Hearing Panel Dismisses Claims Against Charles Schwab & Company, Inc. Concerning Class Action Waiver

February 22, 2013 By Jay Eng

Yesterday, a Hearing Panel dismissed two claims brought by FINRA against Charles Schwab & Company (the “Broker”), Inc. concerning the Broker’s use of new provisions in customer agreements which provide that any customer claim against the Broker must be arbitrated solely on an individual, case-by-case basis.  The provisions provide that customers “waive any right to bring a class action, or any type of representative action” against the Broker or any related third party “in court.”  This would force all customer claims to arbitration without exception.   Since FINRA rules prohibit class actions in arbitration, the provision would have the effect of barring any class actions against the Broker in any forum.

In response to the use of these new provisions, FINRA brought an enforcement action against the Broker claiming that such class action waivers violate FINRA rules which prohibit members from imposing “limits” on the ability of a party to file a a claim in court if the rules of the of the forum where the claim might otherwise be filed permit filing in court.

According to the Decision,

The first two causes of action in this disciplinary proceeding against Respondent, Charles Schwab & Company, Inc., charge that new provisions in Respondent’s customer agreements by which a customer waives any ability to assert a claim by means of a judicial class action conflict with and violate FINRA Rules 2268(d)(1) and (d)(3) and NASD Rules 3110(f)(4)(A) and (4)(C). These Rules operate to preserve judicial class actions as an alternative to arbitration, even when there is a pre-dispute arbitration agreement between a FINRA member firm and its customer. The Hearing Panel concludes that Respondent’s new language does conflict with and violate these Rules. The Hearing Panel further concludes, however, that these Rules may not be enforced. Enforcement is foreclosed by the Federal Arbitration Act, as construed by the Supreme Court in Concepcion and other decisions. Those decisions hold that adjudicators must enforce
agreements to go to arbitration to resolve disputes and must reject any public policy exception that disfavors arbitration, unless Congress itself has indicated an exception to the Act. Accordingly, the Hearing Panel dismisses the first two causes of action.

FINRA may appeal the hearing panel’s decision to the National Adjudicatory Council or NAC.

Compelling arbitration has been a hot issue over recent years with the Concepcion decision and the enactment of Section 921 of Dodd-Frank which gives the SEC authority to limit or prohibit the use of mandatory arbitration provisions.

Dept. of Enforcement v. Charles Schwab & Company, Inc., Disciplinary Proceeding No. 2011029760201 (Feb. 21, 2013).   See the decision here.

FINRA Proposes Rule to Increase the Promotion of BrokerCheck Website to Assist Investors in Their Investigation of Brokers and Their Firms

January 30, 2013 By Jay Eng

The Securities and Exchange Commission (“SEC”) has issued a notice of a proposed rule change to FINRA Rule 2267 to require that members include a prominent description of and link to FINRA BrokerCheck on the “on their Web sites, social media pages and any comparable Internet presence and on Web sites, social media pages and any comparable Internet presence relating to a member’s investment banking or securities business maintained by or on behalf of any person associated with a member.”  The intent of this rule is to promote the use of BrokerCheck by investors.  See the proposed rule here.

In 1988 FINRA established BrokerCheck (previously, the “Public Disclosure Program”) to provide the investors with information on the background and conduct of FINRA member firms and their associated persons.  The information that FINRA releases to the public through BrokerCheck is derived from the Central Registration Depository (‘‘CRD’’), the securities industry online registration and licensing database.  FINRA-member firms, their associated persons and regulators report information to the CRD system.  Red flags, such as prior complaints and disciplinary history, are useful information to customers, and can assist investors in choosing the brokers to work with.

FINRA’s BrokerCheck tool can be found here.

Risks and Problems with Sales of Reverse Convertible Securities

October 10, 2012 By Jay Eng

At a the recent SIFMA Complex Products Forum, Susan F. Axelrod Executive Vice President, Member Regulation Sales Practice, discussed recent problems with reverse convertible securities.  In her prepared remarks, Axelrod noted that “reverse convertibles are often attractive to customers because of the high initial yields they offer.”  Axelrod commented that

Investors and brokers may misunderstand this complex product—and its downside. A reverse convertible is a note that pays a high initial fixed coupon—sometimes ranging up to 30 percent per year. The return of principal is tied to the performance of a basket of stocks or, sometimes, the performance of a specific security. I will call these the “underlying assets,” or just “the assets,” for our discussion today. The performance of the assets determines whether, at a specified date or performance level, the investor will receive the assets—essentially giving the issuer a “put” option should their value decline. The investor typically does not benefit if the underlying assets increase in value. And, it is generally true that the higher the coupon rate, the higher the volatility of the underlying asset. This can increase the chance that the investor will receive less than a full return of principal.

(Emphasis added).

FINRA has discovered that some brokers have over-concentrated their customers in reverse convertibles due to unsuitable recommendations.  Further  FINRA has brought a number of enforcement actions against firms for failing to ensure that their supervisory systems were adequate.

Brookstone Securities of Lakeland, FL Closes Shop After Order Finding Securities Fraud

June 15, 2012 By Jay Eng

Brookstone Securities of Lakeland, Florida, which was found to have committed of securities fraud by a FINRA Hearing Panel, reportedly shut down effective June 14, 2012.  According to the Investment News, the Company may not have paid its representatives and advisors on Friday, June 15, 2012.

FINRA Hearing Panel Hammers Brookstone Securities for Securities Fraud In Connection With CMO Sales

June 6, 2012 By Jay Eng

A FINRA Hearing Panel has hammered Brookstone Securities of Lakeland, Florida.  According to a FINRA release, the panel found that from July 2005 through July 2007, the firms owner and a former broker “intentionally made fraudulent misrepresentations and omissions to elderly and unsophisticated customers regarding the risks associated with investing in [collateralized mortgage obligations].” The panel fined Brookstone $1 million and ordered it to pay restitution of more than $1.6 million to customers.  The decision may be appealed to FINRA’s National Adjudicatory Council.

A collateralized mortgage obligations or “CMO” is a security that is collateralized by mortgage-backed securities, which in turn are undivided interests in a pool of mortgages. The principal and interest from the mortgages underlying a mortgage-backed securities are used to pay CMO investors principal and/or interest, depending on the type, or “tranche,” of CMO that they own. CMOs are classified, in part, based on the entity that guarantees them.

In Notice to Member 93-78,FINRA provided guidance to brokers alerting them to their obligations when recommending CMOs stating, in part, that

In light of the complexity and the varying risk characteristics of CMOs, under Article III, Sections 1 and 2 of the Rules of Fair Practice, members and their associated persons must be conversant in all of the characteristics of CMOs to assess adequately the suitability of CMOs for their customers. Moreover, they must ensure that their customers understand the characteristics and risks of CMOs. Further, adequate supervisory procedures must be in place to monitor CMO activity within each NASD member firm.

Emphasis added.

SEC Charges Phoenix Advisor For Failing to Disclose Conflict of Interest and Inflating Value of Investment

May 31, 2012 By Jay Eng

The SEC charged a Phoenix-based investment adviser, Walter Clarke, for recommending investments without telling clients about his personal stake and exploiting a client who was buying an ownership share in the firm. According to the SEC, Clarke advised clients at Oxford Investment Partners LLC (“Oxford”) to invest in two businesses without disclosing that he co-owned one of them and had financial ties to the owners of the other. Further, Clarke’s own financial problems prompted him to sell a stake in Oxford to a client, he fraudulently inflated the value of his firm by at least $1.5 million to make the client overpay by at least $112,000.

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Eleventh Circuit Reverses Trial Court In Part In SEC v. Richard L. Goble

May 30, 2012 By Jay Eng

Today, the Eleventh Circuit Court of Appeals reversed in part, a district court’s decision that found the defendant guilty of securities fraud. Securities Exchange Commission v. Richard L. Goble, No. 08-cv-00829 (11th Cir. May 29, 2012). In 2008, the SEC’s attorneys alleged that Goble had engaged in a sham money market transaction to free up funds in a customer reserve account to keep his firm afloat in violation of federal securities laws and regulations.

Former Merrill Lynch Broker-Lawyer Suspended by FINRA for Practicing Law

May 17, 2012 By Jay Eng

In April, a former registered representative (a licensed attorney) at Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill” or “ML”) entered into an AWC with FINRA consenting to a 30 day suspension.  The former Merrill broker who was a licensed attorney had  drafted a will for an individual who was not a customer of the firm. The broker was paid $200, and this activity was made outside the scope of his employment with Merrill.  Merrill had denied the broker’s request to practice law outside the scope of his employment. Merrill’s written procedures prohibited representatives from practicing law unless an exception is granted.

FINRA Rule 3270 provides:

No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member, in such form as specified by the member. Passive investments and activities subject to the requirements of NASD Rule 3040 shall be exempted from this requirement.

Emphasis added.

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