Customer Seeks $2 Million In Puerto Rico Bond Arbitration

October 12, 2018

If you've been following Puerto Rico's financial crisis, you know that the Commonwealth's bonds are worth about the paper that they were printed on, but for the fact that there are liens on the paper and pending judgments on the ink. Some folks knew that they were investing in junk, however, and paid pennies for what they hoped would be dollars in returns. They knew the risks. They accepted it in consideration of the pay-off. Other folks bought what they were sold in the form of tax-advantaged debt from the purportedly venerable Commonwealth: turned out to be dollars invested into what may pay pennies. In today's featured FINRA arbitration, we got an unhappy customer who is seeking at least $2 million in damages from her Puerto Rico bond investments. It sort of seems like a slam dunk win. Then again, wasn't that how the bonds were marketed?

Case In Point

In a Financial Industry Regulatory Authority ("FINRA") Arbitration Statement of Claim filed in June 2017, public customer Claimant Leviton asserted breaches of contract and fiduciary duty, violation of FINRA Rules, and negligence. Claimant sought not less than $2 million in compensatory damages, attorneys' fees, costs, and expenses. In the Matter of the FINRA Arbitration Between Rose Leviton, Claimant, vs. Janney Montgomery Scott LLC, Stifel, Nicolaus & Co., Inc., and David Neal Cohen, Respondents (FINRA Arbitration 17-01478, October 3, 2018).

Respondents generally denied the allegations and asserted various affirmative defenses. Respondent Cohen sought the expungement of the matter from his Central Registration Depository records ("CRD"), which Claimant contested.


The FINRA Arbitration Panel denied Claimant's claims.

The Panel recommended the expungement of the matter from Respondent Cohen's CRD based upon a FINRA Rule 2080 finding that the claim, allegation, or information is factually impossible or clearly erroneous and false; and the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds. In recommending expungement, the Panel offered this rationale:

The Claimant's account was non-discretionary and claimant authorized or consented to each and every sale/buy. The percentage of Puerto Rico bonds in Claimant's account was not excessive, taking into account all findings, including total balance in account, that entire account made a profit, and that some of the bonds were insured.

The Panel found Claimant's credibility to be lacking as follows: (1) Claimant's investment practices were basically the same before, during and after the period in question; (2) Claimant's claim of inexperience or naivete was disproven by her activities, i.e., she initiated some investments, including at least one IPO; she was day trading in a separate account, unbeknownst to Respondent David Neal Cohen, during part of the period in question; she informed Respondent David Neal Cohen of a desire to invest in Chinese stocks unfamiliar to Respondent David Neal Cohen; her net worth was Approximately $15 million including real estate holdings.

The Panel also found Respondent David Neal Cohen's expert testimony to be more thorough and convincing than Claimant's testimony. Taking into consideration the broker's unblemished 35-year CRD record, the Panel found grounds for expungement.

Bill Singer's Comment

An interesting aspect of the FINRA Arbitration Decision was its finding that Claimant Leviton was not the inexperienced investor that she apparently tried to present to the arbitrators. Notably, she was characterized in the Decision as "day trading in a separate account, unbeknownst to Respondent David Neal Cohen." As to Claimant's willingness to take on risk, the Decision relates that she had expressed an interest to Cohen in investing in Chinese stocks that were unfamiliar to the stockbroker. Add into that mix the fact that Leviton had a net worth of some $15 million, and it's not a cocktail that will likely persuade many impartial arbitrators that they are dealing with a vulnerable, unsophisticated, and impressionable customer. Worse for Leviton, the arbitrators recognized that her account showed a net profit and some of the bonds were insured. Even worse for Leviton, the arbitrators weighed her credibility against Respondent Cohen's "unblemished 35-year CRD record."

What then are we to make of the appropriateness of an investment such as Puerto Rico bonds? More to the point, let's just agree for argument's sake that there was a point in time when the bonds were reasonable investments presenting known risks and offering a calculated benefit. Let's also agree that at some point in time, as the Commonwealth's financial status became better known, repayment of principal and ongoing interest was doubtful. Let's also acknowledge that speculative investments -- wildly, off-the-chart-risk -- may still present a reasonable investment opportunity for an investor who does her due diligence, is fully aware of the enormous risks, and knowingly chooses to invest in an uber-speculative piece of junk. Sometimes that gambit works. Most of the time, however, when you pay pennies on the dollar, you lose the pennies. 

Is it the role of Wall Street or its regulators to eliminate opportunities to invest in "excessive" risk? Should Wall Street offer investors an insurance policy against speculative losses? The quick answer is "No," but the more thoughtful answer is that it sort of depends on what Wall Street thinks are the ethical principles upon which its client relationships should be based. When was the last time you saw a regulator at a casino crap table checking the financials of those who wanted to throw the dice? Yes, I know, that's different. Gambling is not investing. Except when it is.

Is it okay for Wall Street to sit back and watch its customers commit economic suicide? I don't think so. Which prompts me to ask, yet again, why Wall Street doesn't have an Anti-Fraud Fund to compensate investors who were proven defrauded by insolvent broker-dealers or their associated persons. And while you're pondering that ethical challenge, consider the ongoing debate among proponents and detractors of the "Best Interest," "Suitability," and "Fiduciary" standards. For those of you wondering, I am a libertarian who is suspicious of big government and its clumsy interventions into our bedrooms and boardrooms. On the other hand, after some four decades on Wall Street, I know it is an industry rife with fraud and lacking in effective regulation. Investors must be protected. It is in the industry's best interest to police the markets and sales practices. In providing such protections, we must be careful not to quench the fires of entrepreneurship and risk-taking. 

Free markets thrive on risk. 

Free markets can only survive if they are fair. 

Fair markets require intelligent regulation.

Today's FINRA arbitration is a useful tool. It warns public customers that their backgrounds and investment histories may well influence a decision on awarding them damages. For those in the industry, today's case shows that all is not lost and that industry respondents can prevail in a FINRA customer arbitration. As to the costs of winning or losing those arbitrations, well, that's another lesson to be gleaned from today's case. Given that an independent panel of three FINRA arbitrators denied all of the public customer's claims and recommended an expungement for the victimized stockbroker, how much do you think FINRA managed to rake in for conducting this piece of dubious litigation? Go ahead . . . guess. And when you come up with your guesstimate, apportion it as you think fair among the Claimant and three Respondents. Okay, pencils down. Books closed. And the answer is:

Total Charges and Fees: $40,450:

Claimant Leviton: $2,000 Initial Claim Filing Fee; $9,325 Hearing Session Fees

Janney Montgomery Scott LLC: $3,025.00 Member Surcharge; $6,175.00 Member Process Fee

Stifel, Nicolaus & Co., Inc.: $3,025.00 Member Surcharge; $6,175.00 Member Process Fee; $1,400 Postponement Fee

Janney Montgomery Scott LLC,  Stifel, Nicolaus & Co., and David Neal Cohen: $9,325 Hearing Session Fees (joint and several)