Simplified Arbitration can be a great cost-effective way to resolve your dispute for only about $350 in FINRA fees.

If an investor or financial services employee has a dispute with a FINRA registered firm and the alleged damages are $50,000 or less, excluding interest and expenses, the claimant can bring a claim under FINRA's Simplified Arbitration Rules. These cases are decided by one arbitrator.

A claimant in these cases has three options:

Option 1: a claimant can choose to have no hearing. These cases are "decided on the papers," meaning the arbitrator will render his or her decision based upon the written papers filed by the parties. This option may appeal to many investors or employees who find testifying at an arbitration too stressful. The parties can still request--and fight over--documents from each other in discovery. The arbitrator will resolve all discovery disputes. This is the most cost-effective option, but some feel that it does not allow a claimant to "have their day in court."

Option 2: a claimant can request a full hearing with a single arbitrator. If a hearing is requested, it is generally held in person and is subject to the regular arbitration provisions including all rules relating to prehearings and hearings. There is no limit to how many days it can take or the total amount of fees that can be charged. This option can quickly become expensive.

NEW Option 3: a claimant can choose to bring a "Special Proceeding." This option was designed to strike a balance between keeping costs in check, but still allowing a claimant to have their day in court. The Special Proceeding is subject to the regular arbitration rules but with certain limitations. According to FINRA, these conditions are intended to ensure that the parties have an opportunity to present their case to an arbitrator in a convenient and cost-effective manner that is less demanding that a regular hearing. Specifically:

- A Special Proceeding is held by telephone unless the parties agree to another method of appearance;

- the claimants, collectively, are limited to two hours to present their case(s) and half hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;

- the respondents, collectively, are limited to two hours to present their case and half hour for any rebuttal and closing statement, exclusive of questions from the arbitrator and responses to such questions;

- notwithstanding the above conditions, the arbitrator would have the discretion to cede his or her allotted time to the parties;

- in no event could a Special Proceeding exceed two hearing sessions [usually morning and afternoon on the same day], exclusive of prehearing conferences, to be completed in one day;

- the parties will not be permitted to question the opposing parties' witnesses;

- the Customer Code provides that the customer could not call the opposing party, a current or former associated person of a member party, or a current or former employee of a member party as a witness, and members and associated persons [brokers] could not call the customer of a member party as a witness; and

- the Industry Code [for disputes between financial services employees and their employers] provides that members and associated persons could not call an opposing party as a witness.

These three options will allow claimants in both customer and industry disputes to more tailor their arbitrations to their needs. For more information, see FINRA Regulatory Notice 18-21.

Program Description:
The key to successful securities arbitration and mediation is telling your story in memorable and persuasive fashion. This program will help you master those skills while also bringing you up-to-date on recent developments in the law. Gathered from the "best and brightest" of the New York State Bar, this program will, in one day, highlight the most critical advancements in securities arbitration and mediation since this program was last presented.

Our faculty is usually large so that our attendees get the best cross-section possible of experienced practitioners. The subjects selected are based on the assessment of our faculty. Don't miss this opportunity to get a complete update on the law and a thorough analysis of how to succeed in Securities Arbitration and Mediation!

Who Should Attend:

Attorneys practicing securities law should not miss this program, and attorneys involved in Arbitration and Mediation in other fields will also find this program to be most beneficial.

Program Co-Sponsors:
Securities Litigation and Arbitration Committee of the Commercial and Federal Litigation Section
Committee on Continuing Legal Education

Thursday, November 29, 2018
9:00 a.m. - 4:45 p.m.

CFA Society NY
1540 Broadway, Suite 1010
New York, NY 10036
Entrance on West 45th Street

Live & Webcast

7.0 MCLE Credits: 2.0 Professional Practice; 4.0 Skills; 1.0 Ethics

Pre-Register for the Video Replay on December 10, 2018

NYSBA Member: $195 ($170 if you register by October 30, 2018)
Non-Member: $295
Commercial and Federal Litigation Section Member: $170
FINRA Arbitrators and Mediators: $195

A Live Webcast Option is Available*

*Note: Newly admitted attorneys (less than 24 months) who attend via webcast are only eligible to receive Professional Practice and Ethics MCLE credits. Please note that Ethics credits must be viewed simultaneously with the live webcast to receive MCLE credit. Newly admitted attorneys must attend the program in person to receive New York MCLE credit for Skills.

Overall Program Co-Chairs:

James D. Yellen, Esq. | Yellen Arbitration and Mediation Services | New York, NY
David E. Robbins, Esq. | Kaufmann Gildin & Robbins LLP | New York, NY

Topics to be Covered Include:
- 30 Years of Mandatory Arbitration
- How Pre-Hearing Motions Can Win a Case
- Fee-Based vs. Commission-Based Accounts
- Elder Abuse and Elder Exploitation Cases
- Whether and When to Settle a Securities Mediation
- Expungement Cases
- Ethics

To register and for more information, click HERE.


Thursday, September 27, 2018 at 6:00 PM

SPEAKER: Hon. John G. Koeltl (Southern District of New York)

Hosted by:

Morrison & Forester LLP
250 West 55th Street
New York, NY 10019

Buffet dinner and drinks will be served.

Committee Members should RSVP to

Meeting Announcement for 09.27.18.pdf

Securities Arbitration and Mediation 2017: The Courage to Simplify

Thursday, April 6, 2017
9:00 a.m. - 4:30 p.m.

New York Society of Security Analysts
1540 Broadway, Suite 1010
New York, NY 10036
Live & Webcast

7.0 MCLE Credits: 2.0 Professional Practice; 4.0 Skills; 1.0 Ethics

Sign up here.

Overall Program Co-Chairs:
James D. Yellen, Esq. | Yellen Arbitration and Mediation Services | New York, NY
David E. Robbins, Esq. | Kaufmann Gildin & Robbins LLP | New York, NY

Program Description:
The key to successful securities arbitration and mediation is telling your story in memorable and persuasive fashion. This program will help you master those skills while also bringing you up-to-date on recent developments in the law. Gathered from the "best and brightest" of the New York State Bar, this program will, in one day, highlight the most critical advancements in securities arbitration and mediation since this program was last presented.

According to a recently published article in OnWallStreet by Professors Christine Lazaro and Benjamin P. Edwards, a delay in the implementation of the Labor Department's Fiduciary Rule will harm investors.

"The Office of Management and Budget's notice explains that the 180-day delay the Labor Department initially proposed would have reduced investor gains by $441 million in the first year and $2.7 billion over a decade. The current proposed 60-day delay will still hurt investors, reducing gains in the first year by $147 million and $890 million over a decade. Those figures understate the stakes because they assume that the rule will go into effect immediately after the delay. Cutting the rule entirely will cost investors billions more."

Lazaro and Edwards state, "Wall Street continues a doomed fight for brokers' right to give bad advice to retirement savers, all in the hopes of propping up earnings. After three stinging courtroom defeats, the industry procured a presidential memorandum directing the Labor Department to review its ban on giving disloyal advice to investors."

Here is a link to the full article.

Law Offices of Brent A. Burns, Esq.

by Brent A. Burns

Last week, the Second Circuit refused to reverse a Southern District of New York decision enjoining a FINRA arbitration against a non-FINRA member in the absence of an agreement to arbitrate. Citigroup Global Mkts. v Ghazi Abdullah Abbar, No. 13-2172 2014, 2014 U.S. App. LEXIS 14861 (2d Cir. Aug. 1, 2014):

In so doing, the court defined "customer" under FINRA Rules:

[A] "customer" under FINRA Rule 12200 is one who, while not a broker or dealer, either (1) purchases a good or service from a FINRA member, or (2) has an account with a FINRA member.

. . .

The only relevant inquiry in assessing the existence of a customer relationship is whether an account was opened or a purchase made; parties and courts need not wonder whether myriad facts will "coalesce into a functional concept of the customer relationship."

Citigroup v. Abbar, Id. at *17-18.

The court, however, did leave the door open a crack by noting that "exceptions may be compelled in rare instances of injustice" Id. at *20. The court cited Oppenheimer & Co., Inc. v. Neidhardt,56 F.3d 352,357 (2d Cir. 1995) which found a "customer relationship with FINRA member, despite the claimant's lack of an account with the member, because the claimant would have had an account with the member but for the fraud asserted in the FINRA arbitration." Id.

The court also referenced UBS Fin. Servs., Inc. v. W.Va. Univ. Hosps., Inc., 660 F.3d 643, 650 (2d Cir. 2011) noting "that a customer may also be one who undertakes to purchase a good or service from a FINRA member."

Brent A. Burns, Esq. represents individual and institutional investors as well as financial services professionals in arbitrations and litigations and maintains the Law Offices of Brent A. Burns, LLC with offices in New York City and Alpine, New Jersey.

by Adam J. Heckler

FINRA filed with the SEC on April 14, 2014 its proposal to adopt FINRA Rule 2081 to prohibit member firms and associated persons from conditioning the settlement of disputes on a customer's agreement to consent to, or not oppose, expungement of the dispute information from the Central Registration Depository ("CRD"). The proposal stems from issues arising from the construction and application of FINRA Rule 2080 (formerly NASD Rule 2130).(I)

By Brent A. Burns

There has been a fair amount of controversy over how much information BrokerCheck should include. The debate appears to be heating up again. In a recent InvestmentNews article, Professor Ben Edwards of Michigan State University College of Law argues that BrokerCheck should include information about brokers' exam scores and failures. Prof. Edwards runs a law clinic focused on protecting the interests of small investors.

In March, the Public Investors Arbitration Bar Association released a study arguing that FINRA's BrokerCheck should disclose all material public information about a broker that it possesses. More on PIABA's study can be found here. The PIABA study was co-authored by Prof. Edwards, Jason Doss, PIABA's president, and St. John's Law School Professor, Christine Lazaro, who is also the Chairwoman of PIABA's Legislation Committee.

The PIABA Study highlighted categories of information, such as broker exam scores and failure rates that are contained in FINRA's Central Registration Depository database (CRD), but are not disclosed through BrokerCheck. Edwards argues in InvestmentNews that exam scores and test failures are indisputably material information for investors citing a recent Wall Street Journal study which found that brokers "who failed the test at least three times . . . were about two-thirds more likely than brokers who passed the first time to have three or more red flags on their record."

However, the Securities Industry and Financial Markets Association (SIFMA) opposes the exam disclosures. According to an earlier InvestmentNews article, SIFMA's Managing Director and Associate General Counsel, Kevin Carroll does not feel such information is relevant or helpful to investors and could in fact be prejudicial to brokers and their firms. Carroll gave a hypothetical example of a broker who failed an exam 15 years ago, but has been successfully performing ever since. "What's the point? Are you saying he's not competent now?"

In his InvestmentNews piece, Edwards seems to be responding to this argument when he writes that including exam scores should not cause brokers to "panic" because a "reasonable investor would expect someone to get better over time." Putting a different angle on the issue, Edwards notes that "in cases where an industry veteran keeps flunking exams by wide margins, investors might want to exercise a bit more caution."

Edwards opposes what he views as the paternalistic decision to draw a modest curtain over exam scores and failures. He argues that this information is useful "input for investors--presumably competent adults who should be able to make their own decisions." He believes that "a higher score points to something--perhaps greater mastery" and that "many investors probably would deem the information material."

It remains to be seen whether FINRA will agree with Edwards and "make it easier for investors to get the gritty truth" or if FINRA will agree with SIFMA's Mr. Carroll that "there's more potential for that information to be misused and abused than to help investors make informed decisions."

Brent A. Burns, Esq. represents individual and institutional investors as well as financial services professionals in arbitrations and litigations and maintains the Law Offices of Brent A. Burns, LLC with offices in New York City and Alpine, New Jersey.

By Christine Lazaro

FINRA Board of Governors Found Charles Schwab & Co. Violated FINRA Rules by Adding a Class Action Waiver to its Customer Account Agreement; Schwab Settles
On April 24, 2014, the FINRA Board of Governors issued a decision finding that Schwab violated FINRA rules when it included a clause in its customer account agreements which prevented customers from bringing or participating in judicial class actions and arbitrators from consolidating individual claims filed in FINRA's arbitration forum. The decision affirmed in part and reversed in part an earlier FINRA Hearing Panel decision.

On February 1, 2012, FINRA Enforcement had filed a three cause complaint against Schwab. The first two causes of action alleged that Schwab had violated NASD and FINRA rules by including the Waiver language in its customer agreements. The Hearing Panel found that the Waiver language violated NASD and FINRA rules, but determined that based on the holdings of the Supreme Court, specifically AT&T Mobility LLC v. Concepcion, 131 S.Ct. 1740 (2011) and CompuCredit Corp. v. Greenwood, 132 S.Ct. 665 (2012), the FAA precluded enforcement of the NASD and FINRA rules. The Hearing Panel found that under the FAA, arbitration agreements are "valid, irrevocable, and enforceable" unless "overridden by a contrary congressional command," and there was nothing in the securities laws that exempted FINRA rules from the FAA's general applicability. Therefore, if there is no clear expression of congressional intent preserving judicial class action as an option for resolution of customer claims, the arbitration agreement is enforceable. The third cause of action alleged that Schwab violated FINRA rules by preventing arbitrators from consolidating claims. The Hearing Panel found that this portion of the Waiver clause also violated FINRA rules and that the FAA did not preclude enforcement of FINRA rules in this respect.

After affirming the Hearing Panel's decision that the Waiver language violated NASD and FINRA rules, the FINRA Board decision engaged in lengthy discussion of whether the FAA precludes enforcement of FINRA rules. The Board recognized that the FAA is applicable to the arbitration agreement. The question therefore is the interplay between the FAA and FINRA rules.

The Board found that the text of the Exchange Act and FINRA's rulemaking history demonstrates a statutorily authorized intent that overcomes the federal policy favoring arbitration agreements. Congress has given FINRA the authority to regulate brokerage firms, including how they resolve disputes with customers, subject to SEC oversight. The Board recognized that SEC oversight of the rules governing the dispute resolution process was central to the Supreme Court's holding in Shearson/Am. Express Inc. v. McMahon, 482 U.S. 220 (1987) that arbitration agreements covering Exchange Act violations were valid and enforceable. FINRA has a history of enacting rules which impose restrictions on predispute arbitration agreements, all of which have been approved by the SEC as consistent with the Exchange Act.

The Board also found that FINRA rules have the force and effect of federal regulation for the purposes of resolving conflicts of laws. The Board cited a number of cases, explaining that FINRA rules have the force and effect of federal law because they are derived from the Exchange Act. See Credit Suisse First Boston Corp. v. Grunwald, 400 F.3d 1119, 1132 (9th Cir. 2005). The Board extended the reasoning that since the Supreme Court has held that the Exchange Act, SEC and FINRA rules take priority over federal antitrust law, the Exchange Act and FINRA's rules specifically prohibiting class action waivers take priority over the FAA.

Because the Hearing Panel had dismissed the first two causes of action, the Board remanded the case to the Hearing Panel for a hearing on the appropriate measure of sanctions. The Board upheld the sanction the Hearing Panel had imposed for the finding on the violation of the third cause of action - $500,000.

Following the Board's decision, Schwab submitted a Letter of Acceptance, Waiver and Consent. It consented to a fine of $500,000 for the NASD and FINRA rules the Board found it had violated. It also agreed to notify all of its customers that the Waiver had been withdrawn and was no longer in force and effect in its next quarterly mailing of account agreements.
Prof. Christine Lazaro is Director of the St. John's Law School's Securities Arbitration Clinic and can be reached at

By Joan Stearns Johnsen, Esq.

When you choose to negotiate directly rather than mediate, you may not give much thought to how you communicate with the other side. You may do whatever is most convenient including sending off your offer or demand in an e-mail. However, there are factors you should consider when choosing whether to engage in face to face, telephonic, or email negotiation. Each method of communication has its advantages and disadvantages.

Email negotiation increasingly is a popular choice. Distinguishing characteristics of email negotiation are the fact that it is asynchronous-- information is not exchanged in real time, and it is a less rich medium than either face to face or telephone communication-- it lacks nuance and subtext.

Among the advantages of email negotiation is the time it allows for reflection, analysis, and consultation with clients and partners between offers and demands. This is much more difficult when the communication is conducted in person. Email provides an opportunity to exchange carefully worded proposals with a written record of terms and language. Email negotiation is convenient, it precludes the need for scheduling face to face meetings or telephone calls. Lawyers accustomed to communicating by email adapt easily to electronic negotiation.

Email negotiation has drawbacks. The most obvious are concerns about confidentiality and privacy. You never really know the full universe of people with whom your communication will be shared. Additionally, email negotiators miss out on contextual information -- conveyed through tone of voice, inflection, facial expression, gesture, etc.-- which discloses important subtext such as joking, anger, or seriousness. The asynchronous nature of email may lead to misunderstanding and misinterpretation. We tend to attribute motive to a delayed response when none exists. The nature of email communication does not allow for natural pauses and interruptions as occur in synchronous communication. These pauses provide opportunities for clarification, agreement or response which aid the parties in understanding as well as in building rapport and trust.

Email negotiation is an important negotiation option and increasingly difficult to avoid entirely. Today we do not just email from our desks, but also from our smartphones and tablets. Email negotiation offers distinct advantages and disadvantages over other choices, so negotiators should choose strategically.

If you would like to read in greater depth about negotiating by email, you may enjoy this article by Professor Noam Ebner.

Joan Stearns Johnsen has been a full time neutral for over twenty years. Her practice is primarily in the areas of financial services and employment. Most recently, Joan was a Visiting Assistant Clinical Professor at Albany Law School where she directed the Securities Arbitration Clinic and taught Negotiation and Alternative Dispute Resolution. Joan is a frequent trainer of mediation advocacy and negotiation skills and theory. Joan can be reached at

By Alex Stone

Mandatory pre-dispute arbitration has been a cornerstone of the securities industry for almost three decades, but its continued existence may be in jeopardy. While many commentators and industry professionals agree that arbitration is a cost effective and efficient way to resolve disputes, there has been a wave of rhetoric demanding mandatory arbitration be prohibited altogether.

The legality of mandatory pre-dispute arbitration agreements ("PDAAs") was not always an accepted fact. In Wilko v. Swan, 346 U.S. 427 (1953), the Supreme Court held that PDAAs violated the anti-waiver provisions of the Securities Act of 1933 and were thus unenforceable. The issue was again brought in front of the Court 35 years later in Shearson/American Express v. McMahon, 482 U.S. 220 (1987). In a contentious 5-4 decision, the Court held that the anti-waiver provisions of the '33 and '34 Acts only prohibited waiver of the Act's substantive provisions, and therefore did not prohibit PDAAs, which were essentially procedural in nature. In McMahon, the SEC submitted an amicus brief in support of the industry's position that PDAAs should be enforceable.

Mandatory FINRA-administered arbitration has thus been the status quo since McMahon, but this paradigm shift did not occur without controversy. Proponents and detractors are largely divided depending on what side of the industry they represent. Investor advocates favor a ban on mandatory arbitration, while brokerage firms oppose such a ban.

Section 921 of the Dodd Frank Wall Street Reform and Consumer Protection Act ("Dodd Frank") amends Section 15 of the Securities Exchange Act of 1934, 15 U.S.C. 78o (2006) as well as Section 205 of the Investment Advisors Act of 1940, 15 U.S.C. 80b-5 (2006) by adding a new subsection to each. The amendment grants the SEC the authority to restrict mandatory pre-dispute arbitration. It states, in relevant part, "The Commission, by rule, may prohibit, or impose limitations on the use of, agreements that require customers or clients of any broker, dealer, or municipal securities dealer to arbitrate any future dispute between them arising under the Federal securities laws..."

Advocates of mandatory arbitration argue that current law protects against unconscionable arbitration agreements and that arbitration benefits the customer (and the public) through lower costs and efficient dispute resolution. Proponents of the status quo also point to the "all-public" arbitration panel option, which was put in place in early 2011, although this option is only available for customers with claims over $100,000.

Critics of PDAAs claim that FINRA-administered arbitration is categorically unfair to customers. FINRA, the securities industry's self-regulatory organization, is comprised of securities dealers and brokers, and critics argue that allowing them to oversee the arbitration process is akin to letting the fox guard the henhouse. The critics also point to a low customer win rate and the potential for bias amongst the FINRA arbitrator pool.

The SEC has taken no action since soliciting comments on the costs and benefits of arbitration in March 2013 and does not seem eager to make changes to forced arbitration. However, Rep. Keith Ellison, D. Minn, introduced the Investor Choice Act of 2013 H.R. 2998 (2013) in the House of Representatives, and it was assigned to the House Financial Services Committee in August of 2013. If enacted, the bill would prohibit stockbroker and investment advisory firms from using mandatory PDAAs. Similar bills have been unsuccessfully introduced in the Senate over the years, but that was prior to the enactment of Dodd Frank Section 921. If nothing else, Rep. Ellison's bill is indicative of increasing frustration with mandatory PDAAs amongst government representatives and industry professionals. Whether the SEC promulgates rules under Section 921, or its enactment was merely symbolic, remains to be seen.

Although mandatory arbitration is cost effective and efficient, its restrictive nature and potential for bias cannot be ignored. Contracts between customers and securities brokers are not entered into at arms-length, because the relationship between broker and customer is fiduciary in nature. Customers should, at the very least, have the option to forgo arbitration in favor of traditional litigation procedure. Court litigation offers greater procedural safeguards, appellate review, and greater legal expertise. As securities claims become increasingly rife with legal morass, it may be wise to leave these complex disputes in hands of experienced judges who have the resources of the judiciary at their disposal. Ultimately, investors and their lawyers should be able to choose the best forum for dispute resolution.

Alex D. Stone is a third year student at Fordham University School of Law who has focused his studies on corporate and securities law. He worked as a legal summer intern at FINRA - Market Regulation. Alex can be reached by email here.

By Brent A. Burns, Esq.

Today the Public Investor Arbitration Bar Association issued a press release about a study urging congress to pass legislation requiring brokers to reveal more information from the CRD system than is currently available on FINRA's BrokerCheck. Much of this same information is already publicly available through some state regulators.

The study was co-authored by Jason Doss, President of PIABA; Christine Lazaro, Director of the Securities Arbitration Clinic at St. John's University School of Law; and Benjamin P. Edwards, Director of the Investor Advocacy Clinic at Michigan State University College of Law.

"Investors go to BrokerCheck to get information about their broker. They should not have to then follow-up with their state securities regulator to possibly obtain additional, relevant information about that broker that is already in FINRA's possession. They should be able to get all of the relevant information from one central location," said Lazaro.
"All investors should be able to obtain complete and consistent information about brokers. Period. The quality of the disclosure you get about brokers should not depend on which state you live in. There is no rational basis for FINRA to hide key 'red flag' information that investors in some states can get from state-level agencies. Given that FINRA has failed repeatedly to take action to increase the disclosures in BrokerCheck,Congress and the SEC need to compel them to do so if necessary," said Doss.

As reported by OnWallStreet, PIABA claims the key information left out of the BrokerCheck reports but included in reports from state securities agencies includes:

  • Whether a broker has filed for personal bankruptcy.

  • The reason why a broker may have been fired from a firm.

  • Whether a broker was ever under internal review for fraud.

  • If there is a federal tax lien filed against a broker.

  • If a broker failed any industry qualification examinations.

In response, FINRA said "While the system may not be perfect, we do have to make determinations on what information about registered representatives is appropriate to release, while at the same time balancing fairness rather than ignoring it."

The self-regulatory organization was also reported to have said that it has committed considerable resources to make BrokerCheck, which is a free service, a more user-friendly interface that quickly provides investors with information on the background of brokers. See OnWallStreet

The story was also reported in the Wall Street Journal and Reuters.

Prior to the press release, the Wall Street Journal had already reported earlier this morning that their own analysis shows more than 1,600 stockbrokers have bankruptcies or criminal charges in their past that weren't reported.

Brent A. Burns, Esq. represents individual and institutional investors as well as financial services professionals in arbitrations and litigations and maintains the Law Offices of Brent A. Burns, LLC with offices in New York City and Alpine, New Jersey.

By Leland Solon

A post here on March 1, 2014 discussed the United States Supreme Court's pending decision in Halliburton Co v. Erica P. John Fund (13-317), a decision which calls into question the continued use of the "fraud-on-the-market" presumption § 10b and Rule 10b-5 securities fraud class actions. This post reviews some of the Halliburton plaintiffs' allegations, and the case's procedural history.

Plaintiffs' Factual Allegations

The Halliburton plaintiffs' action, commenced in 2002, asserts three instances of Halliburton allegedly recklessly falsifying financial results and misleading the public between 1999 and 2001. The plaintiffs alleged that, while Halliburton represented in January 2001 that prospective asbestos liability in connection with a subsidiary "should have minimal adverse impact" going forward, in June 2001 Halliburton disclosed and predicted that its net exposure would be more than $50 million dollars. The day after the disclosure Halliburton's stock allegedly declined 4.6%. The plaintiffs further alleged that later in the year, months after Halliburton issued statements that asbestos exposure concerns were "overblown" and a "manageable problem," a $30 million dollar verdict against Halliburton's subsidiary was announced, followed by a single-day 42.7% decline in stock price. The plaintiffs also contended that, during the class period, Halliburton lost 3.9% in stock price, allegedly in connection with Halliburton's booking as revenue nearly $200 million dollars on contracts that were not probable for collection, and misrepresenting the benefits of a merger.

2011 Supreme Court Decision

This is the Halliburton case's second appearance in the United States Supreme Court. The District Court for the Northern District of Texas and Fifth Circuit had denied the plaintiffs class certification under Fed. R. Civ. P. 23 because the plaintiffs purportedly failed to prove "loss causation" by a preponderance of the evidence. Requiring plaintiffs in putative securities fraud class actions to prove loss causation - that the defendant's deceptive conduct caused the claimed economic loss - as a prerequisite to class certification was a unique requirement imposed only by the Fifth Circuit. By a 9-0 decision in 2011, the United States Supreme Court vacated the Fifth Circuit's ruling and remanded, ruling that §10(b) and Rule 10b-5 plaintiffs do not need to prove loss causation in order to attain class certification. 131 S. Ct. 2179 (2011).

The Plaintiffs' Class Is Certified

Halliburton subsequently appealed the District Court's order on remand certifying the class, and the Fifth Circuit's affirmance thereof. Both courts had rejected Halliburton's argument that it should be able to introduce evidence at the class certification stage that the alleged misrepresentations did not result in any adverse price impact, i.e., rebutting the fraud-on-the-market presumption invoked by plaintiffs. The Fifth Circuit ruling, and the district court's opinion it affirmed, are appendices "C" and "D" to Halliburton's petition for writ of certiorari, found here

The Fifth Circuit emphasized that refusing to permit Halliburton to permit evidence of alleged lack of price impact at the class certification stage was the correct decision, because the inquiry at the class certification stage is limited only to whether the requirements of Fed. R. Civ. P. 23, and specifically in this case the question of common question predominance, were met. Hallburton's proposed evidence of lack of price impact to defeat class certification was impermissible, the Fifth Circuit ruled, for two reasons.

First, the evidence of price impact, an objective measure typically based upon expert testimony, "inherently applies to everyone in the class", and thus did not bear upon whether individual questions of law or fact predominated under Fed. R. Civ. P. 23. Second, the Fifth Circuit ruled, the evidence of price impact, and any failure by plaintiffs to establish price impact following class certification, would not cause individual questions to predominate later. If Halliburton were to successfully show a lack of price impact, the Fifth Circuit reasoned, then no plaintiffs would be able to establish loss causation later, and thus the claims of all plaintiffs would necessarily fail for inability to prove an element the 10b-5 fraud claim. The Fifth Circuit was clear that the evidence of lack of price impact could be used later, on the merits, just not at the class certification stage.

Supreme Court's 2013 Amgen Ruling

The Fifth Circuit's opinion relied heavily on the Supreme Court's decision in Amgen v. Connecticut Retirement Plans & Trust Funds, 133 S. Ct. 1184 (2013) In Amgen, the Court held that proof of materiality is not a prerequisite to class certification in a Rule 10b-5 action. A showing that statements were material, the Court explained, while necessary to prevail on the merits, was not necessary in order to obtain class certification under Fed. R. Civ. P. 23.

The Court reasoned that because materiality is an "objective" standard, it is a question common to all members of a class. Additionally, the Court pointed out, there was no risk that individual questions would predominate later if the plaintiffs later subsequent to certification failed to prove materiality. According to the opinion of the Court, since materiality is an essential element of the securities fraud claim, if the plaintiffs later failed to prove it, the case would be over, i.e., there was no way any single or group of plaintiffs would be able to prove materiality if the class could not. A central premise of the Court's opinion is that the Fed. R. Civ. P. 23 class certification is meant to facilitate the administration of class actions - not to adjudicate them on the merits.

If the Halliburton defendants prevail and the Court overrules or modifies Basic, it likely will establish a precedent that would greatly impair the ability of plaintiffs to attain class certification, and the resulting financial leverage that accompanies it. An overview of the some of the specific arguments raised by the parties and amici in Halliburton will be the subject of a future blog post here.

Leland S. Solon is an associate at the Law Firm of Gary N. Weintraub, LLP (link:, a general litigation firm in Huntington, New York, serving the metropolitan area and Long Island. He can reached at

By Leland Solon

Under the "fraud on the market" theory, purchasers of securities traded in a well-developed market can invoke a rebuttable presumption that they "relied" on the alleged misrepresentation in making their purchasing decision. Blessed by a four-member majority of the United States Supreme Court in Basic Inc. v. Levinson, 485 U.S. 224 (1988), the fraud on the market theory is based upon the notion that developed markets incorporate material statements about a security into its stock price, and that an investor who buys or sells stock in such a market necessarily does so in reliance on the integrity of that price.

Class Certification, Commonality

The doctrine facilitates class action certification and is a critical component of § 10b and Rule 10b-5 plaintiffs' class actions. Under Fed R. Civ. P. 23, class actions are permitted if, among other things, there are questions of law or fact "common to the class", and "the court finds that the questions of law or fact common to class members predominate over any questions affecting only individual members."

Problem With Reliance In Securities Fraud Class Actions

As a fraud action, a necessary element of § 10b and Rule 10b-5 claims is "reliance." By permitting plaintiffs to use objective, class-wide evidence of market price with the fraud-on-the-market presumption, individual putative class action members do not each need to prove reliance. Were individual plaintiffs in a putative class required to prove their actual reliance, individual issues would likely overwhelm the common ones, and thus § 10b and Rule 10b-5 classes would rarely be certified, as it would not be proper under Fed. R. Civ. P. 23.

Supreme Court's Highly-Watched Decision

The viability of the fraud-on-the market presumption is being tested. On March 5, 2014, the Court will hear oral arguments in Halliburton Co v. Erica P. John Fund (13-317), a highly-anticipated decision in which the petitioners have asked the Court to reconsider Basic's fraud-on-the-market presumption.

In Halliburton, the defendants who are alleged to have committed fraud in a putative class action are seeking to introduce evidence at the class certification stage that the alleged misrepresentations did not cause a distortion in the price of defendant Halliburton's stock. They argue that the plaintiffs should not be able to invoke the fraud-on-the market presumption and obtain class certification unopposed on the issue of reliance. Should Halliburton prevail and the Court overrule or modify Basic, it could be substantially more difficult for plaintiffs to obtain class certification - and the resulting financial leverage - going forward.

Leland S. Solon is an associate at the Law Firm of Gary N. Weintraub, LLP (link:, a general litigation firm in Huntington, New York, serving the metropolitan area and Long Island. He can reached at

By Brent A. Burns, Esq.

In a brief video, Chairman Bill Ketchum discusses issues raised at the February 13, 2014 Board Meeting. FINRA's summary of the meeting, which is also printed below, is available here, and the video is available here.

BrokerCheck Link in Online Retail Communications With the Public

The Board authorized FINRA to seek comment in a Regulatory Notice on a revised proposal to amend FINRA Rule 2210 (Communications With the Public) to require firms to include a readily apparent reference and link to BrokerCheck on any member firm's website that is available to retail investors. In addition, the proposal would require a firm to include a readily apparent reference and link to BrokerCheck in any online retail communication that includes a professional profile of, or contact information for, an associated person, subject to specified conditions. The proposal would not apply to (1) electronic mail or text messages; (2) a retail communication that is posted on an online interactive electronic forum (such as a message board, Twitter feed or chat room); (3) a member firm that does not provide products or services to retail investors; or (4) a directory or list of associated persons limited to names and contact information.

The Brooklyn Law School Securities Arbitration Clinic is seeking referrals in the Metropolitan New York City, Tri-State Region. If you have been consulted by potential clients living in the 5 boroughs of New York or surrounding areas of New York, New Jersey and Connecticut who cannot afford to pay legal fees or whose cases are too small for you to handle, our Clinic is here to help.

In addition to representing Claimants in arbitration proceedings our students are also representing investors in proceedings to confirm and/or vacate arbitration awards in New York State and Federal Courts and in Supplementary Proceedings, attempting to collect on judgments resulting from confirmed arbitration awards.

If you have any matters to consider referring to our Clinic please contact me, Joel Bernstein, at the telephone or e-mail address below, or write to:

Brooklyn Law School
Securities Arbitration Clinic
One Boerum Place
Brooklyn, NY 11201
(718) 780-7994

Thanks very much. We look forward to working with you.

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Brent A. Burns, Esq.

According to the Wall Street Journal, next week FINRA's Board of Governors will be working on rule changes that will prohibit the practice of conditioning settlements on an investor's agreement not to oppose expungement.

FINRA is focusing again on the expungement issue as a reaction to the Public Investors Arbitration Bar Association's (PIABA) scathing study released last fall and at the recent urging of two United States Senators.

The PIABA study found that in cases resolved by settlements or stipulated awards, expungements were granted an astounding:

  • 89% of the time from June 1, 2007 through mid-May 2009, and

  • 96.9% of the time from mid-May 2009 through the end of 2011.

FINRA initially downplayed the study's conclusions noting "[w]hile still significant, the number of arbitrator-recommended expungements executed by FINRA following a court order during the five-year period (838 orders) covered by the study is less than 5 percent of the total number of customer disputes filed (17,635)." However, FINRA also promised to review "its rules and interpretations and consider changes to provide more clarity as to what actions in connection with conditions on settlements violate conduct rules."

As you can imagine, the PIABA Study raised more than a few eyebrows and was widely reported by the press: Reuters, Wall Street Journal and others media outlets. Eventually it got the attention of United States Senators Jack Reed (D - RI) and Chuck Grassley (R - Iowa) who sent a joint letter to FINRA on December 16th demanding it address the issues raised in the PIABA Study explaining:

We believe that meaningful investor protection includes the disclosure of whether a customer dispute was settled. Not just for transparency sake, but also to help prospective investors make informed decisions about which individuals or firms with whom to do business.

On January 6th, FINRA responded to the Senators in a nine page letter in which they acknowledged that there was a serious problem:

We remain extremely concerned over the inordinately high percentage of expungement relief granted by arbitrators in settled cases.

In its comprehensive response, FINRA addressed the competing policy concerns and detailed the expungement framework including explaining how FINRA responds to expungement requests and how BrokerCheck works. FINRA also discussed its continuing efforts to educate arbitrators and monitor expungement awards and other issues.

Significantly, as a result of the PIABA study, FINRA confirmed that it was working on a rule that would prevent respondents from conditioning settlement on an agreement by claimants to not oppose engagement:

We are presently developing rule changes that would prohibit the practice of conditioning settlements on an investor's agreement not to oppose expungement. While the suggestion to include such conditions in exchange for additional settlement compensation does not always originate with the brokerage firm or broker, this practice may interfere with the arbitrators' ability to independently determine the appropriateness of expungement and make the requisite affirmative finding.

Interestingly, FINRA also flat out rejected a proposal from the PIABA study that would have invited FINRA and a designee of the state securities commissioner to appear at the hearing on the motion for expungement relief and to oppose expungement relief when such opposition was appropriate. FINRA reasoned that allowing third parties, like state regulators or even FINRA itself, to insert themselves into a private contractual arbitration proceeding was problematic, impractical and could threaten the ability of FINRA Dispute Resolution to operate a neutral arbitration forum.

That being said, FINRA did say it would continue its practice of opposing expungements in court to protect the integrity of the CRD system and BrokerCheck and to establish and maintain precedents that support FINRA's legal arguments.

It will be interesting to see what the final rule proposal looks like. Although FINRA will seek the approval of its Board to file the rule proposal during its February Board meeting, it is unclear how long it will take FINRA to file the rule proposal with the SEC. Until then, it seems there is nothing preventing firms from continuing to bargain for cooperation in expungement requests.

Brent A. Burns, Esq.
represents individual and institutional investors as well as financial services professionals in arbitrations and litigations and maintains the Law Offices of Brent A. Burns, LLC with offices in New York City and Alpine, New Jersey. He also maintains the Brokers in transition blog

by Brent A. Burns, Esq.

Today's Wall Street Journal article entitled, "Securities Lawsuits are Rising" cites to three separate studies for the proposition that the number of securities class action lawsuits are increasing. However, a closer reading of the article reveals that in 2013, while the size of average settlements broke historic records, the median dollar amount of those settlements was down significantly.

In addition, while the aggregate dollar amount of settlements combined was up significantly from the previous year, the number of settlements remained relatively low. This means that a few large settlements last year skewed the average amount up, but that it was still a challenging time for most of the plaintiff's bar.

Number of filings are up, but only slightly. The first study the WSJ looked at was by NERA Economic Consulting which concluded that 234 federal securities class actions were filed against United States companies last year, the most since 2008. However, the NERA Study points out that this number is only slightly higher than the 213 cases filed in 2012, or the 224 average number of filings in the period of 2008 to 2012.

Average settlements break records, but median amount tanks. The WSJ also notes that the combined value of court approved settlements last year was $6.5 billion, nearly doubling the 2012 total. 2013 was also a record setting year for average settlements, but the median was way-off:

Average settlement amounts for "usual" securities class actions (i.e., excluding settlements over $1 billion, merger objection settlements, and IPO laddering settlements) in 2013 broke prior records, reaching $55 million, an increase over 2012 and a 31% increase over the previous high in 2009. The median settlement amount for 2013 was $9.1 million, a 26% decrease compared to 2012.

The number of settlements in 2013 was only 100, just above the 94 settlements in 2012 which was a record low, according to the NERA Study. To put that in perspective, the average number of settlements per year between 1996 and 2011 was 127.

Types of cases are changing. Allegations that companies gave misleading earnings forecasts accounted for 41% of class-action filings in 2013, up from 29% in 2012, according to the WSJ and NERA.

The NERA Study also reported that the number of lawsuits over corporate mergers was up, accounting for 20% of new securities class action filings in federal court last year. The WSJ article cited to a second study by Gibson Dunn & Crutcher LLP, which shows that more than 80% of all mergers and acquisitions were challenged by investors last year.

But losses aren't what they used to be.
And finally, the WSJ cited to a third study by Cornerstone Research which shows that the losses alleged in last year's complaints declined significantly in large part because the stock market ended the year in record territory.

So what should Plaintiffs lawyers take away from all of this data? While the number of cases are up, the risk reward paradigm applies to lawyers as well as investors.

(WSJ link requires a subscription)
The Law Offices of Brent A. Burns, LLC represents individual and institutional investors in arbitrations and litigations and has offices in New York City and Alpine, New Jersey

by Edward Pekarek, Esq. and David Haimi

Dodo-bird.gifDo you want a safe "middle of the road" investment that isn't affected by ups and downs on Wall Street? Do you want 7-8% dividends? Do you want the peace of mind that comes from putting your hard-earned cash in a proven investment featuring years and years and years of stable stock prices and returns? Then you need to invest in non-traded REITs right now! Variations of this "too good to be true" sales pitch have been the sales siren for many of the non-traded Real Estate Investment Trusts sold domestically to thousands of elder investors seeking steady income in an unprecedented low interest rate environment. FINRA has focused enforcement efforts on deceptive sales of these illiquid shares, charging Long Island-based brokerage David Lerner Associates (DLA) (CRD #5397), and its namesake CEO (CRD #307120), in a highly publicized 2011 enforcement action with misconduct related to its sales of allegedly unsuitable "Apple" (no, not that Apple) non-traded REIT shares. Last week, a FINRA arbitrator awarded equitable rescission relief to a pair of Apple REIT shareholders who can now tender the stock and be refunded their original investment. Not surprisingly, a DLA lawyer told the Wall Street Journal that the FINRA member headquartered in Syosset, NY "disagrees with the decision." A number of class actions are pending presently.

A half-century of REITs

REITs date back to the passage of the Real Estate Investment Trust Act, as part of the Cigar Excise Tax Extension of 1960, and have a long history of allowing individuals to purchase a piece of large real estate speculation. REITs collect pools of money from investors and then use the pooled capital to buy real property as assets. Over time, REITs have evolved into three main types: equity, mortgage, and hybrid, and can be either private or publicly held concerns. The non-traded equity REIT variety is distinct because the stock is not traded or quoted on any securities exchange, but these issuers are registered with the Securities Exchange Commission ("SEC"), and subject to SEC (as well as state and SRO) regulation. For a company to qualify as a REIT, and receive an exemption from corporate income tax, it must adhere to sections 856 and 857 of the Internal Revenue Code. The major requisite of these provisions, and what is a major selling point of REITs, generally, is that the issuer must distribute at least 90% of its annual income to its (100 or more) shareholders to qualify for the tax exemption. The seemingly assured large dividends are often used to lure would-be investors.

Questionable to the core?

Non-traded REITs have received substantial negative attention lately, due largely to the FINRA enforcement action and class action complaints against Apple REITs Six through Ten and their sole underwriter, DLA. Roughly 60-70% of DLA's business is comprised of non-traded REIT sales. These Apple REITs, along with other non-traded REITs, are alleged to have lured unsophisticated investors with misrepresented share values and deceptive dividends seemingly sourced from income, but often derived from shareholder capital and extensive debt. Forbes columnist Brad Thomas, established a blueprint for non-traded REIT reform in two April 2012 columns.

Recipe for REIT reform

Mr. Thomas, in Dividend REITs As Reliable As Jack Nicklaus And Tiger Woods, discusses the success of publicly traded REITs, especially eight specific public REITs, comparing them to the success of the famous golfers Jack Nicklaus and Tiger Woods. Mr. Thomas contributes the success of these REITs to their ability to maintain "consistency (including increased dividends during the great recession) and sound risk-control - the mark of greatness." He goes on to state that "[w]ithout fail (sound risk-control), these eight equity REITs are all distinguished by consistency in dividends paid and increased quarterly." Mr. Thomas then concludes his column with investment icon Ben Graham's maxim, "...[w]e think that a record of continuous dividend payments for the last twenty years is an important plus factor in a company's quality rating."

While consistent dividends might be an indicator of a sound REIT in the public securities market, investors in non-traded REITs do not have the benefit of being able to rely on the "efficient-market hypothesis" as there is no regular price discovery for these illiquid securities. Non-trade REITs, as the name suggests, lack a secondary market which often results in significant informational asymmetries between insiders and investors, with no public trading to adjust the imbalance. One of the biggest issues with Apple REITs has been their alleged masking of losses through large scale leveraging and reinvestment of capital, so as to keep dividends constant and create the illusion of operational success.

In Non-Traded REITs: The Evolution Of A Repeatable Income Alternative, Mr. Thomas builds on his previous description of what makes a public REIT exceptional, and identifies some non-traded REIT standouts. Mr. Thomas' work singles out American Realty Capital for its industry best practices of "shorter life cycles, fully covered distributions, elimination of both internalization fees and follow-on offerings, along with lower fees and pay-for-performance management compensation." These practices, along with consistent dividends sourced from Funds from Operations ("FFO"), make up the majority of the recipe for a non-traded REIT to be considered an appropriate investment as a portion of a qualified investor's portfolio.

The shorter non-traded REIT "life cycle" refers to transitioning to the publicly traded market, where price discovery tends to better reflect the true financial condition of an issuer. Mr. Thomas maintains that the REITs that make an expedient transition, typically gain value and achieve great investor confidence with the enhanced transparency offered by publicly traded shares. "Fully covered distributions" means dividends paid from FFO, not from leveraged assets that can and often do lead to a debt spiral. The last of his proposed ingredients is reduction of excessive upfront fees associated with non-traded REITs, which often depress share value by 10-15% immediately upon purchase. Along with substantially lower purchase fees, in Mr. Thomas' view, non-traded REIT managers should only be paid for transparent operational revenue success, as oppose to a murky fixed management fees and a host of other opaque charges for things such as general operations and property transactions. Mr. Thomas sees this list of best practices, along with genuine transparency, as a necessary "evolution" of the non-traded REIT sector.

Transparency, short-term life cycle, no excess fees, and consistent distributions from FFO, all sounds like a fantastic wish list, but these features are not beyond the realm of possibility, particularly as market and regulatory forces appear to be insisting these firms reform or perish. If over-valuation of shares and over-leveraging of assets to pay dividends are the means by which investors are duped into buying illiquid shares, non-traded REITs must remake themselves to be smarter, leaner, and more short-term oriented, or the market will rightfully attach a permanent stigma to the sector. What is meant here by "short-term orientation" is that the overall goal of the non-traded REITs should be to develop or acquire high-quality performing assets, and enter the public securities market as expediently as possible. This is different from the pyramid type non-traded REIT model, where debt and offering proceeds are used to fund future distributions, instead of FFO. If a non-traded REIT faces the prospect of open market trading (and the related price discovery) in 3 years or less, or asset liquidation to pay back shareholders, there would be a greater level of investor confidence for non-traded REITs. More so, if a non-traded REIT successfully transitions to the public market in a reasonably short time period, subsequent offerings of similar ilk will enjoy improved investor confidence.

Darwin or Dodo?

In today's economic climate, with large scale fraud and investor abuse souring the public's perception of Wall Street, the non-traded REITs currently holding some $84 billion in assets, will wither on the vine absent meaningful legislative, regulatory and/or internal reform, as market forces will cause the beleaguered sector to go the way of the Dodo bird. The reform ingredients identified above, combined with short-term oriented business models that lead to publicly held shares, could result in the transformed and legitimized non-traded REIT sector Mr. Thomas envisions. If these changes do not occur in short order, already eroded investor confidence will continue to wane, and the sector may someday soon face extinction with an ice age of investor rejection.

Mr. Pekarek is a Visiting Professor of Law and Supervising Attorney at Pace Law School, who also serves as Assistant Director for the non-profit Pace Investor Rights Clinic of John Jay Legal Services, Inc. He is a former Marketing Manager for Developers Diversified Realty Corp., a publicly traded REIT (DDR: NYSE).

Mr. Haimi is a 2012 Pace Law School graduate and student-intern for the non-profit Pace Investor Rights Clinic, as well as Managing Editor of the Pace Environmental Law Review and a member of the national championship team of the 2011 FINRA/St. John's Securities Dispute Resolution Triathlon. Mr. Haimi is also the recipient of the 2012 Adolph Homburger Humanitarian Award, and is the managing member of Direct Title, LLC, a Boston-based title examination firm.

By Edward Pekarek, Esq. and Kristen Mogavero


One of the nation's largest retail securities brokerages, Charles Schwab & Co., quietly amended its customer agreements in September 2011, just months after the U.S. Supreme Court determined in AT&T Mobility v. Concepcion that a California state law banning "unconscionable" class action waivers was pre-empted by the Federal Arbitration Act.

The firm famous for the slogan, "Ask Chuck," began to distribute the contract in October 2011, with a provision requiring its customers to waive the right to participate in class actions against the San Francisco-based broker-dealer. Schwab initially distributed the amended agreement to approximately seven million customers. Since then, Schwab has required at least an additional fifty thousand new account holders to agree to the contentious contract clause and allegedly continues to use the amended agreement containing the waiver, according to a February 1, 2012 disciplinary proceeding initiated by the Financial Industry Regulatory Authority (FINRA).

A FINRA member since 1970, Schwab has some 340 offices in the U.S., staffed by over 7,000 FINRA-registered employees. Notably, in its SRO membership application, Schwab agreed to abide by and adhere to FINRA (then NASD) rules. On February 1, 2012, FINRA announced it had initiated disciplinary proceedings against Schwab, charging the brokerage firm with violations of FINRA rules by including the provision in its customer agreements. In its disciplinary pleading, FINRA seeks to estop Schwab from including or enforcing the challenged provisions in its customer agreements and also seeks sanctions, including monetary sanctions, pursuant to FINRA Rule 8310(a). Schwab responded with a rush to the San Francisco federal courthouse by its lawyers from the firm Arnold & Porter, LLP, seeking preliminary injunctive relief from the SRO action. Schwab maintained in a press statement that it "believes a federal court is in the best position to properly and efficiently resolve this novel dispute, and intends to defend against any disciplinary action brought by FINRA." In response, FINRA sought an expedited hearing as a result of Schwab's continued use of the agreement.

USMJ LaPorte tells Chuck its complaint is dismissed

Schwab's injunctive relief application was referred to a United States Magistrate Judge, the Honorable Elizabeth LaPorte, of the U.S. District Court for the Northern District of California. Judge Laporte opined on Friday, in a 21-page opinion granting FINRA's motion to dismiss, that Schwab failed to show it had exhausted its administrative remedies, the disciplinary options of the FINRA disciplinary proceedings, before initiating litigation in federal court. Parties must first see the dispute to its conclusion in the administrative forum before seeking relief from a district court, according to the court's order. Judge Laporte agreed with FINRA that Schwab must follow SRO procedures for disciplinary cases before seeking judicial intervention. That process ultimately includes federal court review, but contrary to Schwab's tactic, it does not begin at its endpoint, which Judge LaPorte deemed sufficient to dismiss the complaint.

Schwab maintained it would be "irreparably harmed" by having to endure up to four or more years as the FINRA disciplinary process unfolded. Nonetheless, delay is an insufficient basis to avoid the SRO disciplinary process, according to Judge Laporte. The federal judicial officer opined that Schwab failed to demonstrate it was "entitled to an exception" from FINRA process. President of the Norman, Oklahoma-based group of securities arbitration lawyers the Public Investors Arbitration Bar Association (PIABA), Ryan K. Bakhtiari, told Reuters, "The rules are clear and unequivocal that Schwab did not have the right to prohibit class actions." Despite Friday's dismissal, unresolved questions remain as FINRA continues the disciplinary proceedings against Schwab, William Jacobson, a Cornell Law School professor and director of its Securities Law Clinic in Ithaca, New York, told Reuters.

FINRA alleges class action waivers violate SRO rules

FINRA alleges the class action waiver constitutes a violation of FINRA Rule 2268(d)(1) (formerly NASD Rule 3110(f)(4)(A)), which prohibits members from imposing "any condition" in a pre-dispute arbitration agreement that "limits or contradicts the rules of any self-regulatory organization." FINRA alleges Schwab's waiver is improper as it contradicts Rule 11204(d) of the FINRA Code of Arbitration Procedure for Customer Disputes, which provides that a member firm may not enforce an arbitration agreement against a member of a putative class action unless: 1) class certification is denied by a court, 2) the class is decertified for some reason, 3) the member of the putative or certified class action is excluded, or 4) the member withdraws or chooses not to participate in the class.

Schwab, for its part, contends the waiver provision is entirely valid and consistent with the rule of AT&T Mobility, decided on April 27, 2011, in which the U.S. Supreme Court held that California state contract law, which deems class action waivers in arbitration agreements to be unconscionable, and therefore unenforceable, when certain criteria are met, are preempted by the Federal Arbitration Act (FAA). The Court found California's law created an impermissible obstacle to the accomplishment and execution of the full proposes and objectives of Congress and was therefore preempted.

Does AT&T Mobility even apply?

At first glance, it may seem that the Supreme Court's AT&T Mobility decision specifically invites provisions such as the class action wavier included in Schwab's customer agreements. However, there is an important distinction to be made between the customer agreement in AT&T Mobility and the Schwab customer agreement. The disputed provision at issue in AT&T Mobility was part of a cellular telephone contract between a customer and a wireless service provider. In contrast, Schwab customer contract clause is part of a brokerage firm's customer agreement, and the particular brokerage firm, Schwab, is a registered FINRA member.

Schwab is bound by the rules and regulations of FINRA, an SRO overseen by the SEC. Moreover, the FINRA Rules, by which Schwab promised to abide, are approved by the SEC, pursuant to the Securities Exchange act of 1934. As such, FINRA's rules are federal law equivalents and therefore federal preemption, which carried the day in AT&T Mobility, is not a valid argument for Schwab in this dispute, according to Pace Investor Rights Clinic Director, Jill I. Gross, among the first academics to address the Schwab matter in her February 1, 2012 blog post, the same date the FINRA disciplinary proceeding was initiated and when Schwab rushed to the federal courthouse to seek the judicial intervention Judge LaPorte denied.

Considering the quasi-federal nature of the FINRA Rules, we suspect FINRA will ultimately prevail on this issue. However, AT&T Mobility and the Schwab class action waiver raise serious concerns about the future of class actions. Many, if not the majority, of consumer transactions in the U.S. are accompanied by a customer agreement which includes some type of dispute resolution clause. If these clauses are amended to include class action waivers, it will eventually pose significant barriers to justice for those customers. In many cases, customer claims are of low dollar value, individually, to warrant litigation or arbitration, and the only way for those customers to have their day in court is through consolidated or class actions. Without these options, customers will be denied the judicial or dispute resolution process, rights we believe are a universal entitlement for U.S. citizens. Moreover, such obstacles will inevitably encourage corporations to commit "small frauds" and other wrongs that in the aggregate may amount to substantial harms to society.

Therefore, the issue here is bigger than the parties' right to contract and federal preemption─-there remains the fundamental question of whether the judicial system will allow U.S. citizens to be deprived of court access through the use of adhesive consumer contracts. We hope judicial officers will recognize the potentially disastrous impact of these draconian waiver provisions and determine them to be unenforceable, particularly in the securities context.


Mr. Pekarek is a Visiting Professor of Law and Supervising Attorney at Pace Law School, who also serves as Assistant Director for the non-profit Pace Investor Rights Clinic of John Jay Legal Services, Inc.

Ms. Mogavero is a third-year law student at Pace Law School and student-intern for the non-profit Pace Investor Rights Clinic, as well as a member of the Pace Law Review and the national championship team of the 2011 FINRA/St. John's Securities Dispute Resolution Triathlon, and winner of the 2012 Justice Sondra Miller Scholarship, awarded by the Westchester County Women's Bar Association.

Written by Ryan Adams and Christopher Haner*

In the wake of the financial crisis of 2008, many commentators called for increased regulatory oversight on behalf of the Securities Exchange Commission ("SEC") and the Financial Industry Regulatory Authority ("FINRA"). Despite a growing public movement for increased oversight, FINRA has been legally hampered in its ability to enforce its own rules. Recently, in Fiero v. Financial Industry Regulatory Authority, Inc.,[1] the Second Circuit Court of Appeals reversed and vacated a district court opinion that authorized FINRA to enforce fines that it had imposed against industry members. In what has been described as a surprising decision,[2] the Court of Appeals held that FINRA lacked the authority to bring federal court actions to collect disciplinary fines it has imposed. The opinion, written by Circuit Judge Winter, held that FINRA cannot enforce monetary sanctions in court under either federal securities laws or as an internal "house-keeping"[3] rule.

winners group photo_NYSBA.jpg

WHITE PLAINS -- Two teams represented Pace Law School last weekend in a "triathlon" that had nothing to do with swimming, cycling or running--and emerged victorious. One of Pace's teams won the third annual FINRA / St. John's Securities Dispute Resolution Triathlon. Held in the shadow of the new World Trade Center "Freedom Tower" at St. John's University's Manhattan campus, the national competition field featured 24 teams from 17 schools, hailing from as far west as Texas and as far south as Florida.

The two-day event, sponsored by the Financial Industry Regulatory Authority (FINRA) features three individual rounds of competition in negotiation, mediation and arbitration, the primary areas of dispute resolution. The Pace team, comprised of Pace Investor Rights Clinic (PIRC) students, 3Ls David Haimi, Kristen Mogavero and Genavieve Shingle, went home with the championship trophy and an individual event medal. The victorious Pace team prevailed as the winner of the arbitration round, and were narrowly edged out of yet another award in the mediation round by a team representing William and Mary Law School, from Williamsburg, Virginia.

Pace also fielded a second team for the event, comprised of 3Ls Katerina Davydov, Eleanor Osmanoff and Jay Park. All six students are current or summer student interns with PIRC. The teams were coached by PIRC Assistant Director and Visiting Professor Ed Pekarek, who served as faculty advisor and coach, with assistance from coaches Christine Goodrich '11 and Bryn Fuller '11 during the competition, and by Chris Bloch '10 in the days preceding the annual event. Adjunct Professor Louis Fasulo and PIRC Director Jill Gross each provided key skills-based training sessions as part of the teams' preparation.

mediation feedback_NYSBA.jpgPekarek noted that as a result of what they are learning in their clinical studies, each Pace Law competitor "possesses dispute resolution skills that will permit them to be zealous advocates in securities dispute resolution if they choose that career path." He added, "as a result of their assigned casework, all six Pace students were more prepared and less nervous than their opponents, in no small part because they have already represented real clients in securities disputes, and in some instances against seasoned opposing counsel." Shingle noted that this event was a great warm-up for her role in the Willem C. Vis competition in the spring and Haimi observed, "this is truly a great day for Pace."

The Negotiation medal winner was a first-time entrant, Florida International University, coached by Robert "Bert" Savage. The Mediation medal went to William & Mary, and the Advocate's Choice award went to West Texas University. Prior champions are Seton Hall (2010) and St. John's (2009).

The Make Believe of Janus

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By Edward Pekarek* and Genavieve Shingle

The United States Supreme Court created a troublesome rule recently with its opinion in Janus Capital Group, Inc. v. First Derivative Traders.[1] First Derivative alleged that Janus Capital Group (JCG), and its wholly owned subsidiary, Janus Capital Management (JCM), made false statements in prospectuses filed by the Janus Investment Fund (JIF), and those statements affected the price of JCG's shares.[2] Throughout the pertinent time period, JCM provided JIF with "the management and administrative services necessary for the operation" of JIF.[3] First Derivative argued that JCG should be held liable for the misdeeds of JCM as a "controlling person" under section 20(a) of the 1934 Securities Exchange Act ('34 Act).[4]

Is the Sophisticated Investor Theory Still Relevant?

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By Edward Pekarek, Esq.* and Christian Obremski

The "sophisticated investor" theory, as it applies to securities arbitration, is derived from the notion that an investor's level of knowledge, experience, wealth and general intelligence has an effect on how panels award damages.[1] The doctrine is typically employed by a respondent as an affirmative defense to suitability claims, designed to persuade the panel the customer-claimant has an appropriate level of knowledge and experience to be capable of evaluating risks associated with investing[2] and was able to properly evaluate the risks of any particular disputed transaction(s).[3] Once an investor is portrayed as "sophisticated," it has the potential to diminish the burden a respondent must meet to establish the customer-claimant was provided a suitable investment recommendation, based on investment objectives, financial needs and other customer based considerations.[4]

Curbing Discovery Abuse: No Laughing Matter

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By Edward Pekarek, Esq.* and Christian Obremski

Funnymen Larry David and Will Ferrell were not laughing after a crushing securities arbitration defeat in late 2010. The "Seinfeld" creator and "Elf" star sought rescission in a dispute with JPMorgan related to various securities transactions totaling more than $18 million. Due to what the panel determined were discovery abuses, coupled with a failure to comply with the forum's discovery rules and procedures, the arbitration was dismissed with prejudice.[1] The panel added to the sting of dismissal, by ordering the celebrated claimants to pay roughly $600,000 in respondent costs and fees, as well as an additional $22,500 sanction for discovery abuses and disregard for FINRA discovery rules.[2] The potential sanctions a party may face as a result of a strategic misstep, intentional misconduct or even a lack of due diligence can be substantial as this recent arbitration award demonstrates.

By Edward Pekarek, Esq. and Anna Dokuchayeva*

Beleaguered French national, Goldman Sachs executive and current London resident, Fabrice Tourre, recently moved to dismiss civil enforcement pleadings the SEC lodged against him last April based on the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. Mr. Tourre maintained the United States Supreme Court provided him grounds for dismissal at the end of its 2009-2010 term when it resolved Morrison v. National Australia Bank Ltd.[1] The Morrison Court used a “transaction test” to determine that federal securities laws, particularly § 10(b) of the 1934 Act (and Rule 10b-5 thereunder), were intended by Congress to apply only within United States territorial jurisdiction. Judge Barbara Jones of the United States District Court for the Southern District of New York had dismissed the matter on October 25, 2006, citing jurisdictional grounds. The United States Court of Appeals for the Second Judicial Circuit affirmed Judge Jones’ dismissal. The issue came full circle when Mr. Tourre attempted to persuade Judge Jones to dismiss the claims asserted against him by the SEC, maintaining the controversial ABACUS 2007-1 CDO offering was sufficiently analogous to the transactions in Morrison to militate dismissal.

A (Dodd-)Frank Primer of Some Imminent Regulatory Reforms

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Written by Edward Pekarek, Esq. and Christine Goodrich*

President Obama signed into law the DODD-FRANK WALL STREET REFORM AND CONSUMER PROTECTION ACT (“Dodd-Frank”) on July 21, 2010, signifying the most extensive regulatory reform for Wall Street since the INVESTMENT ADVISORS ACT OF 1940. Title IX of Dodd-Frank contains a host of investor protection provisions that portend for increased enforcement and regulatory activities by the SEC. Rather than reforming various controversial areas of the financial services industry regulatory schemes, Dodd-Frank instead directs the SEC to undertake various studies within a specified time period and determine whether further rulemaking and/or legislation is appropriate based upon those many studies.[1] Dodd-Frank is expected to double the SEC budget over the next five years and expand the organization through increased enforcement powers and personnel.[2]

By Edward Pekarek, Esq. and Bryn Fuller

Well before the failures of Bear Stearns and Lehman Brothers, and well after the collapse of Barings Bank and the scandals involving Allied Irish Banks (AIB) and Vienna-based BAWAG bank,[1] along with its imploded U.S. trading partner and co-conspirator, Refco,[2] financial markets were somehow surprised to learn billions in trading losses were realized by Société Générale (“Soc-Gen”), the result of proprietary trades made by the now 32-year-old Jérôme Kerviel, a bank trader who exposed Soc-Gen to €50B ($69B) in uncovered trading activity that inexplicably went undetected for years. Much like the original “Rogue Trader,” Barings’ Nick Leeson,[3] Mr. Kerviel was from a working class upbringing and learned how to conceal leveraged losses from supervisors using knowledge he gained as a former low level back-office employee. On October 5th, Mr. Kerviel was convicted by the Paris Criminal Court of computer fraud, forgery, and abuse of confidence.

Non-Signatory Compelled to Arbitrate

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Written by Charles Hecht, Esq.

Last week, in In the matter of the Application of Samuel Belzberg et al. v. Verus Investments Holdings, Inc., Justice Kornreich issued an important decision concerning when a non-party to a customer's agreement may be compelled to arbitrate.

We represented Verus, who was a named respondent in the arbitration before FINRA. Verus filed a third-party claim against several parties. Third-party Respondent, Samuel Belzberg, then moved in New York state court for a permanent injunction on the grounds that none of the third-party respondents were signatories to the Customer Agreement between Verus and the Claimant broker dealer. We cross moved to compel arbitration on the grounds that these persons were customers of the broker dealer under the broad definition of FINRA Rule 12200, or alternatively that they were equitably estopped because they received a direct benefit from the Customer Agreement. The court disagreed with us as to the definition of a customer but agreed with us on the doctrine of equitable estoppel. It granted the cross-motion as to one third-party respondent without hearing and ordered a hearing for two other third-party respondents on the issue of receiving direct benefits.

CFTC, SEC Staff to Host Roundtable on Credit Default Swaps

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On Friday, October 22nd, the CFTC will host two roundtables, one jointly with the SEC on Credit Default Swaps and the other on Customer Collateral Protection.

Sunlight Urged for the Shady Side of Muni Street

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By Edward Pekarek, Esq. and Nicole Grospe

As scandal and financial woe impugn the municipal bond market’s former reputation for safety, financial regulators have increased safeguards on a market once thought to be a safe, albeit boring, bet for investors with abundant tax advantages. The major financial regulators made their concerns known again on September 20, 2010: FINRA issued a Regulatory Notice[1] warning municipal securities broker-dealers of their disclosure duties; and the SEC posted an Investor Alert to educated investors on the municipal-bond market.[2]

Written by Brent Burns, Esq.

Today FINRA announced that it will be filing a rule proposal next month that will allow investors filing arbitration claims the ability to select an all-public panel, “greatly increasing investor choice in the FINRA arbitration program.” If approved by the SEC, investors will still be allowed to choose a panel consisting of one industry and two public arbitrators, but they will also now have the option of choosing a panel consisting of three all-public arbitrators. The press release quotes Richard Ketchum, the FINRA Chairman and Chief Executive Officer, explaining that the new option for investors will “increase the perception of fairness in the FINRA process. . . All investors will have greater freedom in choosing arbitration panels, and any investor will have the power to have his or her case heard by a panel with no industry participants.”

A copy of the FINRA News release can be found here.

By Edward Pekarek, Esq. and Brody Tice

High Frequency Trading, commonly known as “HFT,” is a controversial method of computer-driven trading that can be traced back to the 1980s. Counted among HFT ancestry is “program trading,” widely attributed as one of the causes of the near 25% decline in broad equity indices[1] that occurred on October 19, 1987, a crash known on Wall Street as “Black Monday.”[2] If HFT was born on Black Monday, it is almost certainly the child of a “SOES bandit.”

During the ‘87 crash, brokers ignored ringing telephones and their frantic customers who were calling to place sell orders.[3] NASDAQ responded to this panic-fueled nonfeasance by developing the Small Order Entry System (SOES), a trading platform designed specifically for priority processing of retail customer orders. Unscrupulous traders known as “SOES bandits” would slip large trading volume under the radar by dividing it into smaller pieces that appeared to be retail trades, gaining an ill-gotten speed advantage over other traders’ orders.

Inverse Floaters, FINRA Fine, Leave HSBC with a Sinking Feeling

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By Edward Pekarek, Esq. and Mark A. Boustouler*

The perfect storm of subprime mortgage defaults left Wall Street reeling, adrift in a sea of questionable investment products with many brokerages struggling to remain buoyant.1 Some brokers sold exotic high-risk products, such as Collateralized Mortgage Obligations (“CMO”), to unsophisticated retail customers, perhaps in some misguided effort to successfully navigate the swells of a growing market bubble.

As those rough seas settled, FINRA issued a $375,000 fine to HSBC Securities (USA) Inc. (“HSI”) for violations of self-regulatory organization (“SRO”) rules in connection with its CMO sales practices. HSI registered representatives sold in excess of 250 different CMO to retail customers between January 1, 2004 and June 7, 2007, including approximately 50 inverse floating rate CMO, so-called “inverse floaters.”2

Goldman Sachs: The year of the tiger could end with a scapegoat

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Written by Edward Pekarek, Esq. and Christopher Lufrano*

At the zenith of the domestic real estate “bubble” from 2004-2007, Goldman Sachs Group, Inc. facilitated several controversial structured finance derivative transactions that referenced domestic residential mortgage-backed securities (RMBS) which contained mortgages with subprime credit quality. In at least one of these RMBS deals, Goldman facilitated a short sale for one of its hedge fund clients, Paulson & Co., through the creation of a Credit Default Swap (CDS) contract that referenced a synthetic Collateralized Debt Obligation (CDO) known as “ABACUS 2007 AC-1.” Unbeknownst to ABACUS investors, and in an apparent conflict of interest, Paulson also participated extensively in the selection of the RMBS reference portfolio for ABACUS.

Written by Nancy Campanozzi, Esq.

On July 27, 2010, the Securities and Exchange Commission (SEC) published a request for public comment on a study the SEC is required to conduct regarding the obligations of brokers/dealers, and investment advisers to retail customers as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act that President Obama signed into law on July 21, 2010. [Release No. 34-62577; IA-3058; File No. 4-606]

FINRA Proposes New Discovery Guide for Customer Arbitrations

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Written by Nancy Campanozzi, Esq.

On July 12, 2010, FINRA filed the Notice of Proposed Rule Change Amendments to the Discovery Guide and Rules 12506 and 12508 of the Code of Arbitration Procedure for Customer Disputes with the SEC.

The Amendments to the Discovery Guide, (Guide) proposes to replace the 14 current Lists of “presumptively discoverable documents” with two lists.

The Guide’s Introduction would be revised to expand the guidance given to parties and arbitrators on the discovery process generally and provide clarification as to how arbitrators should apply the Guide in arbitration proceedings. In addition to the section of the Introduction that states that arbitrators can order parties to produce documents that are not on the lists or alter the parties’ production schedule, the proposed rule would add flexibility to the arbitrators by enabling them to order that parties do not have to produce certain documents.

SEC Approves FINRA Rule Proposal to Expand the Arbitrator Lists

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Written by Christine Lazaro, Esq.

On July 9, 2010, the SEC approved FINRA’s proposal to increase the number of arbitrators on lists generated by the Neutral List Selection System (NLSS) under FINRA Rules 12403, 12404, 13403 and 13404. The lists of arbitrators presented to parties in arbitrations before FINRA will be expanded from eight names to ten names, but the number of strikes available to each party will remain the same.

SEC Approves Further Changes to FINRA’s BrokerCheck

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Written by Christine Lazaro, Esq.

On July 8, 2010, the SEC approved FINRA’s proposal to expand BrokerCheck. Once implemented, the changes to BrokerCheck will result in an increase in the number of customer complaints reported publicly because all historic complaints against a broker dating back to 1999, when electronic filing of broker information began will now be reported. Additionally, FINRA has extended the public disclosure period for the full record of a broker who leaves the industry from two years to 10 years. Additionally, FINRA is making certain information about former brokers available permanently, such as criminal convictions and certain civil injunctive actions and arbitration awards against the broker.

Written by Christine Lazaro, Esq.

On June 2, 2010, the SEC approved FINRA's proposed changes to Rule 9554, eliminating the inability-to-pay defense in the expedited proceedings context when a member or associated person fails to pay an arbitration award to a customer. FINRA is required to consider the defense in disciplinary cases, however, the SEC pointed out that the reasons present that require FINRA to consider the defense in disciplinary cases are not present in expedited cases.

Thanks Dave!

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The New York State Bar Association would like to thank Dave Welch for his innovation, creativity and leadership in building this blog. Dave has moved on to the next step in his legal career and we wish him all the best in his future endeavors. Dave - you will be sorely missed!

We hope to keep this blog running - but we need bloggers. If you are interested in being part of a committee of bloggers writing for this site, please contact and put Securities Litigation blog in the subject line. Thank you for your interest.

Barbara Beauchamp
New York State Bar Association

Written by Brent A. Burns

On April 1, 2010, FINRA announced it is amending its rules regarding the selection of hearing locations to allow customers and associated persons more flexibility. The effective date of the amendments is May 3, 2010.

Under the current customer code, Rule 12213(a), the Director of FINRA Dispute Resolution selects the hearing location closest to the customer’s residence at the time of the events giving rise to the dispute. Under the amended rule, a customer will now also be able to request a hearing location in the state where the customer resided at the time of the event giving rise to the dispute.

SEC Warns of Investor Scam Relating to Madoff

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Written by Christine Lazaro, Esq.

On March 10, 2010, the Securities and Exchange Commission issued a press release alerting investors about a web site that falsely claims to have recovered $1.3 billion in funds hidden by convicted Ponzi schemer Bernard Madoff in Malaysia. The website purports to be that of the "International Security Investor Protection Corporation", which is a ficticious entity.

FINRA Proposes to Further Expand BrokerCheck

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Written by Christine Lazaro, Esq.

On February 17, 2010, FINRA announced that it will submit a proposal to further expand BrokerCheck to the SEC shortly. FINRA describes BrokerCheck as a free tool offered by FINRA which allows investors to check the professional background of current and former FINRA-registered securities firms and brokers.

In the press release, FINRA explains that the proposal would increase the number of customer complaints reported publicly; extend the public disclosure period for the full record of a broker who leaves the industry from two years to 10 years; and, make certain information about former brokers available permanently, such as criminal convictions and certain civil and arbitration judgments.

Written by David Welch, Esq.

...Continued from Control Person Liability Post on September 21, 2009:

The success or failure of a pre-hearing Motion to Dismiss a control person liability claim may at times depend on which standard the arbitrators or judge choose to adopt: the “culpable participation” standard or the “potential control standard.” Although some courts are bound by precedential case law to apply a certain standard, many jurisdictions have not definitely selected an appropriate standard and arbitrators, after all, are free to apply whichever standard they deem appropriate.

Thus, parties involved in control person liability disputes often commit significant efforts to advocating the standard that best suits their needs. Although defective control person liability claims can be dismissed under the “potential control” standard, as discussed below, it generally behooves control persons to advocate in favor of the application of the “culpable participation” standard.

The “Culpable Participation” Standard

The SEC has approved FINRA's Proposed Amendments to the Industry and Customer Codes of Arbitration that clarify the definition of "associated person" making it conform to the FINRA By-laws, streamline procedures related to the distribution of the Discovery Guide, and clarify that customers could be assessed hearing session fees based on their own claims for relief in connection with an industry dispute.

FINRA provides an explanation of the changes, which apply to claims filed on or after January 18, 2010, along with the new rules in their entirety in Regulatory Notice 09-74. The changes, in pertinent part are as follows:

A bill proposed by Senator Christopher Dodd would require brokers to register as advisers with the Securities and Exchange Commission. This means that brokers would be subjected to the Investment Advisers Act of 1940, requiring them to act as a fiduciary to their clients.

The Dodd bill differs from the proposed Investor Protection Act approved Oct. 28 by the House Financial Services Committee in that the House bill would require the SEC to write regulations defining the fiduciary standard for advisers. The Senate bill, however, extends the fiduciary duty to broker-dealers by eliminating the broker-dealer exclusion from the Investment Advisers Act. The current exemption spares brokers from registering as advisers if the advice they provide to clients is “solely incidental” to selling products.

Under the Dodd’s proposed legislation, an Office of the Investor Advocate would also be created within the Securities and Exchange Commission.

The new office would report yearly to Congress on the twenty most pertinent issues facing investors. The report would also include data indicating the length of time that each issue has remained on the list and what actions were taken by the SEC or FINRA, if any, to resolve the problem(s).

An Investor Advocate would appointed to lead the Office and would have the power to employ independent counsel, research staff, and other services that Investor Advocate feels necessary.

The draft bill can be found here.

The SEC recently settled two actions for selling short within the five days prior to an offering. The two proceedings, In the Matter of First New York Securities LLC, (Oct. 20, 2009) and In the Matter of Perceptive Advisors LLC, (Oct. 20, 2009), involved alleged violations of Rule 105 of Regulation M. Rule 105 prohibits the cover of a short sale with securities obtained from an offering if the short sale occurs during the five business days before the pricing of the offering. In the case involving New York Securities, the firm was alleged to have violated Rule 105 on two separate occasions, once in September 2005 and again in January 2007. Overall, according to the SEC, the firm made profits of approximately $40,000. Perceptive Advisors was alleged to have violated Rule 105 on five different occasions resulting in profits of around $245,000.

Each firm settled with the SEC and agreed to pay disgorgement of profits as well as a civil penalty. New York Securities’ penalty was about $20,000 and Perceptive Advisors agreed to pay a penalty of $125,000. Each firm also consented to the settlements without admitting or denying any of the allegations.

The SEC’s Order for each proceeding can be read here (New York Securities) and here (Perceptive Advisors).

For more on what constitutes a violation of Rule 105 read here.

Written by Arpan Parmar*

In April 2009, FINRA’s Board of Governors established a Special Review Committee to conduct an internal review of FINRA’s examination program as it relates to FINRA member firms associated with R. Allen Stanford and Bernard L. Madoff. The Committee consisted of four FINRA public governors: Ellyn L. Brown, Brown & Associates; Harvey J. Goldschmid, Dwight Professor of Law at Columbia University; Joel Seligman, President of the University of Rochester; and, Committee Chair, Charles A. Bowsher. The Board asked the Committee to recommend changes in the examination program to improve member oversight, fraud detection capability and FINRA’s monitoring of compliance with examination program policies. In September 2009, the Committee provided a report of their findings.

NY OCA: Volunteer Attorney Program

Volunteer Attorney Program

The sharp downturn in the economy has had a profound impact on the justice system and the legal community. The number of unrepresented litigants in court has increased dramatically. At the same time, substantial numbers of attorneys find themselves unexpectedly unemployed.

In response to these concerns, the court system has established the Volunteer Attorney Program, offering attorneys opportunities to volunteer to serve the courts and the public.

Under the Program, attorneys can volunteer to provide advice and assistance to unrepresented litigants (Pro Bono Volunteer Attorney); or, they can serve in a judge’s chambers, performing legal research, writing and related functions (Chambers’ Volunteer Attorney).

Attorneys can volunteer full-time or part-time, on a schedule that is convenient to them. Participating attorneys select the court in which they want to serve and the type of cases they prefer to handle (subject to availability).

Mr. Sienko's original post can be found here.

Written by Christine Lazaro, Esq.

Chairman of the House Financial Services Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Paul E. Kanjorski (D-PA), released discussion drafts of three pieces of legislation on October 1st. The drafts include the Investor Protection Act, the Private Fund Investment Advisers Registration Act, and the Federal Insurance Office Act.

In a press release, Chairman Kanjorski stated “With these three bills we will address many of the shortcomings and loopholes laid bare by the current financial crisis. The Investor Protection Act will better protect investors and increase the funding and enforcement powers of the U.S. Securities and Exchange Commission. We must ensure that investor confidence continues to increase for the betterment of our financial system.”

Written by Arpan Parmar*

The Second Circuit Court of Appeals issued an opinion vacating and remanding a district court opinion that denied the Securities and Exchange Commission’s (“SEC”) motion for a preliminary injunction against an alleged computer hacker and insider trader on July 22, 2009, SEC v. Dorozhko, Docket No. 08-0201-cv. This case represents an important win for the SEC in an age where technology often outpaces securities law.

In early October 2007, the defendant, Oleksandr Dorozhko opened an online trading account with Interactive Brokers LLC (“Interactive Brokers”) and deposited $42,500 into that account. That same month, IMS Health, Inc. (“IMS”), was scheduled to announce its third-quarter earnings during an analyst conference call scheduled for October 17, 2007 at 5 p.m. IMS had hired Thomson Financial, Inc. (“Thomson”) to provide investor relations and web-hosting services, which included managing the online release of IMS’s earning reports. Prior to the open of the securities markets on October 17th, an anonymous computer hacker attempted to gain access to IMS’s earnings report from Thomson’s secure server. At 2:15 p.m., minutes after Thomson actually received the IMS data, that hacker successfully located and downloaded the IMS data from Thomson’s secure server. Beginning at 2:52 p.m., Dorozhko, who had not previously used his Interactive Brokers account to trade, purchased $41,670.90 worth of IMS put options that would expire on October 25th and 30th, 2007.

Control Person Liability

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Written by David Welch, Esq.

As a general rule, when there is a significant and sustained drop in the stock market, there is a significant increase in law suits and arbitration claims against stock brokers. In addition to stock brokers, plaintiffs’ lawyers will often try to name “control persons” individually to increase the settlement pool or insulate the viability of their claim against a possibly insolvent broker. Control person liability claims in the realm of broker-dealers are typically brought under §20(a) of the Securities Exchange Act. Interestingly, in a recently settled case brought by the SEC against Nature's Sunshine Products, Inc. (not a broker-dealer), the SEC named individual executives of the company under §20(a) and did not alleged that the executives had personal knowledge of the underlying Foreign Corrupt Practices Act (“FCPA”) violations.

This is noteworthy because there is somewhat of a split among the courts about what needs to be alleged under §20(a) to bring a control person into a case or arbitration. Generally, the courts are divided between one standard that requires some level of participation on the part of the control person, and another that maintains that participation is not required. Thus, it will be interesting to see if plaintiffs’ attorneys, who advocate for the broadest of standards, will try to use the SEC’s decision not to allege knowledge as support for their control liability claims. Although it is plausible that they will try to do so, that fact remains that such an argument would be without merit because, among other reasons, the FCPA is an entirely different animal than the typical violations brought against brokers.

Control person liability is defined under §20(a) as:

Written by Arpan Parmar*

On September 17, 2009, the SEC unanimously proposed a rule amendment that would prohibit the practice of flashing marketable orders.

Rule 602 of Regulation NMS requires every national securities exchange to make the best bids and offers available in the consolidated quotation data that is widely disseminated to the public. However, the rule excludes bids and offers communicated on an exchange that are executed immediately after communication or cancelled if not executed immediately after communication. Orders that are immediately executed or cancelled have come to be known as flash orders.

Written by Christine Lazaro, Esq. reports that, as Congress discusses regulatory reforms, judges are issuing rulings with national impact. For example, last week, U.S. District Judge Shira Scheindlin threw out a key free-speech defense that credit raters had used for years to thwart investors’ fraud suits. Click here for the full story.

Written by Christine Lazaro, Esq.

The Commodity Futures Trading Commission (CFTC) and the Securities and Exchange Commission (SEC) are holding joint meetings to seek input from the public on harmonization of market regulation. The first meeting is being held at the CFTC on September 2nd, and the second meeting will be held at the SEC on September 3rd.

The amendments to Rules 13402, 13403 and 13406 of the Arbitration Code for Industry
Disputes (Industry Code) change the criteria for determining panel composition when
the claim involves an associated person in industry disputes. Specifically, the
amendments to the rules of the Industry Code:

- require that the parties receive a majority public panel for all industry disputes
involving associated persons (excluding disputes involving statutory employment
discrimination claims, which require a specialized all public panel);

- clarify that in disputes involving only member firms, parties will receive an all
non-public panel; and

- provide that if a party amends its pleadings to add an associated person to a
previously all-member firm case, parties will receive a majority public panel.

The full text of the new rules can be read here.

Written by David Welch, Esq.

Efforts to conceal Rule 105 violations, like those which were alleged by the SEC in its complaint against New York hedge fund, Colonial, LLC (see previous post), are often referred to as “Sham Transactions.” A Sham Transaction is when a hedge fund or broker-dealer receives shares as part of an offering, sells them on the open market, and almost immediately buys them back in an attempt to technically change them from being labeled as “offering shares” to “open market shares.” The motivation to make this quick change is to surreptitiously use the newly labeled open market shares to cover short sales, because covering short sales with “open market shares” instead of “offering shares” is technically outside of the scope of Rule 105.

Written by David Welch, Esq.

In the wake of the ubiquitous economic troubles and consequent hasty finger-pointing, many commentators predicted that the largely unregulated hedge fund industry would be effectively dismantled by over-reactive regulatory authorities. Although such draconian responses have yet to be seen, some level of increased regulation has occurred.

On July 7, 2009, the United States District Court for the Southern District of New York found a New York hedge fund, Colonial Fund LLC, and its adviser, Colonial Investment Management LLC, were liable for violations of Regulation M, Rule 105. The Court found that Colonial Fund LLC engaged in illegal trading relating to eighteen registered public offerings and ordered defendants to pay disgorgement of profits totaling more than $1.4 million. The fund was controlled by Cary G. Brody, who was required to pay a civil penalty of $450,000.

The goal of Rule 105 is to maintain the integrity of the offering price by ensuring it is based on market forces (supply and demand) and not “artificial forces" (market manipulations).

In that regard, two actions have to occur to trigger a violation of Rule 105:

From the "Securities Docket: Global Securities Litigation and Enforcement Report," July 9

Webcast: “2009 Mid-Year Review - Securities Litigation and Enforcement”

On July 9, 2008, Securities Docket will host a webcast entitled, “2009 Mid-Year Review - Securities Litigation and Enforcement.” The webcast, which is part of BrightTalk’s Securities Litigation Summit, will be a follow-up and update to the popular “2008 Year in Review” presented in January 2009.

Sign up through BrightTALK for free here:

The Securities and Exchange Commission's public comment period on the uptick rule concludes June 19. In sum, the outstanding questions is whether short sale price restrictions or circuit breaker restrictions should be imposed on the market.

Comments can be submitted here.

Comments submitted thus far express a wide range of opinions. For example, one writer suggested that reinstating the uptick rule is necessary for "national security."

Not to go unnoticed, of course, is Jim Cramer and his continuing campaign for a reinstating the uptick rule. It appears from the SEC's website that Cramer petitioned over 5,000 people to submit a template letter urging the SEC to instate a "price test" rule. Cramer's letter can be viewed here.

Written by Christine Lazaro, Esq.

FINRA filed a proposed rule change with the SEC on April 24, 2009, to expand its BrokerCheck service. BrokerCheck is a free tool offered by FINRA which allows investors to check the professional background of current and former FINRA-registered securities firms and brokers. BrokerCheck currently allows individuals to look up member firms and associated persons (brokers) who have been registered with FINRA within the past two years.

The proposed changes would expand BrokerCheck so that certain information would be permanently available. Specifically, FINRA proposes that records relating to final regulatory actions against brokers would be permanently available. FINRA describes a final regulatory action as “any final action by the SEC, Commodity Futures Trading Commission, a federal banking agency, the National Credit Union Administration, another federal regulatory agency, a state regulatory agency, a foreign financial regulatory authority, or a self-regulatory organization as those terms are used in the uniform registration forms.”

Written by Christine Lazaro, Esq.

On May 6th, the Securities and Exchange Commission filed a suit against two lawyers, Albert J. Rasch, Jr. and Kathleen R. Novinger, both with Albert J. Rasch & Associates in Costa Mesa, California, and Sandra B. Masino and her company 144 Opinions, Inc. Suit was filed in the U.S. District Court for the Northern District of Georgia.

The complaint alleges that the defendants operated a legal opinion mill. 144 Opinions promoted itself as a “Restricted Stock Service” that provided legal opinions letters relating to the removal of restrictive legends on unregistered stocks. According to the complaint, Masino worked with Rasch & Associates along with the shareholder’s broker-dealer and the issuer’s transfer agent, to obtain the necessary paperwork to smooth the process of selling restricted stock. Between 2007 and the first four months of 2008, Masino prepared and Rasch or Novinger executed a total of 1,312 legal opinions.

Written by Lauren Buonome*

The Fifth Circuit Court of Appeals issued an opinion on March 5, 2009 (revised on March 18, 2009), Citigroup Global Markets v. Bacon, vacating and remanding a district court opinion that granted Citigroup Global Market’s (“Citigroup”) motion to vacate an arbitration award. The arbitration claim, brought by Debra Bacon (“Bacon”), was filed in 2004 against Citigroup. Bacon asserted her husband had withdrawn funds from her account without authorization, totaling $238,000, and that Citigroup was liable for permitting such unauthorized withdrawals. The arbitration panel found for Bacon, awarding her $218,000 in damages and $38,000 in attorney fees. Consequently, Citigroup filed in the district court to vacate the award, citing § 10 of the Federal Arbitration Act (“FAA”).

Written by David Welch, Esq.

The SEC met this past Wednesday and voted to review whether short sale price restrictions or circuit breaker restrictions should be implemented, and whether such measures will provide market stability and restore investor confidence. Reinstating some version of the uptick rule, irrespective of its precise details and actual impact on short selling, may in and of itself restore investor confidence. That is, even if short selling does not actually contribute to market volatility, and even if the uptick rule does not actually prevent short selling, just the knowledge that an uptick rule exists may encourage an otherwise apprehensive investor to ease back into the stock market.

"Clearly, the practice of short selling has both strong supporters and detractors. Today, we begin what will be a very deliberative process to determine what is in the best interests of investors,” SEC Commissioner, Mary Schapiro said.

Although many blame short-sales for causing a snowball effect on stocks already under pressure, Schapiro said there is no "specific empirical evidence" that the absence of the uptick rule fueled the recent descent in the market.

In fact, the SEC repealed the uptick rule, which had been active since the Depression, in 2007 when a test by the SEC (which removed the uptick rule for one-third of the stocks in the Russell 3000 index) found it could be eliminated without causing significant harm. Skeptics of the 2007-test point out that the rule wasn’t tested during a volatile or downward pressurized market.

The five possible uptick rules the SEC voted to consider are as follows:

Written by David Welch, Esq.

Last week, before the Senate Banking Committee, SEC Chairman Mary Schapiro made it clear that she intends to consolidate oversight of financial services firms and subject them to stricter regulatory controls. Currently, FINRA and the SEC share supervision of broker-dealers and investment advisers. Investment advisers are required to abide by a “fiduciary duty” standard and brokers are held to a standard of “suitability.” Arguments regarding which standard is more stringent aside, Schapiro views the inconsistency as an encumbrance on regulatory oversight and implied that a uniform standard is on the horizon.

Schapiro and FINRA CEO, Richard Ketchum, explained that enforcement of the uniform standard will be consolidated under the purview of FINRA, for brokers and advisers alike. In his testimony before the banking committee, Ketchum stated:

Written by David Welch, Esq.

A lot has been said lately about naked short selling and its potential for market manipulation. Short selling, aka, "covered" short selling, occurs when a trader sells a borrowed stock with the intent to buy it back elsewhere at a lower price and pocket the difference. A short sale is considered “naked” if the trader has not made arrangements to borrow (or "cover") the stock before he sells it. Naked short sales that are never “covered” sometimes result in a “failure to deliver” and it is this practice that has produced divided factions regarding ethics and the need for greater regulation.

Those against naked short sales claim that the practice can be used to manipulate the market because more shares can be sold short than actually exist, which in turn:

Written by Christine Lazaro, Esq.

FINRA filed a proposed rule change with the SEC on March 11, 2009, seeking to amend the Code of Arbitration Procedure for Customer Disputes (Rule 12206) and the Code of Arbitration Procedure for Industry Disputes (Rule 13206), to clarify that the rules toll the applicable statutes of limitation when a person files an arbitration claim with FINRA.

Current Rule 12206(a) provides that “no claim shall be eligible for submission to arbitration under the Code where six years have elapsed from the occurrence or event giving rise to the claim.” Rule 12206(c) provides that “The rule does not extend applicable statutes of limitations…However, where permitted by applicable law, when a claimant files a statement of claim in arbitration, any time limits for the filing of the claim in court will be tolled while FINRA retains jurisdiction of the claim.” Rule 13206 contains identical language. FINRA has proposed deleting the phrase “where permitted by applicable law” from Rule 12206(c) and Rule 13206(c).

Written by Christine Lazaro, Esq.

On March 12th, the Securities and Exchange Commission filed a suit against two brokers, David Harrison Baker ("Baker") and Daniel Schreiber ("Schreiber"), and the broker-dealer with which Schreiber was associated, Granite Financial Group, LLC ("Granite"), and Brian Travis ("Travis") and Nicholas Peter Vulpis, Jr. ("Vulpis"), two employees of a hedge fund investment adviser. Suit was filed in the U.S. District Court for the Southern District of New York, and alleged that Travis and Vulpis solicited bribes in exchange for routing hedge fund trades, and the associated commissions, to Baker, Schreiber and Granite.

The complaint alleges that Travis and Vulpis received at least $312,000 in personal benefits such as international air travel (including for family members), hotel arrangements, fully-paid vacations, daily car service, computer equipment, and monthly rent payments for a personal residence; and that Baker, Schreiber and Granite received a total of approximately $10,702,105 in commissions from trades that Travis and Vulpis directed to them.

Written by David Welch, Esq.

The Quadruple Witch is a term used to describe the occurrence, which happens only 4 times a year, of 4 different types of derivative instruments expiring in a single day. The 4 derivative instruments are (1) Stock Index Futures, (2) Stock Index Options, (3) Stock Options, and (4) Single Stock Futures.

In the US market, Stock Index Options and Stock Options expire every month, while Single Stock Futures and Stock Index Futures expire four times per year in March, June, September, and December. The combined expiration of these four derivative instruments creates the “Quadruple Witching."

The Quadruple Witch day can be slightly more volatile as options holders begin to exercise their options contracts and roll forward to contracts with later expiration dates. This Friday is a Quadruple Witch day and thus, according to theory, this week could be more volatile than usual.

Citigroup was recently in the news related to a violation occurring on a Quadruple Witch day (See previous post, here).

According to FINRA, who fined Citigroup $2 million:

Written by David Welch, Esq.

On March 9th, the SEC charged Locke Capital Management with falsely creating a billion dollar client in order to establish credibility and lure investors. See news release, here.

On March 11, the SEC announced that it fined Merrill $ 7 million for failure to protect confidential “Squawk Box” information. See news release here.

And lastly, on March 17th, FINRA released that it fined Citigroup $2 million for Range of Trade violations, including, failure to monitor trading systems at the opening of a Quadruple Witch Expiration Friday. See news release, here. Quadruple Witch Friday happens 4 times a year when 4 different types of derivative instruments expire. In theory, this causes more volatility on that day and throughout the week in which the day falls. This Friday, March 20, 2009, is a Quadruple Witch Expiration Friday.

Article written by Christine Lazaro, Esq.

At the G-20 Finance Ministers and Central Bank Governors meeting on March 14, 2009, U.S. Treasury Secretary Timothy Geithner announced that the United States would soon release a comprehensive framework for regulatory reform.

Geithner stated:

“We have committed to broad principles to guide the reform of the financial system:
First, all institutions that are important to the stability of the financial system should come within a much stronger framework of oversight, with clearer rules of the game that are enforced more evenly and consistently across countries.

Article Written by David Welch, Esq.

Effective April 13, 2009: The Securities and Exchange Commission Approved Amendments to Require FINRA Arbitrators to Provide an Explained Decision upon a Joint Request From the Parties.

FINRA has announced that the new rule (outlined in an earlier post here) will become effective on April 13, 2009. Under the new rule, FINRA will require arbitrators to provide an explained decision upon a request from both parties.

Written by David Welch, Esq.

About two weeks ago, on March 3, 2009, the Securities and Exchange Commission approved FINRA’s proposal to adopt NASD Interpretive Material 2110-7 as a stand-alone FINRA rule which will be renumbered as “FINRA Rule 2140.” Securities and Exchange Commission Release No. 34-59495 (March 3, 2009); File No. SR-FINRA-2008-052.

The new Rule, which codifies a long-standing FINRA policy, provides that it "shall be inconsistent with just and equitable principles of trade…to interfere with a customer’s request to transfer his or her account in connection with the change in employment of the customer’s registered representative[.]

Written by David Welch, Esq.

Securities and Exchange Commission 17 CFR Part 242. Release No. 34-56206. Short Selling in Connection with a Public Offering.

Current economic conditions lend itself to increased short selling and, consequently, shorting has come under increased scrutiny by the SEC. Rule 105 of Regulation M prohibits purchasing securities as part of an “offering” if that security was also shorted within the five days immediately preceding the “pricing” (or within the period between the registration statement and the pricing, whichever is shorter).

Put another way, two actions have to occur to trigger a violation of Rule 105:

FINRA fined Robert W. Baird & Co. $500,000 for supervisory violations relating to its fee-based brokerage accounts and ordered the company to return $434,510 in fees to 154 customers. FINRA found that customers were charged fees in accounts that were not generating any activity, otherwise known as “reverse churning.”

According to FINRA Baird failed to adequately review or supervise its fee accounts and allowed numerous customers to remain in the program despite conducting no trades for at least eight consecutive quarters. These accounts paid over $269,000 in fees during the inactive quarters.

According to Andrew Stoltmann at Investmentfraud.PRO, this type of fee based account has become more prevalent in the past 7 years and Baird is only one firm out of many who engaged in so-called reverse churning. Recent actions involving firms such as AXA Advisors, Morgan Stanley, SunTrust Investment and Wachovia Securities ranged from $700,000 to $6.1 million.

Written by David Welch, Esq.

Written by David Welch, Esq.

Under the new rule, parties to an arbitration may require an arbitrator to provide an explanation of decision if the request is made jointly (by both parties) 20 days prior to the first scheduled hearing date. An arbitrator must provide a fact-based award stating the general reason(s) for the arbitrator's decision. However, the rule does not require the arbitrator to include legal authorities and/or damage calculations.

The chairperson required to write the explained decision will receive an additional honorarium of $400 and will allocate the cost to one party or between/among all parties. The 20 day deadline coincides with the time that parties must exchange documents and identify witnesses they intend to present at the hearing. In FINRA's view, this establishes a clear deadline, gives the parties sufficient time to request an explained decision, and provides notice to the arbitrators that an explained decision will be required before the hearing begins.

The new rule is likely an attempt by FINRA to appease a common perception among customers that the arbitration process favors the industry. Although FINRA has conducted studies and published results that tend to discredit the validity of industry favoritism, FINRA maintains that the mere perception of inequity is a concern that they are taking steps to eradicate.

Two broker-dealer side securities litigators from Sutherland Asbill & Brennan LLP conducted a study that concluded broker-dealers can benefit from fighting proceedings brought by the SEC and FINRA. The study says that firms who fought proceedings brought by the SEC won a dismissal 19% of the time and FINRA complaints that were fought were dismissed 15% of the time. With regard to fines, respondents to SEC charges convinced the judge to lower the fines 83% of the time and FINRA respondents succeeded in reducing fines roughly 50% of the time.

Another interesting but not surprising statistic published by the study is that respondents who hired counsel were overwhelmingly more successful than those that did not. SEC respondents represented by counsel succeeded in getting approximately 22% of charges dismissed, and FINRA respondents with counsel succeeded in getting approximately 19% of charges dismissed. SEC and FINRA respondents without counsel went 0-for-16 from January 2006 through December 2007.

Clearly, the terrible rate of success for pro-se respondents is a testament to the unfortunate pay-to-play factor in our justice system that favors those with resources to hire a lawyer. However, another possible factor not discussed in the study is that a respondent who believes he or she is guilty or liable, may be less likely to fight or spend money on counsel. If true, this factor would slightly skew the pool of pro-se respondents towards a lower “success” rate.

Read the study results here.

Written by David Welch, Esq.

Written by Dan Fried, Esq.

In In re: American Express Merchants' Litigation, 06-1871-cv, decided on January 30, 2009, the Second Circuit ruled for the first time that the class action waiver provision within a contract between American Express Co. and merchants is unenforceable under the Federal Arbitration Act. The Court held that to enforce this agreement would "grant Amex de facto immunity from antitrust liability by removing the plaintiffs’ only reasonably feasible means of recovery."

The Court did not go so far as to rule that class action waiver provisions are either void or enforceable per se, focusing solely on the provision contained in the specific contract being argued before them.

The Court also held that the authority to determine the enforceability of a class action waiver is a matter for the courts, not the arbitrator.

Although Luparello's testimony was comprehensive, the overarching theme was that disparate treatment by fractured regulatory authorities fosters failed oversight. His testimony emphasized the need for "a consistent level of protection no matter which financial professionals or products [investors] choose." See his entire testimony here.

Written by David Welch, Esq.

Written by David B. Harrison, Esq.

In Cozzarelli v. Inspire Pharmaceuticals, Inc., 549 F.3d 618 (4th Cir. Dec. 12, 2008), the Fourth Circuit applied the strict pleading standards for scienter set forth by the PSLRA and interpreted by the Supreme Court in Tellabs, Inc. v. Makor Issues & Rights, Ltd., ---U.S. ----, 127 S.Ct. 2499, 168 L.Ed.2d 179 (2007). The Court affirmed the District Court’s dismissal, finding that plaintiffs failed to raise a strong inference of wrongful intent required to support their securities fraud claims.

Plaintiff class sued biopharmaceuticals company, Inspire, for violations of the federal securities laws, alleging defendants made false and misleading statements regarding clinical trials of a new drug, diquafasol, a treatment for dry eye disease. Plaintiffs alleged that defendants fraudulently misled investors as to the trial’s likelihood of success in meeting the FDA's standards for approval.

Written by David Welch, Esq.

Despite the Supreme Court's ruling in Tellabs, the Second Circuit continues to apply its two prong motive and opportunity or strong circumstantial evidence test. In ECA and Local 134 IBEW Joint Pension Trust of Chicago v. JP Morgan Chase Co., Case No. 0-1786-cv (2nd Cir. Jan. 21, 2009) the Second Circuit affirmed the District Court’s dismissal for failure to sufficiently plead scienter.

The case addressed the issue of whether the complaint adequately alleged (1) a false statement or omission of material fact, and (2) a strong inference of scienter.

A plaintiff must establish that the defendant made a materially false statement or omitted a material fact, with scienter. The complaint must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(1), (2); Tellabs, 127 S. Ct. at 2508.

The Second Circuit's test required that the complaint allege facts that show either:

Written by David Welch, Esq.

In Waldman v. Wachovia Corp., 2009 WL 86763 (S.D.N.Y. Jan. 12, 2009), the Court found that maintaining a discovery stay with regard to documents already produced to state and federal authorities would unduly prejudice plaintiffs because the documents could be determinative of plaintiffs’ decision whether to continue pursuing the case.

This case addressed the issue of when a discovery stay reaches the point of undue prejudice.

The PSLRA states that “in any private action arising under [federal securities law], all discovery and other proceedings shall be stayed during the pendency of any motion to dismiss, unless the court finds upon the motion of any party that particularized discovery is necessary to preserve evidence or to prevent undue prejudice to that party.” 15 U.S.C. § 78u-4(b)(3)(B).

Written by David Welch, Esq.

In In re Hydrogen Peroxide Antitrust Litigation, No. 07-1689 (3d Cir. Dec. 31, 2008), the Third Circuit vacated a district court’s decision to certify a class in an antitrust lawsuit, and held that the lower court left unanswered disputed elements of Federal Rule of Civil Procedure 23.

The Court stated that the requirements set out in Rule 23 are not mere pleading rules." Szabo, 249 F.3d at 675-77. The court may “delve beyond the pleadings to determine whether the requirements for class certification are satisfied.“ Newton, 259 F.3d at 167.

Plaintiffs moved to certify a class of purchasers of hydrogen peroxide and other chemicals, alleging that the defendant manufacturers had fixed prices in violation of the Sherman Act. The district court granted the motion and defendants appealed arguing that plaintiffs failed to satisfy Rule 23(b)(3)’s requirement that common questions of law or fact predominate.

The Third Circuit held that three key aspects are necessary for class certification. “First, the decision to certify a class calls for findings by the court, not merely a “threshold showing” by a party, that each requirement of Rule 23 is met. Factual determinations supporting Rule 23 findings must be made by a preponderance of the evidence. Second, the court must resolve all factual or legal disputes relevant to class certification, even if they overlap with the merits-including disputes touching on elements of the cause of action. Third, the court’s obligation to consider all relevant evidence and arguments extends to expert testimony, whether offered by a party seeking class certification or by a party opposing it.”

Written by David Welch, Esq.

In the Ninth Cirucit, if you don't meet pleading standards under a segmented approach, maybe a "holistic" approach will work.

Rubke v. Capitol Bancorp LTD, 2009 WL 69278 (9th Cir. Jan. 13, 2009) and Zucco Partners, LLC v. Digimarc Corp., 2009 WL 57081 (9th Cir. Jan. 12, 2009) alter the approach to evaluating scienter allegations by first using a segmented analysis, and second using a holistic approach. It appears to give plaintiffs a second bite at the apple.

The complaint alleged that Capitol Bancorp, Ltd. and CEO Joseph Reid misled investors by incorporating two fairness opinions in a registration statement issued to minority shareholders. The plaintiffs also alleged that defendant’s registration statement omitted information related to a prior offer for the holding company’s shares, future income projections, likelihood of a premium on fair value of shares, and a strategy of board members to convince minority shareholders to sell their shares to Capitol.

The district court dismissed the complaint for failure to meet the pleading standards of the Private Securities Litigation Reform Act, and the Circuit court affirmed, stating:

“The First Amended Complaint has also failed to allege with particularity that Capitol made any of the statements or omissions “intentionally or with deliberate recklessness.” Daou, 411 F.3d at 1015. The complaint’s allegations about Pedisich’s telephone calls do not adequately plead that the defendants in this case had the requisite mental state. The complaint’s remaining allegations concerning Capitol’s mental state allege nothing but “motive and opportunity,” which is not enough to create a strong inference of scienter. Silicon Graphics, 183 F.3d at 974…These allegations are hardly indicative of scienter…Even considered holistically, under Tellabs, these motive allegations cannot support a strong inference of scienter.”

Written by David Welch, Esq.

Written by David Welch, Esq.

The Ninth Circuit issued its first analysis of Tellabs in Zucco Partners, LLC v. Digimarc Corporations, 2009 WL 57081 (9th Cir. Jan. 12, 2009).

The case was dismissed based primarily on the confidential witnesses' lack of personal knowledge but the interesting part was that the Ninth Circuit seemed to imply that the new Tellabs standard is less strict than the Court's previous standard (or, at least confirmed that Tellabs didn't raise the standard).

They applied a dual part test for pleading scienter: first, a segmented evaluation of each allegation, then a "holistic" evaluation under Tellabs.

Examples of the Court's perspective on the new Tellabs standard compared to the Ninth Circuit's previous standard:

"Tellabs did not materially alter the particularity requirements for scienter claims established in the court's previous decisions, but instead only added an additional "holistic" component to those requirements."


Written by David Welch, Esq.

The court in In re Cooper Companies Inc. Securities Litigation, 2009 WL 32568, 13 (C.D.Cal., Jan. 5, 2009) granted Plaintiffs' Motion for Class Certification according to Rules 23(a) and 23(b)(3).

In re Cooper addressed certification of a class alleging false statements regarding the company's overall business condition and the proper time for a court to address the common reliance element of fraud-on-the-market.

Federal Rule of Civil Procedure 23 sets forth two sets to maintain a class action. First, the proposed class must satisfy the four requirements of Rule 23(a): (1) the class is so numerous that joinder of all members is impracticable; (2) there are questions of law or fact common to the class; (3) the claims or defenses of the representative parties are typical of the claims or defenses of the class; and (4) the representative parties will fairly and adequately protect the interests of the class. FED.R.CIV.P. 23(a).

Written by David Welch, Esq.

Rosenberg v. Gould, --- F.3d ----, 2009 WL 50721 (11th Cir. Jan 09, 2009).

The district court held, and the 11th Circuit affirmed, that the complaint failed to satisfy the heightened standard for pleading scienter.

This case addressed whether a complaint alleging that a CEO (and the company) who granted and received backdated options in 2000 and 2001, and overstated earnings between 2004 and 2006, satisfied the heightened standard for pleading scienter, under section 10(b), of the Securities Exchange Act, 15 U.S.C. § 78j(b).
The Private Securities Litigation Reform Act of 1995 imposed a heightened standard for pleading scienter. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308, 127 S.Ct. 2499, 2504, 168 L.Ed.2d 179 (2007). A plaintiff must “state with particularity facts giving rise to a strong inference that the defendant acted with the required state of mind.” 15 U.S.C. § 78u-4(b)(2). “An inference of scienter must be more than merely plausible or reasonable-it must be cogent and at least as compelling as any opposing inference of nonfraudulent intent.” Tellabs, 127 S.Ct. at 2504-05.

The SEC adopted FINRA’s recommendation to limit motions to dismiss before an investor presents his or her case. Under the new rule, if a party brings a dispositive motion before the claimant has presented, it can only be granted on three grounds: the parties have settled in writing, there is a factual impossibility, or a party doesn’t file a claim within six years of the events at issue.

The Wall Street Journal reported that FINRA proposed the new rule in response to repetitive filings of dispositive motions that raise the cost of arbitration for retail investors. In adopting FINRA’s rule, the SEC has undoubtedly reduced costly motion practice and paved the way for investors to have a hearing of their case on the merits. For more on the rule itself, click here and here.

According to solo practitioner, John Castro, Esq., “the economic downturn and recent corporate scandals, like Madoff, have already increased the amount of investor arbitration claims. It’s even apparent on the New York State Bar Association's listserv; attorneys are sending referrals and asking me advice more and more frequently. This new rule will only add to the number of securities cases brought before an abitrator.”

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