It doesn't walk like a customer. It doesn't quack like a customer. But one court says it looks like one -- so it's a customer.
In March 2011, Claimants Lucy and John Mattinen filed a Financial Industry Regulatory Authority ("FINRA") ArbitrationStatement of Claim against Respondents White Pacific Securities, Inc. (a FINRA member firm) and Krittibas Ray. The Mattinens alleged that WPS was in the business of marketing investment opportunities and that they dealt with Ray and others at WPS with the understanding that they were associated persons and employees of WPS.
The Mattinens alleged that Respondent Ray was a WPS registered person who had
- breached his fiduciary duties;
- made material misrepresentations; and
- used their funds for his personal expenses rather than investing them.
Further, the Mattinens alleged that Respondent WPS had failed to supervise its agent Respondent Ray.
Ray Pacific Fund
The FINRA Statement of Claim alleged that the Claimants Mattinens had invested $200,000 in the Ray Pacific Global Opportunity Fund ("Ray Pacific Fund") on or about February 19, 2010.
Thereafter, the Claimants received emails from Respondent Ray (transmitted from his WPS email account) in which the broker claimed to have achieved substantial trading profits.
The Claimants' first statement did not come until July 3, 2010, and reflected an initial investment of only $50,000, and a loss of 41.5% of that amount. Upon receipt of that statement, the Mattinens immediately requested their funds be returned to them by contacting WPS associated person Kim Wong at his WPS email address. Subsequently, a second statement showed an initial $100,000 investment with a $38,000 loss. When their requested $200,000 investment was not returned, the Claimants filed their FINRA ArbitrationStatement of Claim.
Claimant Lucy Mattinen contended that Respondent Ray had solicited the Mattinens through several communications and provided information about the Ray Pacific Fund, and in so doing, listed his address at WPS as his contact on the brochure and on his business card. Further, when Lucy Mattinen telephoned Ray, Respondent WPS answered the calls; and her emails to Ray went to his WPS email address. Finally, when she met with Ray, it was at WPS's San Francisco office, where she was also met by WPS associated person Kim Wong.
On February 13, 2012, WPS moved for a restraining order in federal court in the Northern District of California against the Mattinens in order to prevent them from continuing with their FINRA arbitration proceeding against WPS and third party Ray. White Pacific Securities, Inc.v. Lucy Mattinen And John Mattinen, (NDCA, 12 cv 151 YGR, March 19, 2012). WPS argued that it could not be compelled to arbitrate the Mattinens' claims because they had never entered into any arbitration agreement with WPS and were not "customers" of the firm.
On February 16, 2012, the Court denied WPS's TRO request but set the matter for a hearing on the propriety of a preliminary injunction .
In support of its request for injunctive relief, WPS submitted the Declaration of President Robert T. Angle, in which he stated that the Mattinens never opened or maintained an account at WPS. Further, Angle asserted that WPS was never the broker-dealer of record for the Mattinens' investment in Ray Pacific Fund. Angle denied that WPS had any association with the Ray Pacific Fund and claimed that his firm never participated in, supervised, or received compensation or commissions related to the fund.
SIDE BAR: FINRA Arbitration Rule 12200. Arbitration Under an Arbitration Agreement or the Rules of NASD
Parties must arbitrate a dispute under the Code if:
- Arbitration under the Code is either:
(1) Required by a written agreement, or
(2) Requested by the customer;
- The dispute is between a customer and a member or associated person of a member; and
- The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.
The Mattinens concede the absence of a written arbitration contract but cite to FINRA's rule that compels member firms to arbitrate all customer disputes in connection with its or its associated persons' business activities.
SIDE BAR: FINRA Arbitration Rule 12100. Definitions
Unless otherwise defined in the Code, terms used in the Rules and interpretive material, if defined in the NASD By-Laws, shall have the meaning as defined in the NASD By-Laws. . .
A customer shall not include a broker or dealer.
No, that's not a typo. The critical definition of "customer" in FINRA's rules is someone who is not a broker or a dealer. Talk about the difficulty of proving a negative! Frankly, the courts have played loosey goosey with this definition, showing a predilection for stretching the coverage of this characterization to great lengths.
Bill Singer's Comment: While this what's a customer issue may seem laughable, it has proven a particularly troubling bit of elasticity for many broker-dealers. Whether a small independent/regional firm or one of Wall Street's major players such as Merrill Lynch, Morgan Stanley Smith Barney, JP Morgan, Wells Fargo, or UBS, the unauthorized and possibly illegal activities of individual associated persons expose the employer firm to millions of dollars in liability from defrauded customers - even if those victims never had an account with the firm, never did a single trade on the firm's books, and never wrote out a check to the firm. On the other hand, investor advocates say that it is precisely this open-ended exposure for outside business activities and private securities transactions that should serve to make employers more vigilant about the activities of their employees.
Likely aware of courts' tendency to interpretive generosity, the Mattinens argued that they were customers of WPS because:
- they were not a broker;
- they were not a dealer;
- they had dealt with Ray;
- Ray was WPS's associated person; and,
- WPS failed to supervise its associated person Ray.
Not prepared to go down without a fight, WPS conceded that some relationship had existed between it and Ray, but not to the extent that the firm had any role in the Ray Pacific Fund. Notwithstanding the firm's protestations, the Court ruled that:
To the extent that WPS rests its argument on the assertion that its relationship with Ray was "independent" of Ray's activities in connection with investment in Ray Pacific, and that WPS was "unaware" of Ray's conduct in connection with that fund, the argument lacks merit. While such a distinction may bear on WPS's ultimate liability, it has no significance to the question of whether arbitration is required here. Under the FINRA Rules, there is no exemption from the obligation to arbitrate claims based upon an assertion that the activities of the associated person were unknown to the firm or were outside the normal scope of the relationship. .
King Pyrrhus of Epirus
Exit the courtroom. Enter the arbitration hearing room. Now, does any respondent have any money left to pay off any winning claims?
Oh, you think that's a joke? Before you get too carried away, how about you read this: http://www.whitepacific.com/ After being in business since 1996, WPS ceased operations on February 29, 2012.
Ray Pleads Guilty
On December 16, 2011, Ray, Albany, CA was arrested following the filing of a federal Criminal Complaint. On December 29, 2011, he was indicted on two counts of wire fraud and one count of money laundering.
On March 30, 2012, Ray, 43, pleaded guilty in federal court in San Francisco to two counts of wire fraud. As part of his plea, Ray admitted to
- enticing victims to invest in hedge funds he operated by falsely telling them that by placing funds into banks in India he could guarantee returns of 7 to 8.5 percent and that the hedge funds he was operating were profitable;
- failing to disclose to investors that he was using their money for personal expenses and to pay other investors, and that the gains he reported to investors were false; and
- receiving approximately $3.3 million from investors between February 2008 and December 2011, as part of a fraudulent scheme causing more than $2.5 million of losses.
Ray faces a maximum statutory penalty for each count of wire fraud of 20 years in prison, a fine of $250,000 and restitution.
For additional background, read
Using Promissory Note Proceeds For Weed Whacker Doesn't Cut It With FINRA ("Street Sweeper," September 16, 2011).