SECURITIES AND INVESTMENT BLOG-COSGROVE LAW GROUP, LLC

            Advisors terminated by their broker-dealer should immediately retain experienced legal counsel.

The broker-dealer has 30 days after termination to file the mandatory U-5.  Legal counsel can help you negotiate fair and accurate language for this critical and potentially public disclosure.  Moreover, how the U-5 is completed above and beyond the narrative “reason for termination” can be pivotal.

          Many advisors fail to appreciate that, for the most part, their broker-dealer can terminate them without cause.  But there are contractual and public policy exceptions to this general rule that must be evaluated.  Cosgrove Law Group has extensive experience working with financial advisors who have been terminated, including not just U-5 issues, but also issues such as promissory notes and other compensation matters.

            April 26, 2022, brought us two new arbitration rulings to sink our teeth into. One ruling was issued by the Supreme Court and the other by the Court of Appeals. I think the court of Appeals decision might get reversed.

            In Car Credit, Inc v. Pitts, the Supreme Court considered a challenge to a judgment confirming an arbitration award. The appellant claimed that the award should be vacated because the arbitration forum designated in the arbitration clause was not utilized because it was unavailable. In my opinion, the Supreme Court (and Federal courts) go out of their way to confirm arbitration awards. This case was no different, but it relied upon a rule that the Supreme Court has repeatedly articulated. It is highly technical but lawyers in this field need to know it. The Court found that the arbitration agreement contained an enforceable delegation clause and the appellant failed to challenge the validity and enforceability of that clause.

         The appellant did challenge the AAA arbitrator’s authority to hear the case on jurisdictional grounds. The arbitrator denied that challenge. But the appellant failed to challenge the arbitrator’s jurisdiction to make that ruling. Regardless, the Court of Appeals ruled in her favor. But the Supreme Court reversed, noting in part that “the delegation provision is an agreement to arbitrate threshold issues concerning the arbitration agreement”, citing the Seminal case of Rent-A-Center, W., Inc. v. Jackson.

            In what may be the next arbitration ruling to be reversed by the Supreme Court, the Court of Appeals ruled in favor of the appellant in Wind v. McClure. In that case, the Court of Appeals held that the Circuit Court was correct in refusing to enforce an arbitration agreement because its language and format failed to comply with state law mandates. To be specific, the arbitration agreement failed to include certain large font warnings, regarding the existence of an arbitration clause.  The requirement in question, however, is not included in the Federal Arbitration Act, the supremacy of which the Supreme Court strictly enforces. Perhaps the appellate will not appeal. Food for thought.

          In Jarkesy v. Securities and Exchange Commission, Case No. 3-15255, a panel of the U.S. Court of Appeals for the Fifth Circuit ruled on May 18, 2022, in a 2-1 decision that the U.S. Securities and Exchange Commission (“SEC”) may no longer use its own administrative proceedings framework to enforce SEC securities fraud cases. Instead, the SEC must bring such actions in federal district courts where respondents may exercise their rights to civil jury. This is a stunning development for the SEC because the case finally recognizes that the SEC should not be acting as both prosecutor and jury in securities fraud cases nor require respondents to exhaust their administrative remedies before having their day in court.

In Jarkesy, the SEC brought administrative enforcement proceedings against the respondents alleging securities fraud. From the inception of the matter, however, respondents challenged the SEC’s right to bring such a matter administratively because it deprived them of their rights to civil jury. The administrative law judge ruled against respondents as did the SEC upon review and ordered respondents to cease and desist from committing further violations, pay a civil penalty of $300,000, and to disgorge nearly $685,000 in alleged ill-gotten gains.

“The case finally recognizes that the SEC should not be acting as both prosecutor and jury in securities fraud cases nor require respondents to exhaust their administrative remedies before having their day in court.”

On appeal, the 5th Circuit vacated the SEC’s judgment and held that the SEC’s administrative proceedings were unconstitutional for at least two reasons: (1) respondents were deprived of their Seventh Amendment right to civil jury; and (2) Congress unconstitutionally delegated legislative power to the SEC by failing to give the SEC an intelligible principle by which it could determine what matters it could use its administrative proceedings framework and what matters it was required to file suit in federal district courts. It remains to be seen whether the SEC will request a rehearing before the entire panel of the Fifth Circuit or seek redress from the U.S. Supreme Court, and whether other circuits of the U.S. Court of Appeals will follow suit. But as of now, the SEC should no longer use its own administrative enforcement proceedings in securities fraud cases.

For further guidance on Jarkesy or SEC enforcement proceedings in general, feel free to give us a call at (314)-563-2490.

Author: Brian St. James

It should come as no surprise to anyone that if purchasers of securities or a state’s securities commission bring an  enforcement action for the unlawful sale or contract for sale of unregistered securities, then they will seek recourse against anyone involved in the transaction because the proceeds of such sales have often been spent by unscrupulous issuers in many of these circumstances. Self-directed IRA custodians are no exception. 

Such was the case in Boyd v. Kingdom Trust Company, et al.,[1] where two Ohio residents opened self-directed IRA accounts to invest in promissory notes as alternative investments. As practice dictates, the promissory notes were purchased by the self-directed IRA custodians for the benefit of the Ohio residents and the physical promissory notes held by the custodians in the self-directed IRA accounts. 

The residents argued that the self-directed IRA custodians and the issuer were jointly and severally liable pursuant to Ohio Securities Act provision that states: 

“The person making such sale or contract for sale, and every person that has participated in or aided the seller in any way in making such sale or contract for sale, are jointly and severally liable to the purchaser … for the full amount paid by the purchaser and for all taxable costs.”[2]

The Ohio Supreme Court in this case took a narrow view of this enactment by distinguishing the self-directed IRA custodians’ role as purchasers of the promissory notes as opposed to either participating in the sale or aiding the issuer in the sale and vindicated them, finding that “a financial institution’s mere participation in a transaction, absent any aid or participation in the sale of illegal securities, does not give rise to liability under R.C. 1707.43(A).”[3]

 But every self-directed IRA custodian should also note that this Court also stated that: 

“Nothing in our holding today would insulate from liability a self-directed IRA custodian who colludes with the seller in an unlawful sale of securities or actively participates or aids in the sale of illegal securities. But the certified question before us is limited to the liability of a self-directed IRA custodian whose only alleged participatory conduct was the purchase of illegal securities on behalf and at the direction of the owner of a self-directed IRA.”[4]

Consequently, the self-directed IRA custodians escaped liability in this case merely because the two Ohio residents failed to allege any other participatory activity in the sale of the promissory notes, such as providing the templates for the promissory notes, drafting them, being included in the issuer’s pitch materials, etc.[5] And in a regulatory environment such as the present one in which plaintiffs and enforcement sections of  state securities commissions seek restitution for defrauded investors by all means available to them, self-directed IRA custodians should be extremely mindful of their participation in these transactions. 

There is plenty of room for conflict when a financial advisor is leaving his or her broker-dealer. Although the departure may start off in an amicable fashion, tensions often flare once promissory notes and client retention issues arise. Moreover, an involuntary or “for-cause” termination may implicate defamation and regulatory issues. In other words, your broker-dealer may defame you on your U-5/U-4[1] providing you with an arbitration claim but also subjecting you to months of regulatory scrutiny from FINRA and state regulators. So here is my lecture: it is wise to retain independent counsel as soon as you are even contemplating leaving your current broker-dealer. Your legal counsel can help you achieve a smooth transition or at least advocate for you during the termination process. Our firm has represented countless departing brokers on a nearly endless array of issues. We have also recouped millions of dollars in defamations awards and settlements. Food for thought.

 On October 5, 2021, Securities and Exchange Commission Chairman Gary Gensler addressed the House Financial Services Committee regarding the agency’s role in regulating the cryptocurrency markets. His remarks regarding Congress’ need to fill the regulatory gaps in cryptocurrency markets have been criticized as confusing considering his past statements that most cryptocurrencies are securities and therefore already fall under the SEC’s regulatory scheme. Adding to the uncertainty is his refusal to stake out a clear position as to whether the two biggest cryptocurrencies, Bitcoin and Ethereum, are securities. 

The SEC and its state counterparts presently apply the Howey[1]/Forman[2] tests set down by the U.S. Supreme Court in analyzing whether cryptocurrencies are “investment contracts” within federal and state securities laws. This fact extensive analysis that is applied on a case-by-case basis may lead to different results from one cryptocurrency to another. Consequently, if faced with an enforcement action by either the SEC or the States of Missouri, you may wish to consult with experienced securities enforcement counsel at Cosgrove Law Group.

The organization of North American securities regulators recently had their annual conference. The organization is known as NASAA.

During the conference presentation and panel discussion, it was reported that much attention was paid to self-directed IRA’s. The regulators believe that SDIRA’s are being used in conjunction with investment “scams.” It was reported that the regulators are anxious to work with federal legislators, but it was unclear as to what the proposed legislative solution to the alleged problem would be.

In conjunction with the discussions, the regulators referenced the precious metals industry. Our firm has worked with stakeholders in the precious metals industry for over a decade. Many of those industry players take compliance and ethical business practices very seriously. We also represent precious metals industry stakeholders when they are contacted by or receive a subpoena from a regulator. It was reported that state regulators opened more than 80 investigations of offerings related to SDRIA’s last year and brought 53 enforcement actions as well. The results of these investigations and actions were not, however, reported.