FINRA vs. the NARs- Round 3; Same Old Nonsense


A simple question: If a “bad” stockbroker rips you off, can a “bad” lawyer help you recover your losses? The answer should be obvious; but for some people, especially some lawyers, it is not.

For the third time in the last 20 years FINRA has asked the SEC to allow it to restrict an aggrieved customer’s right to have the representative of their choice at FINRA sponsored arbitration.  The previous two attempts were dead on arrival because there was no compelling reason to enact that limitation. The same is true this time. Let’s hope that the Commission staff is not asleep.

The issue is whether or not you must be an attorney to represent a party in a non-judicial arbitration proceeding. There have always been non-attorneys (NARs) representing parties in securities industry arbitration. Member firms would often send branch office managers into arbitration to collect a margin debt from a recalcitrant customer or to defend against a customer claim. Non-attorney representatives in securities arbitration was never an issue until the lawyers realized that they could make a lot of money for a lot less effort than they would put into resolving the same disputes in Court.

In the early 1990s, as real estate took a dip in various parts of the country and the value of real estate backed securities fell, a lot of people who were promised appreciation and steady income from these investments wanted their money back.  It was shown that Prudential Securities and other firms had sold billions of dollars’ worth of questionable real estate backed securities to 10s of thousands of investors around the US. 

The number of arbitration claims skyrocketed.  A lot of attorneys and others saw an opportunity to represent these investors on a contingency basis and an industry of customer representatives, both lawyers and non-lawyers was born. 

As these claims wound their way through the arbitration system the number of new claims began to slow down.  Appalled that they might make less money because there were fewer claims to file, the lawyers started a turf war with the NARs, seeking to get the latter barred for an ever-changing number of reasons.

At that time, the vast bulk of labor arbitrations around the country were being handled by shop stewards because they knew the shop floor rules.  Other state and federal government agencies permitted non-attorney representation in their arbitration forums. The trend was to leave the courtrooms to the attorneys and view arbitration as an alternative system where disputes could be resolved quickly and efficiently with or without lawyers.

Notwithstanding, the lawyers claimed that by representing customers in an alternative dispute resolution system, the non-attorney representatives were engaged in the un-authorized practice of law.  This was absurd on its face, especially since they did not think that true if a non-lawyer represented a member firm.

Admission to practice law is governed state by state.  Out of state lawyers need permission to appear in local courts and then usually with a local lawyer beside them. The same lawyers who claim that you must be a lawyer to represent a party in FINRA arbitration do not seem to care if you are not a lawyer in the state where the customer lives or where the arbitration is being held.  There are many lawyers who specialize in securities arbitration who are admitted in one or two states, but who have a national practice.  If NARs are practicing law in states where they are not admitted to practice law then so are these lawyers.

The lawyers also know that the large wirehouses often send inhouse lawyers to defend these claims and the wirehouses do not have lawyers licensed in every state on staff.  So not being admitted to practice law in the state where the customer resides has never been an issue to either the customers’ lawyers or the industry, unless they are referring to NARs.

The current iteration of the proposed rule allows non-attorneys to continue to represent customers in smaller cases. That is like saying: okay, you can be a little pregnant, because it is not the un-authorized practice of law if you only handle the smaller claims. The “unauthorized practice of law” argument, which never made any sense in the first place, seems dead.

Because of the continuing complaints by lawyers, in 1994 the NASD commissioned a study of its arbitration system chaired by former SEC Chair David Ruder. The report specifically looked at non-attorney representatives and left them in place. It called for more study on the subject and called the complaints against the non-attorney representatives “anecdotal”.  The actual complaints against the non-attorneys were never disclosed and more than one person at the time questioned if those “anecdotal complaints” had any substance.

The Ruder Commission Report did express its concern that “the increasingly litigious nature of securities arbitration has gradually eroded the advantages of SRO arbitration.”  FINRA has always advertised arbitration as a quick, inexpensive way to resolve a dispute with your stockbroker.  When I started doing arbitrations in the 1970s, a dispute could usually be resolved with one day of testimony or less. Now they often take weeks because lawyers have complicated a system that should be easy.   

There was another study and a similar request to limit NARs in 2007. The SEC staff asked FINRA to withdraw that request because the Commission staff thought it not in the customers’ best interest.  That reality has not changed.  

Over the years there were a lots of problems in the arbitration system specifically caused by lawyers. After the “tech wreck” claims went through the system in the early 2000s a significant number of the member firms were sanctioned for repeated violations of the arbitration rules specifically because they intentionally hid documents that the customers sought. Several of the member firms were fined $250,000 and FINRA noted that the practice of hiding documents occurred in multiple claims. 

In virtually every claim where a FINRA firm had been sanctioned for discovery violations the firm had been represented by an attorney. It was attorneys who time and again stood before different panels of arbitrators stating, falsely, that their client had no more documents to produce.  Were any of these lawyers sanctioned for lying to arbitrators? (No). Were any attorneys barred from representing parties again? (No.) Are the “anecdotal” problems with NARs worse than this? (Not by a long shot.)

I think that the SEC staff would be appalled to read the pleadings and briefs that a lot of attorneys present to FINRA arbitrators. Many will cite case law that is not applicable and often out of context. FINRA does not provide arbitrators with law clerks or even a law library. Briefing can be a useless exercise that often obfuscates more than it clarifies.    

Arbitrators are fact finders, not judges. They should examine the actions and utterances of the brokers and compare them to industry rules and regulations.  In many claims the panel is examining a transaction that began with an order to purchase a particular security.  In industry parlance, the question that the arbitrators consider is often the same: is this a “good” order? Did the order comply with the industry rules? Was the broker correct in submitting this order and was the supervisor correct in approving the order for execution?

Industry rules can be nuanced and complex. But every day, in every brokerage office, managers, supervisors and compliance personnel review and approve orders written by stockbrokers and ask and answer that question.  If you have a dispute with your broker because you believe your broker broke those rules, why should you not be allowed to be represented by a retired branch office manager or someone else who has worked with those rules and who can explain them to a panel of arbitrators better than most lawyers?  

It is comical that anyone would think that just because you went to law school you can competently represent a party in securities arbitration.  I have lectured at one of the law school securities arbitration clinics.  Students get taught the arbitration procedures but not what they need to know about the investments or the transactions that are at issue.   

Over the years I worked with a number of attorneys who represented public customers and with several of the large and small NAR firms. The simple truth is that you either know how the securities industry works or you don’t.The best arbitration lawyers often started their careers in house at one of the large brokerage firms where they learned how the firms operate and why.  

Over the years NARs have successfully handled thousands of claims. If the NARS were so bad you would think that there would be stacks and stacks of complaints from their clients about them but there aren’t.

I know that there are arbitrators and industry lawyers who have referred their family and friends to NARs. I know that there are professional traders, fiduciaries, sophisticated investors, lawyers and government officials who have sought out and hired NARs to represent them at FINRA arbitration. They do so specifically because the NARs understand how the rules are actually applied and how firms and brokers are supposed to act.

The lawyers’ current beef with NARs is that the NARs charge investors too much which is a sick joke coming from lawyers. No one really knows what NARs charge because no one asked.  And I suspect that the lawyers would object to disclosing their fees for a meaningful comparison.

When the Ruder Report came out suggesting further study of the NARs, there was some hope that the research would tell the investors what they really wanted to know: which representatives get the best results for their clients. That never happened.

FINRA could break down that data so that consumers might also see which representatives have handled more claims involving annuities or options and what percentage of the amount of the claim was actually returned to the investors through awards or settlements.  We live in a time of almost too much data. Why not collect the data and let the consumers decide?

This issue has come up again because the rising market has substantially reduced the number of claims that are being filed. There were over 10,000 claims being filed in the years after the 2008-2009 crash. I expect the number of claims filed in 2018 will be closer to 4000.  That is the only reason that anyone is talking about banning NARs from arbitration, again. The lawyers do not want any more competition.

I do know that this time out,several of the NARs are thinking about litigating any restrictions that the SEC approves.  That should provide fodder for a lot more articles going forward.

More On Internet Stock Manipulations; SEC v. Lebed (2000), revisited


I was reminded recently of the story of Jonathan Lebed, a 14 year old kid from New Jersey who was investigated by the SEC for stock manipulation using the internet back in 2000.  This case was a big deal at the time, garnishing a segment on 60 Minutes and some interesting discussions in the financial and legal press.

Even though he was underage, with the help of his parents, Lebed had managed to open an account at one or two of the discount brokerage firms. He was apparently trading his accounts in low price stocks when the SEC came knocking on his parents’ door. 

It seems that in the course of trading Lebed liked to post positive comments about what he was buying on various websites, bulletin boards and chat rooms where people who might be interested in purchasing these stocks would see them.  This was in 2000 when the chat rooms were not sophisticated and the web reached a fraction of the people it reaches today. 

Lebed would buy a low priced stock and then say something nice about the company in a message that he posted in a chat room. Using multiple e-mail addresses he might get that same, positive message posted in 200 chat rooms.  Some of the people who saw his posts would re-post them again. 

Lebed knew that his simple postings would create significant interest in these shares and that the price would move up.  He commented that posting the messages with key words in all capital letters would actually get even better responses. 

Bringing a lot of attention to a more obscure, low priced stock can, indeed, lift the price. The SEC called it an intentional market manipulation.  Lebed said that he was only doing what the research analysts at the big firms did, publish their opinions about companies whose share price they wanted to go up. 

Lebed did all this out in the open. Several of his classmates and school teachers followed his leads and invested with him. They were willing to take a chance of doubling their money if the share price of one of these companies went from $.30 to $.60. 

Many of these investing neophytes did understand the positive effect that Lebed’s postings and his quasi investor relations campaigns had on these stocks.  They wanted to buy before he posted and get out as the buyers reacting to his posts pushed up the price.  

Lebed was not the only person or group at that time that was using the internet to enhance the price of shares of small public companies.  But he demonstrated that in the year 2000 the power of the internet to sell investments directly to investors was underrated.  In the almost 20 years since, the use of the internet to sell almost anything, including investments, has become much more powerful and pervasive. 

In the regulated financial markets the dissemination of information is encouraged, but it is also controlled.  Regulations require that information be accurate and complete. Public companies are required to report specific information about their business, to present that information in a specific manner and to release that information on a regulated schedule. 

For a licensed stock broker or investment advisor every e-mail, tweet, posting, comment and utterance about any investment is subject to the scrutiny of his/her employer and by regulators. The SEC depends on the market professionals and market participants to play by the rules. There are significant penalties for non-compliance. 

But Lebed was not a market professional. He was an outlier. He was an independent investor, not a licensed participant in the marketplace.  In the end the SEC let Lebed keep most of the money that he made from his trading as long as he promised to stop.  

At the time, no one really questioned the SEC’s jurisdiction over Lebed or what he was doing. Lebed was a US citizen, operating out of New Jersey. His posts were about US companies whose shares traded in the US markets. Many of his posts were made through a US based internet company (Yahoo Finance). 

In the ensuing 20 years, social media and on line platforms, publications and unregulated “experts” have demonstrated that they can easily sell investments directly on line to millions of investors.  Moreover they have demonstrated that they can disseminate information about public companies and new issues without regard to the truth of the information.  And they can do so without regard for regulations or national borders.

In the “direct to investors” investment world, social media “followers” has replaced “assets under management” as a measure of how many investors’ dollars a person can bring to an investment or new offering.  And you can buy people who have a lot of followers.

If I wanted to hype a stock, either a new issue or one that is already trading, I can make a financial arrangement with any number of independent “experts” who have a lot of social media “followers”.  Some may write articles for financial publications, some write books and blogs and many can be found going from conference to conference and podcast to podcast. 

Any financial “expert” can purchase the right to give the keynote speech at a conference and purchase any number of other speaking slots and sponsorships as well.   Anyone can buy interviews on financial websites, blogs and podcasts or pay for the right to create and distribute positive content on these sites.   

If you look at the numbers you can get an idea of how this works.  I can hire a financial “expert” to tout any stock that I wish. The “expert” will send his/her followers a series of e-mails, appear at a series of conferences and write a series of articles about that company. An expert with 1 million followers might reach 2 million other investors who see re-prints and references to it.

If only 10,000 investors of those followers invest an average of $1000 a new issuer can raise $10,000,000. That much new money coming into a thin trading market can often raise the trading price of the shares of a smaller company.  

There is no limit to the number of experts I can hire or the size of the e-mail lists I purchase for their use to augment their own list of followers.  If I hire multiple experts to hype the same stock, other experts who have not been paid may mention the company independently.  And before you say that this type of scheme using paid experts to hype the stock may be questionable under US law, who said that US law applied?   

If you solicit investors in the US for a new issue the offering is subject to US law.  That would require full and fair disclosure to investors in the US and provide for government penalties for non-disclosure.  But what if you donot make the necessary disclosures and you only solicit investors in other countries? 

The capital markets are regulated country to country.  Each country has its own rules which apply to financial transactions involving its citizens and issuers.  Each has rules governing transactions executed on the exchanges domiciled in their country. The laws of the country where the issuer is domiciled, the exchange is located and where the investors reside may all apply to a single transaction.  An overriding question with the direct to investor market is which country has jurisdiction and over what actions and activities.

If an article about a company’s share price or prospects from a European website gets republished or re-distributed in the US is the author subject to US law? What if the author knew the information in the article was false; do US investors have any recourse?  Does it matter if the author got a royalty for the re-print?

Would the answer be different if the false information originated with just one shareholder who bought a large block of shares cheap and now wants to pump up the price?  Does it matter if that person is in a country other than where the shares trade or the articles originate? 

I recall that when the Lebed case was discussed a lot of people thought that the internet would change and globalize the capital markets. It clearly has.  

I think that there is still a lot of discussion that needs to be had and a lot of questions that need to be asked and answered.  In the meantime, it should be obvious that the current international regulatory scheme does not overlap as well as it could.   

The current and expanding global reach of social media create opportunities and but also highlights problems.  The flow of capital and information continue to globalize. At the same time I am certain that it would is a lot easier today for a 14 year old to manage a single successful, global stock manipulation.