Morgan Stanley Hit with $3 Million FINRA Discovery Sanction

July 17, 2019

In retrospect, Puerto Rico bonds were a bad investment. All of which explains the legions of devastated  investors who have sued and continued to sue any moving target that might offer some recompense for their losses. In many cases, investors lost everything and were left destitute. Frankly, far too many Wall Street participants knew that they were pushing garbage, knew that the debt was beyond repayment, and should have known that the powder keg was going to explode -- none of which stopped anyone from pushing the paper on the unwary. Hard to imagine a more compelling set of circumstances suggesting fraud. Thus we arrive at the underlying dispute in today's featured FINRA customer arbitration.

Case In Point

In a FINRA Statement of Claim filed in July 2017 and as amended thereafter, public customer Claimants asserted breaches of fiduciary duty, contract, and third-party-beneficiary contract; negligence; negligent supervision; fraud; violation of Sections 10(b) of the Securities Exchange Act and Rule 10b-5 of the Securities and Exchange Commission; violation of the Florida Securities and Investor Protection Act; and violation of the Puerto Rico Uniform Securities Act. The causes of action purportedly arose in connection with Claimants' investments in Puerto Rico bonds and closed-end bond funds, and a securities-backed loan. At the close of the FINRA Arbitration Hearing, Claimants sought at least $2,739,792.00, plus $515,624.00 in attorneys' fees and $10,959,168.00 in punitive damages. In the Matter of the Arbitration Between Isabel Litovich-Quintana and Jose A. Torres, Claimants, v. Morgan Stanley Smith Barney, LLC d/b/a Morgan Stanley, Respondent (FINRA Arbitration Decision 17-01908 / July 16, 2019) 
http://www.finra.org/sites/default/files/aao_documents/17-01908.pdf

Respondent Morgan Stanley generally denied the allegations and asserted various affirmative defenses.

Motion for Discovery Sanctions

As set forth in pertinent part in the FINRA Arbitration Decision:

During the evidentiary hearings, Claimants made an oral Motion for Discovery Sanctions against Respondent. Respondent opposed the Motion. The Panel held any ruling on the Motion for Discovery Sanctions in abeyance until the conclusion of the evidentiary hearings. After the hearings concluded, the Panel issued an Order on April 30, 2019, instructing the parties to file briefs on the Motion for Discovery Sanctions. Both parties filed briefs on or about May 31, 2019. In its Motion for Discovery Sanctions post-hearing brief, Claimants argued that Respondent failed to produce critical documents responsive to Claimants' discovery request and thereby concealed documents relevant to the central issues in the matter. In its opposition to the Motion for Discovery Sanctions post-hearing brief, Respondent argued, among other things, that it complied with all discovery obligations and did not engage in any conduct warranting sanctions. . . .

SIDE BAR: FINRA Arbitration Code Rules for Imposing Sanctions

FINRA Code of Arbitration Procedure for Customer Disputes Rule 12212: Sanctions

(a) The panel may sanction a party for failure to comply with any provision in the Code, or any order of the panel or single arbitrator authorized to act on behalf of the panel.

Unless prohibited by applicable law, sanctions may include, but are not limited to:
  • Assessing monetary penalties payable to one or more parties;
  • Precluding a party from presenting evidence;
  • Making an adverse inference against a party;
  • Assessing postponement and/or forum fees; and
  • Assessing attorneys' fees, costs and expenses.

(b) The panel may initiate a disciplinary referral at the conclusion of an arbitration.

(c) The panel may dismiss a claim, defense or arbitration with prejudice as a sanction for material and intentional failure to comply with an order of the panel if prior warnings or sanctions have proven ineffective.

FINRA Code of Arbitration Procedure for Customer Disputes Rule 12511: Discovery Sanctions

(a) Failure to cooperate in the exchange of documents and information as required under the Code may result in sanctions. The panel may issue sanctions against any party in accordance with Rule 12212(a) for:
  • Failing to comply with the discovery provisions of the Code, unless the panel determines that there is substantial justification for the failure to comply; or
  • Frivolously objecting to the production of requested documents or information. 

(b) The panel may dismiss a claim, defense or proceeding with prejudice in accordance with Rule 12212(c) for intentional and material failure to comply with a discovery order of the panel if prior warnings or sanctions have proven ineffective.

Award

The FINRA Arbitration Panel found Respondent Morgan Stanley liable and ordered the firm to pay to Claimants $261,420.63 in compensatory damages with interest. FINRA and/or the Panel assessed the following fees:

Claimants (joint and several): $2,000 Initial Claim Filing Fee; $200 discovery-related motion fees; $32,900 in hearing session fees

Respondent Morgan Stanley: $3,025 Member Surcharge; $6,175 Member Process Fee; $200 discovery-related motion fees; $33,350 in hearing session fees

Oh, and one other thing -- almost forgot -- the FINRA Arbitration Panel imposed upon Respondent Morgan Stanley a $3,000,000 monetary sanction (in accordance with Rules 12212 and 12511 of the Code of Arbitration Procedure).

Yeah. $3 million. In monetary sanctions. 

No -- that's not a typo. Again: $3 million in sanctions! 

So, you might be wondering, what the hell did Morgan Stanley do (or not do) to warrant getting slammed with $3 million in sanctions. Gee, no wonder I like you, you've got an inquiring mind. As set forth in part in the FINRA Arbitration Decision:

During the course of the evidentiary hearing, the Panel was made aware of Respondent's alleged failure to comply with a discovery request Order, which was granted pre-hearing by the prior Chairperson with respect to the production of documents related to the termination of a key employee of Respondent. After hearing oral argument on the issue by both parties, the full Panel issued the same Order as was previously issued by the prior Chairperson for production of "all" related documents by midnight. The Panel noted that the prior Chairperson's Order did not limit itself to "pre-termination" or "post-termination" documents when it stated "all." Respondent did not send the requested documents to Claimants' counsel by midnight, nor did Respondent's counsel provide opposing counsel with the courtesy of an email by midnight explaining why "all" the ordered documents were not being produced. The evidentiary hearing was delayed, for a second time, to permit both parties to provide oral argument on the "settlement privilege" which Respondent's counsel alleged applied to the documents that Respondent was withholding and proposing to have the Panel review "in camera." The Panel again ordered the withheld documents to be handed to Claimants' counsel, and not to the Panel for in camera review. The Panel took note of the extreme prejudice Respondent's failure of compliance caused Claimants' counsel in preparing their case and asserting their claims without the withheld documents which the Panel deemed were highly relevant to the dispute in question, the central figure of which was the terminated employee whose related documents were being withheld. Claimants' counsel repeatedly requested that Respondent be assessed monetary sanctions for its failure of compliance with the Panel's Orders. At the conclusion of the evidentiary hearing, the Panel ordered both parties to submit post-hearing briefs on the issue of the sanctions requested by Claimants against Respondent. 

The Panel noted that Rule 12506(b)(2) of the Code related to parties' obligation to "act in good faith when complying with subparagraph (1) of this rule. 'Good faith' means that a party must use its best efforts to produce all documents required or agreed to be produced. If a document cannot be produced in the required time, a party must establish a reasonable timeframe to produce the document." The Panel also took note of Rule 12212 of the Code related to sanctions: "(a) The panel may sanction a party for failure to comply with any provision in the Code, or any order of the panel or single arbitrator authorized to act on behalf of the panel. Unless prohibited by applicable law, sanctions may include, but are not limited to: 

  • Assessing monetary penalties payable to one or more parties; . . ." 

In accordance with the above, after due deliberation and upon consideration of the negative effect that Respondent's noncompliance with the Panel's Orders had on its efforts to achieve a fair arbitration hearing, the Panel hereby orders Respondent to pay monetary sanctions to Claimants in the amount of $3,000,000.00. . . .

Bill Singer's Comment

One goddamn rousing round of applause for Chairperson/Public Arbitrator Jill Pilgrim, Public Arbitrator Constance P. Barr, and Public Arbitrator Irlanda Ruiz!  It's about time that three FINRA arbitrators finally stood up against FINRA's Large Member Firms when they jerk public customers around for the sport of it. As this Panel so eloquently made the case:

[T]he Panel took note of the extreme prejudice Respondent's failure of compliance caused Claimants' counsel in preparing their case and asserting their claims without the withheld documents which the Panel deemed were highly relevant to the dispute in question, the central figure of which was the terminated employee whose related documents were being withheld. . . .

One of the great advantages of being an old fart such as I am is that I have a loooong and often unforgiving memory. Yeah, I've heard all the assurances from NASD and FINRA about how they were/are fair regulators and how they don't have two sets of rulebooks (one for the Large Firms and another for the Small Firms and industry's associated persons).  I've read the endless hypocrisy about how Wall Street's self-regulation is unbiased, unconflicted, and will be applied evenly to all comers. So, let's see how FINRA-the-regulator responds to the intentional and wrongful withholding of "highly relevant" documents by one of its largest member firms in a mandatory FINRA customer arbitration.

You may say that I'm being harsh. After all, games always get played during Discovery. Fair point -- I'll give you that one. You may say that Morgan Stanley doesn't have a history of violating arbitration Discovery rules and, at worst, today's case is likely a one-off, aberrant example of when lawyers get just a tad out of control. No -- I'm not going to give you that one. What I am going to do is dredge up a bit of FINRA regulatory history and throw it in the self-regulator's face: "Morgan Stanley to Pay $12.5 Million to Resolve FINRA Charges that it Failed to Provide Documents to Arbitration Claimants, Regulators" (FINRA News Release / September 27, 2007). FINRA entered into a settlement with Morgan Stanley to resolve charges that its former affiliate Morgan Stanley DW, Inc. had " failed on numerous occasions to provide emails to claimants in arbitration proceedings as well as to regulators . . ." Further, the settlement resolved:

additional charges relating to the firm's failure to provide required supervisory materials to numerous arbitration claimants. The settlement announced today is the first of its kind - in that it provides for distribution of $9.5 million to two groups of customers who had arbitration claims against the firm. FINRA estimates that several thousand customers may be eligible to receive payments. FINRA also imposed a $3 million fine on the firm for its failure to provide pre-9/11 emails and updates to a supervisory manual.

In addition to hitting Morgan Stanley with $12.5 million in sanctions, FINRA trumpeted this:

Also as part of the settlement announced today, Morgan Stanley is required - again, at its own expense - to retain an independent consultant acceptable to FINRA to review the firm's procedures for complying with discovery requirements in arbitration proceedings relating to the firm's retail brokerage operations. The firm will be required to implement the independent consultant's recommendations for improving those procedures, or alternative improvements acceptable to the independent consultant.

Some 12 years later in 2019, it just doesn't seem that Morgan Stanley is following the independent consultant's recommendations for "complying with discovery requirements in arbitration proceedings relating to the firm's retail brokerage operations . . ." Of course, you know, I'm sure that Morgan Stanley will argue that I'm raising old news via an outdated FINRA settlement. I'm sure that Morgan Stanley will point out that the FINRA Press Release conceded that the 2007 settlement involved merely a "former" affiliate. Similarly, I'm sure that FINRA would just as soon forget this victory lap that was run by its "former" Chief of Enforcement:

"The integrity of our process demands that brokerage firms comply with their obligations to search diligently for, and provide in a timely way, information and documents required in arbitration proceedings and regulatory investigations," said Susan Merrill, FINRA Executive Vice President and Chief of Enforcement. "The action announced today underscores FINRA's commitment to ensuring that firms live up to those obligations. We are particularly pleased that this unique settlement directs the bulk of the monetary sanction to the customers in arbitrations, to remedy MSDW's discovery failures."

As far as I'm concerned: blah, blah, blah, blah. 


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