In Pandemic Times An SEC Investment Advisers Act Fraud Complaint Survives a Motion to Dismiss

The SEC's complaint alleges that Defendant Michael Sztrom has worked as an investment adviser and/or broker for over fifteen years for various securities firms. (Compl. ¶¶ 2, 12.) In August 2015, he allegedly resigned from his role as an investment adviser for a large securities firm in order to form his own investment advisory business. (Id.) Upon his resignation, he allegedly learned he was the subject of an investigation by the Financial Industry Regulatory Authority ("FINRA"). (Id. ¶¶ 2, 23-24.) After moving most of his advisory clients from his former employer to Charles Schwab & Co. ("Schwab"), Schwab informed Michael that it was prohibiting him from using its brokerage platform due to the ongoing FINRA investigation. (Id. ¶¶ 25-26.) Other broker-dealers allegedly also informed Michael he could not use their platforms, meaning he would no longer be able to execute trades for his clients. (Id. ¶¶ 2, 26-27.) At this point, Michael allegedly reached out to Mr. Paul C. Spitzer, the founder and CEO of Advanced Practice Advisors, LLC ("APA"), to inquire about joining APA. (Id. ¶¶ 28-29.) Mr. Spitzer allegedly inquired with Schwab about allowing Michael access to its platform if Michael became associated with APA; Schwab rejected the proposal. (Id. ¶¶ 29-30.) The SEC alleges that due to the ongoing investigation of Michael and his inability to access Schwab's brokerage platform, Mr. Spitzer decided to not associate with Michael, and to instead allow Michael's son, Defendant David Sztrom, to serve as an investment adviser representative ("IAR") with APA. (Id. ¶¶ 2, 31-32.) David had just passed his securities licensing exam and had limited prior advisory experience. (Id. ¶¶ 3, 31-32.) Michael allegedly told Mr. Spitzer that he would serve in a limited role as a financial planner for clients. (Id. ¶¶ 33-34.)

The complaint alleges that upon David's association with APA in November 2015, the advisory clients that followed Michael from prior firms and any new clients while David was associated with APA (collectively, the "Sztrom clients") allegedly all signed an agreement to engage Sztrom Wealth Management, Inc. ("SWM") as their investment adviser representative with APA. (Id. ¶¶ 32, 35.) SWM was incorporated by David in August 2015 and was solely owned by him until March 2018 when Michael became a coowner. (Id. ¶ 14.) The SEC alleges that Michael and David both controlled SWM throughout the relevant time period, and that both Michael and David were paid by SWM. (Id. ¶¶ 14, 39-41.) The SEC alleges that from when David became associated with APA in November 2015 to when he left APA in March 2018, Defendants deceived the Sztrom clients in breach of their fiduciary duties by having Michael continue to act as the clients' investment adviser despite not being an IAR associated with APA and being prohibited from using Schwab's brokerage platform. (Id. ¶¶ 5-8, 44-67.) The SEC alleges Michael communicated with Sztrom clients about investment advice, researched investments using David's access to Schwab's platform, made portfolio recommendations to clients, conducted trades for clients, and accessed client information and portfolios. (Id. ¶¶ 45-67.) Defendants allegedly created the impression that Michael was associated with APA by sharing office space and telephone lines, describing both Michael and David on SWM's website, and referring to Michael's 35 years of investment advising experience on SWM's website. (Id. ¶¶ 68-84.) The SEC alleges many Sztrom clients believed Michael was their IAR with APA and authorized to make trades on their behalf, and that Defendants failed to correct the Sztrom clients' confusion as to Michael's lack of association with APA out of concern that David's inexperience would cause clients to leave. (Id.) As a result of Defendants' alleged deception, the Sztrom clients were allegedly unaware that the investment advice Michael provided to them was not subject to any oversight or supervision by APA or other investment advisory entities. (Id. ¶¶ 95-101.)

The SEC also alleges that Michael impersonated David and purported to be associated with APA on approximately 38 telephone calls with Schwab between November 2015 and May 2016. (Id. ¶¶ 102-14.) When Schwab learned of the alleged impersonation, it terminated its relationship with APA and gave APA ninety days to find a new broker. (Id. ¶ 113.) On June 2, 2016, Schwab sent a letter to all APA clients using the Schwab platform informing them that it was terminating its relationship with APA "due in part to failure to adhere to Schwab's process standards." (Id. ¶¶ 118-19.) The SEC alleges that when the Sztrom clients asked Defendants about the change in platforms, Defendants misrepresented the reason for Schwab's termination, for example, by telling one client Michael had only impersonated David on a single call with Schwab. (Id. ¶¶ 115-29.)

The SEC has pled sufficient detailed allegations of the Defendants' alleged fraudulent scheme to mislead and deceive the Sztrom clients by concealing that Michael was not associated with APA or another registered investment adviser as an IAR,¹ that he was banned using from the Schwab platform,² that his investment advice and trades were unsupervised by APA, that he impersonated David on calls to Schwab,³ and that Schwab kicked the Sztrom clients off of their platform because of Defendants' impersonation and deception. (Compl. ¶¶ 44-52, 68-84, 95-110, 113-17.) The SEC explains how the alleged failure to disclose this information to the Sztrom clients misled and deceived them. (Id. ¶¶ 84, 100-01, 129, 140-43.) The complaint provides several specific examples of Defendants' alleged emails and text messages to the Sztrom clients in which Defendants made misrepresentations and omissions, including examples with the exact language of the communication, which would allow Defendants to discern who the unnamed clients are. (Id. ¶¶ 52-66, 121-27.) Additionally, the Court disagrees with Defendants' assertion that the complaint does not contain any specific allegations demonstrating that Michael actually performed trades for the Sztrom clients during the relevant period. (Doc. No. 9-1 at 7 n.9, 8.) The complaint contains several factual allegations indicating that Michael performed trades for the Sztrom clients when he was not associated with APA as an IAR and was banned from Schwab's platform, without informing the Sztrom clients of either fact. (See Compl. ¶¶ 56-66; ¶ 110 (In April 2016, "Michael contacted Schwab, identified himself as David, and informed the Schwab representatives that he was trying to place some long trades in a Sztrom client account").) These allegations are sufficient to give Defendants notice of the particular misconduct alleged so that they may prepare an answer and defend against the charges. See Kearns, 567 F.3d at 1124. 

Defendants also argue that the complaint lacks specific allegations regarding David's role in the alleged fraud. (Doc. No. 9-1 at 11-13.) They contend the SEC's allegations only show that David was aware of and occasionally present for his father's alleged actions, which they argue is insufficient for Rule 9(b). (Id.) The SEC responds that the complaint alleges that David had an active and integral role in the alleged fraudulent scheme, for example, by sharing his office space, telephone line, client information, APA master account number, and APA research materials with Michael, (Compl. ¶¶ 47, 51, 68), giving Michael access to both the APA system and the Schwab platform to conduct trades on the Sztrom clients' behalf, (id. ¶¶ 47-51), facilitating Michael's unauthorized communications with the Sztrom clients, (id. ¶¶ 67, 95-97), and helping to create the impression that Michael was the IAR for the Sztrom clients, even though David was the actual IAR for those clients, (id. ¶¶ 68-84). The SEC's allegations regarding David's involvement in the alleged fraudulent scheme are sufficient to meet Rule 9(b). In sum, the SEC has met its burden to plead its section 206(1) and 206(2) claims with sufficient particularity to satisfy Rule 9(b). See Fecht, 70 F.3d at 1082. Accordingly, the Court denies Defendants' motion to dismiss the SEC's complaint for failure to satisfy Rule 9(b).

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Footnote 1: Defendants challenge the SEC's allegation that APA told Michael he was not entitled to associate with APA as an IAR during the relevant time and contend that Michael was never legally prohibited from associating with APA. (Doc. Nos. 9-1 at 2 n.3; 11 at 1-2.) Defendants' challenges to the SEC's factual allegations are better suited to a motion for summary judgment when the record is more fully developed. See Cook, Perkiss & Liehe, Inc., 911 F.2d at 245. Furthermore, the Court notes that whether or not Michael Sztrom was legally ineligible to be a registered IAR with APA during the relevant time period is not dispositive; rather, the relevant issue is whether he was not associated with APA as an IAR but still conducted himself and held himself out to the Sztrom clients as such.

Footnote 2: Defendants challenge the SEC's allegation that Michael Sztrom was "banned" from working with broker-dealers during the relevant time period. (Doc. No. 9-1 at 1 (citing Compl. ¶¶ 3, 5).) They request that the Court take judicial notice of Michael Sztrom's FINRA report as evidence that he was not banned by any regulatory or judicial authority. (Id. at 1 n.1, Ex. 1.) The Court grants the request but notes that the SEC has not alleged that Michael was the subject of a regulatory bar or ban. Rather, the SEC alleges that Schwab informed Michael that it was prohibiting him from using its brokerage platform due to the ongoing FINRA investigation, and that Michael nevertheless continued to use the platform through David's access. (Compl. ¶ 26.) 

Footnote 3: Defendants also request that the Court take judicial notice of examples of prior fines and suspensions imposed in FINRA settlements involving impersonation. (Doc. No. 9-1 at 7 n.8, Ex. 2, Ex. 3.) The Court grants the request, but they do not change the Court's determination on the motion to dismiss; as the SEC notes, determinations regarding unrelated third parties by FINRA, a private self-regulatory organization, are not relevant to SEC enforcement actions like the current matter. (Doc. No. 10 at 2 n.1.)

The SEC alleges that Michael Sztrom knowingly or recklessly: (1) concealed from the Sztrom clients that he was not associated with APA as an IAR and thus, among other things, was not allowed to use APA's systems or execute trades on their behalf; (2) used David's Schwab account to access Schwab's platform and impersonated David on phone calls with Schwab regarding client information; and (3) provided false information to and omitted material information from the Sztrom clients regarding the real reason for APA's departure from the Schwab platform. (Compl. ¶¶ 131-32.) It alleges David Sztrom and SWM (through the actions of Michael and David) knowingly or recklessly: (1) permitted Michael to use David's access to the Schwab platform, access Sztrom client information, and impersonate David in communications with Schwab; and (2) concealed from the Sztrom clients that Michael was not associated with APA as an IAR but was nonetheless accessing their client information and executing trades on their behalf. (Id. ¶¶ 133-35.) The SEC alleges Michael and David Sztrom have admitted under oath that they knew it was wrong for Michael to impersonate David on telephone calls with Schwab. (Id. ¶¶ 111, 134.) The SEC alleges Michael and David knew the Sztrom clients were confused about who their IAR was and yet did not take any opportunity to correct their clients' confusion, and in fact undertook actions to maintain the misconception, such as by referencing Michael's thirty-five years of experience on the SWM website and forming the non-operational Sztrom Capital Management. (Id. ¶¶ 68-94.) These allegations are sufficient to plead that Defendants acted with scienter throughout the relevant period. See Fernandez v. U.S., 329 F.2d 899, 908 (9th Cir. 1964) ("If the fact that Fernandez made telephone calls to the bank officer and prospective purchaser, impersonating others, was independently proved, an improper intent was likewise independently proved, because the nature of the act involved such an intent."); In re Galena Biopharma, Inc. Sec. Litig., 117 F. Supp. 3d 1145, 1166 (D. Or. 2015) (noting that defendant's alleged attempts to hide and cover up the specifics of the alleged fraudulent scheme supported an inference of scienter); Nathanson v. Polycom, Inc., 87 F. Supp. 3d 966, 979-80 (N.D. Cal. 2015) (noting that the defendant's attempts to hide his fraudulent conduct was evidence of scienter). In sum, the Court denies Defendants' motion to dismiss the SEC's section 206(1) claim for failure to plead scienter.

[D]efendants note that many of the Sztrom clients stayed with them despite Schwab's letter notifying them of the change in platforms, and argue this fact demonstrates that the alleged misrepresentations and omissions cannot have been material to the clients. (Doc. No. 9-1 at 14-15.) But the "reasonable investor" test is an objective standard, and thus the reactions of the actual Sztrom clients are not dispositive; furthermore, the SEC alleges that at least four of the Sztrom clients and several other APA clients did terminate their relationship following Schwab's letter. (Compl. ¶ 128.) Finally, Defendants challenge the SEC's allegation that they failed to fully inform or provide notice to the Sztrom clients about the termination of APA's relationship with Schwab; they argue Schwab terminated the relationship and contemporaneously notified the Sztrom clients in June 2016, meaning there could not have been a fraudulent omission. (Doc. No. 9-1 at 15 (citing Compl. ¶¶ 117-19).) But the SEC alleges that the Schwab letter did not inform the Sztrom clients of the specific reason for the termination, i.e., Michael's repeated impersonation of David and access of the platform. (Compl. ¶ 119.) When the Sztrom clients asked Defendants about the change in platforms, Defendants allegedly provided false and misleading explanations, for example, that the new broker had "more advanced portfolio management capabilities" or that Michael had only impersonated David on a single call. (Id. ¶¶ 121- 27.) 

[D]efendants argue that the SEC's allegations only show David's "mere awareness and approval" of the primary violation. (Doc. No. 9-1 at 17-18.) But the SEC has alleged that David's affirmative actions - choosing to communicate with the Sztrom clients outside of the APA system and allowing his father to do the same - in violation of APA's compliance system led directly to APA's inability to review or preserve the client communications for compliance purposes. (Compl. ¶¶ 156, 162-68, 184-85.) As such, the Court denies Defendants' motion to dismiss the SEC's aiding and abetting APA's violations of section 204 claim against Defendant David Sztrom. Defendants' arguments are better suited to a motion for summary judgment when the record is more fully developed.

• Sztrom
• SEC
• Motion to Dismiss
• SDCA
• Schwab
• Investment Advisers Act
• Schwab
• FINRA
• PSLRA
• Particularity
• Materiality
• Scienter
• aiding and abetting
• BrokeAndBroker
• Bill Singer