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C'mon And Take A Free Ride. FINRA Arbitration Considers Failed Customer Payment
February 17, 2020
A few months ago, we reported about a FINRA Arbitration case filed by member firm Claimant Ustocktrade Securities, Inc. "Wide Open Arbitration Slam Dunks For Two FINRA Firms. One Scores. One Clangs" (BrokeAndB roker.com Blog / August 15, 2019)
http://www.brokeandbroker.com/4751/finra-slam-dunks/
As explained in part in that August 2019 article:
http://www.brokeandbroker.com/4751/finra-slam-dunks/
As explained in part in that August 2019 article:
In a FINRA Arbitration Statement of Claim filed in April 2019, FINRA member firm Claimant Ustocktrade asserted breach of a customer agreement and fraud, and the firm sought $1,301.69 in compensatory damages. Public customer Respondent Woods did not file a Submission Agreement and did not appear. In the Matter of the Arbitration Between Ustocktrade Securities, Inc. Claimant, v. Jamal Woods, Respondent (FINRA Arbitration Decision 19-00988)http://www.finra.org/sites/default/files/aao_documents/19-00988.pdf As set forth in part in the FINRA Arbitration Decision:[T]he causes of action relate to Claimant's allegation that Respondent requested that Claimant initiate certain deposits from Respondent's bank account into Respondent's brokerage account for the purchase of securities; however, after the securities were purchased, Respondent instructed his bank to reverse the deposits, causing a loss to Claimant.Seems like a fairly open-and-shut case, and all the more so with a non-appearing customer Respondent. Unfortunately for the Claimant, the sole FINRA Arbitrator dismissed the claims without prejudice. As noted in part in the FINRA Arbitration Decision:The Arbitrator determined that Respondent was not properly served with the Statement of Claim and did not receive due notice of the proceedings.Bill Singer's Comment: Respondent Woods engaged in a bit of legerdemain when he showed the deposited funds to Ustocktrade and then, presto-chango-hocus-pocus, he had his bank reverse the deposits. Given that Woods did not file a Submission Agreement (and presumably did not file an Answer) or appear at the hearing, we have no idea as to what his defenses may have been. Accordingly, this case set up as a slam-dunk for Ustocktrade. The thing about slam-dunks is that they sometimes clang off the rim. As was the case with this whiff by Ustocktrade.
Ustocktrade v. Kandel
As it turns out, Claimant Ustocktrade had filed another insufficient-funds FINRA Arbitration Statement of Claim in October 2019 asserting fraud and breach of contract, and the firm sought $6,575.47 in compensatory damages. Public customer Respondent Kandel did not file a Submission Agreement and did not appear. In the Matter of the Arbitration Between Ustocktrade Securities, Inc. Claimant, v. Suman Kandel, Respondent (FINRA Arbitration Decision 19-03091)
https://www.finra.org/sites/default/files/aao_documents/19-03091.pdf
As set forth in part in the FINRA Arbitration Decision:
As set forth in part in the FINRA Arbitration Decision:
[R]espondent failed to ensure that sufficient funds were available to transfer to his brokerage account despite having utilized such funds to purchase securities in the account, resulting in a loss to Claimant.
The sole FINRA Arbitrator found Respondent Kandel liable and ordered him to pay to Claimant Ustocktrade $6,575.47 in compensatory damages plus interest.
This slam-dunk was slammed through the rim for a score. In contrast to Ustocktrade v. Woods, the Arbitrator determined that Respondent was properly served with the Statement of Claim and received due notice of the proceedings by both regular and certified mail. Like Respondent Woods, Respondent Kandel engaged in a bit of legerdemain when he apparently failed to cover the purchase of securities with adequate funds. Given that Kandel did not file a Submission Agreement or Answer, and did not appear at the hearing, we have no idea as to what his defenses may have been. Regardless, this one goes in Ustocktrade's win column.
Bill Singer's Comment
I wish that the sole FINRA Arbitrator had utilized a more direct approach in characterizing what had allegedly taken place in Kandel's account. As the Arbitrator explained the underlying problem:
[R]espondent failed to ensure that sufficient funds were available to transfer to his brokerage account despite having utilized such funds to purchase securities in the account, resulting in a loss to Claimant.
According to the FINRA Arbitrator, Kandel had "failed to ensure that sufficient funds were available to transfer to his brokerage account . . ." Ummm . . . what? I hardly think that the issue here was that Kandel had failed to ensure sufficient funds were available to transfer because, you know, who the hell cares if a debtor intends to transfer sufficient funds. The issue -- the concern -- is whether a customer deposits sufficient funds into his brokerage account in order to timely pay for purchases or cover margin calls.
Which leads us to the second issue. What did the Arbitrator mean by asserting that Kandel had "utilized" his allegedly "sufficient funds" to purchase securities?
If we try to follow the Arbitrator's logic, Kandel supposedly had purchased $X in securities at Ustocktrade. The $X was what the Arbitrator calls the "sufficient funds" supposedly ensured by the customer as available to transfer to Ustocktrade. As such, apparently Ustocktrade allows its customers to place orders to purchase $X in securities without having $X in sufficient funds on hand in the customer's account. This approach is practiced by many FINRA brokerage firms, which forces us to shift our concerns from the wisdom of accepting orders when sufficient covering funds are not in an account, to concerns about whether this is a sound compliance policy -- and then, whether, this policy may involve potential regulatory concerns.
In both Woods and Kandel, Ustocktrade apparently accepted customers' purchase orders for which the respective accounts lacked available sufficient funds. $X is securities were purchased at a time when $X in funds were not in the accounts. In Woods, the firm relied upon the transfer of funds from a bank (which were reversed), and in Kandel, the firm relied upon the customer's obligation to cover his debit. It's a very risky proposition to accept purchase orders without covering margin equity -- and if these are merely Cash Accounts, then margin would not be an option. Given that Ustocktrade filed one arbitration in April 2019 and then another in October 2019, and both seek damages for insufficient funds to cover securities purchases, that's sort of proof that relying upon a customer's promise to timely deposit sufficient funds to cover new purchases is bad business on the Street. As to whether Woods and/or Kandel failed to pay for first-time or additional transactions in their accounts is not stated in either FINRA Arbitration Decision.
"Free Riding" occurs when a customer sells stock in a Cash Account at a time when payment for the purchase of said stock was not timely made. The rule in a Cash Account is that you have to first pay for the securities with settled funds before you can sell them. If you violate that rule, your account will be frozen for 90 days absent proof of an inadvertent error or misunderstanding. See: Updated Investor Bulletin: Trading in Cash Accounts (SEC / September 12, 2017)
https://www.sec.gov/oiea/investor-alerts-and-bulletins/ib_cashaccounts
Unfortunately, the FINRA Arbitration Decisions do not state whether Woods and/or Kandel merely walked away from their obligations after an initial purchase in a newly opened account. Similarly, the Decisions do not disclose whether the cited activity took place in a Cash or a Margin Account. Sometimes this is a misunderstanding by the customer. Sometime this is a fraud. As has been demonstrated over the years, there are many unscrupulous public customers who open brokerage accounts, enter an initial purchase, and then effectively ghost the brokerage firm if the trade goes against them. It's a classic heads I win, tales you lose proposition. In some instances the SEC or the DOJ will file charges resulting in, respectively, civil and criminal charges.