May 11, 2017
VirnetX Holding Corporation and Apple have been fighting a patent infringement case in the federal courts with victories for VirnetX in the district court but with Apple prevailing on appeal. Still, the war wages on. In a recent Financial Industry Regulatory Authority arbitration, we find a public customer suing JP Morgan over losses sustained in her massive position of VirnetX, a company purportedly founded by her uncle. The customer was demanding at least $6.6 million in damages. There was a lot at stake for both sides. There are also many lessons taught in this arbitration as to what customers and industry participants may need to preserve and to prove in order to prevail in such disputes.
Case In Point
In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in October 2015, Claimant Nosbaum asserted negligence; violations of FINRA Conduct Rule 3010: Failure to Supervise; breach of fiduciary duty; violations of the Illinois Consumer Fraud and Deceptive Practices Act; violations of FINRA Conduct Rule 2111: Unsuitability; breach of contract; and common law fraud. The causes of action allegedly arose in connection with Respondent JP Morgan's recommendations to hold shares of VirnetX Holding Corporation ("VHC") instead of diversifying. Claimant sought $6,638,553.00 in compensatory damages plus punitive damages, interest, attorneys' fees, and costs. In the Matter of the FINRA Arbitration Between Britta Nosbaum, Individually and on behalf of the Finn G. Nosbaum Trust and the Lillian R. Nosbaum Trust, Claimant, vs. J.P. Morgan Securities, LLC, Respondent (FINRA Arbitration 15-02672, May 5, 2017).
Respondent JP Morgan generally denied the allegations and asserted various affirmative defenses.
Motion for Directed Verdict
At the final FINRA arbitration hearing, after the presentation of Claimant's case-in-chief, Respondent made an oral Motion for Directed Verdict, that Claimant opposed. The FINRA Arbitration Panel denied the motion as to the negligence and suitability counts but granted as to the remaining.
At the final hearing, Respondent sought the expungement of the matter from the Central Registration Depository records ("CRD") of non-party Christopher D. Nield, which Claimant opposed.
The FINRA Arbitration Panel denied Claimant's claims.
The Panel recommended the expungement of non-party Nield's CRD based upon a finding that Claimant's claims were clearly erroneous. The Panel succinctly noted that:
The evidence produced by witness testimony and exhibits presented by both parties during arbitration established that at no time did Christopher D. Nield violate any statutory or common law obligations. Mr. Nield always made suitable and appropriate investment recommendations to Ms. Nosbaum, both individually and as trustee for the separate trusts of her two children.
In setting forth its basis for the expungment recommendation, the Panel offered this detailed rationale:
Bill Singer's Comment
At the first meeting between Mr. Nield and Ms. Nosbaum, Mr. Nield made an explicit recommendation to sell the single concentrated stock position to create a diversified managed portfolio. During this meeting, Mr. Nield supported his discussion with Ms. Nosbaum and her husband through a presentation and delivery of a personalized, sample portfolio. Nowhere in this proposed well-balanced managed portfolio was there a recommendation to maintain or hold a majority or any position of this single security or any other specific security. During this meeting, Ms. Nosbaum acknowledged she must give up her discretion to make this happen; however, at no time with JP Morgan Securities did she ever give up her 100%, non-discretionary account.
Neither Mr. Nield nor anyone at JP Morgan Securities ever recommended maintaining or holding a concentrated position in this security. Mr. Nield communicated regularly with Ms. Nosbaum by phone, email or in person 1-4 times per month, although not every conversation was memorialized in the call log or in an email. At Ms. Nosbaum's request, Mr. Nield emailed her news (positive and negative) on this stock as it became available. She also emailed him news. Mr. Nield was never comfortable with the maintenance of a highly-concentrated position in a single, highly volatile stock.
While no explicit recommendation to hold exists, numerous explicit references to sell are present. Sometimes, Ms. Nosbaum followed a recommendation to sell, but she never sold the recommended number of shares and she refused to sell enough shares to create a well-balanced portfolio.
Ms. Nosbaum arrived at JP Morgan Securities with a portfolio of predominantly a single stock. She possessed approximately 84,891 shares and each of her children's trusts had approximately 47,114 shares. Ms. Nosbaum received this stock in gift from her mom years earlier, as reflected in SEC S1 filing. Despite Ms. Nosbaum's direct request for financial planning advice, she ignoring [sic] this stock's extreme volatility, as well as her prior signed acknowledgement of the risks of owning this single, concentrated stock position. Ms. Nosbaum was not a naive investor. She watched the stock "legitimize itself over time" with a prior brokerage firm, and experienced dramatic ups and downs. She followed this stock on her smart phone and on her computer. She talked about it also with family members and her uncle, who was the founder and CEO of this security. She also received emails directly from the security communications officer. Although Ms. Nosbaum expected to hear from JP Morgan Securities precisely when she should sell and how much, no one on earth could predict this. In this case, Ms. Nosbaum always chose when to sell and how much to sell. Mr. Nield's actions with this customer were suitable and not negligent. Mr. Nield did not violate the FINRA Security Suitability Rule based on his investment strategy and advice for this customer. Furthermore, Mr. Nield was not negligent in making trade recommendations to sell and create a diversified balanced portfolio, and as opposed to holding concentrated shares in a single stock position.
Compliments to this FINRA Arbitration Panel on a very compelling presentation of the pertinent content and context of the underlying facts in this dispute. Also, the extensive rationale used to support the expungement recommendation is thorough and provides helpful guidance to customers and industry participants planning to file or defend against similar cases.
Perhaps the most fascinating aspect of this arbitration was the degree to which the Panel referenced the content of meetings, the topics of discussions, the subject of emails, and similar communications between Nield and Nosbaum. Although the FINRA Arbitration Decision does not explain the basis upon which the arbitrators made their findings about the exchanges between the customer and the stockbroker, consider the granularity of what was stated in the arbitrators' rationale:
At the first meeting between Mr. Nield and Ms. Nosbaum, Mr. Nield made an explicit recommendation to sell the single concentrated stock position to create a diversified managed portfolio.
How did the Panel come to know about this first meeting? What exhibits were entered into the record in that regard? Did Nield and Nosbaum remember the "explicit recommendation" or had they retained notes to refresh their memories? Imagine that you are a public customer or stockbroker and the ability to sway three arbitrators concerning a $6.6 million dispute depends on your ability to prove your version of a single meeting. Think about what you would need to prove that your recollection of that meeting is correct and that your adversary's is wrong. As noted in Nosbaum, someone was able to the Panel that the explicit recommendation made by Nield to Nosbaum specifically involved the sale of a single concentrated position in order to diversify the portfolio.
Additionally, consider that the arbitrators ultimately believed that during the first meeting:
[M]r. Nield supported his discussion with Ms. Nosbaum and her husband through a presentation and delivery of a personalized, sample portfolio.
Note that not only was there a "discussion" between Nield and Nosbaum and her husband, but, more critically, that Nield made a "presentation and delivery of a personalized, sample portfolio." One meeting. Three participants. A presentation. The delivery of a sample portfolio. That's a lot of facts. That's a lot of information to recall and to prove. In Nosbaum, it appears that the Panel opted to largely believe Nield and JP Morgan's version of events, which was likely prompted by records that were or weren't retained and credibility determinations pertaining to various witnesses' recollections. All of which underscores the need to document communications and retain supporting proof. Re-read the Panel's rationale and take note of references to the "call log" and email (which may have been produced from the firm's digital archive).