FINRA Enforcement Loses Dramatic ARS Case

September 4, 2012


On April 14, 2010, the Financial Industry Regulatory Authority's ("FINRA's") Department of Enforcement ("Enforcement") filed a Complaint against Respondent Richard E. Morrison ("Respondent") asserting three cause of action:

  1. material omissions in the sale of Auction Rate Securities ("ARS") to eight corporate clients, in violation of NASD Rule 2110 ("First Cause");
  2. failing to disclose in late 2007/early 2008 to one of the eight corporate clients that the market for ARS was "under stress or otherwise in trouble," in violation of NASD Rule 2110 ("Second Cause"); and
  3. failing to obtain written authorization from the eight clients for the exercise of discretion, and failing to obtain written acceptance of the accounts as discretionary from his firm, in violation of NASD Rules 2510 and 2110 ("Third Cause").

FINRA Departtment Of Enforcement, Complainant, v. Richard E. Morrison,Respondent (FINRA Disciplinary Proceeding 2008013863702, August 28, 2012).


Respondent was one of three members of the Corporate Cash Management Group ("CCM") at Jefferies & Co., Inc. ("Jefferies"). CCM managed the cash needs of about 40 corporate clients by investing in safe and liquid investments. Respondent's CCM role was primarily to solicit clients and structure their portfolios; he did not select ARS for the clients or execute any trades.

The FINRA Decision characterizes the bulk of CCM's clients as "sophisticated companies," among which were those seeking CCM's management of their cash needs and for which CCM exercised limited discretion by selecting investments and making the decisions on when to buy and sell, subject to the clients' investment guidelines. The average size of the limited-discretion clients' accounts was about $75 million.

CCM did not charge its clients for transactions or services but received most of its compensation from issuers as trailing commissions on the ARS in its clients' accounts. When CCM bought new issue ARS, it typically received additional compensation from the underwriters in the form of discounts on the price of the ARS. CCM received a share of the discounts from Jefferies as additional compensation for the members of the group.

The FINRA Complaint alleged misconduct involving eight companies for which CCM exercised limited discretion, and of those eight, only three were Respondent's clients - notwithstanding, Enforcement charged that Respondent had a duty to make disclosures to all eight limited-discretion clients because of the close working relationship among the members of the CCM team.

First Cause Dismissed

In dismissing the First Cause, the FINRA Extended Hearing Panel found that Respondent had, in fact,  disclosed to his clients that CCM would purchase new issue securities and receive additional compensation - moreover, the Panel deemed such disclosures as not material under the circumstances of the client relationships because, among other considerations:

  • the new issue securities satisfied the clients' investment guidelines,
  • any yield differences would be eliminated at the next auction, and
  • CCM could not share in the new issue discount.

Further the Panel found that Enforcement failed to prove that there were comparable or similar ARS with a higher yield.  As to the non-disclosure of CCM's practice of engaging in cross trades among clients, the Panel found that this was not a material factor and the crossing of trades actually benefited clients.

Second Cause Dismissed

In dismissing the Second Cause, which related only to a single limited-discretion client, the Panel found that Respondent did not believe that the market was in trouble during that relevant time, and was not negligent in failing to conclude and warn clients that market was "under stress" or "in trouble." The Panel noted that:

In fact, the ARS market collapse was catastrophic for the market as a whole precisely because it was unforeseen by the sophisticated investors who had $330 billion invested in ARS at the time the ARS market collapsed in February 2008.

Third Cause Dismissed

Finally, the Panel dismissed the Third Cause because Jefferies was fully aware of and approved CCM's practice of trading in the subject accounts without written authorization, which was consistent with industry practice.

Bill Singers Comment

As I and many other industry commentators have long noted, the ARS market collapse was a circumstance that has victimized many public customers andmany registered persons.  While hindsight gives us superb 20/20 vision, the fact remains, and this Panel eloquently restated it, that this was an unforeseen collapse that bushwhacked even sophisticated market participants.

Think of a tsunami wave - you didn't know it was coming; by the time the warning was issued, the wave was upon you; there was nothing you could have done to prevent it; there was nothing you could have done to avoid it; and you and everyone else were swept away in it path.

Proactively, Wall Street now knows that market earthquakes produce tsunami, and the oft-repeated ARS assurance that the auction markets were liquid and the investments "good as cash in the bank" were dead wrong.  Nassim Taleb has explained the stupidity of such false assurances and misplaced comfort in his Black Swan Theory, and I will not attempt to footnote his extensive treatise.

Suffice it to say, in my opinion, this FINRA Panel got it right.

The Respondent here was more victim than malefactor.  That, however, does not lessen the burden on Wall Street for having buried the markets and investors under a killer wave of toxic and exotic garbage; nor does it lessen the failure of too many industry professionals to have done more exacting due diligence.

Ultimately, these ARS cases have taken their toll among all facets of the brokerage industry - from smaller indie/regional firms, to the likes of E*Trade, Oppenheimer, Bank of AmericaCitigroup,  UBS and others.  The simple point in this case is that given the Respondent's state of mind, he did not appear to have engaged in fraud or material misstatements - he repeated what he thought was correct without any obvious intent to defraud.

See some of these "Street Sweeper" articles:

E*Trade Settles Auction Rate Securities Case But The Product Keeps On Giving Grief (May 16, 2012)

Public Customer Seeks $1 Million From Oppenheimer in ARS Arbitration (December 2, 2011)

The Ghost of Bear Stearns Raised in $59 Million FINRA ARS Arbitration Against JP Morgan (November 8, 2011)

US Airways Lands $15 Million FINRA Auction Rate Securities Award (June 2, 2011)

Arbitration Litigates ARS Suitability (December 29, 2010)

Also see,  the Securities And Exchange Commission's "Auction Rate Securities" webpage for a comprehensive discussion of ARS, why it failed, and the industry's settlements.