Thursday, May 8, 2014

FINRA and Brown v. Wells Fargo Bank

            Another reason to proceed with caution when dealing with senior citizens, clients with disabilities and any client who could be perceived as “vulnerable.”

            The point of this article is to highlight another procedural trap into which an unwitting adviser may step when dealing with seniors or others perceived to be “vulnerable.”  In the context of the adviser - customer relationship, vulnerability can include “...advanced age, youth, lack of education, ill health and mental weakness.”1  Perceived vulnerability coupled with the fiduciary duty owed to customers by all investment advisers and by brokers in many states may result in a customer successfully avoiding FINRA arbitration (despite signing an arbitration agreement), and forcing an investment professional to litigate a customer claim in court.2

            Such a result is shocking for 2 reasons.  First, arbitration agreements in new account documents and other agreements signed by the customer are generally rock solid and uniformly upheld by courts.  Many creative ways to avoid them have been shot down over the years.  Second, an arbitration agreement can be declared void in cases of a “vulnerable” client because the investment professional did not read and explain or otherwise fully disclose, in a manner the individual understands, the material terms of a contract, including the meaning and effect of the arbitration provision.3

            The Brown v. Wells Fargo Bank case involved the enforceability of an arbitration provision in a stockbroker agreement of which the Plaintiffs - an elderly couple where the husband was legally blind and thus unable to read - said they were unaware.  The broker’s expert witness testified that it would be contrary to accepted industry practice to require an investment professional to read aloud a customer agreement or arbitration provision or attempt to explain the document before the customer signed.  Investment professionals are usually not licensed attorneys and he opined that it would be a mistake that they should be compelled to interpret contracts for prospective customers.  By doing so they could misinterpret words and phrases or leave out essential terms. 4  The Court dismissed these concerns but was careful to point out that its conclusion does not require that an investment professional read or explain their initial agreement to prospective customers.

            The facts in Brown were unusual.  So much so that one of the Appellate Court Justices recommended limiting this opinion to “the unusual facts of this case.”5  Notwithstanding this
             recommendation, one Judge in Santa Barbara County, California recently relied heavily on the holding in Brown to invalidate an arbitration provision.  So, despite the lack of a requirement to read and explain the terms of an agreement with a customer, courts seem more willing to rule that the failure to do so as a fiduciary dealing with a customer who is vulnerable will invalidate the arbitration provision.

            What should investment professionals take from the Brown decision?  First, Judges are people, with children and, more importantly, parents who are or soon will be senior citizens who may be perceived to be vulnerable by their child.  Second, despite shrinking judicial budgets and a heavier caseload (which usually results in arbitration provisions being enforced to reduce the caseload) if Judges perceive that a vulnerable customer was taken advantage of, they may compel the investment professional to defend herself in Court, rather than before a FINRA hearing panel. The likelihood of this result could be increased in areas of the country with a large population of senior citizens.  While customer attorneys complain that FINRA arbitrations are more favorable to investment professionals (a view which I don’t share) the investment professional is in an unquestionably worse position having to defend her conduct before a state court jury.  The sympathies that will naturally attach to the “vulnerable” customer, along with the lack of industry and product knowledge held by most lay people, are difficult hurdles to overcome.          

            If confronted with a customer who is or through conversation and observation could soon be considered vulnerable, consult your compliance department.  If advised to read or otherwise review and explain the legal provisions in the new account documents(most notably the arbitration provision), document the efforts made in this regard.  The best protection in the case of a later customer complaint or regulatory inquiry is to have the customer sign a document which sets forth the measures taken by the investment professional to disclose and explain such provisions in a manner the customer understood at the time.  In the event that you are advised by your firm not to prepare such a document, an e-mail or letter to the customer confirming your efforts(approved by the firm) would also offer protection.




1           Richelle L. v. Roman Catholic Archbishop (2003) 106 Cal. App. 4th 257, 280.
2           Brown v. Wells Fargo Bank, N.A. (2008) 168 Cal. App. 4th 938.
3           Brown, supra at 962.
4           Brown, supra at 951.
5           Brown, supra  at 962.

Friday, April 25, 2014

FINRA Response and U4/U5 Explanations – Get it Right the First Time and be Consistent

In my practice I have noticed a recent uptick in terminations for cause as well as (particularly in the case of a registered representative attempting to change firms) the necessity to provide an explanation for any CRD blemish to new broker dealers,  clearing firms and insurance companies.

Terminations for cause from a broker dealer automatically trigger an inquiry from FINRA and often one or more states.  The RR’s response to this inquiry is very important in that the response has more than one purpose.  The first goal of any communication with FINRA is to illicit a ‘no-action letter’ (FINRA’s expression that no enforcement action will be pursued) Secondly, the substance of the response may be used to explain the termination to a new broker dealer, insurance company or clearing firm.  Given the multiple uses of the response it is critical that it be (1) well thought out; (2) succinct but informative; and (3) contain no admissions to the extent they can be avoided.  These guidelines should apply to any communication with FINRA given the stakes and the very real possibility that FINRA may elect to take formal action if they are not convinced that no action is appropriate.  The guidelines are also important in the ever changing regulatory environment in which states may take the lead in termination investigations and industry members are increasingly demanding explanations for any CRD entry.

While many RRs are good writers and communicators, they seem not to understand the above guidelines or that their initial explanation to FINRA may lock them into a position which hurts (sometimes permanently) their ability to move to another firm or get appointed in certain states or with certain insurance companies.

I recommend that RRs hire counsel at the first sign that they might be released from their broker-dealer under any circumstances other than a voluntary resignation.  I understand that such awareness is not realistic in those instances in which a RR has unwittingly violated a firm procedure or industry rule/law.  But, however slight the chance, the possibility that a firm may reconsider a termination for cause and charge the reason for separation to voluntary or permitted to resign could make a huge difference in a RR’s career.

Further, I recommend that upon termination for cause, the RR absolutely retain counsel to assist in the formulation and submission of the RR’s response to the FINRA inquiry.  This step is essential, with the understanding and mindfulness that the RR’s explanation will be scrutinized by FINRA, one or more states and industry members (including potential hiring firms) with the power to dramatically impact the RRs career.

Learn More About FINRA Arbitration at www.ZafisLaw.com

Thursday, January 3, 2013

Clients and Your Arbitration Clause



           

If Clients Are Vulnerable, Your Arbitration Clause May Be Too


By Craig Zafis


           
            Financial professionals take heed of a procedural trap into which an unwitting adviser may step when dealing with seniors or others perceived to be “vulnerable.”  In the context of the adviser/customer relationship, vulnerability can include “...advanced age, youth, lack of education, ill health and mental weakness.” Couple this real or perceived vulnerability with the fiduciary duty owed to customers by all investment advisers and by brokers in many states and a crack in the rock of a solid arbitration clause may result. In fact, based on recent case law, a customer may successfully avoid FINRA arbitration (despite signing an arbitration agreement), and force a dispute into costly litigation in court.

            Such a result is shocking if you consider all the implications. First, arbitration agreements in new account documents and other agreements signed by the customer are generally rock solid and uniformly upheld by courts.  Many creative ways to avoid them have been shot down over the years.  Also, the standard written form of an arbitration agreement has been a reliable disclosure, however based on the court’s ruling in Brown v Wells Fargo Bank, NA (2008) 168 Cal. App. 4th 938, an arbitration agreement can be declared void in cases of a “vulnerable” client because of the manner in which it was delivered.  In Brown, the clause was deemed void because the investment professional did not read and explain or otherwise fully disclose, in a manner his client understood, the material terms of a contract, including the meaning and effect of the arbitration provision.

            The Brown  case involved the enforceability of an arbitration provision in a stockbroker agreement of which the Plaintiffs - an elderly couple where the husband was legally blind and thus unable to read - said they were unaware.  The broker’s expert witness testified that it would be contrary to accepted industry practice to require an investment professional to read aloud a customer agreement or arbitration provision or attempt to explain the document before the customer signed.  Investment professionals are usually not licensed attorneys and he opined that it would be a mistake that they should be compelled to interpret contracts for prospective customers.  By doing so clients could misinterpret words and phrases or brokers might leave out essential terms. The Court dismissed these concerns but was careful to point out that its conclusion does not require that an investment professional read or explain their initial agreement to prospective customers.

            The facts in Brown were unusual; so much so that one of the Appellate Court Justices recommended limiting this opinion to “the unusual facts of this case.” Notwithstanding this recommendation, one Judge in Santa Barbara County, California recently relied heavily on the holding in Brown to invalidate an arbitration provision.  So, despite the lack of a requirement to read and explain the terms of an agreement with a customer, courts seem more willing to rule that the failure to do so as a fiduciary dealing with a customer who is vulnerable will invalidate the arbitration provision.

            What should investment professionals take from the Brown decision?  First, judges are people:  and, more importantly, have parents who are or soon will be senior citizens who may be perceived to be vulnerable by their child.  Second, despite shrinking judicial budgets and a heavier caseload (which usually results in arbitration provisions being enforced to reduce the caseload) if judges perceive that a vulnerable customer was taken advantage of, they may compel the investment professional to defend herself in Court, rather than before a FINRA hearing panel. The likelihood of this result could be increased in areas of the country with a large population of senior citizens.  While customer attorneys complain that FINRA arbitrations are more favorable to investment professionals (a view contrary to statistics, and one which I don’t share) the investment professional is in an unquestionably worse position having to defend her conduct before a state court jury.  The sympathies that will naturally attach to the “vulnerable” customer, along with the lack of industry and product knowledge held by most lay people, are difficult hurdles to overcome.  

            If confronted with a customer who is or through conversation and observation could soon be considered vulnerable, best practices dictate that you should consult your compliance department.  If your CCO is unfamiliar with the Brown ruling, best to have a copy of the ruling or this article available to share. If you are advised to read or otherwise review and explain the legal provisions in the new account documents(most notably the arbitration provision), document the efforts made in this regard.  The best protection in the case of a later customer complaint or a FINRA regulatory inquiry is to have the customer sign a document which sets forth the measures taken by the investment professional to disclose and explain such provisions in a manner the customer understood at the time.  In the event that you are advised by your firm not to prepare such a document, an e-mail or letter to the customer confirming your efforts (approved by the firm) or a diary entry would also offer protection.         

            For additional information, please contact R. Craig Zafis, a  FINRA arbitration and regulatory defense attorney.

Tuesday, April 24, 2012

FINRA Disciplinary Actions for April 2012

FINRA has just released their disciplinary actions for this past month and the have been busy again. Further analysis to come, if you are on the receiving end of any form of FINRA action, it is very important to contact a securities fraud defense attorney as soon as possible.  Time is of the essence and you will need experienced representation through all stages of this process.