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FINRA Arbitrators Find Everyone At Fault In Customer Case
April 14, 2017
Under consideration today is a FINRA public customer arbitration in which the suing customer is awarded about 19% of what he was seeking. It's an odd result because the arbitrators found that the firm and its representative were negligent in communicating with the customer; but the arbitrators also found that the customer hadn't done enough due diligence. Add into that mix a finding that the firm had not adequately trained a raw rep.
All of which leaves us with "on the one hand" and "on the other hand." Frankly, it left me spinning in circles trying to figure out liability and the calculation of the award. That being said, no matter where you come down on the result, this Panel should be complimented for explaining their view of the claims and facts. If nothing else, should this case wind up on appeal, a court will have something to chew on when deciding whether to affirm or vacate.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in May 2016, public customer Claimant Bertoldi asserted negligence, misrepresentation, failure to supervise, breach of fiduciary duty, breach of contract, and promissory estoppel in connection with the recommendation and purchase for his Individual Retirement Account of Behringer Harvard and ICON Leasing. The investments are characterized in the FINRA Arbitration Decision as "risky private placements." Claimant sought $144,000 in compensatory damages plus punitive damages, attorneys' fees, and costs. In the Matter of the FINRA Arbitration Between Rohn Bertoldi, Claimant, vs. IMS Securities, Inc. and Steven Knowlton, Respondent (FINRA Arbitration 16-01390, April 5, 2017)
Respondents generally denied the allegations and asserted various affirmative defenses. Respondents also requested the expungement of the matter from their Central Registration Depository record ("CRD").
Award
The FINRA Arbitration Panel found:
- Respondent IMS Securities liable to and ordered it to pay to Claimant Bertoldi $20,250.00 in compensatory damages; and
- Respondent Steven Knowlton liable to and ordered it to pay to Claimant Bertoldi $6,750.00 in compensatory damages.
In expressing the rationale for their Decision, the arbitrators offered this commentary:
Bill Singer's CommentKnowlton was negligent in violating FINRA Rule 2210 because the "Projections/Allocations" presented to Bertoldi should not have been given to him and were misleading. These "Projections/Allocations" were a cause of Bertoldi buying the securities. Bertoldi was contributorily negligent at a percentage of 25% by his failure to investigate. The total damages is in the amount of $36,000.00 less 25% equals $27,000.00. IMS failed to supervise and train Knowlton, who was a broker with little experience when he was hired. The fault of Respondents is assessed at 75% to IMS and 25% to Knowlton.It is found that there was not a violation of the following rules by Respondents: FINRA Rules 2010, 2020, 2110, 2310, FINRA NTM 03-71, and FINRA RN 10-22.It is found that there was not a violation of suitability rules under FINRA Rule 2111 by Respondents.It is found that there was not an intentional misrepresentation by Respondents or a breach of fiduciary duty or breach of contract.The principle of promissory estoppel does not apply to give relief to Claimant.4. IMS Securities, Inc. and Steven Knowlton's requests for expungement of their CRD records are denied.5. Other than forum fees which are specified below, the parties shall each bear their own costs and expenses incurred in this matter.6. Any and all claims for relief not specifically addressed herein, including punitive damages and attorneys fees, are denied.
FINRA Notice to Members 03-71: Non-Conventional Investments / NASD Reminds Members of Obligations When Sell Non-Conventional Investments (November 2003) offers this synopsis in its "Executive Summary":
FINRA Regulatory Notice 10-22: Obligation of Broker-Dealers to Conduct Reasonable Investigations in Regulation D Offerings (April 2010) offers this synopsis in its "Executive Summary":In the aftermath of the recent downturn in the equity markets, NASD reviewed the services and products offered by members and observed that retail investors were being offered an array of different investments as alternatives to conventional equity and fixed-income investments. These alternative investments do not fall under a common category; the staff review indicates that brokers and retail investors have shown increased interest in products such as asset-backed securities, distressed debt, and derivative products (for ease of reference these products are collectively referred to as non-conventional investments or "NCIs"). NCIs often have complex terms and features that are not easily understood. NASD staff reminds members that the fact that an investment is an NCI does not in any way diminish a member's responsibility to ensure that such a product is offered and sold in a manner consistent with the member's general sales conduct obligations. This Notice to Members reminds members offering NCIs of their obligations to: (1) conduct adequate due diligence to understand the features of the product; (2) perform a reasonable-basis suitability analysis; (3) perform customer-specific suitability analysis in connection with any recommended transactions; (4) provide a balanced disclosure of both the risks and rewards associated with the particular product, especially when selling to retail investors; (5) implement appropriate internal controls;.and (6) train registered persons regarding the features, risks, and suitability of these products.
FINRA reminds broker-dealers of their obligation to conduct a reasonable investigation of the issuer and the securities they recommend in offerings made under the Securities and Exchange Commission's Regulation D under the Securities Act of 1933-also known as private placements. Regulation D provides exemptions from the registration requirements of Section 5 under the Act. Regulation D transactions, however, are not exempt from the antifraud provisions of the federal securities laws. A broker-dealer has a duty-enforceable under federal securities laws and FINRA rules-to conduct a reasonable investigation of securities that it recommends, including those sold in a Regulation D offering. Moreover, any broker-dealer that recommends securities offered under Regulation D must meet its suitability requirements under NASD Rule 2310 (Suitability), and must comply with the advertising and supervisory rules of FINRA and the SEC
Notwithstanding my sincere appreciation for the arbitrators' publication of their rationale, I would still note that I am a bit puzzled by their finding that Respondent Knowlton was
negligent in violating FINRA Rule 2210 because the "Projections/Allocations" presented to Bertoldi should not have been given to him and were misleading . . . . IMS failed to supervise and train Knowlton, who was a broker with little experience when he was hired.
To some extent, it seems that the arbitrators found that IMS gave Knowlton a loaded gun, told him that it was unloaded, told him to point it at customer Bertoldi, and then urged him to pull the trigger. Under those circumstances, I'm not sure that I agree that Knowlton was 25% responsible but since I did not hear testimony, did not read any documents, and am inclined to give this particular FINRA Arbitration Panel credit for a commendable effort in explaining itself, I will accept the parsing out of liability.
I'm also puzzled by the Panel's finding that:
What exactly should Bertoldi have investigated beyond what he did (or didn't)? Similarly, at what point do we place the blame for unsuitability upon a FINRA member firm that "failed to supervise and train" an inexperienced stockbroker? If nothing else, this case highlights the dramatic difference between an industry that is subject only to a "Suitability" standard and not a "Fiduciary" standard.Bertoldi was contributorily negligent at a percentage of 25% by his failure to investigate.
My musings are at odds with the Panel's unequivocal findings that there were no violations of either the suitability or fiduciary rules. Similarly, the Panel did not find any intentional misrepresentation by the Respondents. As to what the Panel did find as the basis for its Award . . . well, best I understand it, the arbitrators seemed to have premised their decision on a negligent communication with the public by the respondents and some lack of due diligence by the public customer. Not sure I can reconcile all of that but I do appreciate the effort made by the arbitrators to offer us their version of events.