February 25, 2019
In today's featured FINRA arbitration, we have Charles Schwab winning its case against two public customers. Winning as in one customer is dead and the other is nowhere to be found. Hey, at least the lawyers get paid. Making matters worse, the lawsuit revolves around the much-maligned VelocityShares Daily Inverse VIX Short-Term Exchange Traded Note. Wow, that's a mouthful. Inverse as in what goes down, theoretically goes up. Theoretically as in, holy crap, are you going to be in for a nasty surprise. Exchange Traded Note as in ETN as in, whoa, that's not the same as an ETF, is it?
Case In Point
In a FINRA Arbitration Statement of Claim filed in April 2018, FINRA member firm Claimant Charles Schwab & Co., Inc. asserted breach of contract. The FINRA Arbitration Decision asserted that the:
cause of action relates to Respondents' allegedly self-directed decision to utilize margin and accumulate a long position in VelocityShares Daily Inverse VIX Short-Term ETN ("XIV"), and Respondents' alleged contractual obligation to remit full payment of the debit to Claimant, after the collapse of XIV.
Claimant Schwab sought $636,284.53 in damages representing the account's unsecured debit balance plus interest, fees, and expenses. In the Matter of the Arbitration Between Charles Schwab & Co., Inc. Claimant, v.. Robert K. Chen and Linda T. Chen, Respondents (FINRA Arbitration Decision 18-01667 / February 20, 2019)
Respondents Robert K. Chen and Linda T. Chen did not enter an appearance but were bound by the FINRA Arbitration Panel's determination.
Following an Initial Pre-hearing Conference ("IPHC") held on August 14, 2018 that Respondents did not attend, the FINRA Arbitration Panel found that service of the Statement of Claim was complete and sufficient albeit on an "unresponsive party." Thereafter, on August 30, 2018, Claimant Schwab filed a letter advising the Panel in pertinent part that:
On August 1,2018, FINRA notified [Claimant] that it had been unable to effect service on [Mrs.] Chen. [Claimant] participated in the IPHC on August 16 under the impression that [Mr.] Chen had been properly served. On the basis that Mr. Chen had been served, the Panel determined during the IPHC that Mrs. Chen had notice of the arbitration and was therefore constructively served. The Panel then set forth in its IPHC Order that service was complete and sufficient upon the unresponsive party.
In an abundance of caution, [Claimant] nevertheless tried to personally serve Mrs. Chen after the IPHC. [Claimant] effected service on Mrs. Chen on August 20, 2018 and filed a certificate of service on the Portal. Attached is a copy of the certificate of service on Mrs. Chen.
On August 17, FINRA conveyed that it had also been unable to serve Mr. Chen. [Claimant has] since unsuccessfully tried to effect service on Mr. Chen. Our process server has been to Mr. and Mrs. Chen's home on nine occasions -- at all times of the day and on weekdays and weekends -- and no one has responded. [Claimant], therefore, respectfully requests the Panel to amend its IPHC Order (or in the alternative issue a new Order) and find that Mr. Chen has been constructively served and that service is sufficient and complete on the Respondents in this case.
By Order dated October 3, 2018, the Panel found that Mr. Chen has been constructively served, and, accordingly, the arbitrators deemed that the Respondents had been served. Thereafter, the Respondents did not appear at the January 14, 2019, evidentiary hearing. The FINRA Arbitration Decision explains that:
On January 17, 2019, the FINRA Senior Helpline received a call from Respondents' son, Mr. Chiein Chen. Mr. Chiein Chen requested that FINRA advise the Panel and Claimant of certain information, including that his father, Mr. Chen, is deceased.
By letter dated January 22, 2019, FINRA advised the Panel and Claimant of the information provided by Mr. Chiein Chen. After due deliberation, the Panel considered the information by Mr. Chiein Chen and has rendered its award.
The FINRA Arbitration Panel found Respondents jointly and severally liable to Claimant Schwab and ordered them to pay to Claimant $636,284.53 in compensatory damages with interest, $40,233.75 in attorneys' fees; $12,092.13 minus the refundable portion of the filing fee (for a total sum of $10,792.13).
Bill Singer's Comment
Ah yes, the stuff of legal fiction. You can actually have "constructive service" on the dead. Go figure! And in keeping with that somewhat odd logic, you have a FINRA Arbitration Panel rendering an award in favor of Schwab but it's on a joint and several basis to the detriment of a wife, who never filed an appearance, and her purportedly deceased husband. Good luck collecting on that.
For some interesting context to all that has become the mess of XIV, READ:
"Credit Suisse was actively manipulating the Inverse VIX Short ETNs by liquidating its holdings in various financial products to avoid a loss," Chahal's attorneys wrote in the complaint. The filing mainly draws on public information, while noting Chahal aims to turn up more evidence to bolster the case .
Credit Suisse disputed the claims.
"The publicly available prospectus accurately and fully disclosed the risks of an investment in XIV, which is only intended for sophisticated institutional clients," the Zurich-based bank said. "Credit Suisse did not engage in any conduct designed to mislead investors regarding XIV's value or cause the February 5, 2018, decline in XIV's price."
The fund's market value topped $2 billion in late January before losing most of its value in early February. Credit Suisse announced it would buy back shares in the product because there was no prospect of price recovery.
https://www.bloomberg.com/news/articles/2018-03-16/xiv-lawsuit-shows-peril-that-lurks-within-democratized-investing As noted in part in the Bloomberg article:
Of course, most investors were informed of the risks in the trade. Charles Schwab Corp. delivers a pop-up warning to those trying to buy a leveraged or inverse ETP that requires the investor to acknowledge the risks. And TD Ameritrade Holding Corp. puts a yellow banner at the top of the screen that outlines increased margin requirements and cautions that such products are not suitable for all investors.
But some fund managers privately wish brokerages would do more to keep their products away from the naive or ignorant. Their thinking is that what they might lose in assets, they'd recoup in minimizing the reputational risk that now casts a pall over their products.
Exchange-traded funds (ETFs) that offer leverage or that are designed to perform inversely to the index or benchmark they track-or both-are growing in number and popularity. While such products may be useful in some sophisticated trading strategies, they are highly complex financial instruments that are typically designed to achieve their stated objectives on a daily basis. Due to the effects of compounding, their performance over longer periods of time can differ significantly from their stated daily objective. Therefore, inverse and leveraged ETFs that are reset daily typically are unsuitable for retail investors who plan to hold them for longer than one trading session, particularly in volatile markets.
This Notice reminds firms of their sales practice obligations in connection with leveraged and inverse ETFs. In particular, recommendations to customers must be suitable and based on a full understanding of the terms and features of the product recommended; sales materials related to leveraged and inverse ETFs must be fair and accurate; and firms must have adequate supervisory procedures in place to ensure that these obligations are met. . .