FINRA Arbitrator Says Compliance Not A Call To Sainthood

April 24, 2017 Blog's Bill Singer at a loss for words? Is that even possible? Yes, dear readers, Bill has virtually nothing to add to today's featured FINRA Arbitration decision. Indeed, Hell has frozen over, pigs are flying, and our publisher is stunned into rare silence. Enjoy it while it lasts!

Case In Point

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in August 2015,  and as amended thereafter, public customer Claimant Beane as representative for Brantley LTD alleged churning, suitability, unauthorized trading, negligence, breach of fiduciary duty, breach of contract, misrepresentation, violation of the Florida Securities and Investor Protection Act, failure to supervise, violation of Florida's Adult Protective Services Act, quantum meruit, violation of the Federal Securities Act, and common law fraud in the sale of securities. Claimant sought $80,970.05 in damages plus interest, punitive and treble damages, attorneys' fees, expert/witness fees, and costs. In the Matter of the FINRA Arbitration Between Kenneth Beane as representative of Brantley LTD, Claimant, vs. Craig Scott Capital, LLC, Craig Scott Taddonio, Richard Hunt Crockett, Brent Morgan Porges, and  Zachary T. Bader, Respondents (FINRA Arbitration 15-02075, April 12, 2017 ).

SIDE BAR: The FINRA Arbitration Decision presents Claimant's case as alleging that:

The causes of action relate to Respondents' alleged short-term day-trading investment strategies in exchange-traded fund ("ETF") and exchange-traded network ("ETN") products in Claimant's account, including but not limited to: Barclays Bank PLC iPath S&P 500 VIX Short Term Futures ETN; Abercrombie & Fitch CL A; AAR Corp.; Accenture PLC Ireland CL A New; Align Technology, Inc.; Basic Energy Services, Inc. New; Block H&R, Inc.; Celadon Group Inc.; DFC Global Corp.; Digital Generations, Inc.; Dominos Pizza, Inc.; Dycom Industries, Inc.; Goodyear Tire & Rubber Co.; Finish Line, Inc. Class A; Gordman Stores, Inc.; Integrated Silicone Solutions, Inc.; Knight Capital Group, Inc.; Omnova Solutions, Inc.; Perfect World Company Ltd. Spons ADR CL B; Quality Distributions, Inc.; Robbins & Myers, Inc.; Shoe Carnival, Inc.; Universal American Spin Corp.; TiVo, Inc.; Verifone Systems, Inc.; and, Wellcare Healthplans, Inc

The Decision references Claimant's allegations about trading strategies "in exchange-traded fund ("ETF") and exchange-traded network ("ETN") products" but then provides examples "including but not limited to" that are corporate names (with the sole exception of the VIX ETN) suggesting investments in shares of individual corporations in contradistinction to ETF/ETNs. That disparity leaves me confused as to whether Claimant alleged improper ETF/ETN trading or if that was merely a sub-set of questioned trading. Note that the ETF/ETN characterization is quoted from the Decision and not the Statement of Claim. Consequently, I do not know if the confusion was sown in the original pleading or in the arbitrator's synopsis.

Adding a Respondent

In July 2016, Claimant filed a motion to amend the Statement of Claim and add Respondent Crockett, who was charged with allegedly failing to prevent quantitative suitability and fraudulent churning violations. In October 2016, at a time when Respondent Crockett had failed to timely respond to the pending motion, the sole FINRA Arbitrator granted the motion to amend/add. Thereafter, Respondent Crockett filed a Statement of Answer to the Amended Statement of Claim but did not sign a Submission Agreement. In November 2016, Respondent Crockett filed a Motion to Dismiss. Respondent Crockett generally denied the allegations and asserted various affirmative defenses.

Matters of Appearances

Respondent Craig Scott Capital LLC was represented by its Owner/President/Chief Executive Officer Craig Taddonio; Respondents Taddonio, Crockett, and Porges appeared pro se; Respondent Bader did not enter an appearance.

The FINRA Arbitration Decision asserts that Respondents CSC, Taddonio, Porges and Bader did not file a Statement of Answer and did not sign Submission Agreements.

Motion to Bar

In May 2016, Claimant filed a Motion to Bar Respondents CSC, Taddonio, Porges and Bader from presenting any defenses or facts at the hearing for failing to answer. Respondents did not file any written responses to the Motion to Bar and in June 2016, the sole FINRA Arbitrator conducted a telephonic pre-hearing conference for argument on the pending motion. Only Claimant, Respondent CSC, and Respondent Taddonio participated in the conference, during which:

[R]espondent Taddonio argued that Claimant's Motion to Bar should be denied on the basis that he and Respondent CSC intended to defend against Claimant's claims and that he and Respondent CSC had participated in the telephonic pre-hearing conferences to date . . .

The sole FINRA Arbitrator barred Respondents CSC, Taddonio, Porges and Bader from:

raising affirmative defenses that must be plead in an answer, and allowed them to present evidence at the hearing on the basic issue of whether they are guilty or innocent of the offenses claimed.

Taddonio Bankruptcy

On or about September 9, 2016, Respondent Taddonio filed for bankruptcy under the United States Bankruptcy Code, prompting a stay of the proceedings as against him.  The FINRA Arbitration Decision accordingly makes no findings with respect to any claims against Respondent Taddonio.

Motion to Dismiss

In November 2016, Respondent Crockett moved to dismiss the claims against him based upon his argument, in pertinent part, that:

he was erroneously named as a party in this action and was not involved with the sales practice violations or the supervision of the account at issue. In its Response, Claimant argued, among other things, that as the Chief Compliance Officer, Respondent Crockett was responsible for exercising compliance-related supervision over Respondent CSC's brokers, and that the Motion to Dismiss should be denied as it was not yet ripe for consideration. On January 11, 2017, the Arbitrator conducted a recorded telephonic pre-hearing conference so the parties could present oral argument on Respondent Crockett's Motion to Dismiss. Respondents CSC and Crockett attended the call. Respondents Porges and Bader did not participate. Thereafter, the Arbitrator entered an Order in which he denied Respondent Crockett's Motion to Dismiss.


The sole FINRA Arbitrator ruled that:

1. Respondents CSC, Porges and Bader are liable for churning, suitability, unauthorized trading, negligence, breach of fiduciary duty, breach of contract, misrepresentation, violation of the Florida Securities and Investor Protection Act, failure to supervise, quantum meruit, violation of the Federal Securities Act and common law fraud in the sale of securities and shall pay to Claimant the sum of $80,970.05 in compensatory damages, plus interest at the rate of $4.84% per annum from August 5, 2015, until paid.
2. Respondents CSC, Porges and Bader are liable for willful wanton reckless disregard for customers and fraud, and shall pay to Claimant the sum of $81,000.00 in punitive damages, pursuant to In Re Phar-Mor, Inc. Securities Litigation, 900 F. Supp. 784 (W.D. Pa. 1995).

3. Respondents CSC, Porges and Bader are liable for and shall pay to Claimant the sum of $36,400.00 in attorneys' fees, pursuant to Florida Statute §772.11.

4. Respondents CSC, Porges and Bader are liable for and shall pay to Claimant the sum of $4,025.00 in forensic analysis fees.

5. Respondents CSC, Porges and Bader are liable for and shall reimburse Claimant the sum of $225.00 for the non-refundable portion of the filing fee previously paid to FINRA Office of Dispute Resolution.

Nice Payday

In terms of monetary damages, costs, and fees, that's a fairly clean sweep of a victory for Claimant. Notably, the Arbitrator awarded $81,000 in punitive damages plus $36,400 in attorneys' fees in addition to the compensatory damages and interest. An impressive victory for Claimant's lawyer, who is referenced in the Decision as
"Hilton Wiener, Esq., Law Office of Hilton Wiener, New York, New York."

No Alamo for This Crockett

Missing from the list of Respondents found liable is Respondent Crockett because the Arbitrator had dismissed all claims against him. In response to a request from Respondent Crockett for an opinion on his alleged liability, the sole FINRA Arbitrator offered the following, which he pointedly admonished was not in response to an expungement request and was only provided for the information of the parties:

The testimony showed that Respondent Crockett was Respondent CSC's Chief Compliance Officer. Respondent Crockett said that he could not remember the particular facts associated with Claimant's case. However, he felt sure it would have been among sixty (60) cases that had been red-flagged to senior management for churning and other nefarious activities. That was because its characteristics matched those of cases he remembered red-flagging.

By the time of closing arguments, Claimant acknowledged that Respondent Crockett did not commit fraud and dropped all such claims. Claimant alleged, however, that Respondent Crockett was nevertheless liable for the losses based upon an alleged violation of FINRA Rule 4530, which requires a person designated within the firm to promptly notify FINRA of misconduct. Unfortunately, full copies of the internal company documents were not available. Respondent Crockett left the firm under hostile circumstances in January 2013 and lost access to firm documents at that time. Respondent CSC should have had all these records, as the corporate Respondent, but did not comply with FINRA's automatic arbitration discovery requirements.

Respondent Taddonio, the Owner, President and Chief Executive Officer of corporate Respondent CSC, appeared as a subpoenaed witness and in his capacity as the limited liability company's designated representative. Because Respondent Taddonio declared personal bankruptcy, the case against him, personally, has been stayed. Respondent CSC, the limited liability company, is not bankrupt and no stay has been imposed with respect to its liability.

Respondent CSC and those remaining Respondents who have access to internal company documents were under a duty to supply them, including a copy of the compliance manual. They failed to do so, violating FINRA's discovery rules. As a result, Claimant requested an adverse inference and the assumption that the documents would have been harmful to their defense. The request for an adverse inference was granted.

Respondent Crockett did manage to obtain various snippets and sections of the firm's compliance manual in January 2017. He testified that he was called by FINRA to testify at a disciplinary hearing and that he was given the documents to review. He appeared live, pursuant to the demand of Claimant, and was cross-examined on March 21, 2017. The next day, while presenting his own short case-in-chief, he appeared by telephone conference call, and proffered the documents he had gathered from the FINRA enforcement action, submitting them as rebuttal evidence to testimony given by Respondent Taddonio, as a subpoenaed witness and representative for Respondent CSC.

Respondent Crockett requested leave to scan and file these documents as "Respondent's Exhibit 1" after the close of the live hearing. The request was granted and Claimant was given five days to object to their admission and consideration. In the end, Respondent Crockett's supplemental documents were received into evidence and carefully reviewed by the Arbitrator. The documents were collectively designated Respondent Crockett's Exhibit "1".

According to the compliance manual snippets, it is clear that Respondent Taddonio was not merely the firm's CEO. He was also branch manager, and he and Respondent Porges were designated as the primary supervisors of this one-branch brokerage house. Both men ignored the red flags raised by Respondent Crockett.

FINRA Rule 4530(b) requires members "to report misconduct that is widespread and arises out of material failure of the firm's policies and practices to FINRA". Rule 4530 went into effect on July 1, 2011, and is a rewritten version of former NASD Rule 3070. It bears noting that many of the Claimant's losses had already occurred by August 1, 2012, when Rule 4530 would have obliged the responsible person at the firm to report misconduct to FINRA. Respondent Crockett admitted to seeing and identifying the misconduct. He then reported it to his superiors, first in 30 customers' portfolios, and then, later, in 60 more customers' portfolios. He waited for the firm's owners, Respondents Taddonio and Porges, to take remedial action. They never did.

In spite of bearing a "fancy" title of "Chief Compliance Officer", given to him by the firm and listed on regulatory documents, Respondent Crockett actually had little real authority. For example, he was not even permitted to call customers of the firm, and his access to exception reports delivered from the clearing firm was sometimes cut off, when it suited the needs of the firm's owners. Regulatory Notice 11-06 provides that a member firm designate a particular "person(s) within the firm who will be responsible for reaching such conclusions" under Rule 4530. Respondent Crockett is a licensed person but is NOT a member firm. Theoretically, Respondent Crockett could have been designated as the person responsible for making such reports, but there is no evidence that he was.

The manifest weight of the evidence supports the probability that either Respondent Taddonio and/or his business partner, Respondent Porges, were the designated persons who had such authority. The law does not require a person without authority to become a self-sacrificing whistleblower.

It is unfortunate that Respondent Crockett was not courageous enough to go outside the chain of authority. If Respondent Crockett had done so, and made an unauthorized report to FINRA, it would have been an admirable act, and it certainly would have benefitted customers. That said, he would almost certainly have been fired for doing it. The law requires compliance but not Sainthood. . .

Bill Singer's Comment

Normally, at this juncture, I would offer my Blog readers my quirky take on the Arbitrator's Decision and his unusual statement about Respondent Crockett's liability. Not today. The Arbitrator's words eloquently and succinctly say what they mean and mean what they say. In response,  I offer a tip of the hat and a respectful bow -- it's hard not to be in awe of anyone who writes that the "law requires compliance but not Sainthood."

Compliments to the sole FINRA Arbitrator, Avery B. Goodman, for a generally superb FINRA Arbitration Decision replete with content and context that rendered the published document comprehensive and compelling.