StateTrust Investments Ordered to Pay $1.5 Million in Fines and Restitution for Excessive Markups and Markdowns in Corporate Bond Transactions Involving Affiliated Companies

The Financial Industry Regulatory Authority (FINRA) has imposed sanctions against StateTrust Investments, Inc. and its head trader, Jose Luis Turnes, for charging customers unfair prices in corporate fixed income transactions.  According to FINRA’s June 26, 2013, news release, StateTrust changed excessive markups and markdowns as much as 23 percent above the prevailing market rate in a total of 563 transactions, which FINRA determined operated as a fraud and decit against its customers.  

FINRA accused StateTrust of charging the excessive rates while engaged in two types of transactions.  In some cases, it bought bonds from a bank or insurance affiliate and then sold the bonds to customers at a price more than 8 percent away from the prevailing market price.  In other cases, StateTrust bought bonds from its customers at prices more than 8 percent below the prevailing market, and turned around to sell them to its affiliate at a slight markup.  Throughout these transactions, Turnes was not only the head trader at StateTrust, he was also chairman and largest indirect shareholder of the affiliated bank and insurance company.  FINRA determined that Turnes was personally involved in at least 85 of these transactions.

While neither StateTrust nor Turnes admitted or denied the charges, they accepted FINRA’s sanctions that included fines exceeding $1.1 million fine, restitution to customers of at lest $353,000, and suspension of Turnes for six months.  FINRA describes the sanctions as part of its ongoing effort “to aggressively pursue firms and individuals who charge customers excessive markups and markdowns.”

Brokerage firms are required to charged reasonable markups and markdowns in its transactions with customers, and charging excessive rates does work a fraud and decit against investors.  Investors who have questions about their StateTrust brokerage accounts, or are concerned about the markups and markdowns their brokers are charging, should contact the securities fraud attorneys at Block & Landsman for a free, confidential consultation.

CFTC Gets Aggressive Against Misuse of Customer Segregated Fund Accounts

The Commodity Futures Trading Commission, the federal agency that regulates the commodity markets, has embarked on an aggressive effort to hold individuals and banks accountable for assisting in the misuse of segregated customer funds by futures commission merchants.  The CFTC’s actions come in response to the stunning failure of two of the nation’s largest FCMs, MF Global and Peregrine Financial Group.  

Both firms engaged in conduct which, their customers discovered too late, had caused the loss of hundreds of millions of dollars the investors believed were safely deposited in customer segregated fund accounts.  In less than a one-year period, both MF Global and Peregrine sought bankruptcy protection, leaving their anxious clients scrambling to understand what happened to their funds and who was responsible. 

MF Global

The 2011 collapse of MF Global occurred under the leadership of Jon Corzine, the former CEO of Goldman Sachs who also served a term as a United States Senator as well as Governor of New Jersey before he was hired to lead the firm.  According to published reports, MF Global was a powerful force on the Chicago Mercantile Exchange.  Its customers constituted 28 percent of the trading volume on the CME, with 3 million futures and options positions with a notional value in excess of $100 billion. 

Upon accepting the CEO position at MF Global in 2010, Corzine pursued a strategy designed to convert the firm’s business from a futures broker to an investment bank by causing it to purchase European bonds at a time that Europe was in financial turmoil, and then borrowing larges sums of money using the bonds as collateral through a series of complex repurchase agreements.   As the countries whose bonds MF Global owned continued to suffer ever-weakening economies, MF Global’s regulators required the firm to raise additional capital in the event of margin calls.  Additional disclosures about the size of its positions caused ratings agencies to downgrade the company, which in turn caused its creditors to demand even more collateral for the loans.   As a result of the growing concern over MF Global’s stability, clients abandoned the firm, creating additional liquidity pressures on the firm.  

The combination of increasing margin calls in the face of a liquidity crisis meant that MF Global was unable meet its debt obligations without falling below its net capital requirements.  Ultimately, the firm reported a serious shortfall of hundreds of millions of dollars in its customer segregated fund account, and on October 31, 2011, it filed for bankruptcy protection.  The bankruptcy trustee investigated the segregated account shortfall, and learned that MF Global had used those purportedly protected funds to meet its increasingly unmanageable debt obligations.   According to a subsequent congressional investigation, the shortfall in the segregated funds account “was without precedent in the history of the futures industry.”  As a result, the losses to investors who deposited money with MF Global for safekeeping have been estimated to be as high as $1.6 billion. 

Peregrine Financial Group

Peregrine’s collapse also centered around the misuse of its customer segregated fund, not as a result of mismanagement but instead because of the outright fraud of the firm’s owner, Russell Wasendorf, Sr.  At the time of its July 2012 bankruptcy, Peregrine was the second largest non-bank, non-clearing FCM in the nation.   As an FCM, Peregrine maintained customer segregated fund accounts with U.S. Bank and the J.P. Morgan. 

Beginning in 1992, Wasendorf used the customer segregated fund account maintained at U.S. Bank (and its predecessor bank) for his own personal and business purposes.  Wasendorf rented a post office box in town of Peregrine’s headquarters, Cedar Falls, Iowa, for the purpose of intercepting mail intended for U.S. Bank by one of the Peregrine’s regulators, the National Futures Association. 

For two decades, Wasendorf misappropriated more than $200 million from the segregated fund account and avoided detection by falsifying bank account statements to misrepresent to NFA auditors the amount of money in the U.S. Bank customer segregated fund account.  At the time of Peregrine’s bankruptcy, only $7 million remained in the U.S. Bank customer segregated fund account.  After his fraud was exposed, Wasendorf unsuccessfully attempted suicide, and has now pled guilty to fraud and is currently serving a 50-year prison sentence. 

CFTC Enforcement Actions

As the federal regulator of FCMs, the CFTC has now adopted an aggressive enforcement strategy for the massive losses suffered in the customer segregated fund accounts for MF Global and for Peregrine which had not been discovered by regulators prior to the firms’ respective bankruptcy filings. 

On June 25, 2013, the CFTC announced its intention to file suit against Corzine for his role in causing the losses in MF Global’s customer segregated fund accounts.  Quoting law enforcement officials, the New York Times reported that the agency will blame Corzine for failing to sufficiently supervise the firm and prevent the bad acts of lower-level employees.  According to the Times, the CFTC advised Corzine’s lawyers that it intended to file the case without first giving him the opportunity to settle, setting the stage for a protracted and public legal fight. 

The CFTC’s expected action against Corzine comes shortly after it filed a lawsuit against U.S. Bank for its participation in Wafendorf’s theft of Peregrine customer funds.  On June 5, 2013, the CFTC filed a complaint against the bank alleging that U.S. Bank knew that Wasendorf was using customer funds in the segregated account for improper personal and business purposes.  Additionally, the CFTC alleges that U.S. Bank improperly used the segregated customer account as collateral for a $6.4 million construction loan to one of Wasendorf’s affiliate companies and a $3 million personal loan to Wasendorf.   While U.S. Bank is not regulated by the CFTC, the agency asserts that the bank’s actions are governed by the Commodity Exchange Act, which makes is unlawful for a bank that has received customer funds to hold or use such funds for the benefit of anyone other than the FCM’s customers.   The CFTC, authorized to enforce the CEA and its implementing regulations, alleges that U.S. Bank violated the statute’s requirements.

Conclusion

While neither CFTC action will directly protect investors from future episodes of FCMs plundering customer segregated funds, they serve as an important message that the federal government will pursue individuals and institutions that assist misconduct that results in the loss of investor monies.  Even though the CFTC does not contend that either Corzine or U.S. Bank actually misappropriated the missing funds, the agency nonetheless considers them responsible for allowing the losses to occur.  While more needs to be done to prevent the misappropriation of customer funds, the CFTC’s actions appear intended to give some assurance to commodities investors that all wrongdoers responsible for their losses will be pursued.

U.S. Supreme Court Enforces Arbitration Provision’s Ban on Class Action Claims

In a ruling that continues a recent trend restricting the use of class action lawsuits to address the collective claims of similarly situated plaintiffs, the United States Supreme Court has ruled that restaurant owners were precluded by an arbitration clause in their American Express agreements from pursing arbitration claims against the financial institution on a class-wide basis.

The plaintiffs in the putative class action case, American Express v. Italian Colors Restaurant, alleged that American Express forced merchants to accept its high-fee credit cards as a condition of accepting the firm’s premium and corporate cards, in violation of federal anti-trust laws.  The merits of the dispute, however, were not addressed because American Express sought to enforce a provision in its service contract that required stores to arbitrate their disputes rather than file lawsuits in court.  Importantly, the standard arbitration clause found in these agreements prohibited the merchants from bringing their claims as a class action on behalf of similarly situated restaurants.  Rather, each vendor was required to pursue its arbitration claim on an individual basis.

The Second Circuit Court of Appeals initially permitted the restaurant owners to bring their case as a class action because the high costs of anti-trust litigation would preclude them from brining individual claims for relief.  According to the plaintiffs, the litigation costs could reach $1 million even though each litigant could expect to recover approximately $40,000.  The federal appellate court agreed that this disparity resulting from the class action waiver provision would effectively preclud the restaurants from “vindicating [their] statutory rights in the arbitral forum.”

The U.S. Supreme Court, however, reversed the Second Circuit’s decision and held that the arbitration provision was enforceable as written.  Justice Antonin Scalia, who authored the 5-3 majority opinion, rejected the lower court’s rationale because the “anti-trust laws do not guarantee an affordable procedural path to the vindication of every claim.”   According to the majority opinion, the large expense of arbitration did not justify weakening the impact of the Federal Arbitration Act’s “core requirement” that arbitration agreements be enforced pursuant to the intent of the parties entering into the contract.  As Justice Scalia explained, “[t]he fact that it is not worth the expense involved in proving a statutory remedy does not constitute the elimination of the right to pursue that remedy.”  The majority concluded that courts must “vigorously enforce” arbitration agreements according to their terms.  Otherwise, the extensive litigation of the merits of a case necessary to allow a court to decide whether to enforce an arbitration agreement “would undoubtedly destroy the prospect of speedy resolution that arbitration in general and bilateral arbitration in particular was meant to secure.”

In her dissent, Justice Elena Kagan was sharply critical of the majority’s decision. She disputed that arbitration should be permitted to be used as a mechanism “easily made to block the vindication of meritorious federal claims and insulate wrongdoers from liability.”  She further wrote, “[t]he monopolist gets to use its monopoly power to insist on a contract effectively depriving its victims of all legal recourse. . .And here is the nutshell version of today’s opinion, admirably flaunted rather than camouflaged:  Too darn bad.” 

Wells Fargo and Banc of America Compelled to Pay More Than $5 Million for Selling Unsuitable Investments in Floating-Rate Bank Loan funds.

On June 4, 2013, the Financial Industry Regulatory Authority (FINRA) announced sanctions imposed against Wells Fargo Advisors and Banc of America (through its successor Merrill Lynch, Pierce, Fenner & Smith) to reimburse a total of $3.1 million to more than 450 customers for recommending unsuitable floating-rate bank loan funds.  In addition, FINRA also imposed fines against the firms of more than $2 million.

Floating-rate bank loan funds are mutual funds that typically invest in a portfolio of secured senior loans made to entities that carry below-investment-grade credit.  As a result, the funds are subject to significant credit risks and can be illiquid. 

According to FINRA, brokers at Wells Fargo and Bank of America recommended that their customers purchase concentrated amounts of the funds despite their clients having investment objectives and risk profiles that were inconsistent with the features of floating rate loan funds.  Many of the brokers’ customers sought investments designed to preserve their capital with conservative risk levels.  In contrast, the brokers recommended the funds without having reasonable grounds to believe that the securities were suitable for the clients.

The sale of investments that are wholly unsuitable for the investors carry potentially devastating financial consequences for unsuspecting clients of brokerage firms.  Any investor who believes he or she has been misled or mistreated by their investment advisor should contact Block & Landsman for a free, confidential consultation to determine if they have a claim to make for investment losses caused by undisclosed risks.

FINRA Orders LPL Financial to Pay $9 Million in Sanctions for Systemic Email Failures

In May 2013, the Financial Industry Regulatory Authority (FINRA) announced that it sanctioned LPL Financial $7.5 million for a large number of significant email system failures that prevented the firm from accessing hundreds of millions of emails.  FINRA also ordered LPL to reimburse $1.5 million to customers who may have been affected by the firm’s failure to produce emails.

Email communications are a necessary tool for brokerage firms to manage the complex relationships with their expanding client base and to ensure customer transactions are being handled in an appropriate manner.   LPL’s rapid growth demanded that the firm devote sufficient resources to update and maintain its email systems.  The firm, however, knowingly failed to do so, as reflected by its failure on at least 35 separate occasions to capture email, supervise its representatives and respond to regulatory requests.  LPL’s repeated failures resulted in the firm failing to produce requested emails to federal and state regulators as well as, likely, private litigants in arbitration proceedings. 

With regard to customer arbitrations, LPL was ordered to notify eligible claimants within 60 days of the create of a $1.5 million fund designed to pay customers for discovery abuses.  Claimants who brought arbitration proceedings against LPL by January 1, 2007, and which were closed by December 17, 2012, will also receive emails that the firm failed to provide in the course of their dispute.  Such customers will have the option of accepting a payment of $3,000 from LPL or have a fund administrator determine an appropriate amount of compensation based on the particular failures of LPL in their cases. 

Brokerage firms are required to maintain and manage email communications with their customers, and to produce all required documents in arbitration and litigation proceedings.  Failure to do so can prejudice customers’ right to ensure that brokers are properly managing their accounts and to seek just reimbursement for improperly caused investment losses.  Investors who have questions about their LPL brokerage accounts should contact Block & Landsman for a free, confidential consultation.