Yesterday, the SEC announced it was charging Vinayak S. Gowrish and Adnan S. Zaman, two former employees of "global firms" in a "serial insider trading scheme" in which the two men "stole confidential information from their firms in connection with five deals and tipped two friends in exchange for kickbacks ... and made nearly $500,000 in illicit profits. The SEC also charged the two "friends" with fraudulent trading based upon the material, non-public information they allegedly received from the tippers Zaman and Gowrish.  According to the SEC's complaint, three of the four individuals were fraternity brothers and the fourth was a friend.

While in the grand scheme of things this may seem like a run of the mill insider trading case, it begs the question - how did these alleged unlawful activities come to light?   One would think that the yellow "post it" notes, in-person meetings and other non-tech methodology discussed in the SEC's complaint would make it highly improbable that such a relatively small purported insider trading scheme would be detected.  This case may be one to follow for this reason alone.

Stay tuned....

Timeliness is everything.  According to the press release, a key criticism FINRA had of the firms' supervisory systems is that no mechanism existed that would allow supervisors to "directly monitor e-mail communications of brokers."  Instead, brokers would forward their e-mails to supervisors and, in the process, could delete e-mail that might otherwise have been "red flags."  In this case, more than 100 e-mails went undetected which later showed that one of MetLife Securities' brokers "stole nearly $6 million from his customers in connection with his participation in numerous private securities transactions to raise capital for real estate development companies with which he had a relationship."  FINRA also found that the "firm's inability to ensure compliance with the e-mail forwarding requirement meant they could not adequately enforce their own supervisory procedures relating to outside business activities and private securities transactions."

Social networking and other forms of electronic communications - recipe for a supervisory nightmare?  Common sense suggests firms should treat all forms of electronic communication like e-mail communications given their similarities until such time as FINRA or the SEC state otherwise.  But policing these communications may prove to be more difficult in practice if the firm is either unaware or ill-equipped to monitor outside e-mail accounts and websites brokers are using to communicate with the public.  While it is unclear at this time how or if FINRA and the SEC intend to tackle the relatively recent explosion of social networking and other electronic media, it's probably a safe bet that we will see more for fines for failure to supervise electronic communications in the coming years.

Fiduciary what?  Sometimes referred to as the "F" word in professional circles, fiduciary duty refers to a heightened duty of responsibility a person owes to his or her client in certain circumstances.   When someone is a fiduciary to you they owe their highest level of loyalty and must disclose, among other things, information such as their compensation and if their interest in a transaction conflicts with yours.  To state the obvious, a natural tension exists anytime someone is sold something whether it be a stock or anything else.  When a person sells a product or service they receive a commission or some other form of compensation and, like most things, can receive higher commissions for selling certain types of products instead of others.  Currently, brokers are not held to the fiduciary standard unless they exercise control over their client's account either expressly or impliedly.  Investment Advisors (IA), on the other hand, who dispense "investment advice," are considered fiduciaries and held to the higher standard.  If you are asking yourself what is the difference between IAs and brokers, check out Kara McGuire's article in the November 22, 2009 issue of the Minneapolis Star Tribune (Section D) titled "Financial advisors don't all follow the same rules."  The article provides an excellent overview, in layman's terms, of some of the key differences between brokers, IAs, and what it means to be a fiduciary.  While the idea of creating a uniform system of conduct for brokers and investment advisors is, on its face, appealing, if not for the simple reason of having one standard of conduct, the proposed standard - that brokers be held to a fiduciary standard for dispensing investment advice - poses potential conflicts for brokers selling proprietary firm products.  

While the IPA is still a ways off from being ready for House approval, it may be a sign of things to come.  Investors and the securities industry would be well served by paying close attention to this and other proposed securities reform regulations in both the House and Senate as sweeping changes are being fast-tracked for approval.  Stay tuned....

Newly discovered Ponzi schemes are hitting the news almost weekly.  Is there an end in sight?  Probably not.  According to various news media outlets, general investor sentiment is one of cautious optimism, but with health care reform and other large issues issues predominating the political arena and news coverage, general optimism about the economy just can't seem to gain traction.  Arguably, in the short run this is good for detecting Ponzi schemes, which rely on an influx of capital from new investors to pay early investors.  In troubled times, people (after a while) tend to hold onto their money tighter, thus making it more difficult for perpetrators to attract new capital to supply the scheme, thereby exposing the schemes when they start to fail.  In the long run, however, the damage Ponzi schemes create may have long lasting impacts.  Investors who have lost their retirement money in Ponzi schemes can't readily replenish their investments to put back in the market when it turns around, and even individuals with the resources to re-invest may be more cautious with their money and less willing to invest. 

While only time will tell how and to what extent the mass uncovering of Ponzi schemes will affect the average investor psyche, no doubt the effects will be felt throughout the market in the coming years.  Stay tuned...

Step 2: Apply healthy skepticism. People have been buying and selling stocks, bonds and many, many other types of investments since the better part of the 20th century. So what is the likelihood that someone has really come up with an unheard of method for making an annual 10-12% return on investment with little or no risk? Keep in mind, over the past 30 years the stock market has only averaged about 10-11% and as anyone looking to retire in the next couple of years can attest, their investments have taken a significant hit and may take several years to bounce back, if at all.

Step 3: Do some due diligence. If nothing else, the Madoff scandal has brought national attention to the fact that people can be very greedy, and in certain circumstances will take advantage of those closest to them - their family and friends. An interesting point about the Madoff scheme is that the promised rates of return were not so high as to draw attention from regulators or even cautious investors - somewhere around 10%. At the very least, this is a signal that Ponzi-scheme artists are getting smarter and more adaptive to changing times. Gone are the Ponzi-schemes of yesteryear, where investors would be promised seemingly unheard of 20-30% returns. With a plethora of information at the fingertips of anyone connected to the World Wide Web, there is probably enough information circulating that most people might pick up on the fact that such investments are a sham. Unfortunately, the Ponzi-scheme artists know this.

So what can investors do? Know the basics. First, be aware that when you generally invest with a broker-dealer you will be asked to fill-out an investment objective questionnaire and other opening account forms. Assuming you have an account you will also receive account statements. Importantly, the account statement is your way to view the performance of your investments. Typically, it contains your account number, the date of your investment, dividends or interest paid, and other information about your investment such as its current value and sometimes whether it gained or lost money since your last statement. More often than not, the statements are printed on company or official looking letterhead (not plain white paper) and will be delivered to you on a regular periodic basis, i.e. monthly, quarterly and annually. Second, get to know your broker and his or her supervisor. Before investing, meet with your broker, at his or her office, and then also ask to meet his or her supervisor. Again, this is not always immediately possible when you are investing with a broker who is located in a satellite office, but more often than not, the branch manager at large broker-dealers are happy to meet their customers - it deepens customer relationships.

Finally, repeat steps 1-3, even after you have purchased your investment. If something doesn't pass the smell test or seem quite right, you owe it to yourself (and your retirement) to dig further.

In a nutshell, there are many fine brokerage firms with top notch individuals ready to help you reach your investment objectives. Unfortunately, it only takes a few large scandals to tarnish the industry and put off many would-be investors. By applying some basic common sense principles and a little bit of skepticism, you will be better prepared to spot a Ponzi-scheme.

Will the pendulum swing in favor of plaintiffs? Maybe. And proponents of the bill have compelling arguments as to why it should. Since Central Bank was decided in 1994, Congress has, for the most part, taken steps to make it progressively more and more difficult for private securities litigants to maintain securities fraud suits. In part, this was in response to rising fears of "strike suits" or what some characterize as abusive or frivolous litigation - a fear which studies have shown, in hindsight, may not have been justified. Moreover, those in favor of the proposed bill will surely point to the numerous scandals that have been uncovered in the past decade and a half as grounds for paring back stringent securities fraud pleading standards. And this dovetails into the argument that the SEC, standing alone, cannot do enough to protect defrauded investors.

It is anyone's guess whether the securities fraud laws will be reformed in the near future. Health care has taken center stage in congressional debates and that will probably not leave room for much else. For now, the prospect of extended securities fraud liability will have to suffice as a deterrent to aiders and abettors.

According to the FINRA release, a hearing panel expelled Legacy Trading Company, and barred the firm’s CEO, Mark Uselton, from the securities industry. The misconduct at issue appears to be wide ranging and included "violations of short selling rules, failure to maintain required books and records, and for providing false information and refusing to provide testimony to FINRA." The hearing panel also fined Legacy and Uselton more than $1 million, finding that they made almost $900,000 in profits from the illegal short sales, which FINRA defines as being "the sale of a security that the seller does not own, or any sale that is consummated by the delivery of a security borrowed by the seller." Not all short sales are prohibited though, but "FINRA and [the] Securities and Exchange Commission (SEC) rules require that short sellers make an affirmative determination that they can borrow the securities for delivery by settlement date, unless the seller is a broker-dealer engaged in bona fide market making activities." You can view a copy of the FINRA release.

Short sellers better watch out; the SEC and FINRA appear poised to aggressively curb non-compliant practices and now have the rules to do it.

The "scheme" the Court is referring to involved the stock of a company known as GenesisIntermedia, Inc. ("GENI"), and affected some of the largest broker-dealers in the world. It came to light after events of September 11, 2001, for reasons still not fully understood today, impacted the scheme in such a way that the underlying fraud became apparent. Needless to say, a full recitation of all the players involved would required pages upon pages of discussion, but any story that include arms dealers, rogue stock traders, paid-off analysts, falsified documents, fraud, and hundreds of millions of dollars doesn't come around every day. Who says securities fraud litigation isn't sexy?

The problem with the GENI stock lending scheme is that it was entirely fraudulent and violated nearly every core securities law. According to the Ninth Circuit's opinion, shareholders of GENI issued themselves unregistered shares (which cannot be resold to the public) and sold those shares to another broker dealer, Native Nations (also in on the scheme), which then falsified records so that the shares appeared to have been received from other broker dealers. Native Nations then lent the shares to other broker dealers (not in on the scheme) under the guise of routine stock lending between member firms. The scheme was orchestrated by individuals on both ends of the chain, i.e. GENI shareholders and a rouge trader, Wayne Breedon at Deutsche Bank. The real tragedy is that unsuspecting broker-dealers who thought they were receiving and on-lending securities exempt from registration were caught in the middle. A casualty of the fall-out was local broker dealer MJK Clearing, Inc., which was forced into bankruptcy after market forces in September 2001 prompted the lenders in the stock lending chain to return their shares of GENI (whose stock price had tanked by this time). Unable to return the worthless GENI shares to Native Nations and other broker dealers closer in the chain to GENI, and after having already returned cash to other broker-dealers further away from GENI in the chain, MJK was forced to cease operations.

This case (and perhaps to a greater extent the companion cases heard in the Federal District Court in Minnesota) contain intrigue that rivals any best seller. If there was a book entitled "How to Completely Violate the Federal Securities Laws" these cases would be in Chapter 1.

At the end of the day, while the courts' opinions from these cases will likely find their way into securities course classroom discussions, they are worth a read, if only to see how creative ingenuity in the wrong hands can wreak havoc on the securities markets and some of its largest participants.

For those of you unfamiliar with securities jargon, a Ponzi-scheme basically takes the shape of a pyramid in which the perpetrator (at the top) takes money one from one or more individuals with the promise to repay them at some point, usually at an attractive interest rate often unobtainable through traditional investments particularly in a troubled economy. As subsequent layers of investors are added to the pyramid, money from new investors is used to repay earlier investors; think along the proverbial lines "robbing Peter to pay Paul." Schemes like this (as evidenced by the Madoff scandal) can go on for years, even decades, without detection. So why are so many scandals coming to light now?

Other types of Ponzi-schemes, which we could call "hybrids," are more complex. There may actually exist an investment vehicle that the perpetrator places some of the money into while at the same time pocketing a portion of the funds for himself. On the other hand, the perpetrator may take the money and put it into an investment completely different than what was explained to the investor with the intention to generate profits to cover those portions of the funds the perpetrator has pocketed for himself. There are numerous other types of Ponzi-schemes as well but these are some of the most common.

The simplest explanation for why the schemes seem to be popping up everywhere now is largely due, in part, to tight credit markets and the near global market downturn. Where as before, Ponzi-scheme artists could have taken a portion of the funds obtained from investors and put the money into a booming sector of the market to generate money in the short term to repay investors at higher levels of the pyramid, there has simply been no thriving sector. Compounding the problem is the fact that banks, in general, have begun to tighten lending requirements making loans to the the public less accessible and less generous, thus foreclosing other avenues of funding for Ponzi-scheme artists looking to keep the scheme afloat. Finally, general investor sentiment and concern has caused individuals to cash out investments and put their money into relatively pedestrian investments such as money market funds or checking/savings accounts. Thus, when an unsuspecting mid-level Ponzi-scheme investor decides to cash in his or her investment, the result of doing so can wreak havoc on a Ponzi-scheme, as the perpetrator will need to scramble to find cash to pay the investor lest the pyramid fall apart - and that cash is not as readily accessible as it once was.

So what can we do to keep this from happening in the future? The short answer is due diligence. Ponzi-schemes, while coming in a variety of flavors, appear to share certain common attributes, including investors being provided very basic account statements, sudden stoppage of investment or dividend payments, lack of transparency in communications with company management, and the promise of seemingly unobtainable, sustainable investment returns often combined with the promise of little or no investment risk. Of course, these are but a handful of cautionary signs investors might look for in assessing whether they are the victim of a Ponzi-scheme, and it should be stressed that just because an investment stops paying dividends or goes out of business does not mean the investment was part of a Ponzi-scheme.

At the end of the day, the old adage "if something sounds to good to be true, it probably is" sill applies in the 21st century, and all of us would benefit from exercising a little more caution. No doubt many more Ponzi-schemes will be exposed in the coming weeks and months, and on that note, you may wish to check out the Securities and Exchange Commission website for its July 27, 2009 litigation release regarding the matter SEC v. John J. Bravata, et al, Case No. 09-CV-12950, a case in which the SEC recently obtained a court order to halt an alleged ongoing fraud and Ponzi scheme conducted in the Detroit area by two individuals and two companies they control involving $50 million and at least 440 investors.

Yesterday, FINRA announced in a news release that Kenneth George Neely, a St. Louis broker formerly employed by Stifel Nicolaus & Co., Inc. and AXA Advisors, LLC, was permanently barred from the industry for having run a Ponzi-scheme in which he "improperly used over $600,000 in investor assets, returned about $300,000 of the funds back to some of the investors and thus converted more than half of this amount to his own personal use." Notably, Neely was not picky when deciding which clients to use as part of his scheme. According to the FINRA release, victims included family members, members of Neely's church, a long time friend and recent retiree, that friend's daughter, and Neely even used his own mother's address as the address for his "St. Louis Investment Club," a purportedly exclusive club fabricated by Neely to lend an air of credibility to investing in his fictitious real estate trust.

For individuals wondering what a typical Ponzi scheme "smells" like, check out the FINRA release.

At present, FINRA has turned the matter over to criminal authorities and only time will tell what happens to Neely and how many more Ponzi-schemes will turn up in 2009.

Stay tuned.

An interesting point made by one of the regulators was the rise of "social networking" sites like Twitter, Linked In and Facebook and how this will affect compliance review of incoming and outgoing client communications - particularly if brokers attempt to conduct business through use of these websites - a course of conduct seemingly fraught with peril.

In the LPL action, the SEC alleged that the firm violated Reg S-P (17 CFR § 248.30(a)) (the "Safeguards Rule"), requiring broker-dealers and SEC-registered investment advisers to adopt written policies and procedures reasonably designed to protect customer information. The SEC's complaint further alleged that despite LPL's having been "aware as early as 2006 that it had insufficient security controls to safeguard customer information at its branch offices, LPL failed to implement adequate controls, including some security measures, which left customer information at LPL’s branch offices vulnerable to unauthorized access. Between mid-July 2007 and February 2008, LPL experienced a series of computer system security breaches in which an unauthorized person(s) accessed and traded, or attempted to trade, in the customer accounts of several of LPL’s registered representatives. As of the date of the "hacking" incidents, LPL had failed to implement increased security measures and adopt policies and procedures reasonably designed to safeguard customer information as required by Regulation S-P. LPL detected the breaches and absorbed the losses in the customer accounts. Nonetheless, LPL’s failures left customer information vulnerable to identity thieves or other unauthorized users at the firm’s branch offices."  Ultimately, the matter was settled, with LPL agreeing to take various remedial measures to correct any noted perceived deficiencies in its systems and to pay a civil penalty of $275,000.  While this action was resolved in September 2008, the specific reference to it during the conference in conjunction with Reg S-P, suggests that consumer data and privacy protection still remain a prime focus of examinations in 2009.

As far as "2009 Examination Priorities" go, the regulators did not provide a "top 10" list but rather a list of 26 items. In no particular order, those topics include: FTC's Red Flags Rule; Alternative Investments; Cash Alternatives; Supervision; Anti-Money Laundering (AML); Unregistered Resale of Restricted Securities (Penny Stocks); Senior Investors; Foreign Corrupt Practices Act; Circulation of Rumors; Order-Entry Controls; Marking the Close; Trade Reporting; Order Audit Trail System (OATS); Variable Annuities; Protection of Customer Information and IT Security; Outsourcing; Information Barriers; Basic Customer Protection; Excess SIPC Protection Inventory and Collateral Valuations; Funding and Liquidity; Counterparty Credit Risk; Intercompany Reconciliations; Suspense Account Reconciliations; Bank Sweep Programs; Fully Paid Lending Programs; and Sales of Equity Securities. Obviously, some of these have been a focus for several years now, e.g. senior investors and variable annuities - with new areas like privacy protection and outsourcing joining the mix.

At this point, it is anyone's guess as to which of these areas the regulators will focus most of their attention during routine exams in the second half of the year.  But it is probably safe to say that customer privacy and information protection will be at the forefront.

A related theme carried throughout the day was that regulators and member firms should have ongoing dialogue before, during and after an examination. As one regulator mentioned, there really should be no surprises at the exit interview if the firm and examiners have been communicating throughout the process. To this end, a best practice shared by a member firm in attendance yesterday was that the first time you interact with the regulators should not be at the start of an examination. Instead, take time to get to know the examiner in your district office and give them a sense of your business, as this will not only help them to tailor the exam to your firm, but will also give you an insight as to what they are looking and how you can best prepare for the exam. Then, during the exam, work with the examining team to set up a periodic time, maybe a Monday morning meeting, to discuss how things are going, thoughts they have at that point in the process, and what you can do to facilitate the exam. For individuals that have not been through an exam before, FINRA has made available at its website, finra.org, web/podcasts which you can watch and that will take you step by step through the examination process.

A final takeaway from the conference is that member firms should get involved on various committees. This is your opportunity to interact with regulators and continue building relations, and, as one attendee put it, "this is your opportunity to help shape policy rather than be shaped by it." I couldn't agree more.

The Court determined that "further amendment [of the pleadings] at this late stage would defeat Congress's expressed intention in enacting the PSLRA and prejudice defendants." See Order at p. 18. Simply put, this is because allowing plaintiffs to raise new theories of recovery at the summary judgment stage would end-run the threshold heightened pleading requirements parties must overcome to survive a motion to dismiss at the outset of litigation - a result antithetical to enactment of the PSLRA.

In short, securities fraud litigants take note: the PSLRA remains a viable hurdle for plaintiffs at all stages of litigation.

In the past, management often used numbers creatively, and reductions in staff levels at many entities historically have come in the form of the elimination of open but unfilled spots on the roster. By not filling the open spot, it may be argued that the group or department is down in head count, hereby meeting the corporate mandate to reduce or eliminate costs. Today, the cuts are deeper and closer to the bone, and they are across the organization. No segment of the business is immune or inured, including compliance staff. 

To appreciate its value to the entity, one must first define the role played by the compliance department. When it is functioning at its best, compliance is a pro-active body, anticipating areas of potential concern when a new product or business line is introduced, or formulating measures that are both practical and effective when regulatory rules change. The compliance arm is often vested with responsibility for identifying issues before they become problems or fester too long, working toward practical and therapeutic solutions and not just treating the side effects. This ability often comes from an innate knowledge of the firm, how it does business, and the standards posed by the regulatory agencies and the world at large on the conduct of firms operating in a highly regulated environment. The seasoned compliance officer develops a sixth sense for problems, recognizing the unusual from the pedestrian, creating his/her own “watch list” of potential sources of problems (e.g. know your broker), and generally being the eyes and ears, and maybe even the conscience, of the organization. 

Unlike the role often assumed by a firm’s legal department, which is frequently reactive and saddled with addressing actual or perceived sales practice violations or probing and demanding regulatory inquiries, compliance is vested with the responsibility to “prevent, avoid, and detect,” and to address in timely fashion procedural weaknesses or ethical shortcomings.

Wall Street today is a broken and battered remnant of a once proud pillar of U.S. economic strength.  While it’s convenient to blame greedy bankers and brokers for this unfortunate turn of events, its difficult to argue that compliance performed exceptionally well or with remarkable effectiveness in the recent past either. History has taught that even when fully staffed, the compliance task is difficult and success often ephemeral. Unfortunately, the short term cost benefits associated with a reduction of compliance personnel may prove illusory, increasing the likelihood that the company will pay later, perhaps at a significantly higher price, for problems that may have been avoided or detected earlier. Unless the organization is prepared to treat these later, magnified problems as simply a deferred cost of doing business, termination decisions should not be made capriciously or without careful and deliberate consideration of the repercussions and ramifications.

This is not to propose that compliance personnel not share in the vicissitudes of the organization, especially if they hope and expect to share in the firm’s fortunes. However, deep and non-surgical efforts to trim compliance staff may not bode well for the future of the firm, and should be exercised prudently and shrewdly. While computerized systems are invaluable tools and allow for extraordinarily creative techniques to aid in the management of the business, they may not universally fulfill the role of a seasoned compliance officer who is armed with the ability to see behind the superficial or the “logical.” Computer systems are beneficial as a tool, but they cannot provide a substitute for experience, perspective, or those intuitive vital skills developed by the compliance officer over years of trial, error, and observation.  

If the ax must fall, a significant component of the firm’s planning must address how the compliance function is to be carried out with minimal disruption to the oversight capabilities of its compliance staff.  Perhaps a new model must be developed for effective compliance. Perhaps technology can fill some of the gaps. Perhaps it is incumbent on management of the compliance function to cross-train the staff so that the disruptions caused by reduced headcount are minimalized. Perhaps people with fresh ideas must be identified, deputized, and given the opportunity introduce untraditional and innovative approaches. But the answer is probably not to impose on another existing and functional arm of the firm duties beyond the capabilities or experience of its personnel. The effort to impose compliance responsibility on personnel with lesser pure compliance expertise, such as staff assigned to the financial or operations sides of the business, may be superficially appealing since they are all “back-office,” non-revenue producing divisions, and work in the arcane world of rules and regulations.  But such an approach may be a recipe for failure, as over-burdened, under-trained staff in accord with the Peter Principle and similar truisms prove incapable of ultimately performing either job to appropriate standards. 

Even if regulatory mandate did not impose on firms the obligation to establish and maintain an effective compliance presence, sound business practices would dictate it. The mantra “good compliance is good for business” still rings true today, and those firms which will not only survive the present economic malaise but will flourish when times are better will be those that strike the appropriate balance between business objectives and oversight necessity.

Arguably, the special arbitration procedures for ARS-related consequential damages is the most striking of the recent additions to the FINRA arsenal. In connection with ARS cases alone, customers are given the option to elect to employ the special procedures or more traditional procedures, and if the former, are given virtually a free opportunity (sans legal fees) to recoup consequential damages from brokerage firms that are parties to ARS-related settlements with the government, imposing on firms the obligation to assume many of the arbitration costs, including filing and hearing session fees, and all expenses for the arbitrators. By employing these procedures, the customer precludes the ability of the brokerage firm to contest liability with regard to the illiquidity of ARS transactions. The customer bears the burden of proving he/she suffered damages due to an inability to liquidate an ARS position. In such instances, the customer may pursue consequential damages only, which FINRA defines as opportunity costs or losses resulting from the investor’s inability to access his/her funds due to the freeze imposed on assets when the ARS market dissolved. Investors seeking punitive or other damages will still have to avail themselves of standard FINRA arbitration procedures. One anticipates that the “lost opportunity” determinant will be hotly contested, as Claimants’ counsel attempt to subsume under this standard a wide array of loses, real and imagined.

The most potentially troublesome of the revisions are new Rules 12504 and 13504, which limit pre-hearing motions to dismiss and impose sanctions when the motion is brought unsuccessfully. Perceived principally as a customer protection provision, the new rule is intended to reduce the number of frivolous and non-meritorious motions brought prior to the presentation of the case-in-chief, and to ensure that customers are provided with an opportunity to be heard by a panel. Designed in an effort to help the customer avoid unnecessary expense, impede efforts to disadvantage unsophisticated claimants, and to expedite hearings on the merits, the movant must first file an Answer. Subsequently, the motion may be brought on one of three grounds:

1) the non-moving party previously released the claims in dispute by a signed settlement agreement and/or written release. Parties seeking this exception should provide arbitrators with valid documents that indicate that the claims in the current dispute have been resolved in a previous dispute. Rules 12504(a)(6)(A) and 13504(a)(6)(A).

2) the moving party was not associated with the accounts, securities or conduct at issue. In essence, there has been a mistake, and the claim has been brought against the wrong person or entity, or a claim names an individual who was not employed by the firm during the time of the dispute or an individual or entity that was not connected to an account, security or conduct during the time of the dispute. Rules 12504(a)(6)(B) and 13504(a)(6)(b).

3) the claim is not eligible for submission to arbitration because six years have elapsed from the occurrence or event giving rise to the claim. Parties seeking this exception should provide arbitrators with valid documents that indicate when the occurrence or event took place. Rules 12206(b)(7) and 13206(b)(7).
Should the panel deny the motion, all motion-related costs must be imposed on the moving party; if the panel views the motion as frivolous, it may also impose costs and attorney fees on the movant and/or impose other sanctions. All of the arbitrators must agree to the dismissal, and explain their decision in writing.

The most glaring infirmity in the motion to dismiss process is the need to file an answer before the submission of the motion. While the new motion requirements may limit the ability of a Respondent to delay inordinately a Claimant’s right to be heard by a panel, by requiring that the answer be submitted before filing a motion the rules impose extraordinary additional costs on a Respondent in cases in which there was either no merit to the claim or it was ineligible for arbitration in the first instance. That facet of the rules seems unfair to the prevailing Respondent, since a party should not have to assume the costs and expenses of submitting a defense when there was no basis for the assertion of the underlying claims. There is no express provision within the rule imposing Respondents’ costs on the Claimant if the motion is brought successfully. One will have to look to other provisions of the Code in order to obtain such a remedy.

The other significant revision of the Code is the raised threshold for the designation of panels. After March 30, 2009, cases seeking $100,000 or less, exclusive of costs and expenses, will be assigned a one person panel. The panel member must be chair qualified and chosen from the roster of public arbitrators. Upon the joint application of the parties, a three person panel may be designated. In theory this procedure should provide a quicker and more efficient resolution of claims falling within this range of damages. Notably, if the dollar amount of the claim is unspecified, or does not request monetary damages, a three arbitrator panel will designated unless the parties agree in writing to have the case heard before a single arbitrator. The rule does not provide a mechanism for the staff of FINRA to make a determination that an unspecified demand should be assigned to the single person panel. Rules 12401 and 13401.

Will these revisions to the Code of Arbitration Procedure provide an elixir that will advance the interests of FINRA’s dual constituency: the investing public and the financial services industry? Will these new rules minimize or avoid log jams if a plethora of new customer cases or intra-broker disputes surface? While in certain instances they may reduce costs to the combatants and expedite the process (e.g. $100,000 threshold rule), the motion practice provisions are unsettling from the defense perspective, necessitating significant and costly procedural steps before having a meritorious and dispositive issue heard. This does not “level the playing field” or otherwise equally advance the interests of Respondents, but in this market environment no one is going to raise the flag in defense of the industry if to do so may be viewed as customer-phobic. Remarkably, no politician has ever been elected by trumpeting the cause of the industry over the public, and FINRA is not about to buck that trend now.
 

Key provisions of the new rule include:

• Parties must jointly request an explained decision;
• Parties must submit their request for an explained decision 20 days before the first scheduled hearing date;
• The Chairperson must write the explained decision;
• The explained decision will be "fact-based," stating the general reasons for the decision;
• The Chairperson will receive $400 honorarium for writing the decision; and
• The honorarium cost will be allocated between the parties.

 The new rule does not allow parties to request an explained decision when (1) the arbitration proceedings are simple and decided solely upon the pleadings and evidence filed by the parties, or (2) the arbitration is conducted under a default proceeding.   While the new rule still gives arbitrators discretion to decide whether to write an explained decision at their own initiative or upon the request of one party, they are not required to draft an explained decision unless both parties agree.

A primary purpose behind the new rule is to address investors’ concerns that they are unable to understand the rationale behind arbitration awards absent explanation. Since application of the rule requires both investor and industry party consent, only time will tell if the new rule will have any impact.*

*Special thanks to Shirley Munson for her assistance with preparing this article.

At the time the Blueprint was released, the financial services and securities industry was headed for rough water:  the auction-rate securities market had cratered; subprime mortgage portfolios and mortgage backed securities were clearly in trouble; concerns were bubbling about naked short selling; Bear Stearns collapsed, and was sold.

Those were the days.  Since then, Lehman Brothers imploded.  Merrill Lynch was sold at a firesale.  AIG required emergency resuscitation to survive. Subprime lending and overinvestment (and misvaluation) of subprime-backed securities has proven to be the biggest disaster, and even more damaging, since the junk bond/leveraged buyout mania that fueled and then destroyed Drexel Burnham Lambert in the 1980s.  And Congress is on the verge of passing a staggering bailout package to try to bring some sort of order to the market. 

In this environment, the push for a regulatory overhaul will only be more intense.  With a new administration on the horizon, the demand for substantial increases in the scope of federal regulation will make change inevitable, regardless of whether it is an Obama or McCain administration.  The Treasury Blueprint  will, undoubtedly, not be the exact model for a new regulatory scheme. However, we can be sure that federal oversight will become both broader and deeper.

Even money market funds are finding themselves embroiled in claims of securities fraud abuses.  Yesterday Minnesota federal judge Paul A. Magnuson extended a temporary restraining order issued last Friday against mutual fund manager Reserve Fund, restraining it from honoring redemption requests from its giant money market fund, the Primary Fund.  The Order stems from a lawsuit filed last week by Ameriprise Financial against Reserve Fund,alleging that it violated federal securities laws and breached fiduciary duties owed to investors by "tipping" certain large institutional investors last Monday that The Primary Fund was exposed to significant debt issued by Lehman Brothers. That was the same day Lehman Brothers filed for bankruptcy. 

The Reserve Fund case may cause investors to question whether the public securities markets are in fact a level playing field, and create heightened investor concern not only for the economic stability of their investments, but also for the impact of corporate wrongdoing on the value of their investments.  During these difficult financial times, investor confidence in the markets is more critical than ever.  Allegations such as those lodged against Reserve Fund, if true, will surely shake that confidence and cause investors to question whether their financial future is really in good hands. 

Perhaps illustrative of the urgency of today's market, the case is on a fast-track:  today, U.S. Magistrate Judge Jeffrey J. Keyes granted Amerprise's motion for expedited discovery, requiring Reserve Fund to produce by this Friday documents involving named executives, institutional salespersons and any institutional investors regarding the financial difficulty of the fund, and requiring certain depositions to take place on October 1, 2008.