The BrokeAndBroker.com Blog publisher, Bill Singer, Esq., frequently derides what he calls the "lack of content and context" in FINRA Arbitration Awards; and he is unapologetic about shining an unwelcome light upon the inequities of mandatory consumer and industry arbitration. That being said, Bill absolutely loved a FINRA Arbitration Award involving an angry public customer's investments in unpopular Puerto Rican debt -- and, on top of that, a federal district court just confirmed that award. Sometimes content and context come together. Sometimes Bill is happy.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in May 2016, Claimant Schwarz asserted breaches of contract and of laws, rules, norms and regulations about good faith and fair dealing; violations of NYSE and FINRA rules, and the securities laws and other laws and regulations of Puerto Rico; and securities fraud in connection with his purchase of Puerto Rico Bonds (including Corporacion del Fondo de Interes Apremiante ("COFINA") (also known as the Puerto Rico Urgent Interest Fund Corporation) and margin loans extended to him by Respondent Merrill Lynch. Claimant Schwarz sought $1,774,301.01 in compensatory damages plus interest; disgorgement of commissions; rescission; $1,774,301.01 in punitive damages; fees, costs and expenses. In the Matter of the FINRA Arbitration Between Angel Collado Schwarz, Claimant, vs. Merrill Lynch Pierce Fenner & Smith, Inc., Respondent (FINRA Arbitration Award 16-01592, March 20, 2018). https://www.finra.org/sites/default/files/aao_documents/16-01592.pdf
Respondent Merrill Lynch generally denied the allegations, asserted various affirmative defenses, and filed a Counterclaim asserting breach of contract in connection with the balance due on margin calls against Claimant Schwarz's account. Counterclaimant Merrill Lynch sought $138,860.00 in compensatory damages plus interest. Merrill Lynch also sought the expungement of the arbitration from the Central Registration Depository records ("CRD") of a non-party who is named in the FINRA Arbitration Award but whose identity will not be provided in this article at the sole discretion of the BrokeAndBroker.com Blog. Pointedly, Claimant Schwarz appeared and opposed the non-party's request for expungement of his CRD.
The FINRA Arbitration Panel denied Claimant Schwarz's claims and found him liable and ordered him to pay to Respondent Merrill Lynch $138,860.00 in compensatory damages plus interest until paid. Additionally, the Panel found Claimant Schwarz's claims to be false and recommended the expungement of the arbitration from the non-party's CRD.
Bill Singer's Comment (about the 2018 FINRA Award)
In offering its rationale for recommending expungement, the FINRA Arbitration Panel offered an articulate and compelling statement. After three decades on Wall Street, this rationale ranks among the finest that I have read. The detail is perfect. The degree of content and context is perfect. Regardless of whether you agree or disagree with the arbitrators' verdict, you come away with an understanding of the nature of their deliberations and findings. The FINRA Arbitration Award is a document that says what it means and means what it says. This is as close to perfection as I could desire. Bravo!
To be clear - to be VERY clear - I am all too aware of the improprieties that occurred during the creation, marketing, and sales of Puerto Rican debt and fully appreciate the anti-fraud concerns raised by many consumer advocates about such transactions. I offer no personal view as to whether Claimant Schwarz's claims were deserving of an award or whether Respondent Merrill Lynch's defenses and Counterclaim were equally meritorious. I was not at any hearing. I did not hear any testimony or read any evidence. I did not represent any of the parties. As such, I defer to the three sitting arbitrators and I am merely reporting about their rendered FINRA Arbitration Award. That being said, I applaud the superb rendition, which is reprinted in pertinent part below:
Claimant stated that he is of "advanced age," a "conservative" investor and "not knowledgeable or sophisticated in securities, investments or finance," but "intelligent . . . with a good understanding of business matters."
Claimant is in his mid-sixties with a B.A. degree in Business from Puerto Rico, MBA from Syracuse University and PhD in History from Spain and has significant experience in private and public businesses. He has been a senior executive in a global marketing company, Saatchi and Saatchi, a senior executive at Pepsi-Cola Bottling Company of Puerto Rico, President of a local university, and an experienced investor in local banks. He hosts a weekly radio show, which frequently focuses on Puerto Rico's politics and economy, and has also published articles on similar subjects, in addition to being a sponsor for the Center for a New Economy which describes itself as a"n independent, non-partisan think-tank that advocates for the development of a new economy in Puerto Rico." He also founded his own political party in Puerto Rico.
The investment strategy used by Claimant at another brokerage firm focused on Puerto Rico government and agency bonds and purchasing U.S. municipal bonds on margin. When he then transferred his assets from this brokerage firm to Respondent, he opened a personal account and a corporate account, Brentanos, Inc., which he had used at a third brokerage firm; this corporate account held real property in New York City, Madrid, the Island of Culebra, and Old San Juan, among other real properties in Puerto Rico, Florida and Vermont.
Claimant rejected Respondent's initial proposal for custody of his assets because it did not provide the more than $400,000.00 per year which he had been receiving from his prior brokerage firm in a portfolio leveraged at approximately 82%. Respondent then prepared an additional package which Claimant approved. This package held Puerto Rico bonds in his individual account and U.S. securities in his corporate account. In his account opening documents, Claimant stated that he had an annual household income of $900,000.00, a net worth of $20,000,000.00, a "moderate" risk tolerance, "growth" and "income" as investment of objectives and 20 years of investment experience.
Claimant's corporate account was part of the investment strategy to create diversification and offset the concentration and attendant risks of investing solely in Puerto Rico securities.
In November 2010, Claimant deposited $600,000.00 in each account. In early 2011, Claimant deposited an additional total of almost $800,000.00 into the personal account. He then stated that he had investment objectives of income, hedging and speculation and 10 years of experience in options. In March 2011, Respondent sent him a letter disclosing risks associated with options trading, stating that "only a small percentage of options accounts are profitable." Claimant purchased call options and received a net profit. It is clear that he was aware of and willing to accept higher risks in order to increase the already high returns he was making. Claimant had not always been successful in his business ventures -- he had invested in a textbook wholesaler and a brewery, which both failed. He clearly understands the risks and rewards in investing.
In early 2012, Respondent recommended that Claimant reduce his exposure to PR bonds and purchase additional U.S. investments, and so he did in his corporate account. Late in 2012 and in early 2013, Respondent recommended that Claimant sell his Puerto Rico bonds. Claimant did sell approximately $1,800,000.00 of Puerto Rico bonds at this time, but he reinvested most of those proceeds in COFINA bonds against Respondent's recommendations. Respondent continued to recommend that Claimant reduce, not increase, his exposure to Puerto Rico securities, but Claimant believed that because COFINA bonds were backed by Puerto Rico sales tax revenues that they were an acceptable risk and of better credit quality than the previously-held Puerto Rico bonds. At these times, he was still active in the Center for a New Economy and fully aware of the Puerto Rico economy. By the end of July 2013, Claimant had approximately $7,700,000.00 worth of COFINA bonds, $1,200,000.00 worth of U.S. Municipal bonds and a margin balance of $4,800,000.00.
From October 2012 to September 2013, Respondent's financial advisors met with Claimant at least 35 times to discuss his accounts and to give written presentations that continued to provide data on Claimant's holdings, their credit ratings, interest and yield, current market values, information about U.S. and Puerto Rico bonds, monthly withdrawals and Claimant's increased use of leverage by withdrawing large sums from his portfolio. Respondent's financial advisors also expressed to Claimant their concerns about the margin calls, actual and potential.
When Claimant opened his accounts at Respondent, his combined leverage in both was 3-to-1. As of mid-2012, that leverage ratio had increased to 5-to-1, and by July 2013, it had increased to 7-to-1. Respondent's financial advisors repeatedly counseled Claimant that his depletion of equity by regularly overdrawing cash from the accounts was increasing his leverage in both, but Claimant refused to curb his withdrawals. Claimant, over time, deposited less than $4,500,000.00 and withdrew $4,100,000.00 between November 2010 and October 2013.
When the Puerto Rican bond market experienced a sharp decline in August 2013, Claimant's investments (the collateral for the margin loan) decreased in value below maintained levels and margin calls were triggered. In less than two months, Puerto Rico investment-grade bonds dropped 25-40% below their values during the Puerto Rico government shutdown of 2006 and the global financial crisis of 2008-2009.
Although Respondent, Claimant and the vast majority of other investors and firms in Puerto Rico were aware of the economic problems in Puerto Rico, no one foresaw the magnitude of the decline. The proceeds from the margin calls were not sufficient to fully pay off the margin loan balances and Claimant still owes $138,860.00.
On September 26, 2013, Claimant met with three Respondent financial advisors to discuss the liquidations in his accounts. Claimant acknowledged that he was aware of the nature and risks of the strategy he employed in the context of the new market conditions.
There exists no basis for Claimant to shift responsibility to Respondent for the losses he sustained as a result of his own fully-informed investment decisions. Based on the explanation provided, the Panel found that the allegations in the Statement of Claim were false, so the arbitration should be expunged from non-party [Ed: NAME REDACTED BY BROKEANDBROKER.COM BLOG]'s CRD records.
SIDE BAR: Federal Rules of Civil Procedure Rule 19: Required Joinder of Parties(a) Persons Required to Be Joined if Feasible.
(1) Required Party. A person who is subject to service of process and whose joinder will not deprive the court of subject-matter jurisdiction must be joined as a party if:(A) in that person's absence, the court cannot accord complete relief among existing parties; or(B) that person claims an interest relating to the subject of the action and is so situated that disposing of the action in the person's absence may:
(i) as a practical matter impair or impede the person's ability to protect the interest; or(ii) leave an existing party subject to a substantial risk of incurring double, multiple, or otherwise inconsistent obligations because of the interest.
(2) Joinder by Court Order. If a person has not been joined as required, the court must order that the person be made a party. A person who refuses to join as a plaintiff may be made either a defendant or, in a proper case, an involuntary plaintiff.(3) Venue. If a joined party objects to venue and the joinder would make venue improper, the court must dismiss that party.
(b) When Joinder Is Not Feasible. If a person who is required to be joined if feasible cannot be joined, the court must determine whether, in equity and good conscience, the action should proceed among the existing parties or should be dismissed. The factors for the court to consider include:
(1) the extent to which a judgment rendered in the person's absence might prejudice that person or the existing parties;(2) the extent to which any prejudice could be lessened or avoided by:
(A) protective provisions in the judgment;(B) shaping the relief; or(C) other measures;
(3) whether a judgment rendered in the person's absence would be adequate; and(4) whether the plaintiff would have an adequate remedy if the action were dismissed for nonjoinder.
(c) Pleading the Reasons for Nonjoinder. When asserting a claim for relief, a party must state:
(1) the name, if known, of any person who is required to be joined if feasible but is not joined; and(2) the reasons for not joining that person. . . .
at Page 9 of the DPR Opinion["W]hen the change in parties does not affect the course of the litigation, and does not embarrass the defendant, requiring the plaintiffs to start over in the district court would entail needless waste and runs counter to effective judicial administration." Cason v. Puerto Rico Elec. Power Auth., 770 F.3d 971, 977 (1st Cir. 2014). Here, Merrill Lynch has expressed that if the Court were to agree with Respondent, it would seek leave to amend its petition to eliminate the request for expungement relief. Petitioner "should not be compelled to jump through these judicial hoops merely for the sake of hypertechnical jurisdictional purity." Newman-Green, Inc. v. Alfonzo-Larrain, 490 U.S. 826, 837 (1989). This goes against judicial economy and the policies that underlie Rule 19 and FINRA's Rule 2080, which requires "[m]embers or associated persons seeking to expunge information from the CRD system arising from disputes with customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief." FINRA, Rule 2080. " '[E]ven on questions of a court's adjudicatory authority in particular, salvage operations are ordinarily preferable to the wrecking ball.' " Cason, 770 F.3d at 978 (quoting Grupo Dataflux v. Atlas Global Grp., 541 U.S. 567, 592 (2004) (Ginsburg, J., dissenting)).