On the art of being a securities lawyer

One of the benefits of having been a lawyer for so many years is that I have heard a great many jokes about lawyers. Most hinge on the idea that lawyers are not very good people or not very good at what they do.

Overall, there is a general theme that suggests that 80% of lawyers give the other 20% a bad name. I bring this up because there is always a modicum of truth in anything that we find to be funny.

For me two jokes stand out.

The first I heard while I was still in law school. A professor suggested that the A students would go on to become judges and law professors while the B students were destined to spend their careers working for the C students.

The second I heard after I became ill with a cancer from which most people do not recover. One of my doctors cheered me up by suggesting that in his experience it was true that good people die young. He told me that he felt any patient who was a lawyer was good for his batting average.

I am not here to defend lawyers; quite the contrary.

I recently read an article that reported that the hourly rate for the top partners in the best Wall Street law firms had broken through $1500 per hour. The comments (more than 100) were universally disparaging.

Certainly this rate would apply to the best securities lawyers. I was never a partner in a major Wall Street law firm, but I have been the client of more than one.

Right out of law school I went to work as an in-house attorney for one of the larger brokerage firms. Certain trades required approval from the legal department before they could be routed to the trading desk or exchange floor for execution. I was one of the attorneys who gave that approval.

If the manager of a branch office wanted approval for a customer to buy or sell 10,000 shares of any stock, they would call the legal department. I would ask for the details and make a decision to allow the trade or not. If I delayed and the stock price moved even ¼ of a point while I was thinking about it, it could cost the customer $2500.

Once in a while I needed help. If I could not get it from one of the other in-house lawyers, I could put the manager on hold and speed-dial a partner at one of the top law firms who was on retainer. If I told his secretary that a trade was pending, he would take my call immediately and help me make a decision.

The experience taught me that to be successful as a lawyer I needed to know what I was doing and not just in a superficial way. It taught me that when I did not have the answer at my fingertips, to admit it and find someone who did.

What makes any lawyer valuable to a client is having the right answer to the questions that the client is asking. Sometimes you need to tell the client what questions they should ask and you have to know why those questions are important.

Last week I spoke to a businessman who had a complicated and fairly unique securities law issue. He was quoted thousands of dollars by other lawyers to research his problem. None had ever encountered it before and none could tell him what he should do.

I told him that I had seen another lawyer solve the same problem back in the 1980s by restructuring the transaction so that the regulation that he was struggling with would not come into play. It was the right answer for him and I was pleased to send him off without charge.

Not one of the commentators on the article about lawyers charging more than $1500 per hour stopped to calculate the enormous value of problems avoided by consulting the right lawyer before you act. Problem avoidance is probably the greatest value that any lawyer can give to their clients.

Perhaps the most valuable answer any lawyer can give to a client is “I don’t know.” It is an answer too many lawyers are reluctant to give.

Good clients often have questions about taxes, patents, immigration and frequently, matrimonial law. I have only a cursory knowledge about any of these subjects. But, I know whom to ask. Part of the value of any good lawyer is their professional contacts, both inside and outside their specialty.

Where even good lawyers get into trouble is by taking on matters that they do not fully understand.

In my own practice I know that the US Supreme Court validated and enforced the arbitration clauses that brokerage firms include in their customer agreements in 1987. Notwithstanding, over the years since then, I have run into lawyers who are prepared to file their clients’ claims in court, confident that the court will let them proceed. It does not happen.

They file in court, spend time, effort and some amount of their client’s money on what is essentially a fool’s errand. A trial court judge is going to go with the Supreme Court every time, if for no other reason than they are themselves overworked and moving a case off their calendar and back to FINRA is a no brainer.

The reason that these lawyers do not want to proceed with FINRA arbitration is because they are not familiar with the forum. FINRA does not permit pre-hearing depositions which can freak out even the best litigators.

Many lawyers do not believe that they can effectively question the stockbroker at the hearing without a deposition beforehand. Having worked in the industry, defended more than a few stockbrokers and having participated in a great many FINRA arbitration claims, I am confident that I know how a broker is likely to testify without a deposition.

Even though I was never a $1500 per hour partner at a Wall Street law firm, I could still give the same advice to my clients. There were always treatises and articles written by lawyers who worked in those firms that addressed my clients‘ issues. Lawyers have always valued scholarship and there has always been enough top-flight literature to keep me educated and up to date.

Equity Crowdfunding is a marginal practice for mainstream securities lawyers. These are smaller issues that do not usually generate enough fees to attract the top law firms. But Equity Crowdfunding is still the issuance of securities. The Equity Crowdfunding portals should have experienced securities attorneys on staff. Many do not. The result is a lack of compliance that can only result in problems in a highly regulated industry.

One of the benefits of blogging is that I read the blogs of others. I learn a lot. Some of the blogs written by lawyers who practice in this area are excellent. Some are mediocre. A few are dangerous because the authors are way out of their element.

There is no excuse for practitioners in this or any area of the law to publish advice that is substantially different than would be published by the top firms. Reading and writing about the law is one thing; offering practical advice without having a fair amount of practical experience quite another.

For all the discussion about how expensive some lawyers have become, and all the jokes, I would invite those lawyers who read my blog to start a discussion about how mediocre many practitioners in our profession have become. How using technology to cut costs has replaced hard work and good judgment. How there is so much careless blogging that we are confusing consumers and others with bad advice.

A little self criticism will not stop all of the jokes, but it might make us better lawyers. Our goal should be to offer advice that is worth $1500 per hour even if we charge less.

Med-X – Crowdfunding, cannabis and chicanery

As a college student during the 1960s, I was exposed to marijuana and had friends who were out and out stoners. As a young lawyer I represented a wholesale head shop company that Time Magazine referred to as “the Dunhill of the industry”. Through them I met many entrepreneurs who had profited in the wholesale and retail paraphernalia industry.

Being a cancer patient I am familiar with medical marijuana. I have read the literature and discussed it with my doctors. I know many people who have used marijuana as part of their recovery from cancer and other illness.

This article is not about the pros and cons of legalizing pot. It is about Crowdfunding, the cannabis industry and a questionable investment.

Sales of marijuana in states where it is legal are expected to top $5 billion this year. Still, I cannot see the loan committee of a major bank or any Wall Street firm step up to finance the cannabis industry in any major way. Even though its use is legal in an increasing number of states, the cultivation, distribution or sale of marijuana is still a federal crime and banks and brokerage firms are regulated by federal agencies.

It is not surprising then, that the cannabis industry has found Crowdfunding to be a source of new capital to fund its growth. Rewards based Crowdfunding campaigns for new vaporizers and similar products are easy to find.

What surprised me was that the Securities and Exchange Commission (SEC) has recently approved a $15 million offering for a cannabis related company under the new Reg A +. The offering for a Southern California based company, Med-X, became effective in early February.

The company has no sales or current business to speak of. The company states that it will use the money from investors to: “research and develop, through state of the art compound identification and extraction techniques, and market and sell medically beneficial supplements made from the oils synthesized from the cannabis plant.”

The Company’s planned compound identification and extraction research and development operation will be conducted primarily at the Company’s existing 600 square foot indoor cultivation center in Chatsworth, California, where controlled quantities of high quality cannabis are being grown, harvested and stored for research and medical use to the extent permitted by California law.

The company has several physicians on its Board of Directors. However, none has disclosed any published research paper on cannabis and none, apparently, works fulltime at the company’s 20’x30’ cultivation center to direct that research. Cannabis is apparently being grown, although the equipment needed to conduct the promised research will not be purchased until the offering is funded. In any event, the research is for future products.

In the meantime the company will use some of the investors’ money “to acquire, create and publish high quality cannabis industry media content through the Company’s media platform, (a website) to generate revenue from advertisers as well as through the sale of industry related products.”

If this were styled as a media company I would not question it. But the website is only a few months old, has no revenue and again the company lacks personnel with a media background to run it.

The company’s other revenue generator will be sales of a product called NatureCide® to cannabis cultivators throughout the world. NatureCide® is an insecticide and pest repellant. This product is owned, manufactured and distributed by a company called Pacific Shore Holdings, Inc. an affiliated company that is controlled by the same person who controls Med-X, Mathew Mills.

Med-X acquired an exclusive license from Pacific Shores Holdings to market NatureCide® products to the cannabis industry in exchange for 10,000,000 shares of Med-X stock. An exclusive license can be valuable, however, in this case the products are readily available on Amazon.com making the value of the exclusive license questionable.

Pacific Shores Holdings is a classic penny stock. Mr. Mills was sanctioned, twice, first in Pennsylvania in 2011 and later in California in 2013 for selling shares in Pacific Shores Holdings to investors he had no business selling shares to. The structure employed here, with one penny stock company acquiring a large block of stock in another pursuant to a licensing agreement is also a classic penny stock tactic.

Like any Crowdfunded offering, shares of Med-X are being sold by the company directly to the public. In theory investors should be able to make an informed evaluation of the company before they invest their money. But most investors cannot.

I expect that many people will line up to send their money to invest in this company’s shares. It certainly will not be because this company represents a good investment.

More likely, if you will forgive the pun, the buzz about this offering will be about its asserted link to the cannabis industry. The minimum investment is $420. (No kidding).

Stop to consider that its main product, NatureCide®, was pre-existing. Its only connection to the cannabis industry is the statement that it can be used by cannabis growers in the same way that people growing virtually anything else can use it.

Mr. Mills was apparently content to sell shares of Pacific Shores Holdings without adequate advice from a securities lawyer. He now proposes to conduct cannabis research without a cannabis researcher on staff and publish a website without an experienced website publisher.

Remember, I want the Crowdfunding industry to succeed. To do so it will need to offer investors the opportunity to invest in companies that at least have a likelihood of success. I do not believe that investors will find that here.

Instead, Med-X is poised to give both the evolving Crowdfunding and cannabis industries a black eye and to leave many investors holding the bag. The cannabis industry will survive.

If Med-X turns out to be a $15 million scam, (and there are others) investors may begin to realize that there are better places to invest their money than a Crowdfunding portal.

Expungement- FINRA’s dirty little secret

Both FINRA and the SEC encourage investors to investigate the record of a financial professional before hiring them. It would certainly be valuable for any customer to know if the stockbroker to whom they are considering turning over their life savings had previous problems with other customers.

For more than 20 years FINRA has provided a free online tool called BrokerCheck. It provides potential customers with a history of where the broker has worked and in which states the broker is licensed to do business.

A BrokerCheck report is supposed to provide accurate information about regulatory problems that the broker may have had and basic information about complaints and arbitration claims that other customers may have asserted against the broker. Unfortunately arbitration claims, even those with serious allegations of misconduct are frequently not reported to the public.

From the outset brokers have strongly opposed this disclosure. They believe that many arbitration claims filed by their customers are frivolous, false or factually incorrect. There have never been any facts or data to support that assertion.

FINRA has always had a rule in place that permitted arbitrators to expunge the claim from the broker’s BrokerCheck record after the hearing or if the claim settled. The rule and the procedures have been tightened up over the years, but the fact remains that BrokerCheck’s record of a broker who has been the subject of multiple customer complaints and arbitration claims may reflect none of them.

There are actually reports of brokers who have been the subject of more than 20 customer complaints or arbitrations having some or all of these complaints expunged. In other words the worst offenders may get the most benefit from expungement. Brokers who have had the most serious problems may have those problems affirmatively concealed from investors.

Over the years there have been multiple studies, law review articles and comments regarding the pros and cons of permitting the expungement of customer claims against stockbrokers. The issue is lot easier to understand if you put it into some context.

If your neighbor slips and falls in front of your home on a snowy morning before you have had a chance to shovel the sidewalk and sues you for medical bills and lost wages, the lawsuit is matter of public record and will be a matter of public record forever. If you fail to pay your student loans or are late with a mortgage payment it will be noted on your credit report for many years.

FINRA arbitrations are private matters. If they are not reported on a BrokerCheck report they are unlikely to show up anywhere else that a prospective customer might access.

Some commentators have suggested an arbitration claim is similar to a bad review on Yelp or similar website. But they are not. A FINRA arbitration claim often means that a customer has lost money that they did not expect to lose. This usually means that the broker did not make a full disclosure of the risks involved.

As an attorney who has represented a great many customers in FINRA arbitrations I always understood that my job was to recover as much of my client’s losses as I could. No claim is perfect and every claim has its strengths and weaknesses. It is for this reason that the vast majority of arbitration claims that are filed with FINRA end up settling.

The question of expunging the broker’s record comes up in settlement discussions almost every time. Most of the defense lawyers with whom I have dealt over the years have been ethical and rarely made expungement a condition of the settlement which is not permitted.

More often, I would offer not to oppose the broker’s request for expungement if they made one to the arbitrators because the client rarely cared about anything more than getting the best monetary settlement they could. That is not the same as suggesting that I believed or in any way acquiesced to the idea that the claim was frivolous, false or factually incorrect in the first place.

Any attorney will tell you that clients do not always walk in the door with all of the paperwork that you would like to see or a firm recollection of all of the relevant facts. It was always my practice therefore to send a draft of the claim, with the client’s approval, to the brokerage firms’ compliance department before I filed the claim with FINRA. I would ask them to tell me if I had the facts correct and would solicit their interest in an early disposition of the matter.

Occasionally, they would respond that the broker named in the claim was actually out of the office when the offending transaction occurred and that a different broker had actually spoken with the client and was the official broker of record. Better to deal with these factual glitches up front than to fight over expungement later.

Understand that both FINRA and the SEC consider information about customer complaints to be information that any customer would consider to be important before they began doing business with a stockbroker.

In the context of an offering of securities the SEC routinely sanctions issuers who omit material facts. In the context of a BrokerCheck report, the Commission has sanctioned the omission of facts that everyone agrees are material.

Every year there are articles in industry publications bemoaning the public’s lack of confidence in the industry. Wouldn’t full disclosure of prior complaints instead of burying them help to restore the public’s confidence?

I have every reason to expect that this controversy will continue, in part because many people in the industry will never get over the arrogance of a customer who dares to file an arbitration claim. Even those with the most to gain, the honest brokers who work for years without a single customer complaint are silent.

For this reason FINRA is unlikely to acquiesce to allowing BrokerCheck to report any and all claims made against a broker without providing some type of escape mechanism. In the meantime, it is impossible for a customer to know if the BrokerCheck report that FINRA urges them to read is accurate. As a practical matter a BrokerCheck report is worthless.

Allow me to offer a practical solution.

If you are considering hiring a new broker and find that BrokerCheck reports no complaints or arbitration claims, send the broker the following e-mail:

Dear Mr. Smith: We have done some research and were very pleased to learn that throughout your many years in the brokerage business you have never had a complaint or arbitration with a customer. Please confirm that this is true and that none have been removed from your record.

That should protect any customer and level the playing field. It is one thing for a broker to have arbitration claims expunged from their record and quite another to lie about it.

How I know that the stock market is coming down

Every investor would like to be able to predict the future. It is not always easy to do, but neither is it that difficult. It helps if you stick to the math.

Income investors aside, most people buy stocks that they believe will appreciate in value. If you own a stock and do not believe it will go up any higher then why wouldn’t you sell it?

The majority of shares in all financial markets trade between large banks and institutions. They have access to much more relevant information about the shares they trade, the world economy and the markets in general. Good research is the key to purchasing good investments.

For the average investor good research is a non-starter. Most people do not know how to do basic research on a company or where to obtain it. That has not deterred millions of people from investing trillions of dollars based upon bad information. Much of that bad information comes from the financial services industry itself.

Companies in the financial services industry need to grow and to be profitable. They grow by adding new customers and by encouraging existing customers to add more money into their accounts.

It should be obvious then that the one word that the industry is least likely to utter is: sell. If you sell, you might ask for a check and take your money elsewhere. That is something that the industry would like to avoid at all cost.

This is the reason that many financial professionals will tell you not to “panic” when markets start to go down. They will tell you to “stay the course” and that you should not worry because the market will “always come back”.

This is a sales pitch. It is not based upon facts or analysis. The charts that you will see accompanying this advice are bogus. The facts the charts assume are never about you and the facts they assume about the market are never real.

Consider that the market decline in the last month has been widely attributed to two factors, slower growth in China and a sharp decline in oil prices. Upon examination neither would seem to have a negative effect on the US economy.

The Chinese market for US goods is not growing as fast as it has in the recent past. China is not in recession. Certain industries and certain companies will surely be impacted. Overall, there is no indication that China will buy substantially fewer goods from US companies this year than it did last year.

Volatility in the Chinese stock markets is also cited as problematic for the US markets. In truth, very little US capital is at risk in the Chinese capital markets. Volatility and higher risks in the Chinese markets will usually cause capital to seek safer markets. That means more capital coming to the US. This is positive for the US economy.

Oil has been priced by a cartel since the 1970s. The current sharp decline in its price is being caused by a political decision to increase the international supply and to force US suppliers out of the market. Dramatically lower prices are not good for domestic oil companies and domestic oil workers.

Lower prices are also not good for the very largest oil producers whose margins and profits are likely to decrease. Shares of large oil companies are found in many portfolios and account for a significant amount of the weight in the Dow Jones Industrial Average and other indexes. So, yes, declining oil prices will bring averages down, but do not negatively impact many industries like pharmaceuticals or housing.

For the rest of us, dramatically cheaper gas prices increase our buying power for other goods and services. They should reduce the price of any goods that are shipped by truck which is almost everything.

Cheaper gas prices should not crash the market. Indeed low gas prices coupled with lower prices for other commodities and low borrowing costs should all continue to bode well for the US economy.

Why then do I believe that the market is coming down?

The upcoming market “correction” will be the 7th or 8th of my career going back 40 years. Throughout, the single factor about which most professional investors concern themselves is a stock’s price to earnings ratio.

Historically, across the market those ratios fluctuate between 10 to 1 and 20 to 1 with a mean in the middle at 15. It should cost $15 dollars to purchase one share of a stock in a company that is earning $1 per share.

So ingrained is the notion of price to earnings ratio as a market indicator that each of the corrections that I have witnessed over 40 years has been characterized as beginning from a point where P/E ratios where at the high end of the range. Markets usually fall from there to a point below the mean and then begin to level off.

That P/E ratios will always revert to the mean is a verifiable and well known fact.

At January 1, 2016 the average P/E ratio for the overall market was in the neighborhood of 20 to 1, which is at the higher end of the range. It might go up a little higher first, but history and mathematics would suggest that it is likely to drop to the 12 -13 to 1 range before it starts back up.

If you stay in the market, your portfolio will sustain that loss. It might take several years for the value of your portfolio to return to where it is today. If you “stay the course” you will have wasted the earning power of those years. You will have ridden the market down and back up and essentially be back to where you are today.

The better strategy would always be sit on the sideline while the market is going down and to invest in the companies that you like when they are cheaper. There has never been a better investment strategy than “buy low, sell high”.

If you do stay in the market then your portfolio should contain stocks that pay dividends. Dividend paying stocks generally decline less than stocks that do not pay a dividend. If you do sell now and accumulate some cash, you will be able to buy these stocks at lower prices and lock in a more attractive yield going forward.

I know for certain that all but a few market professionals will tell me that I am out of my mind. I submit that a great many of these professionals will have a personal stake in your decision to leave the market or stay the course. If every customer decides to sit on the sidelines these market professionals will be washing cars or waiting tables.

If you would like to “gut check” your broker, ask him/her what the average P/E of your portfolio is today and what your portfolio’s value would be if you do stay the course and your portfolio’s value does decline to a ratio of 15 to one or less. Like I said, do the math.

If you stay the course, you will be robbed of the profits that this bull market has given to you.