This post was originally published on Ulmer’s Broker-Dealer Law Corner blog.
Among the criticisms I have leveled against FINRA are (1) that it is increasingly acting like a claimant’s arbitration attorney, by taking every possible opportunity to blame member firms for losses incurred by investors when other palpable reasons for those losses exist, and (2) that it loves, well after the fact, to jump in on things that have managed to garner the attention of others, perhaps just to show that it has not been asleep at the wheel. This week, FINRA issued yet another AWC involving the sales of GPB that serves to highlight both of my observations.
By now, everyone knows about GPB, so I won’t go into any background. But, if you do know about GPB, then you are aware that in the eyes of the federal government, specifically, the SEC and the DOJ, the “bad guy” in the GPB scenario is GPB itself, i.e., the issuer of the securities in question. In the SEC’s complaint, it took pains to clearly and specifically allege that the “downstream broker-dealers,” i.e., the BDs that sold GPB to their customers, were effectively themselves the victims of false and misleading due diligence and marketing materials supplied by GPB, which served to stymie the BDs’ efforts to conduct reasonable due diligence and cover up issues at GPB. Similarly, the DOJ’s Indictment paints the same picture, that the BDs that sold GPB were supplied misleading “written correspondence and marketing materials, including in due diligence questionnaires,” which gave a false impression of GPB’s true financial situation.
Of course, that has not stopped investors from filing hundreds of arbitrations involving GPB against the 60+ BDs that sold the product, in which the BDs – not GPB – are alleged to be the bad guys (for failing to conduct adequate due diligence on the front end, and/or for failing to make suitable recommendations on the back end). These complaints largely, if not entirely, ignore the positions publicly espoused by the SEC and DOJ, and lay all blame at the feet of the BDs, rather than the issuer.
Well, in this world, that’s more than enough reason for FINRA to step in and pile on. I am not saying that this pertains to every BD that sold GPB (or Red Oak or GWG or any other alternative investments that the claimants bar is feasting on) has been subjected to a lengthy series of 8210 requests, but I can tell you from personal experience that, at a minimum, many have. And so far, for six firms, by my count, FINRA has exacted settlements in GPB cases in the form of AWCs, including the most recent one from earlier this week with United Planners.
Not surprisingly, all the AWCs are drafted from the same template, and include the same description of the operative violation: that for some very narrow time period – usually about a month or so – the BD failed to inform a handful of investors that GPB had not timely filed its audited financials with the SEC, or the reasons that GPB had propounded for that delay. According to FINRA, this information was “material information that should have been disclosed,” and the failure to have disclosed it amounted to “negligence,” in violation of Rule 2010.
Let’s talk about that. What does “material” mean? According to the U.S. Supreme Court, it means “a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available.” I want you to take careful notice of the several loosey-goosey words baked into the definition. “Substantial.” “Reasonable.” “Significantly.” By virtue of using such fluffy, deliberately imprecise words, which permit reasonable minds to differ on their application to any particular fact pattern, the Court has explicitly recognized that there is no “bright-line” distinction between a material fact and one that is not. It’s a facts-and-circumstances analysis. Sometimes an omitted fact can be pretty clearly material, but, in most cases, it is a hotly contested issue.
With that said, I get that FINRA is entitled to its opinion on whether something is material or not. The problem is that here, as in many other situations, FINRA is unwilling to consider even the possibility that there are any alternative viewpoints that can be accepted. It’s FINRA’s way or the highway. That sounds to me like a bright-line test, not one that is highly fact-specific and depends entirely on the context of the offering.
So, back to the point of this post. You start with a situation like GPB, where the U.S. government has taken pains to make it clear that it views the selling broker-dealers as victims, yet where claimants are, nevertheless, going to town with arbitrations. You couple that with a dubious, difficult-to-prove legal proposition regarding materiality, i.e., a standard that is not easily divined, and which can trigger legitimate, vigorous debate on both sides of the issue. And you have to wonder: why has FINRA bothered to bring these cases? Do these cases really represent the best use of FINRA’s resources? Does these cases really do anything to address investor protection and market integrity?
As I said at the outset, it seems to me that FINRA’s goal isn’t particularly noble or lofty. FINRA just wants to do something about GPB, maybe just to demonstrate its continuing relevance. I would hope that it has better things to do than to take this opportunity to pile on its member firms who are already grappling with the consequences of having been swindled – allegedly – by GPB.
 All the AWCs are not exactly the same, to be completely candid. In one, for instance, involving Dempsey Lord, in addition to the “template” findings regarding the failure to disclose material information, FINRA also found that the firm made a few unsuitable recommendations.