the Ponzi Scheme falls apart. The term for Ponzi Scheme is from a famous 1920s con man, Charles Ponzi who redistributed investor funds for international reply coupons to himself and other investors. More recently, thousands of investors, many of whom were elderly lost their money in a billion-dollar Ponzi Scheme perpetrated by the Robert Shapiro Woodbridge Group. Not all Ponzi Schemes are as large and notorious as that committed by Bernie Madoff. Many more Ponzi Schemes happen on a much smaller basis and go undetected.

Malecki Law has handled numerous Ponzi cases: McGinn Smith, Robert Van Zandt, Hector May, Illume, and Steven Pagartanis, just to name a few. We are available to review your situation at no cost. Catching these things early inures to your benefit. Investors can fight to recoup their losses from a Ponzi Scheme committed under a FINRA registered firm through arbitration.

Our securities fraud law team aims to equip investors with the knowledge to spot not only Ponzi Schemes but other fraudulent investment opportunities as well. Everyone should be aware of the following signs that could indicate a Ponzi Scheme.

Arbitration is a formal alternative to courtroom litigation for resolving issues with neutral third party “arbitrators” issuing a binding decision after the litigants present their facts and argument. Compared to the usual courtroom procedures, arbitration is a faster, affordable and less formal legal proceeding.  FINRA, a self-regulatory-agency for the securities industry, controls the largest, most prominent arbitration forum for securities disputes. A full FINRA arbitration proceeding from initiation through hearing can take on average 16 months, but cases often are settled before the end. Sick or elderly claimants may request an expedited arbitration process within nine months.

There is a wide range of reasons that investors might want to make a legal claim against their broker-dealer and broker firm. When opening an account with brokerage firms, investors sign a contract that often contains a clause that makes handling disputes through FINRA arbitration mandatory. Notably, investors are bound to arbitrate their securities claim after the Supreme Court upheld binding arbitration provisions in Shearson/American Express Inc. v. McMahon. FINRA registered broker-dealers, and registered representatives are similarly obligated to handle disputes arising through their employment in FINRA arbitration.

The FINRA arbitration process commences when the plaintiff, known as the claimant, submits a statement of claim, outlining the case’s relevant facts, dates, names of involved parties, type of relief requested and name of accused parties. The statement of claim must be filed within the allotted time, which is within six years after the dispute. Compared with a courtroom complaint, a statement of claim is less formal and usually a more detailed account of the background story. In addition to the statement of claim, the claimant needs to pay fees and submit a Submission Agreement. The fees owed for filing a FINRA arbitration claim are based off the sought remedies, hearing sessions, discovery motions and postponement fees. Fortunately, some individuals with financial difficulties can request a fee waiver.

We have previously written on the concept of “churning,” which is a fraud perpetrated by brokers who buy and sell securities for the primary purpose of generating a commission, and where that activity would be considered excessive in light of the investor’s investment goals.  But is it possible to have a churning claim when a broker sells you an insurance product or recommends swapping out one variable annuity policy for another?  And can a single transaction be considered “excessive” in the context of a churning claim?  The answer to both of these questions is yes.

The law appears to provide an opening for churning claims when it comes to investors, and in particular retirees, who find themselves “stuck” with an illiquid annuity in their portfolio.  Retirees, who tend to need access to capital more than other segments of the population (due to not working and the increased medical costs associated with getting sick and old), are often sold unsuitable variable annuities, which can tie up retirement funds for decades.  Technically the investor can get of the policy, but not without paying significant IRS tax penalties and steep surrender charges, sometimes as high as 10% to 15%.  Sadly, these costs and product features are often misrepresented and go undisclosed at the point of sale.

While not all annuities are considered securities under the law, variable annuities certainly are securities.  The SEC requires the seller of a variable annuity to possess a Series 6 or 7 brokerage license with the Financial Industry and Regulatory Authority (FINRA).  Variable annuities can be distinguished from fixed annuities in that their returns are not fixed, but rather determined by the performance of the stock market.  One characteristic of a variable annuity policy is that you get to choose a fund to invest in, much like you would with a mutual fund.  Variable annuities are highly complex investment products.  They are also costly to investors, in part because of the high commissions they generate for the brokers who sell them.  Regardless of whether you were sold a variable annuity or some other type, it should be noted that FINRA requires its member brokerage firms to monitor all products sold by their brokers.

Former President and CEO of a luxury real estate development company in White Plains pled guilty to federal charges after allegedly orchestrating a 58-million-dollar Ponzi Scheme. Last week, Michael D’Alessio pled guilty to one count of wire fraud and one count of concealing assets from a bankruptcy court following his arrest in August. Michael D’Alessio reportedly solicited investor funds for investments in luxury real estate development projects in Westchester, Manhattan and the Hamptons for years. In return for their money, investors were promised monthly interest payments and shares in the properties. Instead, Michael D’Alessio funneled investor money into multiple shell companies to repurpose at his leisure in a Ponzi-like fashion.

Michael D’ Alessio allegedly misappropriated investor funds that should have been used for investments in real estate through his company from 2015 until April 2018. Michael D’Alessio’s former company, Michael Paul Enterprises reportedly specialized in the design, construction, and management of commercial as well as residential real estate. As part of the alleged Ponzi-scheme, investors were offered shares in real estate properties with guaranteed monthly interest payments and profits. Our attorneys specializing in Ponzi Schemes know that any promises of guaranteed returns should usually raise a red flag.

In addition to the suspicious promises, our investment fraud attorneys find that Michael Alessio’s alleged behavior is indicative of your typical Ponzi Scheme perpetrator. In Ponzi schemes, a perpetrator solicits new investor money to pay falsified returns to existing investors. It is alleged that Michael D’Alessio created a limited liability company for each new property to offer shares. Michael D’ Alessio did not keep investor money within the appropriate companies as expected. Rather, Michael D’Alessio reallocated investors’ individual property’s money to cover shortages in separate ones as well as pay his personal expenses. For instance, Michael D’Alessio used investor money to pay off significant gambling debts.

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