In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in August 2010, public customer Claimant Tarrant sought $500,000 in compensatory damages plus interest and cost, and punitive damages, as a result of damages allegedly sustained from his being solicited to invest in a real estate project and the subsequent sale of various securities (among which was a SunLife annuity) in his account to fund a loan made to Claimant's broker. Claimant Tarrant asserted causes of action for

• breach of fiduciary duty;
• negligence;
• negligent supervision;
• fraud; and
• breach of contract.

Respondent Kovack Securities generally denied the allegations and asserted various affirmative defenses. In the Matter of the FINRA Arbitration Between Russell Stephen Tarrant, Claimant, v. Kovack Securities, Inc., Respondent (FINRA Arbitration 10-03532, February 13, 2012).

https://www.finra.org/sites/default/files/aao_documents/10-03532-Award-FINRA-20120213.pdf

SIDE BAR:  Permit me a short rant at this point.

Those of you familiar with my reporting about FINRA arbitrations know that I detest the hide-and-seek nature of far too many of the organization's Decisions. Believing that a cogent presentation of the factual background of a dispute provides meaningful context to the ultimate ruling, I am puzzled as to why there appears no effort to enforce such a presentation.

In this case, for example, what I've written above is pretty much all that the Decision sets forth up to and until the Arbitration Panel announces its findings and sanctions.  I mean, really? You're going to rule on liability in a case demanding at least $500,000 plus punitive damages and all that you're going to explain to us is that there was a dispute about how the customer was solicited and there were some further issues pertaining to the sales of securities to fund a loan to the broker?  Wow . . . thanks for nothing.

DECISION

The FINRA Arbitration Panel found Respondent Kovack Securities liable and and ordered the firm to pay to Claimant Tarrant:

• $100,000.00 (pre-judgment interest specifically denied);
• $200,000 in punitive damages;
• $14,017.00 in costs; and
• $300 reimbursement of FINRA filing fee.

Bill Singer's Comment

You know, it would help - really help - if FINRA required that its Arbitration Decisions followed a somewhat uniform format of setting forth a minimal recitation of the underlying facts so that the rulings are comprehensible and meaningful.  In Tarrant, for example, we have a fairly unusual situation where a FINRA Arbitration Panel awarded punitive damages equaling double the award of compensatory damages.  In and of itself, that's a notable event - it implies that the misconduct at issue was far more than a routine mishap and that the Respondent's future conduct needed to be influenced by this more severe sanction.  Unfortunately, when sending such a message, the missive tends to get lost in the mail, so to speak, because it's virtually impossible to understand who did what here.

In its own words, this is what the Panel explained - not before rendering  the financial awards but as part of that statement:

The panel determined that punitive damages should be awarded due to the egregious behavior on the part of the broker and the apparent lack of any system of supervision by the Respondent. The broker was employed for over two and one-half years by Respondent and there was no evidence of any compliance reports. The situation is more egregious given the Respondent was aware the broker had been terminated from another firm due to unreported and unapproved outside activities. Even though the broker disclosed an outside activity shortly after being employed by Respondent, there was no evidence of any type of supervision or monitoring system to ensure the outside activity was conducted properly. Additionally, the Claimant was never notified that the broker was terminated and continued to receive financial statements from Respondent listing the broker as the financial adviser. . .

Some Snotty Questions

So tell me, pray do, members of this FINRA Arbitration Panel:

• What was the name of the stockbroker who seems to have inflamed your ire?  (You know, in case a public investor would like to look him or her up.)
• What constituted the "egregious behavior" that you cited? (Don't you think it might have been helpful if you set forth the acts and conduct?)
• What was the nature of the prior "unreported and unapproved outside activities?" (Why reference it if you don't explain it to us?)
• Did you vote to refer this matter to FINRA for a regulatory investigation?

Why do I rant about these bits of missing information?  Because there is an obligation by FINRA to inform the public and the industry about these matters - otherwise, what's the point of issuing these Decisions? And while Kovack Securities isn't exactly a household name, that doesn't justify the lack of explanation.

Arbitrations are not supposed to be about punishing individual brokers and brokerage firms but about awarding restitution to harmed public customers or industry participants. In those rare cases where a Panel decides that it needs to do more than award compensatory damages, I think it is critical that such a sanction be justified and placed within its proper context by the arbitrators. It doesn't matter if it's a small indie/regional firm or some behemoth like Wells Fargo, Merrill Lynch, JP Morgan, or Morgan Stanley: The public and the industry are entitled to know sufficient background so as to explain a given Decision and to ensure that the desired message (if any) is properly transmitted.  In the case of a relatively smaller firm such as Respondent Kovack Securities, the lack of detail about the individual broker and the underlying misconduct not only deprives us, the readers, of the ability to judge whether the punitive damages were warranted but also prevents the Respondent from defending itself to the public and the industry.

UPDATE March 2012:

In response to Tarrant's and Kovack Securities' Joint Motion for Order Vacating Arbitration Award and Dismissal of Action and all Claims, the United States District Court for the Southern District of Florida ("SDFL") granted the Motion, vacated the FINRA Arbitration Award, and dismissed the action with prejudice. Russell Stephen Tarrant, Petitioner, v. Kovack Securities Inc., Respondent (Order Vacating Arbitration Award and Dismissing All Claims with Prejudice, SDFL, 12-CV-60272 / March 23, 2012)

https://www.finra.org/sites/default/files/aao_documents/10-03532-Order%20to%20Vacate-FINRA-20120213.pdf As set forth in pertinent part in SDFL's Order:

Petitioner Russell Stephen Tarrant ("Tarrant") filed his Petition to Confirm Arbitration Award [DE 1] seeking confirmation of a FINRA arbitration award rendered on February 13, 2012 ("Award"), in favor of Tarrant and against Respondent Kovack Securities, Inc. ("Kovack"). In response, Kovack filed its Opposition to Petition to Confirm Arbitration Award and Cross-Petition to Vacate Arbitration Award [DE 18], Kovack contended that the Award: (1) failed to comply with Florida law for the issuance of awards containing punitive damages; (2) exceeded the scope of authority afforded by Florida and federal iaw; and (3) demonstrated evident partiality by the arbitration panel. In the present motion filed jointly by both Tarrant and Kovack, the parties have agreed that there exists grounds for vacatur based upon the form of the Award. . . .

On March 31, 2004, FINRA issued Notice to Members 04-26, Unit Investment Trust Sales, which reminded broker-dealers that they should develop and implement procedures to ensure customers receive available sales charge discounts for UITs. The Notice further stated that UIT transactions must take place "on the most advantageous terms available to the customer" and that it is the firm's responsibility to "take appropriate steps to ensure that they and their employees understand, inform customers about, and apply correctly any applicable price breaks available to customers in connection with UITs."

During the Relevant Period, Kovack failed to identify and apply sales charge discounts to certain customers' eligible purchases of UITs, which resulted in customers paying excessive sales charges of $119,319.27. Kovack has paid restitution to all affected customers. Based on the foregoing, Kovack violated FINRA Rule 2010. 

Also during the Relevant Period, Kovack failed to establish, maintain and enforce a supervisory system reasonably designed to ensure customers received sales charge discounts on all eligible UIT purchases. The Firm relied primarily on its registered representatives to ensure that customers received appropriate UIT sales charge discounts despite the fact that the Firm did not effectively inform and train representatives and their supervisors to identify and apply such sales charge discounts. Based on the foregoing, Kovack violated NASD Conduct Rules 3010(a) and (b) and FINRA Rule 2010.. 

FINRA Censures and Kovack Securities for Short-Term Mutual Fund Trading

In the Matter of Kovack Securities Inc, Respondent (FINRA AWC 2018060177801 / August 24, 2022)

https://www.finra.org/sites/default/files/fda_documents/2018060177801

%20Kovack%20Securities%20Inc.%20CRD%2044848%20AWC%20gg.pdf

For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Kovack Securities Inc. submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. The AWC asserts that Kovack Securities Inc. has been a FINRA member firm since 1998 with 380 registered representatives at 230 branches.. In accordance with the terms of the AWC, FINRA imposed upon Kovack Securities Inc. a Censure, $210,000 fine, and an undertaking to certify the establishment/implementation of supervisory systems/procedures addressing the AWC. The AWC alleges in part that:

Bill Singer's Comment: 

Not noted in the FINRA AWC is that from September 2015 through August 2021, Kovack Financial Companies Chief Executive Officer/Co-founder Brian Kovack, Esq sat on FINRA's Board of Governors. https://www.finra.org/about/governance/finra-board-governors/brian-kovack 

Given that the FINRA AWC cites 

• misconduct from March 2015 to May 2017; and 
• Kovack's FINRA Board of Governors tenure overlapped those years; and 
• it is only in 2022 that FINRA finally published the regulatory settlement and imposed its sanctions, 

one would think that, at a minimum, the self-regulatory-organization would feel compelled to  reference Brian Kovack's Board role during the relevant times covered in the AWC. Such a reference would only be made to acknowledge the potential conflict and to set forth the steps taken by FINRA to ensure the integrity of its investigation and ensuing settlement. 

I have raised this same concern when FINRA settlements involve FINRA Large Member Firms and reiterate the issue in order to prompt FINRA to pursue more transparency; see: "FINRA Censures And Fines Securities America Over Outsourced Onboarding" (BrokeAndBroker.com Blog /  March 2, 2021)

https://www.brokeandbroker.com/5714/finra-securities-america/

Clearly, I think it a "Better Practice" for all FINRA settlements to disclose when alleged misconduct occurred at a member firm during times when an employee/agent/officer of said member firm sat on FINRA's Board or its various committees. Moreover, if and when necessary, FINRA should preclude for appropriate periods of time further service from representatives of such member firms if the cited misconduct rises to a level where such a sanction would be appropriate in the public's and the industry's interest. 

According to the SEC's order, contrary to its disclosures and internal policies, KAI failed at various times over several years to review the accounts of clients in its wrap fee program to determine whether the program remained suitable for clients. The order further finds that, as a result of this conduct, certain KAI wrap clients remained in the wrap fee program despite the lack of activity in their accounts. In addition, the order finds that KAI failed to adequately disclose to wrap clients that they would be charged for certain transaction costs, in addition to the wrap program fee.

The SEC's order finds that KAI willfully violated the antifraud and compliance provisions of Sections 206(2) and 206(4) of the Investment Advisers Act of 1940 and Rule 206(4)-7 thereunder. Without admitting or denying the SEC's findings, KAI consented to a cease-and-desist order and a censure, and agreed to pay disgorgement of $166,239, prejudgment interest of $33,274, and a civil money penalty of $700,000. KAI also agreed to distribute the funds to harmed clients and to comply with certain undertakings.

[K]AI has been registered with the Commission as an investment adviser since 2004. KAI is a wholly-owned subsidiary of Kovack Financial, LLC, and offers discretionary and non-discretionary asset management services. According to its Form ADV filed April 12, 2022, as of December 31, 2021 KAI had assets under management of approximately $3,514,635,392 which it managed on a discretionary basis and $1,032,646,181 which it managed on a non-discretionary basis.

10. KAI failed to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules thereunder: 

a. Reviewing Wrap Accounts for Inactivity. KAI's compliance policies and procedures required KAI to conduct reviews of client accounts, including for "volume of trading," but did not provide adequate procedures for conducting such reviews. Beginning in at least 2015, KAI failed to implement these policies and procedures. After the Commission's Division of Examinations began an examination of KAI in 2017, KAI conducted account reviews for the first time in almost two years. After the 2017 examination, KAI failed to adopt reasonably designed policies and procedures concerning inactive advisory account monitoring and review consistent with its representations to wrap clients. Among other things, KAI's policies and procedures provided inadequate details or parameters to IARs or their supervisors concerning how to assess whether a wrap account was and remained suitable for a client. In addition, KAI did not have policies and procedures in place reasonably designed to determine whether inactive wrap accounts were appropriate for conversion to a brokerage or other arrangement. 

b. Accuracy of Disclosures. KAI failed to adopt written policies and procedures regarding the accuracy of its disclosures concerning (i) reviewing for inactivity in wrap accounts, and (ii) transaction costs to wrap clients that could accrue in addition to the wrap program fee. 

c. Annual Compliance Reviews. KAI failed to complete its required annual compliance review for at least the years 2012 through 2015.