FINRA recently published an AWC entered into with Richard L. Langer, a registered representative with Planner Securities LLC. FINRA accused Langer of violating FINRA Rules 2210 and 2220. FINRA Rule 2210 governs communications by registered representatives with the public and FINRA Rule 2220 sets forth requirements with respect to options-related communications.

The review of Langer’s communications originated with a cycle examination conducted by FINRA Member Supervision. According to FINRA, between January 2016 and November 2019, Langer maintained a public Facebook page for an investment club he operated. Langer authored 20 posts on the Facebook page regarding the performance, investment returns, industry standing, and purported successes of the investment club and a separate hedge fund at which Langer traded.

For example, on January 9, 2018, Langer posted:

Good Day to all! Hope everyone had a wonderful Holiday season and wishing everyone a healthy and happy 2018! We did it yet again! #2 top performing options hedge fund for November 2017, 1.93% return. With a year to date return on invest of 29.12% We still remain the Top performing options Hedge fund in 2017!! i can tell you that December record breaking return (to be released in 2 weeks) put us over 34% return for 2017 making [Hedge Fund A] the #1 options strategy hedge fund on the street for 2017,, That’s back to back years we took # 1 best performing options strategy hedge fund on the Planet !! interested in putting your money to work for you? Ask us.

FINRA Rule 2210(d)(l)(A) provides that:

[a]II member communications must be based on principles of fair dealing and good faith, must be fair and balanced, and must provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service. No member may omit any material fact or qualification if the omission, in light of the context of the material presented, would cause the communications to be misleading.

FINRA found Langer’s Facebook posts violative of Rule 2210 because they provided only positive news about the hedge fund and the investment club and did not disclose any risks associated with these investments. As such, the posts did not, “provide a sound basis for evaluating the facts in regard to any particular security or type of security, industry, or service.”

Langer also published 11 Facebook posts regarding options. FINRA Rule 2220(d)(l)(A) provides that options communications regarding standardized options “must be limited to general descriptions of the options being discussed,” and “must not contain … past or projected performance figures, including annualized rates of return, or names of specific securities.” (emphasis added). Langer’s posts went beyond general descriptions and included performance of certain transactions. Langer also failed to state that options are not suitable for all investors as required by Rule 2220(d)(2)(A).

There are also two requirements to the rule that Langer failed to meet. First, retail options communications, “issued by a member concerning options shall be approved in advance by a Registered Options Principal designated by the member’s written supervisory procedures.” Second, retail options communications shall be submitted to the Advertising Regulation Department of FINRA … at least ten calendar days prior to use.” See FINRA Rule 2210(a)(5); FINRA Rule 2220(a)(l)(C).

“Retail” communications are those made to more than 25 retail investors with a 30-day period. Langer’s posts, which were made on a public Facebook page that had approximately 130 followers, are retail communications but Langer neither got approval from a Registered Options Principal before publishing nor were the communications submitted to the Advertising Regulation Department of FINRA.

For these violations, Langer agreed to a 10 business-day suspension and a $5,000 fine. Langer’s sanctions are at the very low end of the FINRA Sanctions Guidelines and arguably lenient given the number of posts, the three-year period of violative activity and the potential investor harm that could have arisen from this sort of marketing. Notably, the AWC is silent as to whether investors bought or sold securities based on the Facebook posts or whether they were subsequently harmed.

Herskovits PLLC has a nationwide practice defending against FINRA investigations and representing individuals in FINRA arbitration. Feel free to contact us at (212 897-5410.

On July 15, 2022, FINRA filed Regulatory Notice 22-15 and announced the amendment of its Code of Arbitration for Industry Disputes to conform to the Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021, Pub. L. No. 117-90, 136 Stat. 26 (2022). The amendments permit person with claims of sexual assault or sexual harassment to pursue those claims in court irrespective of any agreements otherwise mandating arbitration.

Background

FINRA members historically forced employees to arbitrate claims of sexual harassment or assault by use of agreements containing pre-dispute arbitration clauses. The pre-dispute arbitration clauses were typically contained within a Form U4, employment agreements or provisions within an employee manual that the employee was bound by.

Use of pre-dispute arbitration clauses for claims of sexual harassment or sexual assault was upended by the Ending Forced Arbitration of Sexual Assault and Sexual Harassment Act of 2021. FINRA has now changed its rules to comport with the Act.

Amendments to FINRA’s Rules FINRA Rule 2263 Rule 2263 (titled: Arbitration Disclosure to Associated Persons Signing or Acknowledging Form U4) now includes a new Section 4 stating:

“A party alleging a sexual assault claim or sexual harassment claim that has agreed to arbitrate before the dispute arose may elect post dispute not to arbitrate such a claim under the Code. Such a claim may be arbitrated if the parties have agreed to arbitrate it after the dispute arose.”

FINRA Rule 13100 Rule 13100 contains definitions applicable to the Code of Arbitration Procedure for Industry Disputes. FINRA has added a definition for “sexual assault claim,” meaning:

“a claim involving a nonconsensual sexual act or sexual contact, as such terms are defined in section 2246 of title 18 of the United States Code or similar applicable Tribal or State law, including when the victim lacks capacity to consent.”

FINRA also added a definition for “sexual harassment claim,” meaning:

“a claim relating to conduct that is alleged to constitute sexual harassment under applicable Federal, Tribal, or State law.”

FINRA Rule 13201 Rule 13201, as amended, applies to arbitration of statutory discrimination claims and codifies a prohibition against the use of pre-dispute arbitration agreements for claims under a whistleblower statute, or claims sexual harassment or sexual assault. Rule 13021 now includes a new Section (c) stating:

“A party alleging a sexual assault claim or sexual harassment claim that has agreed to arbitrate before the dispute arose may elect post dispute not to arbitrate such a claim under the Code. Such a claim may be arbitrated if the parties have agreed to arbitrate it after the dispute arose. If the parties arbitrate such a claim, the claim will be administered under Rule 13802.”

FINRA Rule 13803 Rule 13803 is triggered when a claimant files certain claims (such as a sexual harassment claim) in court and other claims (such as a compensation claim, for example) in arbitration. In an instance like this, a member is now permitted to file a motion forcing the employee to consolidate all outstanding claim in the court proceeding.

Herskovits PLLC has a nationwide practice representing individuals in the securities industry with claims of sexual assault or sexual harassment. Feel free to call us for a consultation at (212) 897-5410.

On May 6, 2022, FINRA released a “Discussion Paper – Expungement of Customer Dispute Information” (the “Discussion Paper”) to address what FINRA clearly sees as problems with the current system for expunging customer complains. Let’s be clear from the outset, FINRA is openly hostile to the expungement of customer complaint information. FINRA is particularly hostile to what they describe as “straight-in” expungement arbitrations where the financial advisor seeks expungement by naming their firm as the respondent (typically after a customer arbitration has settled).

As many practitioners know, FINRA passed an amendment, effective September 14, 2020, establishing a minimum filing fee for expungement arbitrations. The Discussion Paper touts the success of this amendment in reducing the number of straight-in expungement actions by 37% between 2019 and 2020. Thus, FINRA makes it clear that its goal is reduction of expungement claims rather than making sure the claims have merit.

The tone of the Discussion Paper starts off somewhat defensive as FINRA makes sure to let the public know how few expungements are actually awarded every year. Between January 2016 and December 2021, approximately 8 percent of financial advisors registered with FINRA had a customer dispute disclosure on their record and only 1 in 10 had customer dispute information expunged during that time period. If expungement of customer dispute information is so rare, it is hard to understand why FINRA has as they put it, “engaged in longstanding efforts with NASAA and state securities regulators to explore a redesign of the current expungement process.” I recently blogged about the Alabama Securities Commission’s (“ASC”) intervention into an expungement award confirmation proceeding and the ASC’s very dim view of the “straight-in” expungement process. In light of the intervention and then the subsequent release of this Discussion Paper, it seems likely that more state regulators than just Alabama are unhappy with the current expungement system.

The Discussion Paper notes that FINRA filed a new rule proposal with the SEC in September 2020 known as the “Special Roster Proposal.” The Special Roster Proposal entailed a number of measures that would make expungement of customer dispute information more difficult. For example, the Special Roster Proposal would:

• as its name implies, create a roster of arbitrators with specialized training,

• require a three member panel, and permit no strikes or stipulations to remove an arbitrator,

• set time limits to prevent expungement after more than six years from the complaint or two years from the close of a customer arbitration,

• provide notice to state regulators upon the filing of an expungement request, and

• require financial advisors, when an arbitration has been filed, to seek expungement from the same panel that hears the arbitration.

On May 18, 2021, FINRA withdrew the Special Roster Proposal from the SEC’s consideration “in response to concerns raised by the SEC staff . . . .” The Discussion Paper provides no insight as to what those concerns are but states FINRA’s intention to continue pursuing the Special Roster Proposal, and to “continuing discussion with NASAA . . . regarding a more fundamental redesign of the current expungement process . . . .”

To that end, the Discussion Paper raises a number of possible changes to the existing expungement process, including measures such as raising the standards for awarding expungement set forth in FINRA Rule 2080. FINRA is also considering altering what firms’ and financial advisors’ have to disclose in the first instance, presumably expanding the current universe of required disclosures. FINRA makes clear, however, that it plans on moving forward on a dual track approach. In the near term, FINRA wants to implement the Special Roster Proposal, presumably after addressing whatever concerns the SEC had. In the long term, FINRA wants to completely redesign the expungement process by doing away with arbitration of expungement of customer dispute information entirely and to rely instead on FINRA and state securities regulators to determine what disclosures can be expunged. The Discussion Paper raises many questions about how this “Administrative Process” would work and what it would look like. FINRA also acknowledges that implementing such a process is going to require SEC approval and possibly Congressional action. Putting the details aside, however, the Discussion Paper makes it clear that administrative control over expungement is what FINRA wants for the future.

Herskovits PLLC has a nationwide practice representing registered representatives with Form U4 and Form U5 expungement claim. Feel free to contact us at 212-8907-5410.

At a FINRA arbitration in September 2021, Mr. Kent Kirby, a financial advisor at UBS Financial Services, Inc., sought the expungement from CRD of five customer complaints spanning a time frame from 2002 through 2011. Mr. Kirby was successful in obtaining an award expunging all five occurrences despite the fact that one customer opposed the expungement in a pre-hearing brief and at the hearing. In a detailed award, the arbitrator found that each of the claims against Mr. Kirby were “factually impossible or erroneous” as required by FINRA Rule 2080(b)(1)(A) and “false” as required by FINRA Rule 2080(b)(1)(c). Mr. Kirby then filed an action in the Circuit Court of Palm Beach County, Florida to confirm the award. Kent Kirby v. FINRA, Case No. 50-2021-CA-013816 (15^th Judicial Cir., Palm Beach County, FL).

Many are familiar with FINRA Rule 2080, which involves the expungement of customer complaint information from a registered representative’s Form U4 and from the Central Registration Depository (“CRD”). Rule 2080 requires any arbitration award granting expungement of customer complaint information to be confirmed by a court order. In addition, the rep must name FINRA as a part to the court proceeding or request FINRA to waive that requirement.

What many practitioners may not know is that when FINRA receives a request for a waiver, it takes that request, along with accompanying documents, and sends it to all of the state regulators in each state where the individual is registered. See https://www.finra.org/registration-exams-ce/classic-crd/faq/finra-rule-2080-frequently-asked-questions

This is where the Alabama Securities Commission (“ASC”) stepped into the picture. On February 22, 2021, the ASC filed a Petition to Intervene in Mr. Kirby’s confirmation action and stated its intention to oppose confirmation of Kirby’s arbitration award and seek to vacate it pursuant to 9 U.S.C.A. § 10 and Fla. Stat. § 682.13. The motion to intervene was granted on consent.

The ASC argued, among other things, as the basis for its right to intervene, that the information in CRD is maintained by FINRA pursuant to FINRA’s CRD Agreement with the North American Securities Administration Association (“NASAA”). The CRD agreement explicitly states that the disclosure data in CRD “is owned by the participating stated where a broker is registered.” Thus, Alabama had a property interest in Mr. Kirby’s expungement.

Here is where things get interesting. First, FINRA did not waive the requirement that Kirby name FINRA in his petition for confirmation but then submitted a response to the petition that merely stated that, “FINRA has reviewed the arbitration award and the petition to confirm that was filed in this case. FINRA does not take a position on whether the award should be confirmed.” It leads one to wonder, why did FINRA insists that it be named as a party only to take no position on confirmation?

ASC, however, had no qualms about taking a position in its motion to vacate the award and the Alabama regulator came down hard on the arbitrator (“Arbitrator Linder”). The grounds for vacating an arbitration award pursuant to Florida law are a high hurdlel. The statute provides only a handful of reasons to vacate an award including:

1. where the award was procured by corruption, fraud, or undue means;
2. evident partiality of the arbitrators;
3. misconduct by the arbitrator; or
4. the arbitrator exceeded his powers.

The ASC was not shy about accusing Arbitrator Linder of all of these things; corruption, fraud, partiality, misconduct in refusing to hear evidence, and exceeding his powers.

The ASC did not stop at its criticism of the arbitrator but also attacked the whole process of what it named “straight-in expungement cases” which it described as cases in which the broker names his firm as the respondent. The ASC described these cases as “illusory” because the firm does not oppose the relief and the customers are not named as parties and do not typically participate because their underlying issue has already been resolved. ASC cited to a 2019 study that showed, between 2015 and 2019, 98% of firms did not oppose expungement and 87% of customers failed to participate.

ASC also pointed to studies that show that expungement was granted in 90% of “straight-in expungement cases” and that the data from those studies:

strongly suggests that brokers and their firms are coordinating with each other in the arbitrator selection process to hand-pick arbitrators who will most likely grant expungement.

(original emphasis). The ASC pointed out that Arbitrator Linder had presided over 36 expungements since 2015 and granted expungement in all but one case. ASC relied on this fact to argue that Arbitrator Linder was not an impartial trier of fact.

ASC also went to extraordinary measures to conduct its own investigation of Mr. Kirby’s arbitration and complaint history. ASC obtained the audio recording of the arbitration and created a transcript of the proceeding. ASC also contacted the customer who attended the expungement hearing, obtained an affidavit from him, and conducted a thorough review of the customers’ underlying complaint. The ASC’s presentation of the expungement arbitration as well as the customer’s underlying complaint reads much more like a statement of claim from a plaintiff’s attorney rather than a regulator. For example, it accuses Kirby multiple times of making false statements at the hearing simply because the ASC chooses to believe the customer’s version of events.

Ultimately, the ASC’s opposition to confirmation of Kirby’s award, alleges not just a single flawed award but it calls into question FINRA’s entire expungement regime as being corrupt. The fact that FINRA appeared in this action but took no stance as to confirmation stands in stark contrast to Alabama’s scathing 44 page memorandum of law. It remains to be seen if Alabama intends to frequently intervene in expungement award confirmations or if they found Mr. Kirby’s award particularly offensive. In any event, Alabama has fired a shot across FINRA’s bow that could spark rule changes surrounding what ASC calls of “straight-in expungement cases.”

We believe the Court can and should deny Alabama’s motion to vacate the award. If the State of Alabama has issues with the expungement process, the State should direct those concerns to FINRA and request rule changes. It is unfair, however, for the State to challenge a valid Award that was issued in accordance with FINRA’s rules.

Herskovits PLLC has a nationwide practice representing securities industry participants. Feel free to call for a consultation at 212-897-5410.

Herskovits PLLC is investigating whether Morgan Stanley unlawfully “forfeited” deferred compensation otherwise due and payable to financial advisers formerly employed by the firm. A class action lawsuit involving similar claims has begun in the U.S. District Court for the Southern District of New York. That litigation is in its early stages and may carry on for years before a resolution is reached.

Morgan Stanley’s Deferred Compensation Plan

Morgan Stanley compensates FAs based on revenues generated from the FA’s customers’ accounts. Morgan Stanley typically defers a portion of the fees generated as “deferred compensation” and allocates a substantial percentage of the FA’s deferred compensation to the Morgan Stanley Compensation Incentive Program. 75% of the deferred compensation vests over a six-year period and 25% vests over a four-year period. However, Morgan Stanley “cancels” the deferred compensation if the FA leaves Morgan Stanley prior to the vesting dates.

Potential Legal Claims

In simple terms, it can be argued that the deferred comp plan in an “employee benefit pension plan” under ERISA because it “results in a deferral of income” for services rendered years ago. If this argument proves successful, the deferred compensation program’s “cancellation rule” will be deemed a violation of ERISA’s vesting and anti-forfeiture requirements.

Where to Pursue these Claims?

Certain formerly employed FA’s may be eligible to join the class action lawsuit should the judge certify the class. It is unknown at this time whether or when the court will certify the class. Moreover, if the class is certified, it is unclear whether joining the class – as opposed to pursuing the ERISA claims on an individual basis in FINRA arbitration – is preferable avenue for the FA. FAs are always free to pursue their claims on an individual basis in FINRA arbitration.

Considerations for the FA When Deciding Whether and Where to Pursue the Claims

Class actions lawsuits sometimes result in recoveries of “pennies on the dollar” for the members of the class. This structure nonetheless serves the plaintiffs’ lawyers well, because the lawyers receive a substantial percentage of the class settlement – which may be a large pool of money – whether or not an individual class participant recovers much money.

Another consideration to weigh concerns claims which Morgan Stanley may assert. The firm can – and does – aggressively pursue claims for unpaid “employee forgivable loans” (EFLs). Morgan Stanley will pursue those EFL claims in FINRA arbitration. Therefore, the FA has to carefully weigh whether he would garner greater leverage by meeting the EFL claim with a deferred comp counterclaim in FINRA arbitration. By pursuing the deferred comp claim as part of a class, the FA would be left without a potentially potent defense against than EFL claims in FINRA arbitration.

A second consideration concerns the payout of any settlement in court versus arbitration. An FA has to make a determination when he believes he will recover more by pursuing his claims on an individual basis in FINRA arbitration.

Herskovits PLLC has a nationwide practice representing the interests of financial advisors, including FAs with claims for unpaid compensation. Please call us at 212-897-5410 for a consultation.

We are all painfully aware of the recent volatility in the markets, which has not gone unnoticed by the SEC. On March 14, 2022, the Staff of the Division of Trading and Markets stated that “broker-dealers should collect margin from counterparties to the fullest extent possible in accordance with any applicable regulatory and contractual requirements.” We shall see whether Wall Street acts upon the SEC’s guidance, and whether investors are caught flat-footed by stepped-up maintenance margin requirements.

Regulatory and Contractual Requirements

The regulatory requirements for margin are set forth in FINRA Rule 4210. Although the rule is lengthy, and incorporates other rules including Federal Reserve Board Regulation T, the essence of the rule allows a broker-dealer to lend a customer up to 50% of the total purchase price of an eligible stock. A margin call may be issued if the margin account falls beneath the maintenance margin requirements (generally 25% of the current market value of the securities in the account) or if the margin account falls below the firm’s “house” maintenance margin requirements (which can be substantially higher than 25%). Brokerage firms can, and often do, upwardly adjust “house” maintenance margin requirements if the firm has risk concerns relating to outstanding margin loans. Most margin account agreements specifically permit broker-dealers to increase maintenance margin requirements at the sole discretion of the firm. In light of the SEC’s recent guidance, it seems likely that broker-dealers will act upon its contractual rights and demand enlarged collateral from customers to protect its margin loans.

More Volatility Expected

A primary gauge of stock market volatility is the CBOE Volatility Index (VIX). The VIX volatility index measures how much volatility professional investors think the S&P 500 will experience over the coming month. The VIX index tracks volatility by analyzing trading in S&P 500 options. As a general proposition, a VIX index of 12 or lower is a period of low volatility and a VIX index of 20 or higher is abnormally high volatility. Currently, the VIX index currently sits at 31.04, which is approximately double where it sat in early January 2022.

Increase in FINRA Arbitration Claims?

Undoubtedly, any sizable increase maintenance margin requirements will trigger margin calls. That, coupled with abnormal market volatility, is a recipe for increased FINRA arbitration claims. Investors will point fingers at brokerage firms over suitability and brokerage firms will point fingers at investors for any unsecured debit balances.

Herskovits PLLC has a nationwide practice defending and prosecuting claims in FINRA arbitration. Feel free to call us for a consultation at (212) 897-5410.

The arbitration was conducted under FINRA’s simplified rules before a single public arbitrator and the Claimant represented herself without an attorney. Merrill Lynch was represented by the law firm Seyfarth Shaw LLP.

In her findings, the single arbitrator seemed particularly concerned that Merrill Lynch failed to even speak with the customer about the allegations in dispute. Merrill Lynch also failed to have the customer sign an affidavit supporting the allegations. The client in question was known to be suffering from memory problems so significant that Merrill Lynch terminated her as a brokerage client despite an account balance in excess of $500,000. The client had previously complained about unauthorized trading in her account by her primary advisor.

Reminiscent of the Wells Fargo account fraud scandal, several former Merrill Lynch employees testified that they were encouraged to open new accounts for customers even if the client had existing accounts. Those same former employees testified that the policy for opening up new accounts was “ambiguous and not uniformlty enforced.” Interestingly, the arbitrator noted that the Claimant “only earned $700” from opening up the account in question and concluded that, “[n]o reasonable person would have done so had he or she been aware of the severe consequences that would issue.”

Herskovits PLLC has a nationwide practice representing financial advisors with Form U5 and Form U4 expungement claims. Herskovits PLLC was recently featured in AdvisorHub for successfully obtaining expungement of an FAs Form U5 and even recouping attorneys’ fees. Feel free to contact us for a consultation at (212) 897-5410.

On November 19, 2020, FINRA published a noteworthy arbitration award for a Herskovits PLLC client in FINRA Arbitration No. 20-01054. This case has garnered significant attention in the press due to the fact that Wells Fargo was ordered to pay our client’s attorneys’ fees. Stories about the case have been reported in AdvisorHub, InvestmentNews and ThinkAdvisor.

On February 18, 2020, Wells Fargo terminated the FA and inserted the following allegation on the Form U5:

“WF Bank, N.A., registered banker was discharged by the bank after a bank investigation reviewed complaints received by AMIG from two bank customers alleging the customers were enrolled in renter’s insurance policies for which the banker received referral sales credit without the customers’ authorization. The registered banker denied the customers’ allegations. The activity was not related to the securities business of WFCS.”

The arbitrator deemed Wells Fargo’s disclosure to be defamatory in nature and ordered that (a) the reason for termination be changed from “discharged” to “other”; and (b) the termination explanation be changed to “Not for cause termination.” In addition, Wells Fargo was ordered to pay attorneys’ fees in the amount of $30,000.

Herskovits PLLC has a nationwide practice representing individuals and entities in FINRA investigations and FINRA arbitrations. Additionally, we routinely represent financial professionals in compensation and termination-related disputes, including Form U4/Form U5 expungement claims. We can contacted at 212-897-5410.

On September 22, 2020, FINRA submitted a proposed rule change to the SEC. The proposed rule furthers FINRAs assault on the expungement process by imposing stringent requirements on expungement requests filed during a customer arbitration by or on behalf of the associated person (“on-behalf-of request”) or filed by a registered representative separate from a customer arbitration (“straight-in request”). The proposed rule also (a) establishes a roster of arbitrators with enhanced training and experience, from which a panel of 3 arbitrators would decide straight-in requests; and (b) codifies and updates the Notice to Arbitrators and Parties on Expanded Expungement Guidance.

Here are some of the key takeaways from the proposed rule change:

Denial of FINRA Forum

FINRA proposes to change Rule 12203 (Customer Code) and Rule 13303 (Industry Code) to require the Director of Arbitration “to decline the use of the FINRA arbitration forum if the Director determines the expungement request is ineligible for arbitration under Rule 12805.”

Proposed Rule 12805 will provide substantial limitations on expungement requests as noted below:

Requesting Expungement When FA is Named as a Respondent in an Arbitration

• The associated person must seek expungement in the arbitration or shall be prohibited from seeking expungement at a later date. The associated person must include the expungement request in the answer or other pleading. The expungement request must include the applicable fee, CRD number of the party requesting expungement, CRD occurrence number that is the subject of the request, the case name and docket number that gave rise to the customer dispute information if applicable, and an explanation of whether expungement was previously sought and, if so, how it was decided.
• The associated person shall be prohibited from seeking expungement if (a) an arbitrator previously considered a request for expungement of the same customer dispute information; or (b) a court previously denied a request to expunge the same customer dispute information.
• If the arbitration settles, the panel cannot consider the expungement request and the associated must initiate a new arbitration against the member firm to obtain expungement.

Requesting Expungement on Behalf of an Unnamed Person

• A broker-dealer shall be prohibited from seeking expungement on behalf of an unnamed person if (a) an arbitrator previously considered a request for expungement of the same customer dispute information; or (b) a court previously denied a request to expunge the same customer dispute information
• The unnamed associated person must sign a form permitting the broker-dealer to seek expungement on her behalf.
• The unnamed is prohibited from intervening in the arbitration if the broker-dealer elects not to seek expungement on behalf of the unnamed person.
• If the arbitration settles, the panel cannot consider the expungement request and the associated must initiate a new arbitration against the member firm to obtain expungement.

Straight-in Expungement Requests

• An associated person is prohibited from filing an expungement claim if (a) an arbitrator or court previously denied a request to expunge the same customer dispute information; (b) the customer complaint or arbitration that gave rise to the customer dispute information is not closed; (c) more than 2 years have passed since the arbitration or litigation that gave rise to the customer dispute information has closed, or more than 6 years have passed since the customer complaint was reported to CRD.
• The customer must be notified of any expungement hearing.
• A panel of 3 public arbitrators with certain qualifications will hear the expungement request.

Expungement Hearing

• The panel must hold a recorded hearing.
• The associated person must appear at the hearing. A party requesting expungement on behalf of an unnamed person must also appear at the hearing.
• The customer has a right to appear at the hearing or otherwise state his position in writing. The customer has the right to testify at the hearing and offer opening and closing arguments.
• The panel must review any settlement agreement and consider the amount of payments and other terms of the settlement agreement. The panel must inquire whether a party conditioned a settlement on the customer’s non-opposition of the expungement request.

Herskovits PLLC has a nationwide practice prosecuting and defending FINRA arbitration claims, including expungement requests. Feel free to call us for a consultation. 212-897-5410.

In Next Financial Group, Inc. v. GMS Mine Repair and Maintenance, Inc., Case No. 3:19-cv-168 (USDC W.D. Pa.), the federal court was asked to define the term “customer” as it relates to FINRA’s Code of Arbitration Procedure. The definition of that term carries significance because “customers” can compel a member firm to participate in FINRA arbitration whereas non-customers cannot. In the case at hand, GMS Mine Repair had no account with Next Financial and received no goods or services from Next Financial itself. This case bears some significance because the court compelled arbitration even though GMS Mine Repair was nothing more than an investor in the FAs outside business activity.

Background

The case arose from a supposedly fraudulent investment scheme perpetrated by Douglas P. Simanski, a former registered representative of Next Financial Group. According to BrokerCheck, Next Financial terminated Douglas Simanski in May 2016 because “RR sold fictitious investment and converted funds for his own personal use and benefit.” Mr. Simanksi currently has 30 disclosures on his BrokerCheck report, reflecting numerous settled customer claims. On November 2, 2018, the SEC filed a complaint against Mr. Simanski alleging that Simanksi “raised over $3.9 million from approximately 27 investors by falsely representing he would invest their money in one of three ventures: (1) a ‘tax free investment’ providing a fixed return for a specific number of years; (2) one of two coal mining companies in which Simanski claimed to have an ownership interest; or (3) a rental car company.” According to BrokerCheck, the SEC ultimately barred Simanski and Simanski plead guilty to criminal charges filed by the U.S. Department of Justice.

Underlying Arbitration

In September 2019, GMS Mine Repair initiated a FINRA arbitration against Next Financial. Next Financial asked the court to enjoin the arbitration by arguing that GMS Mine Repair was not a “customer” of the firm. In particular, Next Financial argued that (i) GMS Mine Repair never had a brokerage account with Next Financial; (ii) GMS Mine Repair received no investment guidance from the firm; and (iii) Simanski’s actions were outside the scope of his employment with Next Financial (meaning, his actions concerned an outside business activity).

Despite Next Financial’s arguments, the court compelled arbitration by finding that:

“[GMS Mine Repair] is a customer of [Next Financial] because [GMS Mine Repair] purchased investment services from Simanski, an associated person of [Next Financial]. Simanski provided investment advice to [GMS Mine Repair] about a black diamond mining project, which is within [Next Financial’s] business activities because {Next Financial] is in the business of providing investment advice. It is not necessary for Simanski to be acting in his capacity as a representative of [Next Financial] when he provided investment advice to [GMS Mine Repair] for this dispute to be arbitrable … All that is required for this dispute to be arbitrable under FINRA is for Simanski’s actions to have ‘some connection’ to his business relationship with a FINRA member.”

Takeaway

This case should serve as a warning for those supervising outside business activities. If this case is adopted in other districts, investors in an FAs outside business activity can compel arbitration even if they have no direct relationship with a brokerage firm.

Herskovits PLLC has a nationwide FINRA arbitration practice concerning investment disputes and defends individuals and brokerage firm with FINRA investigations and disciplinary matters. Feel free to call us for a consultation at 212-897-5410.

New Rule

Virginia recently added Section F to 21 VAC5-80-200 (Dishonest or Unethical Practices), which provides: “For purposes of this section, any mandatory arbitration provision in an advisory contract shall be prohibited.”

Background

On June 27, 2019, Virginia issued a proposal to amend certain regulations administered by the Virginia Division of Securities. The State Corporation Commission noted:

“[S]tate-covered investment advisors are now including boilerplate mandatory arbitration provisions in their clients’ contracts. The Division believes, as do many other states, that these “take-it-or-leave-it” clauses in client contracts is inherently unfair to investors. It is particularly unfair when an investment advisor is required by law to act in the best interests of their clients. An investment advisor should not be allowed to force clients to bring any disputes to a forum of the investment advisor’s choosing by contract.

Therefore, the Division proposes to add a new subsection F to the Dishonest or Unethical Practices section of Chapter 80 to prohibit mandatory arbitration clauses in investment advisory contracts. There is nothing to prevent the investment advisor and their client from agreeing to arbitrated disputes after negotiation and discussion between each. To require mandatory arbitration in standard investment advisor contracts is contrary to the investment advisors mandate to act in the best interest of their clients.”

NASAA’s Position

Position statements of the North American Securities Administrators Association can often be viewed as predictive of future legislation by states. On August 9, 2019, NASAA made their views clearly known in a public comment. In supporting Virginia’s proposed amendment, NASAA stated: “Forced arbitration at the demand of an investment adviser is inimical to the basic fiduciary nature of an investment advisory relationship.” NASAA also made an interesting statutory argument concerning Va. Code. Ann. § 13.1-522(F):

“Although the issue has not been extensively litigated, a mandatory arbitration provision arguably would require an investment advisory customer to lose substantive rights under the Virginia Securities Act, namely the right to pursue a claim under the Act in state court, rendering the arbitration provision per se void under Section 522(F).”

Although NASAA’s argument is clever, it does seem to run counter to Virginia’s Division of Securities’ interpretation of its own code (“There is nothing to prevent the investment advisor and their client from agreeing to arbitrated disputes after negotiation and discussion between each.”).

Herskovits PLLC has a nationwide practice representing investment advisors in regulatory investigations, arbitration and litigation. Feel free to consult with us at 212-897-5410.

This blog post looks at an interesting FINRA arbitration award issued on January 7, 2020: Daniel Paul Motherway v. UBS Financial Services, Inc., FINRA Arbitration No. 17-02799. This case seems to prove the old adage: a man who is his own lawyer has a fool for a client. Here we have an FA who proved, quite literally, that UBS defamed him, but was nonetheless ordered to stroke a check to UBS for more than $1 million.

Background Facts

On June 28, 2017, UBS fired Motherway and offered the following termination explanation on BrokerCheck: “Financial Advisor’s employment was terminated after review concluded that he made false claims of merchant fraud on his personal credit and debit cards to an affiliate of the firm and made conflicting statement during the review.”

Apparently, UBS’s Form U5 disclosure didn’t sit well with the FA and he filed a FINRA arbitration against UBS for defamation, among other things. The FA sought $12 million in damages and expungement of the Form U5 disclosure.

UBS likewise filed a FINRA arbitration against the FA seeking repayment of an employee forgivable loan. UBS sought damages of $1,012,729, plus attorneys’ fees and expenses.

Underlying Arbitration

The arbitrators consolidated the 2 arbitrations over UBS’s objection. After 3 full days of hearings, the arbitrators found UBS’s termination disclosure to be defamatory and ordered that: (a) the reason for termination be changed to “other” (according to BrokerCheck, the current reason for termination is “discharged”), and (b) the Termination Explanation be changed to “termination for providing conflicting and misleading information in connection with the firm’s inquiry into a non-securities related matter.”

Regrettably for the FA, however, UBS’s Form U5 defamation did not relieve his obligation to repay the promissory note. The arbitrators really dropped the hammer here, ordering him to pay compensatory damages of $1,012,729, interest at 3% until the award is satisfied, $111,400 in attorneys’ fees, and $20,254 in “late fees,” whatever that may be.

This award underscores the fact that the odds are stacked against the FA when challenging a forgivable loan in FINRA arbitration. In this case, the FA got the money, he signed a promissory note, and the arbitrators strictly held him to the terms of the promissory note, which were likely clear and unambiguous. There are instances in which arbitrators refuse to order repayment of a promissory note. But those cases generally involve instances in which the firm actively took steps to harm the FA’s book of business.

Given that UBS’s conduct was questioned by the arbitrators, one is left to wonder whether the FA’s choice to go it alone was a wise one.

Herskovits PLLC has a nationwide FINRA arbitration practice. Feel free to call us for a consultation. 212-897-5410.

FINRA published an interesting arbitration award on December 27, 2019. In Raymond James & Associates, Inc. v. Gregory D. Clark (FINRA Case Number 18-04011), Raymond James claimed that Mr. Clark breached a settlement agreement related to the repayment of a promissory note. Raymond James requested, and was awarded, compensatory damages of $206,000 plus interest pursuant to Florida Statutes § 55.03. You can access the Award by clicking here.

Things get interesting when analyzing the procedural rulings of this case.

Motion to Bar Presentation of Defenses and Facts

Raymond James filed the claim on November 27, 2018 and Mr. Clark failed to file an answer. Perhaps Mr. Clark was unaware of FINRA Rule 13308, which permits an arbitrator to bar the presentation of any defenses or facts for a party that does not timely answer a claim. Not surprisingly, Raymond James filed a Motion to Bar on February 13, 2019 and the arbitrators granted the motion, with the caveat that Mr. Clark can “appear” and “move for relief.”

Apparently, Mr. Clark “appeared” sometime in May 2019 and filed a motion asking the arbitrators to reconsider the order barring him from presenting facts or defenses. Surprisingly, the arbitration panel denied that motion, yet curiously did so “without prejudice.”

So let’s unpack that. The arbitrators grant a motion to bar but invite Mr. Clark to “seek relief.” Mr. Clark’s follows up on the arbitrators’ invitation to seek relief, yet the arbitrators nonetheless deny the relief sought. However, when denying the relief sought, the arbitrators invited Mr. Clark to ask for the same relief at a later date. Hmmm.

As you may surmise, Mr. Clark did ask for the same relief again, this time at the hearing itself, which was held on December 2, 2019. According to the “Findings of Fact” section of the Award, Mr. Clark “endeavored to offer his own testimony” at the hearing. Raymond James objected (no surprise there). It is surprising, however, that the arbitrators sustained Raymond James’ objection and did so pursuant to the arbitrators’ original order granting Raymond James’ Motion to Bar filed in February 2019.

That is some curious logic by the arbitration panel. If the arbitrators were disinclined to hear Mr. Clark’s testimony, why did they invite him to “seek relief” in the first instance? And then when Mr. Clark did seek relief in May, which did they invite him to seek the same relief at a later date by denying the motion “without prejudice”?

But the arbitration panel’s odd rulings did not end there. According to the Award, Mr. Clark’s “representative was permitted to make a proffer of the testimony [Mr. Clark] would have presented had [Raymond James’] objection been overruled.”

What?? Are you kidding me?? The arbitrators refuse to hear testimony from a party and instead ask for a “proffer” from Mr. Clark’s non-attorney representative. And, just to kick Mr. Clark in the groin, the arbitrators noted that “the proffered evidence would not have changed the Panel’s ruling on the merits.” Ouch.

Although Raymond James was obviously well-represented by Dominque Heller, Esq., the arbitrators’ peculiar rulings would seem to invite a motion to vacate the award.

Herskovits PLLC has a nationwide FINRA arbitration practice. Robert Herskovits has successfully handled hundreds of FINRA arbitration. Feel free to call us for a consultation at 212-897-5410. Also feel free to review our practice area page here.

FINRA operates the largest securities dispute resolution forum in the United States. Virtually all disputes between customers and brokerage firms are resolved by arbitration before FINRA. Similarly, virtually all disputes between employees and brokerage firms are likewise resolved by arbitration before FINRA.

It is common in any arbitration that a party may seek documents or testimony from a non-party. If the non-party is a FINRA member or an employee of a FINRA member, the arbitrators are free simply to “order” that person or company to testify or supply documents (FINRA Rule 12513). However, does the jurisdiction of FINRA arbitrator extend to companies or persons that are not FINRA members or employees of FINRA members? The answer is, kind of sort of yes, but with some wrinkles.

Let me explain and take it from the top. First, the laws in the United States favor arbitration. The Federal Arbitration Act (ʺFAAʺ), 9 U.S.C. § 1 et seq., ʺreflects a legislative recognition of ʹthe desirability of arbitration as an alternative to the complications of litigation.ʹʺ Genesco, Inc. v. T. Kakiuchi & Co., 815 F.2d 840, 844 (2d Cir. 1987). Thus, one question is: does FINRA even have a rule which permits an arbitrator to issue a subpoena to a non-member or an individual not employed by a member? The answer is, yes: FINRA Rule 12512 states, “Arbitrators shall have the authority to issue subpoenas for the production of documents or the appearance of witnesses.”

Ok, so the next question is: what happens if the recipient of the subpoena refuses to comply? The answer to that question is found in two places. First, the answer is found in the FAA. Second, and importantly, the answer changes depending upon which court is interpreting the FAA.

The language of the FAA is pretty clear. Section 7 states:

The arbitrators selected either as prescribed in this title or otherwise, or a majority of them, may summon in writing any person to attend before them or any of them as a witness and in a proper case to bring with him or them any book, record, document, or paper which may be deemed material as evidence in the case. The fees for such attendance shall be the same as the fees of witnesses before masters of the United States courts. Said summons shall issue in the name of the arbitrator or arbitrators, or a majority of them, and shall be signed by the arbitrators, or a majority of them, and shall be directed to the said person and shall be served in the same manner as subpoenas to appear and testify before the court; if any person or persons so summoned to testify shall refuse or neglect to obey said summons, upon petition the United States district court for the district in which such arbitrators, or a majority of them, are sitting may compel the attendance of such person or persons before said arbitrator or arbitrators, or punish said person or persons for contempt in the same manner provided by law for securing the attendance of witnesses or their punishment for neglect or refusal to attend in the courts of the United States.

Ok, so the FAA clearly gives arbitrators the right to compel a non-party witness to appear at a hearing and bring documents with him. But does the FAA give an arbitrator the right to compel a non-party to produce documents in advance of a hearing? The answer to that depends on the judge you ask.

The U.S. Courts of Appeals for the Sixth and Eighth Circuits have answered the question in the affirmative. See Am. Fed’n of TV & Radio Artists v. WJBK-TV, 164 F.3d 1004, 1009 (6th Cir. 1999) and Sec. Life Ins. Co. of Am. v. Duncanson & Holt, 228 F.3d 865, 870-71 (8th Cir. 2000). However, the U.S. Courts of the Appeal for the Second and Third Circuits have answered the question in the negative. See Life Receivables Tr. v. Syndicate 102 at Lloyd’s of London, 549 F.3d 210, 216 (2d Cir. 2008) and Hay Grp., Inc. v. E.B.S. Acquisition Corp., 360 F.3d 404, 408 (3d Cir. 2004). The U.S. Court of Appeals for the Fourth Circuit sort of hedged it bets by answering the question with a maybe, depending on special need or hardship. See COMSAT Corp. v. NSF, 190 F.3d 269, 278 (4th Cir. 1999).

This blog post is limited to an analysis of in federal court, under the FAA. The analysis changes upon consideration of state laws. Some state statutes explicitly grant arbitrators the power to issue pre-hearing document production subpoenas on third parties See, e.g., 10 Del.Code § 5708(a) (2003) (“The arbitrators may compel the attendance of witnesses and the production of books, records, contracts, papers, accounts, and all other documents and evidence, and shall have the power to administer oaths.”); 42 Pa.C.S.A. § 7309 (“The arbitrators may issue subpoenas in the form prescribed by general rules for the attendance of witnesses and for the production of books, records, documents and other evidence.”).

Did you recently lose a serious amount of money because you took the bad advice given to you by your broker? If so, don’t despair. There may be a way for you to recoup the money that you invested. You may even be able to sue for punitive damages on top of the amount that you recently lost. To do so, you will need to contact a firm of experienced NYC investment fraud attorneys.

Don’t Let a Faulty Adviser Drain Your Investment Account If you were misled by a negligent or incompetent financial adviser, you may have recourse to the law. If you can prove that they intentionally misled you, mismanaged your funds, or otherwise behaved in an unlawful manner, you may be able to file a claim against them in arbitration.

You need to get on the phone to an experienced New York City investment fraud lawyer as soon as you suspect wrongdoing by a financial advisor. It’s best to take action immediately because all claims are subject to statutes of limitation and can be lost if not timely filed.

Contact the Firm of Herskovits PLLC Herskovits PLLC is a leading firm of NYC investment fraud attorneys that can help your get back the money that you lose due to heeding faulty advice from your broker or other investment adviser. We may also be able to get you a significant amount of damages to cover the financial hardship, as well as emotional pain and suffering, that you may have had to endure as a result of your loss.

If you want to make sure that the one who gave you bad financial advice gets their due punishment, come talk to us today. We can set up a no-cost initial consultation in order to get the facts of the case and devise a winning strategy. Our goal will be to get your money back plus additional damages if possible. Get in touch with us today to learn more.

When you have a FINRA arbitration case, it can be confusing if you are not familiar with the process. Since arbitration differs from a traditional court hearing, you need an attorney on your side who not only understands the FINRA arbitration process, but who has also helped clients obtain favorable outcomes. If you have an upcoming FINRA case, here are some ways arbitration can help turn the tide in your favor.

Non-Public and Confidential Hearings If you find yourself involved in a court hearing, it will almost certainly be a matter of public record. However, an arbitration hearing is far more confidential, with the only information available publicly being that which is posted on the FINRA Arbitration Awards online database.

Greater Power Over Who Hears Your Case Unlike a court hearing where you may have little control over which judge presides over your case and who sits on a jury, a FINRA arbitration hearing will allow you greater power over who rules on your case. In most situations, a panel of three arbitrators who are deemed to be qualified and neutral will decide the outcome of the hearing. Thus, by working with NYC securities arbitration attorneys at Herskovits PLLC you will have experienced lawyers on your side who are familiar with selecting individuals for this panel.

Less Costly Unlike court hearings where costs can add up quickly, a FINRA arbitration can cost you far less. Depending upon the total amount of your claim, filing fees can range from as little as $50 for claims of $1,000 or less to more than $2,000 if your claim exceeds $5 million or more.

If you have been the victim of broker negligence and fraud, schedule a consultation with Herskovits PLLC at once. By doing so, you will have NYC securities arbitration attorneys on your side who will protect your legal rights and help you gain the compensation you deserve.

The Appeals court’s ruling concluded the case against four former Aprio brokers, who failed to give 60 or 90 days’ notice before moving to Morgan Stanley, as it was established in their employment agreements.

Instead of giving Avrio a heads up, they announced they were leaving and quit on the same day. As soon as they had a foot out the door, they reached out to all their clients, in an attempt to bring them over to Morgan Stanley. Naturally, many followed, and Aprio lost a significant amount of business.

Aprio argued in court that Morgan Stanley had convinced the brokers that the Protocol would protect them from legal action by their former employer, superseding the advance-notice requirements in their contracts.

The aim of the Protocol, which dates back to 2004, is to discourage litigation and facilitate brokers’ transitions between firms. For example, it establishes what kind of client info brokers can take with them when they leave one firm for another.

When Morgan Stanley opted out of the Protocol, they referred to it as, “no longer sustainable,” adding that their exit would enable them to “invest more heavily in its world-class advisors and their teams,” and foster growth.

As per the recent ruling, the Protocol does not absolve departing brokers of their duty to give advance notice to employers. In the words of Judge Christopher McFadden, “the Protocol does not categorically invalidate notice provisions in employment agreements.”

Strictly speaking, the recent ruling refers to Georgia, but it could potentially be cited by courts and FINRA arbitration panels all over the country to undermine the Protocol, which already suffered a great blow when other top wirehouses, like Citigroup and UBS, followed on Morgan Stanley’s footsteps and exited it too.

For registered investment advisers, McFadden’s ruling seems to offer renewed protection from client poaching. Aprio’s CEO Richard Kopelman referred to it as “meaningful decision for small and midsize firms, especially for registered investment advisers that can feel confident they’ll be protected.”

When a broker gives advance notice, firms can have time to take precautions and ensure they do not take all their clients with them.

For these reasons, brokers who are going through this stage are kept on the payroll but with few duties, so as to prevent their potential poaching efforts.

The claims against the former Aprio brokers is not the only one in the case. There is a separate claim against Morgan Stanley for encouraging the brokers to leave without giving the required advance notice.

While FINRA panels are unlikely to cite the recent ruling as a precedent on a regular basis, it is possible that some courts will, further complicating an already complex regulatory scenario.

Rob Herskovits is a NY based securities lawyer with a nationwide practice. Herskovits PLLC, which he founded and leads, represents financial industry participants in legal and regulatory enforcement actions. Connect with Rob

A FINRA arbitration panel has just awarded James L. Springer Jr.; a Sarasota investment adviser, $3 million in damages, to be paid by his former employer, UBS. Springer, who managed $350 million in client assets during his 12 years with the company, claims UBS defamed him in a desperate attempt to keep his clients after he decided to leave.

In 2014, the broker prepared to leave UBS for a lucrative position at Merrill Lynch. Two days before he was supposed to resign, UBS fired him and proceeded to make allegedly false statements to his former clients.

UBS claimed Springer was being fired because he had used a corporate credit card to make personal purchases. The dollar amount of the purchases was, however, insignificant, especially when considering that the broker’s work yielded multi-million dollar profits for the company.

As a spokesperson for Springer Jr. put it, “You don’t fire a four-million dollar producer for a couple of hundred-dollar expense account errors.”

Springer’s initial demands included at least $63 million in damages and the expungement of the reason for termination. Still, the FINRA panel’s decision was seen as a victory for the broker, and I personally view it as a landmark resolution, since the $3 million award is one of the largest ever granted in a defamation case.

According to Springer’s claims, UBS falsely told his former clients that he had routinely acted against their best interests. After being hailed as one of UBS’s top 50 advisers, his reputation underwent radical change.

Immediately after Springer left UBS, his former clients were allegedly bombarded with calls and emails saying he had overcharged them on their fee-based accounts.

In order to retain the majority of Springer’s clients, UBS also offered them thousands of dollars in reimbursements, allegedly, to make up for losses connected to Springer’s practices.

As a result of UBS’s alleged defamation, Springer’s annual production was halved to $2 million. Upon learning of the firing, Merrill Lynch withdrew its job offer and the broker ended up with a total of 18 client disputes on BrokerCheck, which he is now looking to expunge.

Following over 50 hearing sessions initiated in 2016, on October 25, the FINRA arbitration panel found UBS liable, but denied Springer’s bid for punitive damages and attorney fees. As he awaits FINRA’s resolution in regards to his expungement request relating to UBS-client disputes, a spokesperson for Springer referred to the implications of the FINRA decision for the future, saying it will deter broker-dealers from using “these types of inappropriate tactics to retain clients.”

Financial industry employment or termination problems? Herskovits PLLC focuses exclusively on helping securities industry professionals and firms. Talk to an experienced securities lawyer or connect online.

Raiding, hiring groups of brokers from a competitor, happens frequently in the securities industry giving rise to complex disputes and damage claims. Whether your firm is the victim or the accused raiding entity, you will need to understand these basics:

• What is raiding in the securities industry?
• Which legal claims are asserted?
• How are the amounts of damages calculated?

Every circumstance has its own unique facts. As such, the information here should be considered an overview and you should consult a securities lawyer for the applicability in your situation.

What is Raiding in the Securities Industry?

An employee is generally free to decide whether he stays at or leaves his current employer. However, when multiple employees band together to join a competing firm, litigation often soon follows.

Raiding is a serious charge in which one company accuses another of intentionally trying to damage its business by poaching an office, business line or a team of significant producers. The stakes are high in raiding cases with claims for damages often running in the millions of dollars.

This post outlines important considerations for litigants who are wondering whether or not they can sue for raiding or who are starting a raiding lawsuit or defending against a claim of raiding and of course remember Herskovits PLLC is a securities law firm with one primary focus being raiding litigation and defense.

For brokerage firms in the securities industry, it can be difficult to discern the “line in the sand” between fair recruiting practices and recruiting by means of unfair competition (raiding).

Once litigation ensues, raiding claims can be difficult to settle because of:

1. Disagreement in the securities industry regarding what constitutes a compensable “raid”;
2. Lack of explained awards from arbitration panels when deciding raiding claims;
3. The absence of any generally acceptable methodology for calculating damages; and
4. The unique fact patterns of each raiding claim.

According to a recent American Bar Association article Raiding in the Securities Industry: The Search for Consensus, polling among conference participants found indicia of a raid if forty percent of the production of business unit were taken, or if the alleged raider’s behavior showed “malice/predation” and/or “improper means”.

The conference participants expressed differences on whether a one-person office could be raided, and how to treat satellite offices or offices in decline?

Legal Claims Commonly Asserted in Raiding Cases

Five primary legal claims are typical in raiding cases including Breach of Contract, Breach of Fiduciary Duty and Duty of Loyalty, Tortious Interference, Misappropriation of Trade Secrets or Confidential Information and Unfair Competition.

Let’s look at the legal and factual basis for each of those claims.

Breach of Contract

Facts commonly alleged could include breach of post-employment restraints including restraints against competition or restraints against solicitation of customers or employees.

Breach of Fiduciary Duty and Duty of Loyalty

Facts commonly asserted would seek to establish the degree of planning and coordination between the departing employees and the hiring company.

Tortious Interference

Tortious interference is also known as intentional interference with a contractual relationship.

Tortious interference with contractual relations occurs when one person intentionally damages someone else’s contractual or business relationships with a third party causing economic harm.

In other words, the competitor might intentionally encourage the targeted company’s employees to breach their employment contract, non-competition or non-solicitation agreement, confidentiality agreement, or even contracts with customers and vendors.

Notable Case: Front v. Khalil, 103 A.D.3d 481, 483 (1st Dept. 2013)

Misappropriation of Trade Secret or Confidential Information

Uniform Trade Secret Act (UTSA) defines misappropriation as,

“The acquisition of a trade secret of another with knowledge or reason to know that the trade secret was acquired by improper means…and the disclosure or use of a trade secret of another without express or implied consent.”

The UTSA defines a trade secret as,

“Information, including a formula, pattern, compilation, device, method, technique, or process” that carries economic value to the owner by reasonably not making the trade secret known or available to the owner’s competitors.

New York does not adopt UTSA. New York protects confidential information, which might not rise to the level of “trade secret.”

Notable Case: Ashland Mgmt. v. Janien, 82 N.Y.2d 395, 604 N.Y.S.2d 912, 624 N.E.2d 1007 (1993)

Unfair Competition

An unfair competition claim goes hand-in-hand with any employee raid lawsuit. It is a broad tort in business coupled with bad faith.

In order to support unfair competition claims, the claimant must demonstrate three things:

1. Claimants and respondents are competitors; and
2. Respondent competed in bad faith; and
3. Claimant suffered damages due to respondent’s bad faith competition.

Notable Case: Barbagallo v. Marcum LLP, 925 F.Supp.2d 275 (E.D.N.Y. 2013).

What Are the Likely Results of Raiding Claims?

A study in 2016 analyzed almost 100 arbitration awards concerning raiding disputes. The claimant was awarded damages about sixty percent of the time.

However, of the winning cases, the claimant was awarded at least half of the requested damages only about twenty-five percent of the time.

The median award was $500,000.

Common Defense in Raiding Cases

The “Life Boat” defense may be viable if the Respondent can prove:

1. The producers were planning on leaving the Claimant for honestly held, objectively verifiable and substantial reasons, and
2. The producers initiated communication with the hiring company and expressed an intention to seek new employment, and
3. The hiring company acted in good faith, and
4. The producers would have terminated their prior employment and accepted new employment whether or not hired by the respondent.

Calculation of Damages in Raiding Claim

Once a competitor Respondent’s liability for raiding the Claimant’s producers is demonstrated, the question then becomes:

How should the Competitor Respondent fairly compensate the Claimant?

What Damages Can or Can Not be Recovered from Raiding Claims?

Before looking at the detailed factors for estimating the damages in a raiding claim, these principles typically govern the big picture of what damages may or may not be recoverable.

Recoverable damages can include:

• Lost profits
• Compensation paid to producers during time period of breach of loyalty
• Loss of business value and/or goodwill
• Possible consultant fees, expert witness fees etc.
• Damages not routinely recovered can include:
• Punitive damages
• Attorneys’ fees

How to Estimate the Claimant’s Possible Award

Although in the securities industry, arbitration panels are the only forum for raiding claims, the panels are not required to, and usually do not articulate the reasons behind a finding of liability or how they come up with the amount of damages if any.

Below are compilations from various publications in terms of how to reasonably estimate the possible award to which the Claimant should be entitled.

Step 1: Avoided costs are subtracted from lost revenue in arriving at net profit lost.

Avoided costs usually include producer’s salaries and other variable costs associated with maintaining the producers who jumped ship.

Step 2: Separate loss of profits attributable to the raid from other reasons for the decline that might be unrelated to the raid.

Seeking damages from a successful raiding case is not the right way to recover all losses that the Claimant incurred during the time of raiding. It is unreasonable to solely rely on the profitability before and after the raid because it can be affected by general economic environment or any other reasons than raiding.

Step 3: It is important to note that the Claimant has a duty to mitigate its damages.

Mitigation of damages in this scenario means the claimant has to demonstrate that it has attempted reasonable efforts in replacing the lost producer. The qualified candidate to replace a lost producer might be hard to find, however, it does not mean that the Claimant is entitled to give up on mitigating its damages.

Step 4: Applying present value in calculation.

Because the lost profit represents an estimate of future expected revenue from the date of the raid, the future value of accumulated yearly loss of revenues should be discounted to a present value as of the date of the raid to represent meaningful calculation.

Fortunately, there are well-designed financial tools for calculating present value.

Step 5: Both parties present calculation of damages, arbitration panel decides the final number.

As the Respondent has the opportunity to also present its calculation of damages, a sound damage analysis is essential in persuading the arbitration panel. But be aware that the panel can disregard either party’s calculation and come up with its own number.

A sound damage analysis requires the application of reasonable assumptions.

Below are two common approaches reasonable assumptions can be based on in deciding the dollar amount of lost revenue:

1. Historical Approach. The historical approach uses the producers’ previous record of production prior to the raid to estimate the amount of production lost resulting from the raid. In applying historical approach, it is important to decide how far back to go because the record should be far back enough to avoid transitory impact from the raid, yet recent enough to be meaningful.
2. Benchmark Approach. Benchmark approach uses the production of similarly situated producers who stayed with the Claimant as a benchmark to decide the amount of lost production. Naturally, it is important to choose the appropriate benchmark for the approach to be meaningful. Usually, appropriate benchmark means producers who are within the same geographical and demographic area, and similar brokerage activities. One can also apply reputable third parties’ calculation of benchmark as reliable source.

A Sampling of Recent FINRA Arbitrations

• 14-01797 Fulcrum Advisory Services, LLC, Fulcrum Securities, LLC v. Bloxom et al.
• 14-00897 David Lerner Associates, Inc. v. Kovac, et al.
• 15-02080 BMO Harris Financial Advisors, Inc. v. Moscicki et al.
• 15-01217 David A. Noyes & Company v. Falco et al.

Do you have questions about Raiding Claims, FINRA Arbitrations or other Securities Law Matters? Call us at Herskovits PLLC. Securities Litigation and FINRA Arbitrations is what we do: 212.897.5410 or Email US