Terra Extraneus

The new FINRA statistics are always fascinating. While filings are up for 2008, “82%” FINRA says, that is an 82% increase over the fourth lowest number of new case filings since 1994. The lowest since 1994 was in 2007 at 3,238. FINRA is estimating new case filings in 2009 will eventually reach 7,750, even though as of June the new filings had not reached 4,000. Thus, FINRA is predicting for 2009 the fourth highest number of new case filings since 1994.

Why did the number of new case filing in 2007 drop so drastically? Was it because of strong market performance? Was it because of upgraded and determined compliance by the securities broker dealers? Was it because the legal community decided to leave these types of cases to specialists? Was it because the legal community thought that the system was rigged (i.e., the controversy over industry panel members and other disputes) and stopped filing cases?

We have heard anecdotal reports, and seen some news media reports, suggesting that all of these might be true, or might be the perception of at least some participants. If these, in whole or in part, are true, or perceived as true, then FINRA’s projection of new case filings for 2009 may be too high.

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In Colorado, at least, it might matter. In Dish Network v Altomari (Colo. Ct. App. June 25, 2009), the question was whether the employee that supervised some people, probably a sales staff, was in “management.” If the employee was in management, then under the Colorado non-compete statute, a non-compete against the employee was enforceable. The Court of Appeals reversed the trial court and held the employee was in management.

The term “management” is not defined in the Colorado statute. However, it is pretty clear the court is confused about what constitutes “management.” The only employees in “management” are those who can bind the company or otherwise decide company policy, typically corporate officers and directors. That would be a logical purpose of the statute. Applying the statute to middle or lower tier supervisors turns the statute from a fair allocation of business risk to a draconian labor control tool.

Of course, will Financial Advisors in Colorado with titles like “Vice President” or “Director” once again face non-compete risks when they trade jobs? Protocol firms may not be tempted but many will be in the is shaky economy. Financial Advisors in Colorado should try to wheedle an email or something that indicates they are not in management, or obtain a page from a firm policy manual that says something similar.

(Hat Tip: Professor Ross Runkel’s employment law summaries)

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The case reported by Professor Ross Runkel issued by a New Jersey appellate court, Stengart v Loving Care Agency, held that privileged communication by the former employee with her attorney through her employer’s computer retained its privilege.

The case was interesting because the employee made the same mistake many people make. The employee was using a web based password protected email account believing that no trace of the email on the outside website was being left on the computer owned by the employer. That was untrue. Because the employee was viewing web email through the browser on the employer’s computer, the computer captured a picture of every image the employee saw, thus preserving it for the employer’s computer analyst to retrieve.

The moral of the story: do not use an employer’s computer for anything you want to remain private. Go outside of the employer’s hardware.

Most employers are not set up to retrieve or view web images viewed by the employee, but that does not mean a computer expert cannot retrieve the images from the computer when desired. Just because compliance systems are not set up to see every image the employee can see, like web based email, does not mean the email, once viewed on the employer’s computer, cannot be viewed by a computer analyst.

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The federal government is prosecuting far fewer fraudulent stock schemes than eight years ago, according to Eric Lichtblau of the San Diego Union Tribune, in December. Darla Mercado of Investment News reported today that the Attorney General of Massachusetts concluded her prosecution of Goldman Sachs by an agreed fine of $60 million on a neither admit nor deny basis. The Goldman Sachs fine was for Goldman Sach’s role in securitizing subprime-mortgage loans.

While the fine is not insubstantial, the cost of the subprime mortgage collapse has been astronomically more than $60 million. The combined lack of focus on federal stock prosecutions and the devolution to state by state enforcement apparently may have been a factor in bringing about a pervasive lack of securities industry standards. With recent statutory limitations on stock class actions and the general tort reform mood of the country, the ability of the average victim to enforce securities law violations has also been reduced.

With less to fear from the federal government, the fragmentary enforcement available from the state level, and the diminished capacity of the private class action bar, the securities industry may have gotten its wish. But, maybe it should have been frightened of getting it.

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How did Bernie Madoff, the hands-down all-time winner of the title “world’s greatest thief,” get away for so many years with bilking so many investors out of so many billions of dollars?

Madoff awaits sentencing after pleading guilty to 11 felony counts in a Ponzi scheme by which he swindled investors out of $65 billion. Inmate 61727-054 has settled into his new home: a 7½ x 8-foot cinder block cell at the Metropolitan Correction Center in New York City.

How could Madoff get away with such a massive fraud for so long? Don’t we have regulatory mechanisms in place to protect investors against crooked brokers and investment advisors? Yes we do — sort of. If the Bernie Madoff super-con has provoked your ire, how do you react when you learn that one of the people entrusted with preventing such skullduggery was – wait for it – Bernie Madoff. Keep reading.

The Securities and Exchange Commission is the agency charged with enforcing federal securities laws. The SEC was established in 1934 in response to the 1929 crash and the Great Depression that followed. The SEC makes sure that public companies disclose information that investors have a right to know. It also brings enforcement actions against brokers, dealers and advisors who violate securities laws.

However, to a great extent, the SEC allows the securities industry to regulate itself. Come again? That’s right, our first line of defense to protect investors against dishonest brokers and broker-dealers is for the brokers to regulate themselves.

FINRA (the Financial Industry Regulatory Authority) is the self-regulatory organization entrusted by the SEC with making sure that its member brokerage firms and their registered reps follow the law. FINRA can initiate disciplinary actions against its erring members, and also, unhappy customers may file complaints with FINRA against their brokers, which are resolved through arbitration.

By the way, if you have never heard of FINRA, you probably have heard of its predecessor: the National Association of Securities Dealers (NASD). In 2007, the NASD became FINRA and took over enforcement of all major U.S. stock exchanges. So how well does FINRA do at keeping its own members in the financial sector in line? That is, how is FINRA doing besides failing to uncover the biggest swindle in the history of the industry?

According to the Wall Street Journal, in 2008 FINRA levied fines against financial firms totaling $40 million. $40 million? That’s a miniscule sum compared to the trillions being managed by the 5,000 brokerage firms, 173,000 branch offices and 659,000 registered reps that FINRA oversees.

In addition, customers filed about 5,000 arbitration cases with FINRA in 2008. The most common complaints were breach of fiduciary duty, misrepresentation, breach of contract and negligence. However, less than 500 arbitrations in 2008 survived the process all the way to an actual hearing and decision, and less than half of them (42%) resulted in an award for the claimant. About 2,000 more cases were settled or mediated.

To the securities industry, a few million dollars in fines and a couple of hundred arbitration awards is the equivalent of an occasional “traffic ticket.” The industry merely budgets these minor inconveniences as part of the cost of doing business.

And how does Madoff figure into this discussion? Well, believe it or not, Madoff is a former chairman of the NASD’s board of directors, a former member of the NASD board of governors, and a former chairman of Nasdaq, the stock exchange the NASD regulated. In other words, to put it in the simplest possible terms, while Madoff was stealing billions of dollars from unwitting investors, he was also serving as one of the top officials entrusted with making sure brokers didn’t get away with such things. Wall Street, we have a problem.

Dallas money manager Gary D. Halbert writes: “How could regulators have missed this one? Oddly, Madoff appears to have operated below the radar screens of the SEC and various other regulatory agencies for many years. Perhaps this was because of Madoff’s very high Wall Street profile and his service as co-founder, board chairman and governor of the NASDAQ for several years in the late 1980s and early 1990s.”

Halbert continues:

The SEC said it conducted two inquiries [including a 2007 examination] of Madoff in the last several years and did not find major problems. … I find this baffling! My company, Halbert Wealth Management, is a Registered Investment Advisor with the SEC. We have been through a routine examination by the SEC. Our broker-dealer firm, ProFutures Financial Group, has been through multiple routine examinations by the NASD, and more recently FINRA … I can tell you that these routine regulatory examinations – at least among smaller firms like mine – are rigorous. They typically have 2-3 examiners in our offices for up to two weeks at a time looking at all of our books … If my company was running a Ponzi Scheme, or stealing customer monies, I feel confident that the regulators would have caught us upon the next regularly scheduled examination. … Frankly, I have NO CLUE how the SEC failed to discover Madoff’s giant Ponzi Scheme in its various examinations.

Halbert’s observation underscores a frequent criticism of SEC and FINRA enforcement: that the agencies go after small fish to keep up appearances, while failing to uncover large-scale wrongdoing perpetrated by the major players. Madoff was one of the biggest, and he went undetected for years.

As I said, under our current system, our first line of defense to protect investors against dishonest brokers and broker-dealers is for the brokers to regulate themselves. That means that in the case of Bernie Madoff, we have been trusting history’s all-time greatest thief to keep himself honest. That’s not working. New SEC chief Mary Schapiro says a crackdown is coming. “The world has changed dramatically in the last year,” Schapiro recently told Congress. “There will be no sacred cows.”

Given recent headlines, tough talk is to be expected. Tough action is another matter. We’ll believe it when we see it.

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The investment banks, the wirehouses, and the large broker-dealers, which have all but ceased to exist, had a love - hate relationship with “at will” employment law. Even the late and great Merrill Lynch, once the “white hats” in the industry, struggled with it from time to time. In the 2000s, however, Merrill Lynch seemed to lead the industry toward a reasonable set of protocols by which stock brokers, registered representatives could change jobs. Merrill Lynch, at the end of its corporate life, would not engage in retaliatory litigation and disdained forfeitures of earned stock or compensation.

It remains to be seen how industry survivors will fashion their employment policies going forward. However, California courts have recently indicated a no nonsense attitude toward employment contracts containing non-compete clauses and California has always treated forfeitures with disdain. Texas, likewise, seems to have affirmed its own legal, if not moral, prohibition of anti-competitive provisions that go further than necessary to protect legitimate employer interests, such as forfeitures of earned stock or compensation.

The Texas Court of Appeals in Corpus Christi issued its 2009 opinion in Valley Diagnostic Clinic v Dougherty. While this was a dispute between a doctor and his former clinic, in which the clinic sought to forfeit earned but deferred compensation, the principles are the same for other industries. Just as the Texas State Board of Medical Examiners places certain limits on enforcement of these types of clauses, so, too, does FINRA and state regulators (even if they are not identical). Over shadowing that, however, is that the public policy of Texas, like many other states, deems “a compensation provision made only in exchange for a non-compete promise…precisely the sort of restraint of trade that Texas law prohibits.”

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The New York Times reported on January 28, 2009 that JP Morgan conducted a “wide ranging review” of its hedge fund exposure. JP Morgan asked Bernard L. Madoff’s funds questions and did not like the answers. JP Morgan withdrew the money it invested in 2008, prior to the implosion caused by the discovery that Madoff was the greatest Ponzi-scheme offeror in history. But, JP Morgan did not tell its own customers about its experience with the Madoff-linked funds.

No doubt the personnel at JP Morgan that conducted the review, got the answers from the Madoff-linked funds, decided the answers were insufficient, and recommended fund withdrawals, rather than being given a corporate gold star by JP Morgan, will end up being used as cannon fodder while JP Morgan management tries to defend itself against its own unhappy customers that believe JP Morgan should have alerted them, too. JP Morgan will no doubt claim that there was a Chinese wall between its internal corporate investment advisors and its external fund managers. The managers of the funds of JP Morgan customers will no doubt claim they did not get the word from the internal corporate advisors.

The New York Times reported that JP Morgan got itself out of the Madoff-linked funds when the funds were reported to be up five percent while the broad market was down thirty percent. Also, the news report indicated that Madoff accounts were held at JP Morgan, in other words, Madoff was a bank customer, too. Was JP Morgan able to use what it learned from those accounts to protect itself but unwilling, or unable, to use that information to protect all of its customers?

It will be interesting to see whether JP Morgan gets sued in a claw back claim by the regulators. After all, the money JP Morgan withdrew was arguably not their money, but the money of some other dupe.

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In Oklahoma, on a slow news day, you can be sure each local television news broadcaster will have a story about a dog complete with video footage. Movie industry executives also seem to have concluded that movies about dogs sell tickets.

But, it now appears that human civil rights can be curtailed in the face of dog rights. The United States Court of Appeals for the Tenth Circuit reversed the federal district court sitting in Oklahoma City, in a published opinion no less, in a case styled Rajeanna Dixon v Oklahoma Board of Veterinary Medical Examiners. It took thirty pages for the Tenth Circuit to explain this. Indeed, the challenge we are now faced with is to explain why it took thirty pages for the Tenth Circuit to reduce the civil rights of a state employee to zero, elevate dog rights to greater than constitutional importance, and zero out the First Amendment in the absence of a national security consideration. Oh, and the Central Intelligence Agency is involved, so keep reading.

Ms. Dixon was fired from her secretarial job at the Veterinary Board because she allegedly discussed an ongoing investigation into dog fighting and dog doping with her own veterinarian, who happened to be a veterinary association member responsible for legislative over sight of the Veterinary Board and its budgets and powers, largely because she was concerned the agency, which only had four employees, including her, was stepping out side of its mandate. Also, she allegedly told the veterinarian that the board’s investigator was now carrying a gun even when he went to meet with veterinarians.

The federal district court denied the summary judgment motions asserting qualified immunity presented by the board and the board appealed. Thus, this opinion by the Tenth Circuit was doubly weird because normally the mere denial of a summary judgment motion is interlocutory and not appealable.

It has to be noted that the investigation of the Veterinary Board into dog fighting and dog doping resulted in an arrest, probably by another law enforcement agency, that was reported in the news media. It has to be noted that Ms. Dixon comments on the investigation, if they occurred, were made after the news media report made the investigation, at least in part, public. Indeed, the news media report suggests it had become a matter of public concern, at least on a slow news day, and thus Ms. Dixon’s comment upon on it should have been presumptively protected, and not used as a pretext for firing her.

But, the Tenth Circuit concluded that there were “unprotected” statements, in addition to protected ones. In other words, as soon as the Tenth Circuit found that the First Amendment did not reach these statements, then Ms. Dixon could be fired for speaking about the Veterinary Board if the interests of the Veterinary Board, as a government employer, outweighed Ms. Dixon’s right to free speech. The Tenth Circuit concluded that Ms. Dixon’s other comments were “trivial in nature.” (“Serious complaints about discrimination can certainly be a matter of public concern, but the record reveals discussion of nothing more than a few stray comments.”) The right of the state government agency not to have a secretary discuss agency business, public or non-public, was deemed greater than the First Amendment protection.

Comically, the Tenth Circuit put the Veterinary Board of Oklahoma on a high investigatory pedestal when it parenthetically stated: “That is why the CIA regularly responds to inquiries by saying it can “neither confirm nor deny.” Admittedly, sitting in Denver, the Tenth Circuit might not be completely aware that the Central Intelligence Agency of the United States and the Oklahoma Veterinary Board are not handling matters of equal importance. That might explain the lack of a sense of perspective in the opinion and may be the loss of perspective in government generally. Apparently, we dare not have transparency in any government agency, even one that abandoned its mission to regulate veterinarians in favor of investigating dog fighting rings. Apparently, our society will come crashing down around us if we have First Amendment rights about state agency veterinarian medicine regulation.

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There is an old saw that compares lawsuits to two men armed with knives circling each other in a dark room, not knowing whether they can ever put the knives down. During the raiding wars (a/k/a recruitment wars) of the last twenty-five years, the major wirehouses, broker dealers, and investment banks tried to defend their market share by making it difficult or impossible for stock brokers (a/k/a registered representatives, financial advisors, financial consultants)(“FCs”) to change jobs, even though they are mere at will employees.

One of the most aggressive and effective firms at defending its turf when stock brokers tried to change jobs and take their books of business with them was Merrill Lynch. Other firms were more vicious about it, and turned to forfeiture programs designed to put thousands if not millions of dollars of earned compensation at risk just for changing jobs, so Merrill Lynch was by far not the worst with which to deal.

Finally, however, the Courts began to wise up to the fact that, no matter what high sounding moral or legal issues might be used to justify the raiding wars and the TROs and emergency hearings they spawned, what was really at stake was the book of business, market share and business income. That led Merrill Lynch to develop the Protocol for Recruiting Brokers. About sixty broker dealers have signed up and Bank of America, Merrill’s new owner, just joined in the last couple of weeks.

However, during the recruitment drives of 2008, we are seeing the same contracts containing the same clauses that were used to obtain TROs and put the FCs on the beach since time immemorial. Also, no house will agree to insert any language deferring to the Protocol for Recruiting Brokers.

The houses all say the same thing about their refusal to incorporate the Protocol for Recruiting Brokers. Because any house can resign from the Protocols at any time, no house wants to make its employees third party beneficiaries of an agreement others might not keep. The men in the dark room carrying knives are still circling.

In these turbulent times when recruitment and job flight are at all time highs for FCs, it will be interesting to see if the houses panic over market share and withdraw from the Protocols. It will be interesting to see if courts have the sanity to impose the Protocols as an industry standard with or without signatories. A few courts have done so. See, Merrill Lynch v Brennan (D. Ohio 2007) (hat tip to the Firth Law Firm in Roanoke); Citigroup Global Markets, Inc. v Griffin, slip op. (District Court of Suffolk, No. 08-0022, 2008)(hat tip Social Law Library Research Portal at socialaw.com).

Courts should be reminded that historically courts have historically found these cases interesting for awhile and then later rued the day they let them flourish.

Petitioner’s [Smith Barney] protestations to the contrary notwithstanding, the Court does not foresee any cataclysmic repercussions for Smith Barney that cannot adequately be addressed by monetary damages which are easily calculable from the requisite documentation.

Smith Barney, Inc. v. Anthony Cappiello, Supreme Court, County of New York, No. 603445/98, July 20, 1998, Slip Op. at 3.

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Lawyers are generally technology shy because of the time required to master new software. Thus, when this blogsite was the victim of some sort of mishap, it was clear from researching the plague on the web that though the cause might have been a villan roaming through cyberspace, the opportunity given freely to the villan was the failure to upgrade, for which only I can take responsibility. Thus, about six hours later, this blog site is now on the latest platform available that is out of Beta testing. If it was not for forums, blogs and very generous gurus contributing without hope of just reward in this life, I could not have done it. It was a test of wills, me versus the software, and the software won many but finally had mercy and here we are.

Fortunate are the web villians in cyberspace because that is a forgiving and tolerant community, or else they would be developing tracker software, hunting you down, signing an engagement agreement and giving me your identity. Courts would quickly become familiar with such an intriguing subject and district judges are usually adept at making villany pay up and get out.

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