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Monthly Archives: November 2012

Negligent Referrals to Rogue Stockbrokers – New York Law Journal

Can an attorney be liable for the negligent referral of a client to a “rogue stockbroker”, or in the Thanksgiving spirit, a turkey broker?[1]  If an attorney chooses to refer a client to a stockbroker[2], what are the best practices prior to making the referral?[3]  Given the absence of New York case law addressing an attorney’s liability for the negligent referral to a “rogue stockbroker”[4], best practices dictate that at a minimum, an attorney should exercise reasonable care in investigating the stockbroker’s background.  The attorney must also be extraordinarily careful regarding the nature of the referral to the stockbroker.  Initially, it may be best to determine if the person one is referring to is a stockbroker and/or an investment advisor.  Generally, stockbrokers charge commissions per transaction, whereas investment advisors charge fees based on percentages of assets under management.  Some individuals are both stockbrokers and investment advisors.


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[1] See De La Bere v. Pearson, Limited, 1 KB 280 (1907).

[2] Under New York law, a stockbroker, or someone holding a Series 7 FINRA license, is referred to as a “salesman.”  See NY CLS Gen. Bus. §359-e(2012).  FINRA refers to the same Series 7 licensed individual as a “representative”.  See FINRA Rule 1031(b).  For statute of limitations purposes, stockbrokers and financial advisors are not “professionals”.  Ironshore Insurance Ltd. v. Western Asset Management Company, 2012 U.S. Dist. LEXIS 76818 (S.D.N.Y. May 30, 2012).

[3] This article does not address an attorney’s best practices when referring to investment advisors, certified financial planners, or trust officers, unless those individuals also maintain Series 7 licenses.  These entities are distinct and warrant different considerations.

[4] The phrase “rogue stockbroker” is not defined.  However, in a 1996 speech, Mary L. Schapiro, the current Chairperson of the SEC, stated, “we are focusing on innovative ways to deal with the problem of rogue brokers, heightened supervision of these brokers, and inadequate supervision of all brokers by firms.”

SEC Charges JP Morgan and Credit Suisse with Misleading Investors in RMBS Offerings

The SEC charged JP Morgan Securities and Credit Suisse Securities (USA) with misleading investors in offerings of residential mortgage-backed securities (RMBS).  Without admitting or denying the allegations, JP Morgan agreed to pay $296.9 million, and Credit Suisse $120 million to settle their respective charges.  The SEC stated that RMBS and related mortgage products were “ground zero in the financial crisis…misrepresentations in connection with the creation and sale of mortgage securities contributed greatly to the tremendous losses suffered by investors once the U.S. housing market collapsed.”

According to the Complaint, JP Morgan’s December 2006 prospectus supplement for the $1.8 billion RMBS offering included materially false and misleading statements about the loans that provided collateral for the transaction.  Federal securities laws require the disclosure of delinquency information related to assets that are used as collateral for an asset-backed securities offering.  The loans were the primary source of funds that provided investors the ability to earn interest and obtain repayment of their principal.  JP Morgan represented that only 4 loans or .04 percent of the loans collateralizing the transaction were delinquent.  However, the firm actually had information that demonstrated that more than 620 loans, around 7% of the loans that were part of the transaction, were delinquent.  JP Morgan received fees of more than $2.7 million, and investors sustained losses of at least $37 million on undisclosed delinquent loans.   Additionally, JP Morgan was charged for Bear Stearns’ failure to disclose its practice of obtaining and keeping cash settlements from mortgage loan originators on problem loans.  Normally, loan originators are contractually required to buy back loans that are delinquent within the first months after issuing.  Instead, Bear Stearns frequently negotiated discounted cash settlements with loan originators in lieu of the buy back.  The loans were already owned by the RMBS trusts and Bear Stearns failed to disclose the settlements to the trust or the investors, who owned the loans.  For most loans covered by bulk settlements, the firm collected money from originators but failed to pay anything to the trusts.  Bear Stearns’ proceeds from this bulk settlement practice were at least $137.8 million.

According to the SEC’s order instituting a settled administrative proceeding against Credit Suisse, the firm was involved in two separate practices relating to residential mortgage-backed securities (“RMBS”.)  First, between 2005 and 2010 Credit Suisse entered into a number of financial settlements with loan originators relating to early defaulting loans it had already sold to securitization trusts and kept the proceeds without notifying or compensating the RMBS trusts that owned the loans.  The firm failed to comply with offering documents provisions that required it to repurchase the early defaulting loans.  Credit Suisse also failed to disclose this practice to its RMBS investors.  The firm, through this practice, improperly obtained around $55,747,769.  The SEC’s investigation found that in late 2006, in its efforts to market and sell approximately $1.9 billion of subprime mortgages, Credit Suisse made misleading statements about a key investor protection known as the “First Payment Default” or “FPD” covenant, which required the mortgage loan originator to repurchase or substitute loans that missed payments shortly before or after they were securitized.  Furthermore, the company stated that it “enforced” the FPD convenant in order to “mitigate the effect” of fraudulent mortgages, and that its interests were aligned with investors’.  Notwithstanding this provision, the firm did not ensure the removal of all such loans and mislead investors by falsely claiming that all FPDs were removed from its RMBS.  As a result, investors sustained losses of approximately $1,056,561 on the loans that improperly remained in the RMBS trusts.

BP to Pay the Third-Largest Penalty in SEC’s History for Misleading Investors in Gulf of Mexico Oil Spill

The SEC charged BP p.l.c. with securities fraud relating to the April 20, 2010 explosion of the Deepwater Horizon oil rig.  The charges involved BP’s public filings with the Commission that were also made available to investors, wherein the company made fraudulent public statements significantly understating the flow rate at which oil was spilling into the Gulf of Mexico.  According to the Complaint, on April 29 and 30, and May 4, 2010, BP stated that the flow rate estimates were “up to 5,000 barrels of oil per day” or that 5,000 b.o.p.d. was the current estimate, despite having knowledge of higher internal data, estimates and calculations.

The SEC’s complaint further alleged that BP executives made several public statements in May 2010 supporting the 5,000 b.o.p.d. flow rate estimate, and criticizing higher estimates despite internal evidence showing flow rates well in excess of 5,000 b.o.p.d.  On August 2, 2010, a group of governmental and academic experts declared a final official flow rate estimate of 52,700 to 62,200 b.o.p.d.  Notwithstanding the new findings, BP never corrected or updated its material misrepresentations and omissions about the flow rate.  BP’s failure to disclose the existence of higher estimates caused investors to be misinformed about the consequences and the degree of liability BP faced relating to the spill.  The amount of oil spilled would inform any consideration of the costs of offshore and onshore spill response, claims for natural resource damage under the Oil Pollution Act, as well as other potential liability arising from claims, lawsuits, and enforcement actions related to the explosion and the sinking of the Deepwater Horizon.

BP agreed to settle the SEC’s charges by paying the third-largest penalty in agency’s history at $525 million.  The SEC plans to establish a Fair Fund funded by the penalty to provide harmed investors with compensation for losses they sustained in the fraud.  The SEC stated, “[t]he oil spill was catastrophic for the environment, but by hiding its severity BP also harmed another constituency – its own shareholders and the investing public who are entitled to transparency, accuracy, and completeness of company information, particularly in times of crisis.”

SEC Fined MassMutual $1.625 Million for Insufficient Disclosures about Certain Annuities

The SEC charged Massachusetts Mutual Life Insurance Company with securities law violations for failing to sufficiently disclose the potential negative effect of a “cap” included on certain annuity products.  According to the SEC Order Instituting Administrative and Cease-and-Desist Proceedings, MassMutual included a “cap” feature in around $2.5 billion of its variable annuities.  From September 2007 to March 2009, MassMutual offered a “Guaranteed Minimum Income Benefit (GMIB)” rider as an optional feature on some of its variable annuity products.  The products’ prospectuses failed to sufficiently explain that once the GMIB value reached a cap, it would no longer earn interest and withdrawals would cause pro-rata reductions to the GMIB value.  The firm’s failure to sufficiently explain the effect of the cap on withdrawals confused sales agents and others.

According to the SEC’s Order, a variable annuity with a GMIB rider reflects two values, the contract value and the GMIB value.  The contract value fluctuates with market performance.  The GMIB value automatically increases on the contract issue date and each contract anniversary thereafter by 5 or 6% (depending on the product.)   MassMutual refered to the annual increases as interest credits.  GMIB riders were advertised to provide “Income Now” and “Income Later” features to investors.  In the Income Now feature, MassMutual GMIB riders have a “dollar-for-dollar” withdrawal characteristic, meaning that the GMIB value will decline only by the dollar amount of any withdrawal, so long as the withdrawal does not exceed the annual interest credit (of5 or 6%, depending on the product.)  In the Income Later feature, MassMutual’s sales literature stated that “[e]ven if your contract value drops to zero, you can apply your GMIB value to a fixed or variable annuity.”  MassMutual failed to specifically disclose the effect of taking withdrawals after the GMIB value reached the cap, including that: 1) after reaching the cap, MassMutual would no longer apply an interest credit for purposes of taking withdrawals; and that 2) at that point, MassMutual would deem all withdrawals to be excess withdrawals that would reduce the GMIB value in direct proportion to the contract value reduction.  As a result of the improper disclosures, a number of MassMutual sales agents, wholesalers, and at least one annuity specialist at another insurance sales agency did not understand the negative impact the cap feature had on the contracts.

During the GMIB riders offering periods, MassMutual had indications that sales agents and others did not understand the effect of post-cap withdrawals on the GMIB value, which should have alerted it to the fact that its disclosures were inadequate.  MassMutual removed the cap after the SEC’s investigation to ensure that no investors would be harmed.  Without admitting or denying the allegations, MassMutual has agreed to settle the charges and pay a $1.625 million penalty.

FINRA Disciplinary Proceeding against Todd Lloyd Goedeke

On November 7, 2012, FINRA’s Department of Enforcement initiated a Disciplinary Proceeding against Todd Lloyd Goedeke for allegedly misappropriating a customer’s funds and failing to respond to FINRA’s requests for information with respect to the referenced investigation.  Mr. Goedeke entered the securities industry in 1983 and joined Cantella & Co., Inc. in 2004.  He remained with Cantella until his termination on June 18, 2010.

According to the Complaint, on September 14, 2009, at Mr. Goedeke’s directions, one of his customers gave him a check in the amount of $4,800 payable to an entity controlled by Mr.  Goedeke.   Later the same day, Mr. Goedeke deposited the funds into one of his accounts.   In March 2011, the customer accepted a settlement with Cantella in the amount of $4,825.  FINRA Enforcement made several attempts to contact Mr. Goedeke for an explanation and requested information in reference to this investigation.  As of the date of this Complaint, Mr. Goedeke had not responded to FINRA Enforcement’s requests.

FINRA Disciplinary Proceeding against Annie O. Kim

On November 6, 2012, FINRA’s Department of Enforcement initiated a Disciplinary Proceeding against Annie O. Kim for alleged use of unauthorized discretion in a customer’s account, and for failing to appear for an on-the-record interview.  Ms. Kim entered the securities industry in 2004 and remained registered until April 2, 2010.  According to the Amended Complaint, from January 11, 2010 through January 26, 2010, while registered with Wells Fargo Advisors, LLC, Ms. Kim exercised discretion in at least eleven transactions in the securities account of one customer.  The transactions were effected at Ms. Kim’s discretion without written authorization.  According to FINRA, between May 3, 2011 and June 30, 2011, FINRA made several failed attempts to contact Ms. Kim for an on-the-record interview.  FINRA is seeking sanctions, including monetary sanctions.

FINRA Disciplinary Proceeding against Mark C. Hotton

On November 5, 2012, FINRA’s Department of Enforcement initiated a Disciplinary Proceeding against Mark C. Hotton for allegedly funneling over $5,932,000 from his clients for his personal use, or to pay other investors.   Mr. Hotton entered the securities industry in 1993 and joined Oppenheimer in 2005.  He left Oppenheimer in 2009.

According to the Complaint, since at least July 24, 2006, Mr. Hotton engaged in numerous, varied and interrelated schemes to steal his clients’ money.  He diverted funds to various entities he controlled, while his clients believed they were being invested in legitimate businesses.  In other instances, he convinced his clients to invest in securities that did not exist.  FINRA alleged that Mr. Hotton used numerous forged, fabricated and false documents, fictitious transactions, fictitious securities, false statements, and false and misleading account summaries to perpetuate his scheme.

The primary subject of FINRA’s Complaint is Mr. Hotton’s misappropriation of $5,932,000.  In addition, Mr. Hotton caused millions of dollars in clients’ losses resulting from churning and excessive trading, exercising discretion without authorization, and recommending unsuitable transactions.  Furthermore, Mr. Hotton also caused at least an additional $2,584,078 to be wired from his clients’ accounts at Oppenheimer, to his outside business activities and other entities and individuals with whom he was affiliated.

During FINRA’s investigation, Mr. Hotton is alleged to have repeatedly lied under oath, provided false written statements, and forged and fabricated documents.  Furthermore, Mr. Hotton willfully failed to disclose and/or misleadingly described a customer arbitration, settlements, and civil actions on his Uniform Application for Securities Industry Registration or Transfer (Form U-4).  Mr. Hotton’s registrations were terminated on May 31, 2012.  Mr. Hotton is currently not associated with any FINRA member firm.