FINRA maybe in the process of allowing its examiners to punish member firms for rules’ infractions.  See  https://www.law360.com/assetmanagement/articles/1143015/finra-wants-to-let-examiners-lower-the-boom-on-brokers?nl_pk=5882ca7d-b76e-42a1-a1fe-eb96fcbcf60f&utm_source=newsletter&utm_medium=email&utm_campaign=assetmanagement.  There is no proposed rule as of today.  However, such a rule would be a game changer in the sense that examiners, who, generally, do not have the authority to enforce FINRA’s rules would now be in the proverbial “driver’s seat” without any of the ordinary checks FINRA usually provides in the enforcement process.  In any event, this is definitely one to keep an eye on.

Although songs and Broadway musicals routinely call upon “memories” as inspiration, it usually is not the province for decisions in FINRA arbitrations.  However, we were treated to a memory lesson in what, at first blush, seemed to be a run of the mill expungement case. See Evans v. Merrill Lynch Pierce Fenner & Smith Inc., FINRA Office of Dispute Resolution Case No.: 18-00845.

As many know, registered persons may move to expunge certain information from their FINRA Central Registration Depository (“CRD”) records. The burden is quite high, and, unfortunately for many, the results are not always good.  However, for the Evans claimant, luck and a good memory appeared to be on her side.

In Evans, the FINRA panel found that the customer “became a client of Respondent [but] had no recollection of any contact with [customer], making any recommendations to [customer], speaking to [customer] or making any trades on behalf of [customer].”  The broker had stated she believed the customer’s account “had been transferred from another broker to her, without her knowledge or notice.”  The Arbitration Panel was persuaded.

Here is the rub, it was her “memory” that saved the broker– no need to break into song just yet!  The broker told the Arbitration Panel “that she was a practitioner of memory techniques, and that she taught the techniques in one of her son’s classes and would have remembered dealing with [customer].”  The Arbitration Panel went onto reason that she “had an ability to recall details, and she testified that she had no contact with [customer].”  Finally, the Arbitration Panel determined that, as a result of the broker’s memory, “the claim of customer was determined to be factually impossible, and expunged.”

In short, it seems that memories (or lack thereof) are valid for more than just carrying a tune.  You can now start singing to yourselves!

Way back in 2017, the SEC obtained an emergency asset freeze against an internet-based ICO involving certain Canadian residents, who had raised over $15 million on a variety of social media sites through an alleged fraudulent scheme. http://www.sec.gov/litigation/complaints/2017/comp-pr2017-219.pdf.

At the time, it made major news and helped launch the SEC’s Cybersecurity Unit.  Of course, there have been many other actions since that time, but this action demonstrates that, with technology, it is impossible to ignore the potential for cross-border fraud.  Essentially, do you know who you are dealing with on the other screen?  Is it someone in Canada, Lithuania, Malta, Spain, Thailand, Hong Kong or China, among many others?  No one can ever be certain, and this leads to the tremendous risk of hacking or potential for fraud demonstrated by this SEC filing.

In sum, cryptocurrencies and ICOs are not going away, but we must be reminded to be ever vigilant since you may never know who your trading partner is or where they may be– on the other side of your floor or the other side of the world.

 

Over the last several months, there has been an increase in questions from registered investment advisers relating to using hypothetical performance information.  Generally, the use of such information is fraught with danger as well as SEC scrutiny.  Not so long ago, the SEC went after a number of investment advisers and forced them to pay a total in fines, interest, and disgorgement of nearly $10 million.  See  https://www.sec.gov/litigation/admin/2017/33-10443.pdf; https://www.sec.gov/litigation/admin/2017/34-82244.pdf; and https://www.sec.gov/litigation/admin/2017/ia-4823.pdf.

The SEC complained that these advisers did not have sufficient compliance procedures to effectively conduct an adequate investigation into the performance claims.  Essentially, the firms did not test the information being used to make sure it was accurate.  Such failures led to the monetary awards discussed above. 

In short (and as much as we preach), there is simply no way around having adequate procedures that are followed and implemented accordingly— unless, of course, you have a cool $10 million sitting around that you could turn over to the SEC when it knocks on your door.

 

FINRA litigants and arbitrators alike should take note of a federal court’s decision rejecting an unexplained FINRA award when it was unable to discern its basis, notwithstanding that FINRA rules did not require an “explained” decision, and later vacating the explained award once it demonstrated the panel’s manifest disregard of the law. This decision has potentially far-reaching tactical and practical implications, and suggests that arbitrators must be prepared to support their awards whether or not the parties request an explained decision.

Under FINRA dispute resolution rules, arbitrators are not required to issue an explanation of their decision unless requested by both parties. Code of Arbitration Procedure Rules 12904(g) (Customer Code), 13904(g) (Industry Code). Therefore, these “unexplained” awards are customarily devoid of any fact-based explanation, and even explained decisions need not contain legal analysis or damages calculations. Id.

This can present a problem when federal courts are called upon to either confirm or vacate arbitration awards, as was the case in Interactive Brokers LLC v. Saroop, 279 F.Supp.3d 699 (E.D. Va. 2017). There, customers initiated arbitration alleging an array of claims against their online brokerage firm. An arbitration panel entered a substantial monetary award in favor of the customers. However, because the parties had not requested an explained decision under FINRA rules, the panel included little-to-no factual application, legal authorities, or damages analysis. The brokerage moved to vacate and the customers cross-moved to confirm the award.  Although recognizing the “extreme deference” due to arbitrators, the federal court was unable to discern the basis for the panel’s damages award and remanded to the panel for an explanation, noting bluntly that “[j]udges…are not wallflowers or potted plants.” Id. at *708.

Following an unsuccessful appeal to the Fourth Circuit, the panel issued a second award, adding some further text that the federal court found “not very helpful.” Interactive Brokers LLC v. Saroop, Case No. 3:17-cv-127, E.D. Va. (Dec. 18, 2018), Dkt. 95 at 12. The additional explanation, however, showed that the panel based both its damages award and its dismissal of the brokerage’s counterclaims on the brokerage’s alleged violation of FINRA Rule 4210. However, because a violation of FINRA rules does not provide a private right of action, the court vacated the award for manifest disregard of the law, and ordered that the brokerage’s reinstated counterclaims be heard by a new panel of arbitrators. Id. at 19.

There are at least three important takeaways from Interactive Brokers.

First, whether litigants request an explained decision is usually a tactical choice.  Litigants who are concerned about the likelihood that arbitrators will appropriately apply the facts to the law sometimes request explained decisions to force arbitrators into making more reasoned decisions and to provide a basis to seek vacatur of adverse decisions. Interactive Brokers shows, however, that an unexplained decision may also lead to vacatur.

Second, for their part, arbitrators may wish to exercise their discretionary authority to issue explained decisions even where the parties do not request them. See Rules 12904(f); 13904(f). This is especially true where the issues and damages calculations are particularly complex. Issuing explained decisions will not only minimize the uncertainty around post-arbitration proceedings but will enhance the credibility of arbitrator decision-making.

Third, whether or not an explained decision is requested or issued as a matter of arbitrator discretion, an unexplained decision may conflict with the requirement that federal courts have an appropriate record on which to base their post-arbitration decisions. In Interactive Brokers, that conflict resulted in significant delay, extra expense, a new hearing, and a drastic shift in the outcome of the matter—none of which serve the purposes of arbitration, in FINRA or otherwise.

FINRA has published cybersecurity guidance for all its member firms.  See https://www.finra.org/sites/default/files/p602363%20Report%20on%20Cybersecurity%20Practices_0.pdf.

In particular, FINRA is indicating that it wants its member firms to bolster their cybersecurity regimes, and limit both internal and external threats.  The FINRA report also provides a number of resources for firms in applying this guidance.

Please make no mistake about this report.  FINRA is not doing it out of the “goodness of its heart;” instead, member firms should assume FINRA will use this report to bludgeon member firms, who have cybersecurity issues in the future.  That is, member firms should work with counsel to ensure that they have the appropriate cybersecurity policies and procedures in place before FINRA “comes a knockin!”

Ever wonder what it’s like to argue in front of the Supremes? Fox partner Ernest E. Badway will moderate a forum with two Supreme Court advocates – Robert G. Heim and Howard Meyers – that will offer a fascinating glimpse into one of the most intense experiences in the practice of law.  The program will take place on January 3, 2019, from 12 p.m. to 1 p.m. E.S.T., and focus on their recent high court argument in Lorenzo v. SEC, including the preparation and the argument itself.  Registration details will follow.

We wanted to announce that Ernie Badway has taken over the authorship of Chapter 7, Proxy Regulation, in Lexis-Nexis Matthew Bender’s Federal Securities Exchange Act of 1934 treatise: https://store.lexisnexis.com/products/federal-securities-exchange-act-of-1934-skuusSku10509.  His work will be available on November 26, 2018, just in time for the holiday season!

Acknowledging the self-promotion aspect of this blog, we wanted to invite you to attend Josh Horn’s seminar at the NSCP National Conference in Atlanta.  Josh’s presentation is on Monday, October 29, 2018, at 1:55 p.m. and lasts 75 minutes.  Josh, along with Tanya Kerrigan, General Counsel & CCO, Boston Advisors, will be speaking on “Testing the Written Policies & Procedures Lab.”  We invite all to join Josh and Tanya for this very interesting program.

Conference information may be found here: https://www.omnihotels.com/hotels/atlanta-cnn-center/meetings/2018-nscp-national-conferences.

Just this week, a United States District Judge for the Eastern District of New York told a defendant in a criminal case that he was out luck with the claim there was no securities fraud because he was selling  digital tokens.  See United States v. Zaslavskiy, Case Number 1:17-cr-00647 (E.D.N.Y.).

The defendant tried to argue that the digital tokens were not securities.  The court was simply not buying what the defendant was now selling.  The case involved claims the defendant bilked investors in ICOs.  The court refused to say that the tokens were not securities at such an early stage in the case, and believed it was up to the jury to make that determination.

This decision highlights the very fact intensive nature of determining if the federal securities laws apply to these types of digital token fraud claims.  Essentially, the court was relying upon the United States Supreme Court’s SEC v.  W. J. Howey Co., 328 U.S. 293 (1946), test to delineate the respective position these tokens held within the ambit of the federal securities laws.  Ultimately, the court believed there was enough evidence to indicate it was a question of fact for the jury.

One of the big takeaways from this case is that courts, at least, initially, seem to be reluctant to claim crypto instruments are not securities.  It almost appears that, like everyone else, courts such as the one in the EDNY are looking for more guidance, and are reluctant to make any major pronouncements about the status of such items as digital tokens.