Did You Hear The One About The Customer Who Sued Because He Didn't Know Insider Trading Was Illegal?

January 5, 2021

It all started with a customer's complaint. Except the branch manager, who got named in the ensuing lawsuit, had no involvement in, or knowledge of, the activities at issue. Notwithstanding the no-involvement and no-knowledge aspects, FINRA still required that the manager's industry record be marked up by the inclusion of the customer's complaint. Worse, FINRA then collected a number of fees on its way to setting up an expungement arbitration by which the poor manager had to clear his name via a time consuming and somewhat expensive process. Thankfully, a FINRA Arbitrator found that the underlying customer lawsuit was meritless.

Case In Point

In a FINRA Arbitration Statement of Claim filled in July 2020, associated person Claimant Borders sought the expungement of a customer dispute ("Occurrence #1277205") from his Central Registration Depository records ("CRD"). In the Matter of the Arbitration Between William H. Borders II, Claimant, v. Raymond James & Associates, Inc., Respondent (FINRA Arbitration Award 20-02422)

Respondent Raymond James did not oppose Claimant Borders' requested expungement, and, further, the firm did not appear at the hearings. Similarly, although notified about the expungement hearing, the customer involved in Occurrence #1277205 did not oppose the requested relief, declined to attend the hearing, and responded as follows:

Dear Mr. Everest, This is in response to your client William Borders' request to remove my complaint in the Morgan Keegan lawsuit. This is to certify that I have no objections or complaints for Mr. Borders' request. I will not be involved in any future complaints or arbitration.

The Kentucky Lawsuit

In recommending expungement of Occurrence #1277205, the sole FINRA Arbitrator offered, in part, this explanation:

Pursuant to Rule 13805 of the Code of Arbitration Procedure ("Code"), the Arbitrator has made the following Rule 2080 affirmative findings of fact: 

The claim, allegation, or information is factually impossible or clearly erroneous; 

The registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation, or conversion of funds; and, 

The claim, allegation, or information is false. 

The Arbitrator has made the above Rule 2080 findings based on the following reasons: 

Claimant has satisfied each of the three (3) elements for expungement under Rule 2080. Claimant's request for expungement arises from a Kentucky civil lawsuit that a customer of MKG filed against several defendants, including Claimant (the "Lawsuit"). The Customer was not a customer of Claimant. 

The Customer alleged that the defendants in the Lawsuit, including Claimant, failed to inform him that his stock trading activity based on insider information provided by others than Claimant was illegal. The Customer filed the Lawsuit in an attempt to recover fines paid as a result of his insider trading activities. At the time of the Customer's insider trading activity, Claimant was the branch manager for MKG. Claimant did not know and had never met the Customer during the Customer's period of insider trading activity. Claimant had no involvement with, or knowledge of, the Customer's insider trading activities. Regardless, Claimant was named a defendant in the Lawsuit. As a business decision, MKG decided to settle the Lawsuit. Claimant had no involvement in the decision to settle, was not asked to contribute to the settlement, and made no contribution to the settlement. Despite having had no involvement with the Customer, or knowledge of his insider trading activities, Claimant's CRD records reflect the meritless Lawsuit the Customer brought that included Claimant as a defendant. 

Claimant's request for expungement is recommended because the claim that led to the occurrence was without merit, factually impossible and clearly erroneous. Claimant had no involvement in the matters that gave rise to the Customer's Lawsuit that included him as a defendant. Claimant was not involved in the Customer's insider trading activities. The United States Securities and Exchange Commission dismissed all criminal charges against Claimant for insider trading involvement. A jury acquitted Claimant of civil charges relating to any involvement in the Customer's insider trading activities. Claimant had no knowledge that the inside information was being passed to the Customer. Consequently, Claimant could not have advised the Customer that his trades based on insider information were illegal. 

Because Claimant had no involvement in, or knowledge of, the Customer's insider trading activities, the civil claim brought against Claimant is false. While Claimant only needed to satisfy one element of Rule 2080 to qualify for expungement, he has satisfied each. One purpose of the CRD is to provide accurate, useful and actionable information to investors. Removal of the reference to the false and meritless Lawsuit will provide investors with more accurate information about Claimant.

Bill Singer's Comment

Compliments to FINRA Arbitrator Sipper for a thoughtful and compelling rationale replete with sufficient content and context so as to render his findings intelligible!

On Wall Street, there is a tension between, on the one hand, investor advocates, who understandably cast a wary eye on what they see as the industry's too easily granted expungements, and, on the other hand, advocates for those industry participants who are aggrieved by the damage to their reputation that they ascribe to false allegations by disgruntled customers or former employers. More often than not, the overwhelming evidence is that those accused of misconduct by customers are fairly charged -- which is in stark contrast to the far more murky evidence attendant to intra-industry disputes. As such, even if only a relatively small percentage of those accused, many industry participants are victimized by unscrupulous public customers and their lawyers, and, on top of those numbers, many associated persons are also victimized by former employers eager to throw then under the bus. To be clear, my experience has shown that the vast majority of angry public customers are justified in their complaints; but I am also aware of large numbers of stockbrokers and other Wall Street employees who find their careers in ruin because of unwarranted customer complaints or wrongful terminations.

In Borders, we are confronted with a situation where a public customer seems to have argued that he was unaware of the illegality of "stock trading activity based on insider information." Given that professed ignorance of the law, that same customer apparently argued that the servicing brokerage firm and its employees had some obligation -- some responsibility -- to alert him to his folly. Ummm . . . okay . . ..  ummm . . . sure . . . but, you know, the FINRA Arbitration Award makes it clear that Claimant Borders "had no involvement with, or knowledge of, the Customer's insider trading activities." Unfortunately for Borders, his employer settled with the customer for business reasons, and despite not contributing a penny to said settlement, Borders wound up with this mess on his CRD after having been named as a Defendant in the customer's civil suit. You'd think that having "no involvement" would be enough to prompt FINRA or some regulator to take the initiative and expunge Borders' CRD on its own volition without making him jump through hoops afire and at considerable financial cost, but, hey, that's not how Wall Street works. When it comes to the industry's men and women, they are so much fodder for these heartless and expensive protocols.  

SIDE BARU.S. Securities and Exchange Commission Litigation Release No. 18640 / March 26, 2004

SECURITIES AND EXCHANGE COMMISSION v. WILLIAM H. BORDERS II, United States District Court for the Western District of Kentucky (Bowling Green), Case No. 1:03 CV-134-R

The Securities and Exchange Commission ("Commission") today announced that, on March 5, 2004, following a five-day trial, a jury in Bowling Green, Kentucky returned a verdict in favor of the defendant, William H. Borders II. The Commission had charged that Mr. Borders, 41, had engaged in insider trading in violation of the federal securities laws, specifically Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. During the relevant time period, Borders was a stockbroker employed by brokerage firm Morgan Keegan & Co., Inc. in its Bowling Green, Kentucky branch office.

This action was filed on March 14, 2000 against Mr. Borders and eighteen other defendants in the U.S. District Court for the Southern District of New York as SEC v. John Freeman, et al., No. 00 Civ. 1963 (VM). Criminal charges were filed on the same day by the United States Attorney for the Southern District of New York against these defendants for the same conduct. Each of the other eighteen defendants was convicted of insider trading by guilty plea or following a criminal trial. Criminal charges against Borders were dismissed, and the SEC's claims against Borders were severed and transferred to the federal district court in Bowling Green, Kentucky for trial. The SEC's claims against the other eighteen defendants have all been resolved.

The Commission alleged that from 1997 through January 2000, Mr. Borders and others engaged in a widespread insider trading scheme that produced over $8 million in illegal profits from trading in the securities of 23 public companies. The Commission alleged that John Freeman, a temporary word-processing employee at Goldman Sachs & Co., Inc. and later Credit Suisse First Boston, tipped a number of defendants about merger and acquisition transactions involving clients of those investment banking firms. The Complaint further alleged that Borders participated in and profited from the scheme through a chain of tipping and trading that originated with Freeman and ultimately led to Morgan Keegan's Bowling Green branch office.

Securities and Exchange Commission v. William H. Borders II, 1:03 CV-134-R (Western District of Kentucky). See also, Securities and Exchange Commission v. John Freeman, James Cooper, Benton Erskine, Anthony Seminara, Norman Lehrman, Linda Karlsen, Timothy Siemers, Norman Grossman, Lawrence Schwartz, Michael Akva, Robert Fricker, Richard Zelman, Bradley Burke, Benjamin Cooper, Chad L. Conner, Deon Benson, Gordon K. Allen, Jr., Jon Geibel, and William H. Borders II, 00 Civ. 1963 (Southern District of New York), Litigation Release No. 18193 (June 18, 2003). See also: L.R. 16469 (March 14, 2000); L.R. 17267 (December 12, 2001); L.R. 17501 (May 2, 2002); L.R. 17912 (January 2, 2003); L.R. 18149 (May 20, 2003); L.R. 18175 (June 5, 2003); L.R. 18502 (December 12, 2003). 

I applaud FINRA Arbitrator Sipper for getting FINRA Rule 2080 correct, which is not always the case. Let me take this opportunity to, yet again, reiterate that the three elements noted in Rule 2080 are of the "or" and not of the "and" variety. As Sipper accurately set forth in the AWC:

[W]hile Claimant only needed to satisfy one element of Rule 2080 to qualify for expungement, he has satisfied each. One purpose of the CRD is to provide accurate, useful and actionable information to investors. Removal of the reference to the false and meritless Lawsuit will provide investors with more accurate information about Claimant. 

FINRA's rulebook sets out a number of pathways for expungement of customer dispute information. For example, FINRA Code of Arbitration Procedure for Industry Disputes states in part:

FINRA Rule 13805. Expungement of Customer Dispute Information under Rule 2080

In order to grant expungement of customer dispute information under Rule 2080, the panel must:

(a) Hold a recorded hearing session (by telephone or in person) regarding the appropriateness of expungement. This paragraph will apply to cases administered under Rule 13800 even if a claimant did not request a hearing on the merits.

(b) In cases involving settlements, review settlement documents and consider the amount of payments made to any party and any other terms and conditions of a settlement.

(c) Indicate in the arbitration award which of the Rule 2080 grounds for expungement serve(s) as the basis for its expungement order and provide a brief written explanation of the reason(s) for its finding that one or more Rule 2080 grounds for expungement applies to the facts of the case.

(d) Assess all forum fees for hearing sessions in which the sole topic is the determination of the appropriateness of expungement against the parties requesting expungement relief.

Please take note -- careful note --  that Rule 13805(c) states that in granting the expungement of customer dispute information under Rule 2018, a FINRA Arbitration Panel must, in part, state "which" of the Rule 2080 grounds served as the basis for the recommendation. 

Next, let's consider FINRA Rule 2080, which states:

FINRA Rule 2080. Obtaining an Order of Expungement of Customer Dispute Information from the Central Registration Depository (CRD) System

(a) Members or associated persons seeking to expunge information from the CRD system arising from disputes with customers must obtain an order from a court of competent jurisdiction directing such expungement or confirming an arbitration award containing expungement relief.

(b) Members or associated persons petitioning a court for expungement relief or seeking judicial confirmation of an arbitration award containing expungement relief must name FINRA as an additional party and serve FINRA with all appropriate documents unless this requirement is waived pursuant to subparagraph (1) or (2) below.
(1) Upon request, FINRA may waive the obligation to name FINRA as a party if FINRA determines that the expungement relief is based on affirmative judicial or arbitral findings that:
(A) the claim, allegation or information is factually impossible or clearly erroneous;
(B) the registered person was not involved in the alleged investment-related sales practice violation, forgery, theft, misappropriation or conversion of funds; or
(C) the claim, allegation or information is false.
(2) If the expungement relief is based on judicial or arbitral findings other than those described above, FINRA, in its sole discretion and under extraordinary circumstances, also may waive the obligation to name FINRA as a party if it determines that:
(A) the expungement relief and accompanying findings on which it is based are meritorious; and
(B) the expungement would have no material adverse effect on investor protection, the integrity of the CRD system or regulatory requirements.

(c) For purposes of this Rule, the terms "sales practice violation," "investment-related," and "involved" shall have the meanings set forth in the Uniform Application for Securities Industry Registration or Transfer ("Form U4") in effect at the time of issuance of the subject expungement order.

As I recently noted in "Moving The Goal Line In A FINRA Expungement Arbitration / December 30, 2020 " (BrokeAndBroker.com Blog / December 30, 2020)

I have never viewed FINRA Rule 2080 as akin to a FINRA Rule of Evidence. By the Rule's own terms, it merely addresses how one would obtain "an order from a court." Pointedly, Rule 2080(b)(1)(A - C) promulgates the bases upon which FINRA "may waive" being named as a party in the follow-on court proceeding subsequent to the FINRA expungement arbitration. Note that it is a disjunctive "or" that sets the test for (1)(A - C) and not a conjunctive "and." . . .

And so, we start a New Year with a FINRA Arbitrator who gets FINRA's expungement rules correct. Hopefully a favorable portent of more good things to come from FINRA's arbitration forum in 2021.