Finra Panel Orders JP Morgan To Pay Customer More Than $2M

A securities arbitration panel ordered J.P. Morgan Securities to pay a customer more than $2 million, including sanctions, for allegedly failing to adequately respond to the customer’s requests for certain documents.

Michael Hannon, the customer, alleged civil fraud, breach of fiduciary duty and failure to supervise against J.P. Morgan Securities, the retail brokerage unit of J.P. Morgan Chase & Co. (JPM), according to the award.

The claim, filed in 2009 on behalf of Hannon and a revocable trust in his name, related to the purchase of various securities, including Citigroup (C), ING Groep N.V. (ING), Fannie Mae (FNMA), and Freddie Mac (FMCC), according to the award. Hannon originally sought $3.5 million and other relief.

A Financial Industry Regulatory Authority arbitration panel in Richmond, Va., awarded Hannon $1.8 million, plus interest from May 2008. The Finra panel also made an additional–and rare–award of sanctions in the form of $218,000 in legal fees, $25,000 in expert witness fees, and $9,000 in costs, according to the award, dated July 8.

It found that J.P. Morgan and its lawyer, Stephanie Karn of Richmond, Va., allegedly weren’t “wholly forthcoming,” in responding to the customer’s requests for certain emails and other important documents during a phase of the proceedings when parties typically exchange information. The panel had ordered J.P. Morgan to produce the emails and certain correspondence, according to the award.

A J.P. Morgan spokeswoman and Karn declined to immediately comment.

The sanctions against J.P. Morgan are “highly unusual,” says Jonathan Uretsky, a New York-based securities lawyer who represents brokerages. The award may have reflected the panel’s dissatisfaction with the alleged extent of J.P. Morgan’s compliance with its order, he says.

Finra panels that order sanctions don’t typically provide reasons in writing for the basis of the award, says Dale Ledbetter, a securities lawyer in Fort Lauderdale, Fla. who represents investors. “It’s extremely rare, but it should be done in every case where there’s wrongdoing,” he says.

Andrew Park, a lawyer in Richmond, Va. who represented the customer, declined comment.

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Merrill Lynch’s CDOs: The Thundering Herd Tramples Its Wealthiest Clients Yet Again

Individual investors who choose to do business with Merrill Lynch would be wise to take the time to read the complaint filed two years ago by Massachusetts regulators. They outlined, in impressive layman’s language, how the firm deceived its clients into believing that auction rate securities were safe, liquid, cash equivalent investments when in fact they were risky and illiquid.

“Time after time, when confronted with conflicts of interest, Merrill Lynch was consistent in that it placed its own interests ahead of its investor clients,” the complaint alleged.

An excellent compendium to that complaint was an article recently published by the Wall Street Journal about how Merrill brokers duped a bevy of the firm’s high net worth investors into buying high risk collateralized-debt obligations with assurances that they were also risk free.

“This was a great chance to participate with the big boys,” one client whose family lost millions because of Merrill’s CDOs recalls a broker as saying.

CDOs are indeed for the big boys and Merrill was the leading issuer of these toxic products.  But what Merrill clients clearly didn’t understand  — perhaps because they were never told — was that the CDOs they were buying were the lowest-rated slices; the higher rated slices were sold to more sophisticated institutional investors, the Journal says.

The Journal says that Merrill targeted investors with a net worth in excess of $5 million, and, therefore met the SEC standard of what constitutes a “sophisticated investor.”   That standard should have been altered long ago. For example, one of Merrill Lynch’s victims was a hair-salon entrepreneur - should someone who can leverage an expertise in shearing and coloring hair into a multi-million dollar business, automatically be qualified to evaluate highly sophisticated financial products?

Merrill’s defense is that the offering documents disclosed that the CDOs carried considerable risk, but that warning statement is contained in virtually every financial product the firm sells.  That’s why investors rely heavily on the representations made by their brokers.  And those representations will figure heavily into arbitration claims; if clients can prove that their brokers misled them, Merrill will likely need more of a defense than hiding behind it’s standard legal boilerplate.

Merrill ultimately was forced by the SEC to make whole the clients it fleeced with auction rate securities.  Buyers of CDOs likely have similarly strong claims and should aggressively pursue arbitration or court cases.  And investors who choose to continue doing business with Merrill should be wary of any product their brokers pitch that can’t be readily understood.  If a financial product sounds too good to be true, it probably is.

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FINRA and Australian Regulator Enter Cooperation Agreement

The Australian Securities and Investments Commission (ASIC) and FINRA entered into a Memorandum of Understanding (MOU) today to promote and support greater cooperation between the two regulators.  The MOU establishes a framework for mutual assistance and the exchange of information between ASIC and FINRA, to help ensure that high standards of market integrity and consumer protection are maintained in both jurisdictions. Among other things, the agreement will help the regulators to investigate possible instances of cross-border market abuse in a timely manner, exchange information on firms under common supervision of both regulators, and allow more robust collaboration on approaches to risk-based supervision of firms.

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Two Americas and the Prosecution of Securities Fraud

Post From Securities Fraud/Arbitration Lawyer Jacob Zamansky.

Former presidential candidate  Senator John Edwards is hardly someone to be cited in a blog post about morality and fairness, but he was spot on in his rallying cry about there being two Americas.  This painful reality was driven home to me in recent weeks while pursuing a case in New Jersey’s Gloucester County, a predominantly working class area in the backyard of my hometown, Philadelphia.

The case involves a purported “financial advisor” named John R. Montague, who was a registered representative with Questar Capital Corporation. The FBI has been investigating Montague since at least last August and possibly longer, but there appears to be no movement in the case.  I represent some elderly investors who Montague defrauded for over $1 million. Given that there are likely many other victims of  Montague’s alleged wrongdoing, it’s quite possible that Montague’s misappropriation of funds is well in excess of what  has already been documented.

My firm has long been a source of leads and other information for prosecutors and law enforcement agents, however, the Montague case doesn’t appear to be a priority for the FBI. For example, the US Attorney’s office is handling the investigation of Kenneth Starr, a money manager whose well heeled clients reportedly included a litany of bold-faced names such as Al Pacino, Uma Thurman, and Neil Simon.  With miraculous speed, prosecutors managed to nearly double the $30 million originally thought to be allegedly swindled by Starr. “In the less than two weeks since Kenneth Starr’s arrest, this investigation has maintained its velocity,” Manhattan US Attorney Preet Bharara told reporters last week.

Furthermore, Bernie Madoff, who orchestrated the biggest Ponzi scheme of all time, was convicted and sentenced in less time that it has taken the FBI to complete its investigation of Montague. The receiver overseeing the liquidation of the fraudster’s enterprise is reportedly expected to recover more monies than originally anticipated — so much so that some vulture funds are already buying up the claims.

The Montague case isn’t the only example of the wheels of justice grinding to a near halt when working class investors are defrauded of their monies.  I represent some working class investors in Long Island who were defrauded by a convicted felon named Peter Dawson more than three years ago.  Although Dawson sits in prison, Bank of America, Washington Mutual and other financial institutions who enabled Dawson’s fraud have yet to be held accountable.

There is a disturbing lesson here: When it comes to prosecuting securities fraud and garnering restitution for investors, working-class people shouldn’t expect the same level of prosecution and recovery as their wealthy brethren.

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Senate Calls for Audit of Fed Reserve

Expressing its frustration with the secretive policies of the Fed, the Senate voted unanimouslyfor a onetime audit to learn details of the emergency funding made by the Fed during the financial crisis.  The Fed would have to post information on its website about firms that received funding.  This measure is a compromise from previous proposals that would have required regular audits.  For details, see WPost, Senate passes measure for increased Fed oversight.

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Ethical Showdown: Goldman vs. Bear

Goldman Sachs has long reigned supreme on Wall Street because of the widespread perception and belief that they employed the smartest guys in the business.  But the SEC’s fraud charges against the firm have exposed another possible reason for the firm’s stratospheric success: The firm is more ethically challenged than some of its rivals.

We will let the courts decide the legal merits of the fraud charges the SEC filed against Goldman last week, but let’s consider the moral propriety of the firm selling its clients mortgage securities that hedge fund powerhouse John Paulson had determined were most likely to fail.  Goldman steadfastly maintains that it had no legal obligation to disclose that Paulson was the designer of the CDOs, but at least one competitor reportedly couldn’t stomach concocting such an arrangement.

In his book, “The Greatest Trade Ever,” Wall Street Journal reporter Greg Zuckerman discloses that Paulson first approached Bear Stearns trader Scott Eichel to structure  a package of highly toxic securities with a high likelihood of failure, but Eichel and his colleagues apparently wouldn’t do the deal.  According to Zuckerman:

Mr. Eichel said he felt it would look improper for his firm. “On the one hand, we’d be selling the deals to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Mr. Eichel told a colleague; on the other hand, Bear Stearns would be helping Mr. Paulson wager against the deals.”

Zuckerman says that Deutsche Bank and other unnamed banks also worked with Paulson to structure CDOs that he could short, which, if true, raises the question as to why the SEC has singled out only Goldman for fraud.  Bears Stearns was hardly the paragon of ethical propriety (it marketed hedge funds filled with dubious subprime mortgage securities to unsuspecting retail investors), but its impressive that they chose to turn down a lucrative fee arrangement rather than engage in a transaction they perceived as morally wrong. Goldman and Deutsche Bank apparently had no such ethical compunctions.

Ironically, Eichel now reportedly works for Royal Bank of Scotland, which acquired a business unit of ABN AMRO that was on the losing side of the Paulson designed instruments.  Goldman maintains that it also lost $90 million on the deal, but I’m skeptical about the validity of the claim; the firm has long bragged about its risk management and its ability to hedge its trades. So while perhaps Goldman did indeed lose $90 million on one side of the transaction, it’s more than likely that they made it up on another.

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Feds open criminal probe of Goldman

Stepping up the pressure on Goldman Sachs two days after its executives were grilled and publicly rebuked by lawmakers, the Justice Department has opened a criminal investigation of the Wall Street powerhouse over mortgage securities deals it arranged.

The criminal inquiry follows civil fraud charges filed by the government against Goldman two weeks ago and as Congress pushes toward enacting sweeping legislation aimed at preventing another near-meltdown of the financial system.

The investigation by the U.S. attorney’s office in Manhattan stems from a criminal referral by the Securities and Exchange Commission, a knowledgeable person said Thursday. The person spoke on condition of anonymity because the inquiry is in a preliminary phase.

The SEC brought civil fraud charges against Goldman and a trader in connection with the transactions in 2006 and 2007. The agency alleged the firm misled investors by failing to tell them the subprime mortgage securities had been chosen with help from a Goldman hedge fund client, Paulson & Co., that was betting the investments would fail. Goldman and the trader, Fabrice Tourre, have denied wrongdoing and said they will contest the allegations in court.

Word of the Justice Department action came a day after a group of 62 House lawmakers, including Judiciary Committee Chairman John Conyers, D-Mich., asked Justice to conduct a criminal probe of Goldman. “On the face of the SEC filing, criminal fraud on a historic scale seems to have occurred in this instance,” the lawmakers, mostly Democrats, said in a letter to Attorney General Eric Holder.

SEC spokesman John Nester declined any comment on the matter, as did Yusill Scribner, a spokeswoman for the U.S. attorney’s office in Manhattan.

Goldman spokesman Lucas van Praag said, “Given the recent focus on the firm, we’re not surprised by the report of an inquiry. We would cooperate fully with any request for information.”

The Justice Department move was the latest in a dramatic series of turns in the Goldman saga, which has pitted the culture of Wall Street against angry lawmakers in an election year, in the wake of the financial crisis that plunged the country into the most severe recession since the Great Depression of the 1930s.

At the Capitol Thursday, following days of failed test votes, the Senate lurched into action on sweeping legislation backed by the Obama administration that would clamp down on Wall Street and the sort of high-risk investments that nearly brought down the economy in 2008.

And two days earlier, a daylong showdown before a Senate investigative panel put Goldman’s defense of its conduct in the run-up to the financial crisis on display before indignant lawmakers and a national audience. The panel, which investigated Goldman’s activities for 18 months, alleges that the Wall Street powerhouse bet against its clients - and the housing market - by taking short positions on mortgage securities and failed to tell investors that the securities it was selling were at very high risk of default.

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Zamansky: Goldman vs. Bear

Goldman Sachs has long reigned supreme on Wall Street because of the widespread perception and belief that they employed the smartest guys in the business.  But the SEC’s fraud charges against the firm have exposed another possible reason for the firm’s stratospheric success: The firm is more ethically challenged than some of its rivals.

We will let the courts decide the legal merits of the fraud charges the SEC filed against Goldman last week, but let’s consider the moral propriety of the firm selling its clients mortgage securities that hedge fund powerhouse John Paulson had determined were most likely to fail.  Goldman steadfastly maintains that it had no legal obligation to disclose that Paulson was the designer of the CDOs, but at least one competitor reportedly couldn’t stomach concocting such an arrangement.

In his book, “The Greatest Trade Ever,” Wall Street Journal reporter Greg Zuckerman discloses that Paulson first approached Bear Stearns trader Scott Eichel to structure  a package of highly toxic securities with a high likelihood of failure, but Eichel and his colleagues apparently wouldn’t do the deal.  According to Zuckerman:

Mr. Eichel said he felt it would look improper for his firm. “On the one hand, we’d be selling the deals to investors, without telling them that a bearish hedge fund was the impetus for the transaction, Mr. Eichel told a colleague; on the other hand, Bear Stearns would be helping Mr. Paulson wager against the deals.”

Zuckerman says that Deutsche Bank and other unnamed banks also worked with Paulson to structure CDOs that he could short, which, if true, raises the question as to why the SEC has singled out only Goldman for fraud.  Bears Stearns was hardly the paragon of ethical propriety (it marketed hedge funds filled with dubious subprime mortgage securities to unsuspecting retail investors), but its impressive that they chose to turn down a lucrative fee arrangement rather than engage in a transaction they perceived as morally wrong. Goldman and Deutsche Bank apparently had no such ethical compunctions.

Ironically, Eichel now reportedly works for Royal Bank of Scotland, which acquired a business unit of ABN AMRO that was on the losing side of the Paulson designed instruments.  Goldman maintains that it also lost $90 million on the deal, but I’m skeptical about the validity of the claim; the firm has long bragged about its risk management and its ability to hedge its trades. So while perhaps Goldman did indeed lose $90 million on one side of the transaction, it’s more than likely that they made it up on another.

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Black on Fiduciary Duty, Professionalism and Investment Advice

I recently posted on SSRN my latest paper, Fiduciary Duty, Professionalism and Investment Advice.  Because it is a work-in-progress, I welcome comments and criticisms.  Here is the abstract:

Although broker-dealers and investment advisers provide virtually identical services, they are subject to different regulatory schemes and standards. These sharp legal distinctions that do not comport with reality have led to investor confusion and concern about the adequacy of investor protection. The Obama administration’s Financial Regulatory Reform includes proposals that would “establish a fiduciary duty for broker-dealers offering investment advice and harmonize the regulation of investment advisers and broker-dealers.” In addition, the Obama proposal calls for the SEC to study the use of predispute arbitration arguments in securities arbitration and to invalidate them if it would be in the best interests of investors. As of March 25, 2010 Congress has not enacted financial reform legislation. Although the bill passed by the House and the bill approved by the Senate Banking Committee reflect different approaches, any legislation that Congress ultimately enacts is likely to address both these issues in some fashion, probably by calling on the SEC to study them further.

Despite their consensus on the general concept of harmonized regulation, the broker-dealer and investment adviser industry groups are bitterly divided over how to accomplish this. In addition, the broker-dealer industry supports mandatory securities arbitration, while other groups call for its abolition. This paper seeks both to shed some light and remove some heat from these contentious debates. I make four arguments: 1. The fiduciary duty standard is not a useful standard for regulating the conduct of broker-dealers or investment advisers; the standard should be based on professionalism. 2. There are established standards of care and competence that should be applicable to both broker-dealers and investment advisers. 3. Without an explicit federal remedy for negligence, investors do not have adequate protection. 4. If Congress directs or encourages the SEC to invalidate predispute arbitration agreements, small investors are likely to be worse off.

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Zamansky: Regulatory “Reform” Bill Shafts Individual Investors

I should have known it was too good to be true.  A few months ago I was enthusiastically optimistic that the regulatory reform bill Congress was looking to pass would include an important investor protection measure known as the “fiduciary duty” standard, which would require brokers to put their clients’ financial interests ahead of their own.  Senator Christopher Dodd (D-CT) said he supported the measure, as did SIFMA, Wall Street’s lobbying arm. Indeed, John Taft, head of the SIFMA committee on regulatory reform, even acknowledged, “It’s a big deal for our industry to do this.”  The SEC and FINRA also indicated support for adopting the standard.

Despite all the declared “public” support, it’s near certain that the regulatory reform bill Congress is expected to pass next week won’t require holding brokers to a fiduciary standard.  The provision has been quietly dropped from the proposed legislation currently being circulated.  The omission should be of major concern to investors who buy stocks, bonds, and other financial products from Wall Street brokers.

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