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UBS and other well-known investment firms are currently making the news for marketing Yield Enhancement Strategy (YES) to its clients as “safe” and “conservative  .”  While YES was marketed as a safe way for investors to enhance their income stream, YES was anything but safe.   Brokers that recommended YES strategies to clients without proper due diligence and disclosure, or that recommended the strategy to conservative income oriented clients, likely engaged in broker misconduct, which could make them liable to those clients. Rather than enhance yield, as promised, the strategy actually resulted in large losses.

YES, designed to earn investors more yield during a time when the markets were relatively stable and interests rates low, involved investing in a series of four options for the S&P 500 Index (SPX).  This strategy is also known as an “Iron Condor” Options scheme, and involves an options strategy marketed by some brokers as a low-risk way for investors to enhance the yield from an investment portfolio.  An Iron Condor strategy consists of selling one call spread and one put spread, each with the same expiration day, on the same underlying asset. Used properly, the iron condor is designed to have a high probability of earning a small profit, provided that the underlying security has low volatility.

While YES wasn’t going to make investors a huge yield if successful, its intent to hedge risk and earn small returns was not without risk.  Not only is risk involved, but YES is extremely complicated, making it difficult for most investors to understand.  Because of this inherent complexity, it is possible, even likely, that brokers and brokerage firms recommending the strategy failed to adequately disclose the risks involved, resulting in a lack of understanding on the client’s part. A broker has a duty to disclose all risks associated with an investment and firms must implement adequate risk controls and compliance systems to monitor a broker’s recommendation to engage in YES strategies.  Failure to do so constitutes a breach of the suitability rules, is negligent, and also a breach of fiduciary duty.

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Offering bonuses in the form of employee forgivable loans (EFLs) is common in the financial industry, but these so-called bonuses can result in a trap for unsuspecting brokers (see our website here).  While there are a variety of defenses (LINK) available to brokers when a brokerage firm seeks to enforce these EFLs in a FINRA action, the fact is that arbitrators seem to rule against brokers in these matters almost reflexively.  But a couple of novel theories might offer new alternatives.

The Uniform Commercial Code

One potential new defense to an arbitration proceeding to enforce a promissory note is based on the Uniform Commercial Code (UCC).  The UCC is a model law adopted by states throughout the country to insure that certain financial instruments are subject to the same legal requirements nationwide.  The relevant provisions of the UCC for our purposes apply to negotiable instruments, which include, for example, checks and promissory notes.  A negotiable instrument is a signed, transferrable document promising payment to a named payee at a specified time or upon demand.  For example, your mortgage document is likely a negotiable instrument transferrable between banks, which explains how your bank can sell your mortgage to another financial institution, and then you get a notice to send your payments elsewhere.

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The Texas Securities Act , when applicable, is an extremely powerful tool for any investor seeking to recover an investment and other damages when they have been a victim of fraud or when the Texas Securities Act (TSA) has been technically violated, and this is particularly true when an investor invests in a private oil and gas deal that may not be compliant with the TSA or when the deal is misrepresented, or perhaps an outright scam.  Oil and gas scams are, in fact, a staple of the enforcement actions brought by the Texas State Securities Board, and even though the Texas State Securities Board often shuts down the scams and the scammers, investors don’t always get compensated for their losses.

With the stock market reaching recent all time highs in late 2017 and going into 2018, private investment will predictably increase, and in Texas, a lot of investment dollars find their way into oil and gas drilling programs and other investments tied to our so-called “black gold.”   One recent Houston Chronicle article made a good case of why we will see more and more money flowing into the oil and gas and drilling sectors in Texas.   In short, with the price per barrel up from lows of last year, and with the Texas economy booming, it is reasonable to predict that there will be much more drilling activity, and investment into drilling activity.  This usually translates to more private investment opportunities for individual investors in the Texas oil and gas sector, and this predictably will attract promoters and other scam artists hoping to exploit gullible and unsophisticated investors hoping to take part in the energized energy sector.  And, surprisingly, it is still common for promoters of oil and gas deals to abscond with investors’ dollars.

Investments in oil and gas can come in many shapes and sizes.  Investors can, of course, invest in a variety of publicly traded securities, including mutual funds, ETFs, Master Limited Partnerships, and specific companies (e.g. Exxon Mobile, Royal Dutch, and many others who are headquartered in Texas) whose share value is tied to the oil and gas industry.  Investing in a public traded vehicle generally eliminates the opportunity for most registration fraud, IF you are investing through a registered broker that makes a suitable recommendation in light of your investment objectives, risk tolerances, sophistication, and financial condition, but when you are investing in a private investment, the potential of securities fraud may be increased.

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Today, the Texas State Securities Board (TSSB) announced in a Disciplinary Order the suspension of Jason Anderson, a broker from Beaumont, Texas formerly working in the last two years with each of LPL, Kovack Securities, IFS Securities, and since March of 2017, was seeking registration as an investment adviser with IFS Advisory, LLC (later withdrawn), and then went on to seek registration as an investment adviser with Financial Management Services of America, LLC.   Last year, Mr. Anderson was “indefinitely” suspended by FINRA for failing to comply with an arbitration award, pay a settlement, and/or failing to tell FINRA about the status of that award.   Mr. Anderson has been very busy—-why?  Some of the answers may be found in Mr. Anderson’s BrokerCheck, which reveals a rather concerning string of customer complaints and other problems.  So, is Mr. Anderson suspended?  Yes as a FINRA broker, and yes in the State of Texas, just not for long.

Well, while Mr. Anderson was with LPL between 2007 and February 2016, and perhaps while at the subsequent firms, Mr. Anderson was recommending to many of his clients an active trading program pursuant to a technical analysis.  The Texas State Securities Board called the trading program the “Equity Strategy.”  Similarly, there have been a number of customer complaints, and even a lawsuit filed against Mr. Anderson for his practices with his customers.

Mr. Anderson’s, and hence LPL’s, Equity Strategy involved actively trading stocks based apparently on Mr. Anderson’s belief in his prescient technical analysis.  The Texas State Securities Board stated that Mr. Anderson “did not consider the trading costs, which included commissions…or the impact that such costs would have on the rate of return the Equity Strategy would need to earn to generate a positive return for a client.”  The TSSB noted that for one client, the costs were 30%, meaning that in order for the client to breakeven, the Equity Strategy would have to earn 30%–no small feat for an investor with a moderate risk tolerance!  Not surprisingly, the TSSB concluded that Mr. Anderson did not have a reasonable basis to believe that the Equity Strategy was suitable for his clients because of his disregard of the trading costs (his own commissions), and thus such practice was deemed by the TSSB to be “inequitable practices in the sale of securities” and it suspended Mr. Anderson’s registration.  Hmmm…

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While we sometimes hear our politicians scream about someone’s “chickens coming home to roost,” the origin really deals with curses and offensive words and actions that may come back to haunt you.  The old adage suggests your curses and offensive conduct are like young chickens, and will eventually come home to roost–meaning your bad conduct will eventually rebound to cause you harm.   Perhaps investing on margin in a bull market is an apt analogy.

Indeed, all of our accounts should be showing substantial gains in the last 12 months, as the Trump bull market continues to run.  Compared to numbers one year ago, margin investing is on the rise, with more and more accounts showing increasing margin debit balances. At the end of November 2017, FINRA reported there was more than $627 Billion in margin debit balances in retail customer accounts, compared to $553 Billion at the beginning of 2017, more than a 13% increase in borrowing to invest in stocks.  So is this a curse that may rebound to cause you harm?  Maybe…maybe not.

Purchasing on margin carries with it significant risks, particularly in the event of a rapid market decline.  Margin can, for the right situation and the experienced and sophisticated investor be a very good tool to increase returns on certain investments, particularly short term investments, but at the same time, margin can decimate an account in a declining market or when a particular investment’s value declines.   When the stocks in the account decline, or even if the firm believes the overall market conditions are not favorable to margin investing, the account holder may face a margin call.  The rules of FINRA and the exchanges supplement the requirements of Regulation T by placing “maintenance” margin requirements on customer accounts. Under the rules of FINRA and the exchanges, as a general matter, the customer’s equity in the account must not fall below 25 percent of the current market value of the securities in the account. Otherwise, the customer may be required to deposit more funds or securities in order to maintain the equity at the 25 percent level. The failure to do so may cause the firm to force the sale of—or liquidate—the securities in the customer’s account in order to bring the account’s equity back up to the required level. If the account holder does not have sufficient assets, they must either make a deposit of additional funds or securities, or their assets in that account, and possibly other accounts, will be sold so that the firm is not at any risk.  Make no mistake about it, most margin account agreements permit the firm to sell out your investments at any time, without any prior notice to you or consent from you.  Even if your broker promises you that he will call you first, such promises may not be enforceable.  In the event of an acute dip in the market, your account may be sold out at the short term bottom without any prior notice.

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This week FINRA published a Recovery Checklist for Victims of Investment Fraud and at the risk of being called sensitive, it seems the Checklist seemed to omit, at least on its face, that hiring an attorney may be the most direct route to seeking any compensation that may be due from being a victim of a financial crime or a victim of investment fraud.  Granted, if you click through to the embedded links, you will find another page published by FINRA titled “Legitimate Avenues for Recovering Investment Losses.”  Therein you will find FINRA’s suggestion that “…You may want to hire an attorney to represent you during the arbitration or mediation proceedings to provide direction and advice.”  I guess it is nice to be considered a “legitimate” avenue by FINRA, as any suggestion of illegitimacy would not sound quite as nice.

But back to the “Checklist.”  FINRA provided a number of resources to report the crime, and victims of investment fraud and financial crimes should report these crimes to all appropriate agencies, as those agencies represent the only real process that can (whether they will is a different issue) bring criminal or regulatory charges against the perpetrator.  However, it is in my experience rare that the authorities responsible for enforcing the criminal and regulatory statutes will recover the victim’s damages, although it certainly happens from time to time.  That is not their real responsibility–they want to enforce the criminal laws and regulations and put deserving criminals behind bars or revoke licenses.  Yes, recovery will sometimes be the product of criminal enforcement, but hiring someone that has no purpose other than representing the victim in seeking the appropriate recovery is wise.

I am glad FINRA acknowledges that the damage done by investment fraud not only includes the damages from financial loss, but also includes  “…at least one severe emotional consequence—including stress, anxiety, insomnia, and depression.”  These damages are real, and should be recoverable in arbitration, right?  Well, FINRA knows that it is not easy to recover from investment fraud, and states so plainly.  FINRA states, “While full financial recovery may be difficult to achieve…” and again states  “It can be difficult to recover assets lost to fraud or other scenarios in which an investor has experienced a problem with an investment. But there are legitimate ways to attempt recovery. In most cases, you can do so on your own—at little or no cost.”  Alas, is this a comment on the fairness/difficulty in recovering legitimate damages in its own arbitration forum?  Perhaps, but don’t expect FINRA to connect these dots.  But given this  admitted “difficulty”, why does FINRA seemingly encourage victims of investment fraud to go it alone?  FINRA is certainly aware of what can happen to the investor/claimant/victim proceeding on their own  against veteran Wall Street attorneys in its FINRA arbitration forum—something akin to throwing raw meat into a crowded lions’ den comes to mind.  Granted, experienced FINRA arbitrators will recognize a meritorious claim before them, but when it comes to recovering money from investment fraud, don’t go it alone!

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As a Texas securities attorney I have been involved in the securities industry over much of the last three decades, and it seems the debate over the fairness of mandatory arbitration before FINRA between customers and firms or brokers has been heated, and near constant.  Periods of greater scrutiny seem to only coincide with any rule proposal or legislation which has the potential of tilting the playing field in one direction or the other. During this debate, FINRA statistics seem to used by both sides (the consumer advocates and the industry) to support their respective arguments, but do these statistics tell us anything about “fairness.”

For those that may not have had the pleasure of engaging in this titillating debate,  it may be generally summed up as follows:  “Is FINRA Arbitration Fair, And Does It Offer Any Compelling Advantage to Either the Industry or the Public Customer?”  It is not surprising that each constituency group argues zealously they are “right” in their analysis of fairness, or the lack thereof.  However, and more interestingly, these constituencies can sometimes be found to argue “Yes” before some audiences, and “No” before others, perhaps suggesting a more candid insight while their respective guard is down, if not some resignation, about the current process and maybe a “kiss your sister” type of fairness.

Some background may be helpful for those not familiar with the origins of the debate.  In 1987 the United States Supreme Court decided in the Shearson v. McMahon case that brokerage firms can contractually mandate arbitration for claims brought by their customers, thus forcing citizens to give up their right to the court system  and a jury.  It was heralded as a fair trade-off given the so-called fairness, efficiency, and economy of arbitration versus the court system.  Since then, the debate continues:  Is FINRA arbitration fair, and does it still offer compelling reasons to waive a right to a jury trial? Pragmatically speaking, the answer may not matter because it is likely, if not certain, that the customer agreement used by every brokerage firm contains a provision requiring mandatory arbitration before FINRA, and change to the status quo will only come, if at all, from the legislative and rule making process, or perhaps from a new decision from the Supreme Court, but don’t hold your breath.

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Can I Sue My Stockbroker?

Well, yes and no.  The question is more appropriately “How do I sue my stockbroker?” or “Where can I sue my stockbroker?”  As I will explain shortly, the common denominator to all of these answers is that investors can (and should) seek recovery when their stockbroker breaches a duty owed to them and they suffer losses.

The short, but correct answer is “No,” you are likely prohibited from suing your brokerage firm in Court, and can only bring a claim in FINRA arbitration (which may look like a “Yes” answer…).  All broker-dealers (think Merrill Lynch, Edward Jones, LPL, Wells Fargo, and any company that employs a stockbroker) must be registered with the Financial Industry Regulatory Authority (FINRA), the Self-Regulatory Organization that is vested with the regulation of brokers and the enforcement of rules governing the brokerage industry.  All firms and their brokers are supposed to comply with FINRA’s rules and procedures, and these rules set forth many of the duties owed by the firm and the broker to the customer.  When one or more of these rules are violated, a customer can be harmed and lose money (account losses) or be prohibited from making money (missed profits).  One of these rules requires the broker-dealer to submit to a customer’s demand for arbitration using FINRA’s Dispute Resolution Forum–so even if there was no agreement to arbitrate, the customer could mandate that the firm submit to arbitration, but it is generally perceived that investors would prefer to be in a local court, before a local judge, and a jury of their peers.

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Stockbroker Fraud and Investment Fraud: How Is It Discovered?

It should go without saying that it is rare that a stockbroker ever confesses to making unsuitable recommendations, illegally recommending private investments away from the firm, churning an account or switching annuities to generate commissions, pushing variable annuities, or telling the client that they didn’t have the authority to trade without first getting permission. Rare, indeed, it simply doesn’t happen, and with Wall Street refusing to adopt a fiduciary duty standard for its brokers, such confessions won’t happen anytime soon. So if it must be discovered by the client, how is it discovered?

In my experience stockbroker fraud and misconduct is usually noticed by someone other than the client: a CPA, a probate or estate planning attorney, a cynical friend not taken in by the broker’s charm and excuses, or even a new broker that recognizes the misconduct of the prior broker. Of course, the client probably has had suspicions, but acting on those suspicions calls into question why the client trusted the broker in the first place— not an easy self-analysis, and even harder to admit that your choice in brokers was wrong and you have been taken advantage of. Not to mention the fact that the broker is likely explaining that “everyone lost money”, “just hold on…it will come back”, making it even harder to face the problem. Hope springs eternal for many investors and if the markets rebound, thereby hiding the sins, everyone is OK, right? So many claims simply lay dormant while clients ignorantly go along their merry way. Isn’t that what Wall Street and the individual brokers secretly want? It certainly is to their advantage that valid claims go quietly unnoticed.

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Might Just Be A Stockbroker’s Selling Away
And That Could Mean You Get Your Money Back.

We have seen a rise in PONZI schemes since the market dropped, but will they keep going with a strong market? A PONZI scheme is essentially when a con man robs Peter to pay Paul in order to keep the con going, all the while living off of the capital. However, many PONZI schemes involve the help from a Wall Street Stockbroker. Sometimes they are part of the con, and sometimes they are simply reponsible for introducing or referring the investor to the scheme, not even knowing it is a con. Either way, you have valid claims.

Most of the time, victim investors in a PONZI scheme get very little back, although occasionally a Receiver will recover assets that can be distributed to all. However, if any investor was simply introduced to the scheme by a registered stockbroker, such investor may be able to recover his investment.

All stockbrokers are required to be registered by FINRA, the regulatory and licensing body for all stockbrokers and brokerage firms. Fundamentally, brokerage firms are required to protect the public investor by detecting and preventing securities fraud and broker misconduct. When a firm fails to detect and prevent misconduct, it is called a failure to supervise. And in the context of a PONZI scheme that is aided by an unwitting stockbroker, brokerage firms can be liable to those clients. Most importantly, FINRA Rules require every stockbroker that participates in any manner in the sale of a security outside of his/her firm to notify the firm and get permission to participate in the deal. If permitted, the firm is responsible for supervising that broker’s participation. However, brokers often do these deals “away” from the firm, hence the term “selling away“, and when brokers get you involved in these schemes without the protection of their firm, both the broker and the firm can be liable. Why? Because the firm is supposed to detect and prevent the broker’s unapproved participation in the scheme.

Many investors think they have no recourse, but if the broker simply refers you or introduces you to the Ponzi con man, the firm can be held liable even if the broker wasn’t making a specific recommendation for you to invest in the scheme. Your claim is even stronger if the broker is getting paid for his referral. If you have been referred by a stockbroker to some investment that has gone south, contact a good lawyer that knows how to recover your money.
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