Top Executives Involved in Financial Fraud Cases Are Still Innocent Until Proven Guilty … For Now

By Claudio Arruda

“The scars of the Great Recession, its lingering impacts and its echoes throughout our financial system are not hard to find.” These words, spoken by then Attorney General, Eric Holder, to an auditorium filled with judges, U.S. Attorneys, law students, faculty members, administrators, staff and alumni at the New York University School of Law on September 17, 2014, drives a chill through the spine of the majority of investors – large and small.

In an age where financial institutions are facing court battles regarding accusations of money laundering, conspiring to aid tax evasion, and taking risky bets relying on federally-insured capital, all investors should be concerned. Since 2009, the Department of Justice (“DOJ”) has brought over 60 cases against financial institutions which have resulted in recoveries totaling over $85 billion. However, there are rarely any criminal charges against top executives of these financial institutions.

In his speech at NYU, Holder expressed his frustration that the DOJ remains largely powerless to hold top executives liable for their alleged criminal actions. Holder asked “whether the law provides an adequate means to hold the decision-makers at these firms properly accountable.” His answer to the problem is simple: set a strict liability criminal standard in the financial industry.

Thus, he proposed three approaches designed to set a different standard: (1) extend the Park liability doctrine to the financial sector; (2) apply the Sarbanes-Oxley (“SOX”) requirement that senior executives certify financial statements; and (3) create regulations similar to the regulatory reforms in the United Kingdom (“UK”) that require senior bank executives to file a “statement of responsibilities” with the UK regulators.

It is improbable that strict criminal liability will be applied to financial crimes. First, it would require congressional action, which is not likely to gain traction for many reasons. Second, strict liability runs contrary to the principle that justice is fundamentally reserved for intentional wrongdoing. Third, the policy rationale for applying the Park “strict liability” doctrine in food and drug cases, where death can actually occur because of the wrongdoing, is unlikely to have a similar sway for financial crimes. On the other hand, we must always remember that financial losses can cause enormous hardships for investors who lose retirement savings or whose losses leave them unable to afford medical or other expenses.

The practical effect of the Park doctrine, however, should not be ignored. Health care companies doing business under the “threat” of the doctrine have strengthened their compliance programs and required their Boards of Directors to be more closely involved in overseeing regulatory and legal issues of their corporations. Equally, the strict liability threat in the financial services industry would likely spur companies into creating more robust compliance systems, ensuring a free flow of information to top executives, and involving these executives more intimately in managing any of their companies’ operations that raise regulatory or legal risks.

Whether top executives of financial companies will be strictly liable for their companies’ criminal conducts remains to be seen. One thing is certain: the DOJ’s focus has now shifted to making senior corporate executives in the financial industry accountable for wrongdoing within their companies. That is undoubtedly a step in the right direction.

Are You Being Offered an Opportunity to Invest in a Small Company with Tremendous Growth Potential? Ask Yourself, “Why Me?”

By Craig Tompkins

In 2012, the Jumpstart Our Business Startups (JOBS) Act was passed by Congress with the goal of expanding the potential pool of investors from which small businesses can raise capital. While the final rules governing how this new game will be played are still pending, what is known, is that the average investor is now more likely than ever to be offered investments that were previously only available to the very wealthy.

Private placements are a type of investment that were previously only made available to “accredited investors,” with an exception allowing a small number of non-accredited investors to invest in each particular company offering a private placement investment. The fact that these investments are not registered with the SEC makes private placements very risky. When a company is not registered with the SEC, there is no requirement on that company to file detailed financial reports, making it very difficult to determine how the company is performing.

But lack of transparency is only one of many risks inherent in private placements. These types of investments are frequently used as vehicles for scams, and are often pushed on unwitting investors by stockbrokers hoping to score a big commission.

The sales pitch for private placements usually includes mention that you are being given the opportunity to invest in a quickly growing company before its shares become publicly available, and once the company has its Initial Public Offering (IPO), you’ll be able to sell your shares over a stock exchange for a large profit. However, it is important to know that nobody can guarantee that any business will ever even have an IPO. This means you may have an investment that could be impossible to sell.

The JOBS Act has made two changes to the laws governing private placements that affect the average investor. First, companies are now allowed to advertise their private placement offerings to the public at large. While the law states that firms may only seek accredited investors through mass advertising, there is a risk that many more non-accredited investors will become aware of these investment opportunities. This makes it increasingly likely that an individual will be roped into investing in a private placement that is not a suitable investment given their investing knowledge and goals.

The second major change brought on by the JOBS Act is the legitimization of “crowdfunding” as a means of selling an ownership stake in a business. Crowdfunding allows business to sell small ownership stakes to large amounts of individuals. It’s important to remember that crowdfunding investments carry many of the same risks as private placements. It is difficult to determine the financial health of a crowdfunding investment, it may never become a public company and you may never be able to resell your ownership stake.

Your first line of defense in protecting yourself from being duped into a bad investment in a private company is to ask: Why me? If you can answer the question of “Why me?” with an answer that makes sense, investigate the person who is trying to sell this investment to you. Use FINRA’s BrokerCheck to verify that they are properly licensed to sell securities. FINRA also recommends checking to see if the person offering you investment securities has served time in federal prison. Time served could be a very good indication that you are dealing with a con-artist.

If the person selling you the investment checks out, do some research on the company you would be investing in. Read the offering materials in full and search the web for information about the company.

Finally, never invest more than you can afford to lose. Even legitimate private placement offerings, sold by legitimate dealers, are highly risky investments. You could do everything right, and still lose your entire investment.

Elements of Portfolio Management: Recognizing Potential Unsuitability Claims

By David Newfield

The most common claim customers make against their brokers in FINRA arbitrations are unsuitability claims. Under FINRA Rule 2111, a broker has a duty to make sure any recommended transaction is suitable for the customer. Many factors contribute to an assessment of suitability for a portfolio. FINRA issued guidance on the specifics of Rule 2111 in Regulatory Notice 12-25. The notice explains the three main suitability obligations of the rule. These obligations are reasonable-basis suitability, customer-specific suitability, and quantitative suitability.

Customer-specific suitability requires the broker to consider a specific investment, or investment strategy, in the context of a particular customer. The customer’s age, experience, and risk tolerance are a few of the factors a broker must consider. Many brokers fail to consider customer-specific suitability. Therefore, it is important for a customer to be aware of the basic elements of portfolio management, in order to recognize when his or her broker may have behaved improperly.

Traditional portfolio management theory seeks to find an optimal balance of assets in order to effectively manage risk while still seeking maximum return. Most portfolios are made up of a balance of fixed income and equities. Deciding how to balance these elements will depend on the specific needs of the customer. Three useful factors to look at are age, asset, and allocation.

1)     Age: When investing, the age of an investor is one of the first questions to ask. As people age, their needs and investment goals change. Someone starting to invest for retirement may be interested in growth, and have a higher risk profile; whereas somebody already retired will be interest in safe, income-producing, investments. (Tip: A common trick many people use to calculate an ideal stock-bond balance is to invest the same percentage in bonds as a person’s age. Thus, a 25 year-old should invest 75% of his or her portfolio in stock.)

2)     Asset: Not all stocks and bonds are created equal. Although some stocks or bonds may offer a higher return, this comes along with greater risk. It is important for an investor to consider both the asset class as well as the specific asset. (Tip: When choosing stocks, consider the size, style, and sector of the stocks.)

3)     Allocation: Everybody knows the age-old adage: Don’t put all your eggs in one basket. It is important for every portfolio to be appropriately diversified. An investor should consider if his or her investments appear to be too concentrated. (Tip: Try to invest in a handful of companies that you know, trust, or even use in your day to day life.)

Although this list is not exhaustive, an investor can begin to gain insight in to his or her portfolio by considering age, asset, and allocation. Furthermore, FINRA Rule 2090 requires brokers to “know your customer.” A broker has an obligation, when opening and maintaining an account, to know the essential facts concerning every customer. It should raise a red flag to an investor if he or she feels that his or her broker has not inquired about his or her background and investment goals.