A Recent Flood of Cases Has Caused FINRA to Freeze New Arbitrations in Puerto Rico

By Myles Burstein

On March 18, 2014, FINRA announced that due to the recent flood of cases in Puerto Rico, claims would be delayed until FINRA could find additional arbitrators.  In particular, there have been a lot of claims by bondholders who have lost money as a result of misrepresentations as to the risks involved.

Since the city of Detroit filed bankruptcy last summer, Puerto Rico’s municipal bond market has been struggling.  This has provoked investor fears for Puerto Rico’s $70 billion in municipal debt and has set off a wave of claims against the broker-dealers that have sold the bonds.

According to Irvin Jackson, author of the article “Puerto Rico Bond Arbitration Claims Overwhelming FINRA,” “[a]t least 165 Puerto Rico bond fund cases have been filed by investors against UBS and other brokerage firms, claiming that false and misleading information was provided about the safety and security of the investments.  However, some estimates suggest that more than 500 arbitration claims are likely to be filed in the coming months.”  UBS continues to face lawsuits coming from Puerto Rico stemming from the Puerto Rico bond funds.  These types of claims involve the misrepresentation of the risks associated with investing in these bonds.  Generally, these investments were being pitched to elderly investors as safe and secure ways to save for their retirement.

Typically, FINRA arbitration panels have three arbitrators, and a single arbitrator can only hear small claims of $20,000 or less.  According to Linda Feinberg, President of FINRA dispute resolution, FINRA has two ways to handle the shortage of arbitrators in Puerto Rico: it can either recruit locally or send arbitrators to Puerto Rico from nearby locales like Florida.  In the past, this strategy has worked.

FINRA’s BrokerCheck Needs a Gut Check

By Jennifer Allegra

On March 6, 2014, the Public Investors Arbitration Bar Association (PIABA) issued a warning to the investing public regarding FINRA’s failure to disclose “red flag” information in a broker’s background check.  PIABA conducted an analysis and found that FINRA has elected to limit disclosure despite opposition from the SEC.

The FINRA website boasts: “We Believe in Protecting America’s 90 Million Investors, Because That Is Our Job.”  FINRA also encourages investors to protect themselves.  Indeed, the number one tip is for investors to use BrokerCheck to research their brokers’ backgrounds.  In a sense, FINRA is not only inducing the investing public into believing that FINRA is looking out for their best interest, but it is also encouraging investors to rely on BrokerCheck as the holy grail of vetting a broker.  However, an investor would be remiss to rely on BrokerCheck because BrokerCheck fails to include many “red flag” disclosures that could impact an investor’s decision to trust a broker with his life savings.

FINRA is not disclosing all of the information in its possession. Consequently, FINRA is misleading the public to believe that BrokerCheck provides full disclosure.  FINRA maintains a Central Registration Depository (“CRD”), which is a comprehensive national database consisting of information that FINRA gathers as well as the information that each state collects.   However, FINRA has chosen to disclose only a portion of the information it receives from the states.

According to PIABA, FINRA defends the lack of disclosure by protecting the “personal privacy” and “fairness” to its members.  However, it may not be fair to investors who have been induced into relying on BrokerCheck as the number one way to protect their investment. For example BrokerCheck fails to report the reason for which a broker was terminated.  From a logical perspective, FINRA, which has access to this information, should have an obligation to disclose it to the investing public.  FINRA also does not disclose broker bankruptcy and tax liens unless they occurred within the past ten years.  Yet, the investing public should have the opportunity to make a fully informed decision as to whether they want a broker who cannot manage his own finances to be entrusted with the the task of managing theirs.

The problem of inaccurate disclosures are further compounded because often disclosure events slip through the cracks and never make it into CRD’s.  Indeed, the Wall Street Journal recently reported that over 1600 stockbrokers failed to disclose bankruptcy filings, criminal charges, and other red flags.   The report further stated that there was a high correlation between unreported bankruptcies and unfavorable disciplinary records.  Because FINRA relies on self-reporting, brokerage firms have a duty to report this information.  However, much of this important information is falling through the cracks, which makes BrokerCheck disclosures incongruent with FINRA’s purported mission of investor protection.

Investor Rights Clinic Wins Full Recovery in First Arbitration Decision

Thanks to the hard work of its student interns and staff, the IRC obtained a FINRA arbitration award for the full amount of its client Carol Barnes’ net-out-of-pocket losses in a matter adverse to Raymond James Financial Services, Inc. While the IRC has recovered hundreds of thousands of dollars for its clients through settlements, this award marks the first case that reached a final decision from an arbitrator. Read more about the successful outcome and the students who worked on the case here.

FINRA Warns Investors That Bitcoins May Be More Than a Bit Risky

By Bradley Zappala

If you’ve been keeping up with the news over the past year or so, chances are you’ve heard of Bitcoin. Yet while most have heard of the virtual currency, many still do not understand exactly what it is, or how it works. Although many investors have viewed Bitcoin as a way to turn a quick profit, recent developments have reminded the public that Bitcoin remains a highly volatile and speculative product, which is inappropriate for investors without an extremely high tolerance for risk.

This notion was reinforced by FINRA in a recent investor alert entitled “Bitcoin: More than a Bit Risky.” Among other things, the alert highlighted recent events that have brought to light some of the very real dangers of investing in Bitcoin. The most prominent of these events was the recent crash of Mt. Gox, once the world’s largest Bitcoin exchange. Though details have been sparse, it is estimated that Mt. Gox lost approximately $460 million worth of its customer’s Bitcoins due to what its CEO described as “weaknesses” in its system.

Although what happened at Mt. Gox has garnered a tremendous amount of attention due to the eye-popping losses, it is hardly the first time something like this has happened in the world of Bitcoin. As FINRA points out, there have been several other instances of hacking and fraudulent manipulations of Bitcoin platforms. Unfortunately for investors affected by the Mt. Gox fiasco, the lack of regulation and oversight of virtual currencies likely means that they will have little recourse in seeking restitution. Worse still, unlike deposits held in a US bank, Bitcoin deposits are not insured.

Outside of the inherent risk of relying on still imperfect software in a fledgling, online industry, FINRA’s Investor Alert also points toward external factors such as deceitful Bitcoin “brokers” and companies with questionable business practices, several of which have rushed onto the virtual currency scene in an attempt to capitalize off of media hysteria and bamboozle unwary investors. One such example FINRA provided was recent SEC charges against a Texas man who allegedly defrauded investors out of $4.5 million in a Ponzi scheme involving Bitcoin. Unfortunately for the duped investors, the man was able to take advantage of the general lack of understanding and knowledge of Bitcoin to perpetuate his fraudulent scheme, using solicitations on Bitcoin-related websites to falsely assure potential investors that investing in Bitcoin carried little to no risk and would return massive gains. As a matter of practice, it is important that anyone thinking about investing in any financial product realize that guarantees of little risk and massive gains are usually indicative of fraud, and certainly do not apply to virtual currency, which in its current state is a highly volatile and speculative investment at best.

Ultimately, potential investors should be extremely cautious of virtual currencies—at least for the foreseeable future. For purposes of illustration, someone who invested in Bitcoin at its peak of almost $1,200 per coin in December 2013 would be looking at a loss of over fifty percent of his investment today, just three months later. This rapid decline in the value of Bitcoin occurred despite several online articles in December that claimed the price of Bitcoin would exceed $10,000—or even $100,000—per coin. As of this writing, however, the price of Bitcoin has steadily declined since its December peak, and many Bitcoin investors who didn’t lose everything on Mt. Gox have nevertheless suffered substantial losses.

Despite the risk posed to investors, it must also be acknowledged that the concept of Bitcoin—and virtual currency as a whole—is spectacularly innovative and could one day develop into a reliable method of payment, allowing for easier and more efficient transactions for both businesses and consumers. One of the chief advantages of Bitcoin is that it is not tied to any specific country, and allows for people without bank accounts or government issued identification—a large portion of the developing world—to transact online or face-to-face with anyone who accepts Bitcoin, simply through the use of smartphones.

At the current time, however, the relatively young technology remains vulnerable to hackers and fraudsters, and we have yet to see whether platforms for buying, selling, and holding Bitcoin can be made secure. Furthermore, without regulations like those that currently apply to the trading of securities, the world of virtual currency will continue to function like the wild west. Fortunately for Bitcoin proponents, it appears that security fixes—some, at least—are in the works, and that some form of governmental regulation and oversight may be on its way in the US. Until then, it is likely that Bitcoin and other virtual currencies will remain highly volatile gambles, which should be considered as investment prospects only by investors who are willing and able to lose.

SCOTUS to Reconsider “Fraud-on-the-Market” Theory in Halliburton

By Allison Norris

On March 5, 2014, the Supreme Court heard oral arguments in the case of Halliburton Co. v. Erica P. John Fund, Inc., No. 13-317. This case will challenge the “fraud-on-the-market” presumption in securities fraud cases.  Without this presumption, putative class action plaintiffs will not be able to maintain a securities fraud class action unless they can prove that each individual shareholder relied on the alleged misrepresentations in cases involving securities that trade on “efficient markets.”  The presumption is based on the economic theory that states that an efficient market will reflect all publicly available information about a company.  Accordingly, a buyer of the security may be presumed to have relied on that information in purchasing the security.

The Supreme Court first recognized the “fraud-on-the-market-theory” in Basic Inc. v. Levinson, 485 U.S. 224 (1988).  By taking away the need to prove individual reliance, this theory allows classes to be certified under Section 10(b) of the Securities Exchange Act, whereas they would otherwise have to be certified under Federal Rule of Civil Procedure 23(b)(3).  In the latter case, individual reliance questions would likely predominate over common questions affecting the class as a whole.

After the Court simplified the reliance requirement, both the number of securities fraud cases filed and amount of settlements paid increased significantly.  The Court, skeptical of a judge-made rule increasing securities litigation to such an extent, has created a number of limits to § 10(b) actions over the last few years.  Even in Amgen Inc. v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184, 1208 (2013), a case that expanded the reach of Basic, four Justices (Scalia, Kennedy, Thomas, and Alito) went out of their way to note that Amgen had not challenged the validity of the “fraud-on-the-market” doctrine, and those Justices expressed doubts about the legal and economic foundations of the doctrine.

After the concurring and dissenting Justices in Amgen opened the door to a challenge of the continuing validity of Basic’s “fraud-on-the-market” presumption, the Court’s acceptance of Halliburton’s petition for certiorari hints that the Court might be primed to overrule or significantly limit Basic.  If the Court were to abrogate or significantly limit the “fraud-on-the-market” theory, it would dramatically change the landscape of class-action securities litigation.  The need to individually determine investor reliance would make securities fraud class certification difficult or practically impossible in most cases, as common class-wide issues would no longer outweigh individual concerns.


High Alert: FINRA Warns Investors of Marijuana Stock Scams

by Peter Capacchione

On January 10, 2014, FINRA reissued an Investor Alert titled Marijuana Stock Scams, in response to the rollout of new state laws regarding the legalization of marijuana for both medical and recreational purposes.  With the introduction of such laws, more and more investors have been looking to profit by investing in marijuana-related companies.  While traditionally thinly traded, marijuana-related stocks have become more and more volatile, especially with increased coverage of recent legalization efforts and successes.  Price volatility creates an opportunity for investors to buy low and see huge growth, but with chance also comes risk—here, such volatile stocks carry the risk of burning investors, while also opening the doors to hopeful scammers wishing to defraud eager investors.

FINRA first advises investors on how to weed out potential stock scams.  Oftentimes, investment scammers send out alluring sales pitches through faxes, e-mails, text messages, infomercials, tweets, or even blog posts.  Such correspondence will typically attempt to entice investors with overly optimistic—and sometimes false—market data.  If you have seen Scorcese’s The Wolf of Wall Street, just think of Leo suavely pitching penny stocks from a garage-turned-trading-floor.  FINRA calls such ploys “pump and dump” routines, as the scammers will first pump up unwarranted demand for shares of marijuana-related companies, thanks to the willingness of investors that fall for the sales pitch.  Following the pump, as share prices top off, the fraudsters sell off their shares, profiting while hooked investors are left in the dump.

In the InvestorAlert, FINRA provides a number of tips on how to avoid being duped by dealers of fraudulent stock scams.  First off, investors should always ask why a stranger would be telling them about an incredible investment opportunity.  Investors should also be weary of the source of information that indicates the potential for explosive growth—multiple in-house press releases and promotional information dispersed in a short timeframe should heighten suspicions.  FINRA also warns that research should not simply be limited to the company.  Instead, investors should also conduct research on corporate officers and major shareholders of any marijuana-related company.  A search with the Federal Bureau of Prisons Inmate Locator can help investors learn whether company players or investors have been involved in narcotics crimes or financial fraud.

Furthermore, where a stock trades can indicate the legitimacy of a stock—over-the-counter trading platforms do not typically enforce minimum standards on company shares.    Additionally, who sells a stock can also reveal a scam; a legitimate broker for a stock must be properly licensed, and is usually part of a firm that must be registered with FINRA, the SEC, and state regulators.  Before relying on any sales pitch for a marijuana stock, investors should take advantage of BrokerCheck.  Finally, in addition to reading and verifying the information found in any marijuana-related company’s SEC filings, investors should raise an eyebrow at any company that has changed its name or its business focus.

FINRA BrokerCheck: Will New Expungement Guidelines Help or Hurt the Securities Industry?

by Sean McCleary

Despite seemingly rigid rules on granting expungements, arbitrators have been allowing them far too often.  In fact, in mid-October, FINRA sent out a notice to its arbitrators, reiterating the guidelines for granting an expungement, which it considers to be an “extraordinary remedy.” Essentially, expungements cleanse any settlement information from a broker’s record on the Central Registration Depository (“CRD”).  BrokerCheck is the investor resource that allows investors to access certain information from the CRD—specifically, whether there were any past claims against a broker.  Expungements can carry significant implications because it reduces the transparency that potential investors need.

Until recently, FINRA Rules did not expressly prohibit members from conditioning settlements on expungement.  However, on February 13, 2014, FINRA’s Board of Governors moved to file Rule 2081 with the SEC, which will bar broker-dealers from trying to condition customer dispute settlements on the customers not opposing an expungement request.  In settlement negotiations, customers are probably not cognizant of an expungement’s implications—after all, the investor is getting some money back and he probably does not plan on using the broker in the future.  With Rule 2081, brokers will find it considerably harder to sanitize their BrokerCheck report from a past settlement claim.  Further, this will ensure that future investors can more accurately assess the quality and integrity of a broker.

On the other hand, settlements are a significant part of resolving FINRA claims in a timely manner.  If more FINRA claims reached arbitration, then the average FINRA claim would take substantially longer to adjudicate.  Ultimately, Rule 2081 could dissuade broker-dealers from settlement prior to arbitration because they may want to take their chances in arbitration.