IRA Customers Sue Morgan Stanley Over KFN Tax Bill

January 14, 2013

IRS 1040

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claimfiled in November 2011 and thereafter amended, Claimants  asserted unsuitability and negligence in connection with their investments in KKR Financial Holdings LLC ("KFN").

Claimants sought reimbursement for all unrelated business income taxes ("UBIT") generated for tax years 2010 and 2011 as a result of their ownership of KFN in the individual retirement accounts ("IRAs") of Claimant Kenneth Cari ($26,300 and $32,325.70) and Claimant Rebecca Cari ($4,065 and $3,175.32). Additionally, Claimants sought a 30% surcharge ($19,760) to the total taxes due because all tax reimbursements must be paid to the Claimants personally, resulting in further state and federal income tax obligations.  Finally, Claimants sought reimbursements of FINRA's $1,250.00 filing fee; and for travel and lodging and time spent in preparation and handling the arbitration in the amount of $15,000.00. In the Matter of the FINRA Arbitration Between Kenneth J. Cari and Rebecca L. Cari, Claimants, vs. John Cronin Menefee, Morgan StanleySmith Barney, and RBC Capital Markets LLC, Respondents (FINRA Arbitration 11-04219, January  7, 2013).

Respondents generally denied the allegation, asserted various affirmative defenses, and sought the expungement of this matter from Respondent Menefee's Central Registration Depository records ("CRD") .


After the conclusion of Claimants' case-in-chief, Respondent Morgan Stanley Smith Barney made an unopposed Motion to Dismiss, which was joined by Respondent RBC. In granting the motion based upon a finding that the Claimants' evidence did not support their claims, the FINRA Arbitrator dismissed with prejudice all of Claimants' claims against Respondents RBC, Morgan Stanley Smith Barney, and Menefee. Further, the Arbitrator recommended the unopposed motion for expungement of Respondent Menefee's CRD based upon the following finding:

In essence Claimants' petition claimed that selling a security that generated unrelated business income was unsuitable when the registered person and/or member firm knew the security would be held in an IRA. The facts establish that this claim is clearly erroneous: thousands of IRAs contain such securities and the Internal Revenue Service has issued specific guidance concerning the tax reporting of such investments. No IRS, SEC or FINRA rule supports the Claimants' allegations that a UBIT-generating investment is unsuitable if it is to be placed in an IRA. Although the claimants were unpleasantly surprised that tax was due on the income generated by the investment, the cause of their surprise was their failure to read the schedule K-1 tax documents they received. Because there is no evidence even suggesting that a UBIT-generating investment is unsuitable if it is to be placed into an IRA, Claimants' claims were clearly erroneous.

The facts also establish that the registered person did not commit an investment related sales practice violation. No evidence was introduced proving that the registered person's conduct was in any way negligent. The registered person did not give specific tax advice and in fact Claimants received numerous documents notifying them that neither the registered person nor the member firm was in the business of giving tax advice. Although the member firm-supplied documents urging the Claimants to seek professional tax advice in meeting their tax reporting obligations, they chose not to do so. There are no facts that establish that the registered person committed an investment-related sales practice.

Bill Singers Comment

Another Case In Point

A few years ago, I reported about a FINRA Arbitration Statement of Claim filed in October 2009 in which public customer Claimant Susan Hamovitch alleged that Respondents Merrill Lynch and Peter Inserra had been negligent and breached their fiduciary duty to her in connection with advising her about the tax consequences of certain securities transactions. Hamovitch sought sought $32,326.00 in compensatory damages plus interest and filing fees. In the Matter of the Arbitration Between Susan Hamovitch, Claimant vs. Merrill Lynch Pierce Fenner & Smith, Inc. and Peter Inserra, Respondents (FINRA Arbitration 09-05858, September 30, 2010).

READ: "FINRA Arbitration Panel Rejects Duty to Advise on Tax Consequences by Broker" (", October 6, 2010).

In Hamovitch, Respondents denied the allegations, asserted various affirmative defenses, and requested the expungement of the matter from Respondent Inserra's Central Registration Depository records  ("CRD").  The sole FINRA Arbitrator hearing the case denied Claimant's claims and recommended the expungement.

The Arbitrator found that no proof had been offered to provide any statutory, regulatory or policy basis imposing a duty upon Inserra to advise Claimant of the tax consequences of the sale of Claimant's securities. Further, Inserra testified that he provided Claimant with general tax information regarding such sale and advised Claimant to consult with her tax adviser  The Arbitrator found the stockbroker's testimony to be credible and consistent with Respondent Merrill Lynch's tax disclaimers contained in Claimant's account statements and Merrill Lynch's website and the firm's branch officeCompliance Policy Manual.

Practice Pointers

Tax law is a specialized practice and those who would dabble in that area are only courting disaster. In my own law practice, I regularly admonish my clients that I do NOT provide tax advice and that they should direct such queries to a CPA or qualified tax lawyer.

Sure - there are certain basic tax issues that it may be okay for Wall Street professionals to opine about; however, it is far more sensible to direct your clients with tax issues to qualified tax professionals AND to pointedly inform your clients that you are not qualified to give them tax advice. Public investors should consider those limitations before embarking upon plans to buy/sell securities because there could be hidden tax consequences  - resulting in one hell of a nasty surprise comes April.

The takeaway from the Caris and Hamovitch FINRA arbitrations for public customers is that your brokerage firm and stockbroker may not have a legal obligation to offer tax counsel to you when recommending investments; moreover, even if you get whacked with an unexpected (or undisclosed) tax, the totality of the circumstances may not render such a situation as tantamount to recommending an "unsuitable" investment.   All of which should serve to warn investors about the need to carefully read any tax-related disclaimers in your brokerage and investment materials and insist upon written confirmation of any oral representation to the contrary.

As to brokerage firms and industry professionals, the practice pointers are to ensure the existence of tax-advice disclaimers in:

  • new account documentation,
  • account statements,
  • the firm's websites,
  • business-related emails, and
  • relevant manuals addressing sales practices.