July 2009 Archives

July 29, 2009

FINRA Sanctions Merrill Lynch and UBS for Failing to Supervise the Sale of Closed-End Funds

Before discussing the Financial Industry Regulatory Authority's (FINRA's) latest action against Merrill Lynch and UBS, I want to share a related story about a client at my San Mateo, California, securities law practice who had invested a substantial part of her portfolio in a Closed-End Fund (CEF) that, unknown to her, was purchased as part of an Initial Public Offering (IPO). The client, who had recently been widowed, had made a large deposit in her brokerage account following the sale of her deceased husband's business. Needless to say, the widow wanted to proceed cautiously and preserve her capital. Unfortunately for the widow, the broker did not share with her the "dirty little secret" about investing in CEFs:

Customers who invest in Closed-End Funds at the IPO almost always suffer an immediate loss.

This came as a shock to the widow, but it is a well known fact within the industry and is supported by a large body of research going back over 20 years. The reason is simple. CEFs almost always trade at a discount to their Net Asset Value (NAV) in the secondary market. However, when an IPO is structured, the fund's offering price is typically set at or above the NAV. Thus, the fund's price usually plunges after the IPO when the shares begin trading in the secondary market. See e.g., Lipper Research Report, "Buying a Closed-End Fund Initial Public Offering: Caveat Emptor!" (November 8, 2004)

The moral of the story is, never be in a hurry to invest in a newly launched CEF. By waiting several months after the IPO, an investor can purchase the fund at a discount and avoid paying an underwriting charge. The only way to conceivably benefit from buying a CEF at the IPO is to hold onto it for a period of time that is long enough to recoup the higher price paid at the IPO.

Back to FINRA's Recent Action Against Merrill Lynch and UBS

As part of the settlement with FINRA, Merrill Lynch and UBS consented to FINRA's findings that the brokers had earned high fees through short-term trading of CEFs by recommending that their clients invest in CEFs at the IPO and sell them a few months later, usually at a loss, so that the proceeds could be invested in yet another CEF-IPO. FINRA determined that both Merrill Lynch and UBS failed to adequately supervise, monitor and detect the broker's improper activities. Without admitting any fault, Merrill Lynch and UBS agreed to pay fines of $150,000 and $100,000, respectively. They also agreed to repay a total of $5 million to victims that were identified during the investigation.

July 24, 2009

FINRA Sanctions Brokerage Firms Affiliated with Wells Fargo and Washington Mutual Banks for Variable Annuity Sales Violations

Broker-dealers affiliated with Wells Fargo and Washington Mutual, two large banks with close ties to the San Francisco Bay Area, have entered into a settlement with the Financial Industry Regulatory Authority (FINRA) agreeing to pay fines of $275,000 and $250,000, respectively, and consenting to the entry of findings regarding their inadequate supervision of variable annuity, mutual fund and unit investment trust (UIT) transactions with customers. The two bank's sell securities through Wells Fargo Investments and WM Financial Services, which is now doing business as Chase Investment Services. The other firms sanctioned by FINRA are IFMG Securities, PNC Investments and McDonald Investments (now KeyBanc Capital Markets, Inc.). Collectively, the five firms will pay fines to FINRA totalling $1.65 million.

These firms are referred to as "bank broker dealers" because of their close affiliation with a retail bank. A large percentage of a bank broker dealer's business comes directly from referrals by employees of the bank. This arrangement can be misleading to bank customers who are often unaware that they have been referred to a stockbroker who often has a desk or office inside the bank branch.

According to FINRA, the sanctioned firms failed to properly supervise the sales practices of their brokers and did not conduct necessary suitability reviews or investigate questionable variable annuity, mutual fund and UIT sales to its customers, many of whom were elderly. The $1.65 million dollar fine was part of a settlement with FINRA in which the firms consent to the entry of FINRA's findings, but do not actually admit or deny FINRA's findings. Customers affected by these sales practice violations are not entitled to any restitution as a result of the settlement. In order to recoup any losses, affected customers are advised to consult with a securities lawyer.

Click here for all blog postings about variable annuities.

July 21, 2009

San Francisco's Charles Schwab Corp. Facing New Securities Fraud Allegations Over the Sale of Auction Rate Securities

Yesterday, San Francisco-based Charles Schwab Corporation publicly denied recent allegations that it engaged in fraudulent marketing practices in the selling of Auction Rate Securities (ARS). These latest securities fraud allegations come from New York Attorney General Andrew Cuomo who has purportedly uncovered emails and testimony establishing that Charles Schwab brokers had little knowledge about these ARS investments when they recommended them to their unsuspecting customers. Cuomo's office is also alleging that Schwab misrepresented these securities as a safe investment and failed to warn its customers about the impending collapse of the ARS market. So far, Charles Schwab has denied the attorney general's allegations.

Schwab is already facing a slew of customer arbitration claims that allege similar misconduct in connection with the sale of its YieldPlus funds that were marketed to conservative investors as low-risk investments. I have been monitoring these cases and Schwab has been aggressively defending these cases with mixed results according to the results in cases that have already gone to hearing.

Click here to view all YieldPlus blog postings.

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July 9, 2009

Why Having a California Licensed Securities Arbitration Lawyer is So Important

Today, anyone with a website can tout themselves as a "California securities arbitration lawyer" or "California securities fraud lawyer" even though the attorney or law firm does not actually have an office located in California. The World Wide Web's lack of oversight creates an environment where attorneys--and non-attorneys--are able to circumvent California laws that were designed to prevent deceptive legal advertising.

calif-flag.jpgSearching for a securities arbitration attorney is not the same as shopping online for the best deal on a GPS device. Most clients would be better severed by dealing with an attorney that knows the local rules and customs and has an office nearby where they can meet face-to-face. Securities arbitration before the Financial Industry Regulatory Authority (FINRA) is serious business. As any lawyer that regularly handles arbitration cases in San Francisco can attest, the local arbitrators are sometimes hard to please. Currently, I am acting as local counsel for out-of-state attorneys who have California clients with arbitration claims. When handled properly, this type of arrangement works out well for everyone involved.

California does not allow out-of-state attorneys to represent clients in securities arbitration proceedings within the state. California Code of Civil Procedure Section 1282.4, requires non-California lawyers to associate with a California attorney who will serve as the attorney of record. Section 1282.4 was enacted in January 2007 in response to Birbrower, Montalbano, Condon & Frank v. Superior Court, 17 Cal. 4th 119 (1998), which held that non-California attorneys who appear in California arbitration proceedings are engaged in the unauthorized practice of law.

FINRA has also adopted strict guidelines and procedures to ensure that attorneys are in compliance with Section 1282.4. FINRA may deny an out of state attorney's request for qualification to participate in the arbitration if the non-California attorney has repeatedly appeared in California arbitration cases.

July 7, 2009

About the Financial Industry Regulatory Authority (FINRA)

The Financial Industry Regulatory Authority (FINRA) was established in July 2007 when the National Association of Securities Dealers (NASD) and the New York Stock Exchange (NYSE) were consolidated. FINRA is responsible for overseeing regulation and compliance of more than 4,800 brokerage firms and nearly 650,000 stockbrokers.

FINRA's Investor Complaint Program

FINRA's Investor Complaint Program investigates complaints against brokerage firms and their employees. Where appropriate, FINRA will take disciplinary action against brokers. Sanctions can include fines, suspensions and disbarment from the securities industry. FINRA's Investor Complaint Program is a disciplinary program that is separate from FINRA's Dispute Resolution Division. Whenever a disciplinary investigation is started, FINRA often sends investors a standard letter with the following disclaimer:

"Please understand that we are not representing you individually in this matter. There is no assurance that any action will result in the return of funds or securities to you. If you feel you are entitled to monetary relief, you may wish to initiate an individual action, such as mediation or arbitration. FINRA provides a forum for resolving individual disputes through its Dispute Resolution Division."

FINRA's Dispute Resolution Division is responsible for overseeing the arbitration and mediation of disputes between investors and stockbrokers. When a customer opens a brokerage account with a brokerage firm that is a member of FINRA, the customer is obligated to submit any dispute to arbitration in accordance with the rules and procedures of FINRA Dispute Resolution.

Arbitration of Securities Disputes

large_chess.jpgClaims seeking damages of $25,000 or less are usually decided under the "simplified arbitration" procedures in which a single arbitrator decides the case based on the written record without the need for a hearing. Larger claims are decided by a panel of either one or three arbitrators, depending upon the dollar amount involved. A total of 7,173 securities arbitration cases went to hearing during the 5-year period from 2003 to 2008. Customers prevailed in 3,295 of those cases--or just 45% of the time. Securities arbitration is often misperceived as an informal proceeding; however, securities arbitration is a highly specialized area of the law and there are many qualified attorneys who focus exclusively on representing either customers or brokerage firms. When going to arbitration, customers need to be well prepared.

Mediation of Securities Disputes

Mediation is an alternative method of resolving a securities dispute that can be initiated at any stage of the arbitration process. Because participation in mediation is voluntary, both parties must agree to submit a case to mediation. Mediation begins with the selection of a trained mediator whose function is to help the parties negotiate a settlement. Mediation is non-binding, so the dispute will go to arbitration if the parties are unable to reach a settlement.

July 1, 2009

San Francisco, California, Securities Arbitration Award Results During First Half of 2009 Are Well Below FINRA's Nationwide Average

large_san_fransico.jpgHere are the results from my analysis of securities arbitration awards made in San Francisco, California, during the first half of 2009 before the Financial Industry Regulatory Authority (FINRA). The claimants that did the worst were the ones who handled their own cases on a pro se basis. Pro se is Latin for "on one's own behalf." I could find only one instance where a pro se claimant recovered anything at all during the first half of 2009. In that case, the claimant, who was asking for $37,500 in damages, was awarded a mere $792.

Excluding pro se cases, claimants who went to hearing before San Francisco arbitrators in the first half of 2009 with an attorney prevailed 37.5% of the time. This is well below the national average reported by FINRA. According to FINRA, claimants received favorable awards in 47% of all arbitration hearings held during the first half of 2009.

Another telling statistic is the amount recovered by claimants who did win. After weeding out claims with questionable or uncertain damage claims, I found that claimants who won in San Francisco received awards that averaged 59% of their claimed damages during the first half of 2009. Choosing the right arbitrators can have a large impact on the outcome of a case. In reviewing awards, I notice that some San Francisco arbitrators who sat on multiple cases consistently ruled against claimants.

One final note: In each of the cases where the claimants did quite well, they were represented by an experienced securities arbitration attorney. Retaining a knowledgeable securities attorney and having fair-minded arbitrators appointed to a case can have a huge impact on the success or failure of a securities arbitration proceeding--especially in San Francisco where every little bit helps.