Investor Fraud

FINRA RULES EX PARTE TEMPORARY RESTRAINING ORDER RESULTS IN STATUTORY DISQUALIFICATION

October 4, 2022 | Herskovits, PLLC

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FINRA’s Office of Hearing Officers recently rendered a decision on an issue of first impression in Dep’t of Enforcement v. NYPPEX, LLC, et al., (Disc. Proc. No. 2019064813801). Enforcement charged FINRA member firm, NYPPEX, LLC, its former CEO, Laurence Allen, and its CCO, Michael Schunk, with numerous violations of FINRA rules. The charges stemmed from Respondents’ conduct in the wake of a temporary restraining order issued by a New York state court against Allen. Among other things, the order, obtained at the behest of the Office of the Attorney General for the State of New York (“NYAG”), enjoined Allen from engaging in securities fraud and violating New York’s securities laws. Enforcement took the position that the TRO rendered Allen statutorily disqualified from continued association with a FINRA member firm. Allen could have remained associated with the Firm if it applied for, and received, FINRA’s permission pursuant to FINRA Rule 9520. Allen’s supervisor, Schunk, however, purportedly let Allen continue as an associated person at NYPPEX for over a year without seeking a waiver from FINRA.

FINRA’s disciplinary proceeding was triggered by the ex parte TRO. After a two-year investigation, in December 2018, the NYAG commenced an action under Article 23-A of New York’s General Business Law, known as the Martin Act, against Allen and certain others. The NYAG applied on an ex parte basis for preliminary injunctive relief against Allen, NYPPEX Holdings, and others under Section 354 of New York’s General Business Law. The NYAG stated that a preliminary injunction was warranted because of the allegations of fraud and fraudulent practices by Allen and his refusal to produce documents or appear for testimony. In December 2018, the Supreme Court of the State of New York granted the NYAG the relief it sought and issued the TRO without hearing from Allen or NYPPEX. Allan was served with the Order in January 2019 and Schunk learned about it that month as well.

On December 4, 2019, the NYAG filed a complaint in the New York Supreme Court against NYPPEX, Allen and others (Index No. 452378/2019). In February 2020, the New York Supreme Court concluded a five-day hearing and issued a preliminary injunction prohibiting Allen and NYPPEX from, among other things, violating the Martin Act and from “facilitating, allowing or participating in the purchase, sale or transfer of any limited partnership interest in [the fund].” At this point in time, NYPPEX filed an MC-400 Application seeking permission for NYPPEX to remain associated with a disqualified person, Allen. FINRA Enforcement, however, argued that Allen became statutorily disqualified when the TRO was issued in 2018, more than a year before NYPPEX filed the MC-400 Application.

Will We See a Spike in Margin Liquidations Due to SEC Guidance?

March 15, 2022 | Herskovits, PLLC

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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.

THE SEC’s WAR ON 12b-1 FEES

June 9, 2020 | Herskovits, PLLC

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It has long been clear that the SEC opposes 12b-1 fees, the fees that funds use to compensate investment advisors for their sales and marketing efforts. For the past two decades, the SEC has embarked upon various attempts to repeal Rule 12b-1 or render it meaningless. The SEC, however, has never been able to build the political will to amend or repeal Rule 12b-1 and it remains the law.

The SEC’s latest attack on 12b-1 is a classic example of rule-making by enforcement. On February 12, 2018, the SEC issued a press release announcing its new Share Class Selection Disclosure Initiative (SCSD Initiative). The SCSD Initiative relies on Section 206 of the Investment Advisers Act of 1940 (the “Advisers Act”) which imposes a fiduciary duty on investment advisers to act in their clients’ best interests, including an affirmative duty to disclose all conflicts of interest. When an adviser receives 12b-1 fees from a mutual fund it presents a possible conflict of interest if a less expensive share class is available. Prior to the SCSD Initiative, the industry standard was to disclose this conflict of interest in a straight forward manner.

The SCSD Initiative and subsequent guidance put out through FAQs has effectively amended 12b-1 by requiring disclosure of:

FINRA BARS FA JAMES DAUGHTRY FOR FAILING TO COOPERATE WITH THE REGULATOR

March 23, 2020 | Herskovits, PLLC

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On March 18, 2020, FINRA barred FA James Daughtry for his refusal to appear for an on-the-record interview, which is akin to a deposition. Daughtry consented to the bar from the securities industry by executing the Letter of Acceptance, Waiver and Consent (AWC) in Department of Enforcement v. James Blake Daughtry, Matter No. 2020065293201.

Background

According to BrokerCheck, Daughtry entered the securities industry in 1999. He registered with Kestra Investment Services, LLC in February 2015 and remained with Kestra until his termination in March 2020. James Daughtry worked from a branch located in Dothan, Alabama.

FEDERAL COURT EXPANDS THE DEFINITION OF “CUSTOMER” FOR PURPOSES OF COMPELLING FINRA ARBITRATION

March 20, 2020 | Herskovits, PLLC

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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.

VIRGINIA BANS MANDATORY ARBITRATION IN ADVISORY AGREEMENTS

February 5, 2020 | Herskovits, PLLC

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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

FINRA BARS A SUPERVISOR FOR THE MISDEEDS OF ANOTHER

January 31, 2020 | Herskovits, PLLC

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Courts call a lifetime bar “the securities industry equivalent of capital punishment.” PAZ Sec. Inc. v. SEC, 494 F.3d 1059, 1065 (D.C. Cir. 2007). It is a draconian measure which not only permanently removes you from the securities industry but also subjects you to “statutory disqualification” under Section 3(a)(39)(A) of the Securities Exchange Act of 1934 and all the collateral consequences that come with it.

Given the seriousness of a lifetime bar, a recently released AWC presents an alarming fact pattern in which a supervisor was barred due to the transgressions of an FA he failed to properly supervise. Let’s consider the case of Michael Leahy, FINRA Case No. 2019063631802. The question is, why did FINRA go after the supervisor with guns blazing?

The Applicable Rule: FINRA Rule 3110

Massachusetts Watchdog Targets Broker-Dealers’ Inadequate Oversight of Private Placements

July 11, 2018 | Herskovits, PLLC

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The head of Massachusetts’ state securities regulatory body, Secretary of the Commonwealth William F. Galvin, issued a public statement announcing an inquiry into the practices of some of the top local broker-dealers related to private placement investments.

These funding rounds of securities, which are not sold through a public offering, but rather, presented to a select group of investors, commonly involve a higher risk of fraud.

The list of companies that have already received an inquiry letter from Galvin’s office includes, among others, Arthur W. Wood, Bolton Global Capital, Advisory Group, Santander Securities, LPL, U.S. Boston Capital, and BTS Securities.

WELLS FARGO Will Pay $480 Million to Settle Fraud & Insider Trading Class Action Brought by Shareholders

July 9, 2018 | Herskovits, PLLC

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Wells Fargo will pay $480 million to resolve fraud and insider trading allegations brought in a class action in California.

According to the plaintiffs, top executives at the bank engaged in insider trading after employees were directed to create millions of accounts under customer names, without the customers’ consent.

While litigation in California state court continues, the settlement will end the federal lawsuit.

California Attorney Found Guilty in Pump-and-Dump Scheme Case Involving Greenway Technology and Crown Marketing

June 16, 2018 | Herskovits, PLLC

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Jehu Hand, a California-based attorney has been found guilty of securities fraud and is now awaiting sentencing. Following his trial, which took place in Boston, the defendant could be facing up to eight years in prison.

The federal jury found that Hand conspired with his two brothers to run a pump-and-dump scheme by falsifying documents. According to the evidence presented during trial, the defendant and his co-conspirators fraudulently obtained $1.5 million through the scheme.

Hand and his brothers allegedly misrepresented Greenway Technology Inc. as a company with tremendous potential, which was about to acquire lucrative gay-friendly hotels in California and Nevada.