An Introduction to Investment Fraud and FINRA Arbitration

Securities lawyer Jake Zamansky breaks down the benefits of FINRA arbitration and discusses bond losses, Ponzi scams, and unsuitable investments. For more information visit: https://www.zamansky.com/practices/investment-fraud-lawyer/ 

Transcript

00:28 – Nancy Rapp, PaperStreet

Hello, welcome to the Investment Lawyer Speaks a podcast produced by the Zamansky Law Firm. I’m Nancy Rapp from PaperStreet.com and I’m speaking with the founder of the firm Jake Zamansky. Jake is one of the preeminent lawyers in the country for security fraud matters and FINRA arbitration. The law firm represents individual and institutional clients in cases against Wall Street firms for investment fraud losses. Throughout our podcasts, Jake will be providing overviews of investment scams and negligence and identifying how clients can recover their losses.

Jake, you help investors who have lost money through acts of fraud and other broker transgressions. What is the overall process for these kinds of cases?

01:12 – Jake Zamansky, Investment Fraud Lawyer

Okay, if you’ve lost money from a Wall Street brokerage firm, let’s say UBS, Merrill Lynch, or Morgan Stanley, you have to go to what’s called FINRA arbitration. It’s the Financial Industry Regulatory Authority. Why is it that? When you open an account at any of these firms, you sign a customer agreement, and in the fine print at the end of the agreement, it says that you have to go to FINRA arbitration; I actually think it’s a very good place to be as opposed to going to a federal or state court to resolve your dispute.

01:45 – NR

Why would you say that Jake?

01:47 – JZ

Well, when you go to court, you’re talking about a time lag of maybe three to five years, and then there are appeals so it can drag on and on, and it’s very expensive. By contrast, FINRA moves very quickly. So, if I file a case, say in January of the year, I can move quickly by the end of the year to having an arbitration hearing and getting the case resolved. Oftentimes these cases settle the brokerage firms agree to pay money. But the bottom line is I can get your case resolved in a year, as opposed to five years by people in the FINRA process, as opposed to a judge who may throw out a case or a jury that may not side with you.

2:34 – NR

So who decides these cases?

02:36 – JZ

Well, at FINRA arbitration, three arbitrators are appointed, they act as a jury, so to speak, they hear the evidence, the testimony of the customer and the broker, and they make a binding decision. Now they have a chairperson, one of the three who acts as the judge, that chairperson keeps the process moving. They rule on evidentiary issues whether a witness can testify or a document can come into evidence, but they’re also part of the jury. So, you have this three members system.

03:03 – NR

That’s interesting, and do you recover damages for these types of cases? What happens?

03:09 – JZ

Yeah, you can recover… Let’s take an example: Let’s say you lost a million dollars in UBS. The broker puts you into risky investments, you are conservative, you put on your case, you testify, this is what the broker told me, the broker gets cross examined, the documents come into evidence. And if the arbitration panel, you know, buys what you’re selling, then you could get all of your investment money back in this case, a million dollars. If it happened a couple years ago, you could get interest for the time that’s elapsed since then. We charge attorneys’ fees and stuff, generally, lawyers do it on a contingent fee, you can recover your attorney’s fees. Also, if it’s an egregious situation, say an elderly person was taken advantage of by a broker in a really despicable way. They can award punitive damages to punish the firm, so you get a whole possible gamut of recoveries in a FINRA arbitration.

04:03 – NR

Interesting. Now, when you mentioned that claim was with the elderly, but what are some of the typical claims that you assist with? What are some things that people bring to you what a broker has done or things like that? What are some of the transgressions that you see a lot?

04:17 – JZ

Well, the two most prominent cases that I see, (1) is what we call unsuitable investments, which means that the investment is not appropriate for you, the customer, given your investment experience and your background and your financial status. So again, let me give you an example: You have, say an elderly customer, somebody in their 70s or 80s, that’s retired. They’re living off a fixed income generated by their million-dollar portfolio. If the broker says, you know, I want to invest this in a risky technology stock or we’ll talk private investments for private equity investments, and there are substantial losses. If this is a high-risk investment, and the customer in this case the elderly person, was conservative and really needed the income and couldn’t afford to lose, we call that an unsuitable investment. If you don’t have experience in the market if you have limited finances, if the million dollars is your entire net worth, and the broker puts it risk half of your net worth, that would be unsuitable. So that’s the main type of claim we see. There’s another type of claim we call misrepresentation. Oftentimes, a broker will come to a customer and say I have a low-risk investment. It could be an option strategy, could be a hedge fund, and he pitches it as a low risk investment. The customer says, okay, I’m good with a low-risk investment certainly don’t want anything high risk because I can’t afford to lose money well by a broker saying that a hedge fund or an option strategy is low risk. That’s a false statement. That’s misrepresentation. It’s really a high risk investment. So if they misrepresent the nature of the investment, that’s a fraud and investment fraud, and you can recover in these FINRA arbitration cases.

06:17 – NR

So in other words, somebody thinks it’s a safe bet. And it actually becomes a much riskier situation where recovery isn’t possible or likely.

06:24 – JZ

Right, I mean, I call it a disconnect. If you’re looking for conservative and low risk steady investments, you know, safe bets, like municipal bonds, and things like that, and a broker recommends something that’s risky, there’s a disconnect between what the broker recommends and what you’re looking for what you agreed to. That disconnect can be an unsuitable recommendation. FINRA has specific rules on that. Now, it’s really the brokers responsibility to do the due diligence on the customer, they have a “Know Your Customer” rule. They must know, you know, what’s your age? What kind of investment experience do you have? What’s your risk tolerance? What’s your tax situation. They have a responsibility to find out everything about your financial situation and then make an appropriate or suitable recommendation. If they don’t do that, they can be held responsible.

07:20 – NR

What about if they leave out some information?

07:23 – JZ

So, that’s another good point. Sometimes brokers will lie about an investment, we talked about low risk versus high risk, sometimes they leave out an important detail, we call that an omission. That’s the same as investment fraud. So, in an example, if a broker is recommending, say, a private equity investment or real estate investment, trust REIT, non-traded, nonpublic… an important factor there is that there’s no liquidity; you can’t sell that investment to anybody, you have to hold it. If I have liquidity needs, you know, sending my kids to college or getting a divorce or a big tax bill, I want to know that there’s no liquidity here. And if somebody leaves out important information, such as you know, liquidity, such as, you know, some kind of risk or, or some kind of problem with the investment, that also is an investment fraud claim you’ve left out or omitted important information.

08:25 – NR

Basically, when all these people have faith in who their broker is, and the broker either does them harm or just doesn’t listen or things like that we have a breach of fiduciary duty, is that correct?

08:37 – JZ

Right. Now, a fiduciary duty is the highest duty known to law. And it really is important investment advisors, financial advisors have this fiduciary duty they have to put the customer’s interest first, it’s very important. Is this investment, is this strategy right for the customer? A lot of times brokers are interested in their own in their own interest, how much commissions can I generate? How much fees can I generate from this investment? If I put you on margin and you borrow money, I make more money. They have to put your needs first. The customer comes first. That’s what the fiduciary duty means. And if a broker doesn’t do that, then they will be held responsible for breach of fiduciary duty.

09:25 – NR

Interesting. Now what about the cases of if there’s a mistake is there often mistakes that you see that could be a potential investment fraud situation?

09:34 – JZ

Well, you know, people make mistakes, but brokers are held to a duty to do the right thing. If I order, if I have a discussion with the broker, and I order 1000 shares of Microsoft and they put it in an order for 10,000 shares. Stock goes down, I lose money. That’s a mistake, but it’s their mistake and they’re responsible for it. They have to be accurate, they have to, you know, make sure they know what the customer wants; if there’s a miscommunication, it’s the broker’s responsibility to clear that up. So, mistakes that are made are their responsibility. We call that negligence. You know, it’s not like they did anything intentional or venal. But if they made a mistake, and it costs you money, that’s something you can recover for.

10:28 – NR

So same as personal injury cases, essentially, negligence applies in this situation as well.

10:33 – JZ

Well, yeah, you know, if you did something wrong, you’re a landlord doesn’t, you know, shovel the snow off his step, and then somebody falls, you know, that’s negligence. In these situations, you have somebody recommending a stock or strategy that’s not appropriate, or, you know, they, they thought the customer was one thing and, and the customer is something else. That’s negligence.

10:57 – NR

Let’s take one of these claims a little bit further. I mentioned a couple of times about the elderly, with their investments and how those could be investment scams. How do elderly people get into a complicated matter? For example, how is it a question of if the elderly didn’t understand the risks or things like that? How did those cases get proven? What should a loved one do? How do those work?

11:21 – JZ

Okay. The elderly is a very important problem and FINRA, this Financial Industry Regulatory Authority has looked at and put out rules. Every year, millions of seniors become victims of financial exploitation, resulting in billions of dollars in losses. There’s a lot of scams, elderly people, number one are trusting they don’t really do due diligence. For the most part, they are easily convinced about things they often have a nice-sized nest egg. And most elderly people that are retired, are living off fixed income. So, they have to have, you know, conservative investment objectives.

Now, I’ve had situations give you one example, a broker a big Wall Street firm, formed a relationship with an elderly woman in her 80s with health issues. He basically befriended her he took her to charitable events and made her feel good about herself and ingratiated himself to her, took her out to dinners. Well, it turns out that this guy was stealing money from her account. She was in the hospital, a true story. And he had her sign papers to pay his own personal American Express bills and his mortgages, hundreds of 1000s of dollars. I got wind of it, I called the district attorney who started looking at this from a criminal aspect; I sued the firm and was able to get twice the amount of damages because it was such an egregious situation. So, people steal from elderly people, they don’t often look at their account statements. And a lot of brokers put them into risky investments that they don’t understand. It’s a big, big problem.

13:00 – NR

So, what happens if it’s a question of the elderly made a mistake? Is it just a recommendation that a family member assists with these kinds of situations?

13:10 – JZ

Well, you raise a good point, if you have a parent or grandparent who has a brokerage account, it’s a good idea to put someone younger on as a second check on the account, you know, and that’s easily done, you contact the broker and just say I would like to receive every monthly statement that you send to my grandmother or my mother. You get that statement, you look at it, if there’s something you don’t understand or looks out of the ordinary, you contact the brokers or the manager. So yes, that’s a good idea is to have somebody, a second pair of eyes on the account. There’s also a rule at FINRA that you can put a hold to an investment. If you see the broker, you’re the second person on this account, putting something through that you think’s inappropriate or too risky, you contact the brokerage firm, they can put a halt on it while they investigate, and that would avoid a loss.

14:06 – NR

Interesting, that is a good point. And something that I think a lot of family members need to pay better attention to, especially as the elderly make a substantial amount of investments for either themselves or their loved ones. Another set of claims that I know that you’ve handled over the years is bond fraud. What happens in these cases?

14:25 – JZ

You know, for many years bonds were paid basically safe investments; they didn’t lose money, you know, whether it’s, you know, IBM Apple or utility bond. You invest in bonds, you get a fixed rate of return, and most people can rely on when that kind of income. So last year, the bond market changed dramatically. Okay, there had been low returns. And a lot of people were invested in long term bonds, 5-, 10- and 20-year bonds, and at small numbers you get in 2%, or 1.5% percent interest. Well, when the interest rates went up as the Fed chairman has raised interest rates, the bond values have gone down.

So, if I had a million dollars’ worth of bonds paying 2%, and the interest rates go up to four or 5%, the value of my bonds on my statement could be very small, could go down to $500,000 or $600,000. Again, if you hold them to maturity, you’re okay, if you’re going to hold it for 10 or 20 years, but to put somebody in, for example, a large portion of their money – 90% of their money, in long term bonds, when the interest rates were low, that person is going to have a large paper loss. And if they must sell, they have liquidity needs, like I said, for, you know, taxes or a divorce or to pay for a wedding or something, that person is going to suffer a loss. So, this is sort of a new area, because bonds are not as risk-free as they used to be. And their values have plummeted as the interest rates have risen, certainly long-term bonds, and that’ll be the case for a while going forward.

16:13 – NR

Yeah. So, is it something that people should avoid with bonds? Or, what is it that the brokers need to be doing?

16:18 – JZ

The key thing is disclosure and discussion. Brokers need to disclose risks to customers, there’s, they’re not insurance companies, but they have to make sure the customer understands the risk. What are the risks we’re talking about? We’re talking about the risk, the interest rate risk, it’s called and duration risk. If you have a long-term bond, there’s a risk that as years go on, that bond will become worth much less As interest rates rise, you got to advise the customer that the value of your bonds are going to go down, and perhaps you shouldn’t be in such long term bonds. You know, a lot of brokers do what they call a laddered bond portfolio, where you know, every year let’s say you have 1, 2, 3-year bond, six month bonds, that it’s laddered. And then you reinvest at the current rates. So, the key thing here is disclosure. And just to give you some numbers, a lot of the bonds, the long-term bonds, and Bond exchange-traded funds, and bond funds are down 20 to 40% in value over the past year; that’s a huge hit. For most people that is significant. They have to understand customers and brokers have to understand what is the risk from a rising interest rate environment? What’s the risk from long-term duration? Disclosure and discussion is what I say.

17:43 – NR

If those losses are suffered, it follows the same FINRA arbitration process we’ve been talking about?

17:48 – JZ

Yeah, we just filed a case against Vanguard, one of these bond funds, somebody was put into over 90% of their account in long term bonds when the rates were low, that person has a massive loss. So yeah, we bring those cases. And I think they’re strong cases. If this is not something that customer was aware of or understood.

18:10 – NR

That’s, I think, something that people need to definitely be made more aware of, I think just because so many people assume a bond is a safe and a safer investment. Lastly, Jake, one of the things I want to clarify is, I’m sure that a lot of our listeners are familiar with one particular investment fraud scam that seems to get news, attention, and media attention that’s Ponzi schemes, could you elaborate on some Ponzi schemes and what people should really know versus what’s seen in the movies and things like that.

18:35 – JZ

Right, this is a very important area as well. The most famous Ponzi scheme is Bernie Madoff. Bernie Madoff was your prototypical Ponzi scheme. He had a whole bunch of investors and he kept paying interest to old investors by taking money from new investors. That’s the classic Ponzi scheme. And in Bernie’s case, he wasn’t really investing in anything. He was just gathering the money and spending it on cars and yachts and things like that. And we see that a lot. Unfortunately, Ponzi schemes occur in what we call affinity situations. I had a situation in Long Island, New York, a bunch of people belong to a church, and the broker was a member of the church. He got everybody’s account at the church. They figured out he’s a member. They trusted him, they gave him their money. He stole all their money. You see it with ethnic and religious groups, you know, there are a lot of Jewish people with Madoff. Asian and Asian Americans, you know, a lot of them invest with an Asian broker and there have been Ponzi schemes there. Italians and so forth. Just because you identify with someone on a religious or ethnic basis you got to do the same due diligence, because unfortunately, we’ve seen these Ponzi schemes, stealing money from customers. At some point, we’ll talk about whether this crypto is a Ponzi scheme. A lot of people were saying this FTX Sam bank been freed was run as a Ponzi scheme. Those are also areas that you got to be careful with. But basically, it’s trusting somebody, and they can either send you a phony statement, or basically just steal your money.

20:29 – NR

So basically, it’s collecting money, and there’s nothing to actually invest?

20:35 – JZ

Most of the time, they just take your money, and they, they steal it, they spend it on personal expenses. But there are situations I’ve seen where the broker, the portfolio manager, takes in money, he blows it up, he invests in the wrong thing, he loses a ton of money, and he can’t pay people back. So that’s when he starts feeling. You got to be careful there. You have to actually see a statement, an account statement, and ask, “what am I invested in?” If it looks like a phony paper you check it. For example, if he says he bought Apple at $135 a share, ask is Apple really trading at that level? You know, if it’s not, then perhaps that’s not a real statement. So again, very important to do due diligence. These people are very convincing. I have recovered money from firms that in what’s called clearing. So, if you have a firm where, let’s say fidelity or Schwab, and, and the advisor is doing trades through them, sometimes if the firm is on notice the clearing firm, they can be held responsible.

21:48 – NR

Jake, I have actually recalled this from local news. There was a situation where somebody was taking money from friends and colleagues, just as you’re saying, and they were going to supposedly open a golf course. And what happened was, is this golf course didn’t exist, but they were taking the money and putting it towards some of their own interests, would that be considered a Ponzi scheme? Or is that something else?

22:10 – JZ

That’s a Ponzi scheme. A lot of times, yeah, you’re investing, you’re buying a building, you’re buying a golf course, you’re investing in some new technology. Well, you have to make sure that you have details about what is this investment? You know, do your research. Google’s a great place to start. Is there really a golf course? You might want to see a purchase agreement if they say they’re going to buy a golf course. There’s a lot of good stories out there, but there aren’t a ton of great investments supporting those stories. So, if you hear about an investment – broker is going to do real estate, or golf course or something like that. Let’s get some underlying documents, let’s do some research to make sure that what you’re investing… in a lot of times it’s a movie. I just saw one about a movie. The movie didn’t make any money. The movie, you know, was told that it was gonna be a great box office hit; there was no nothing behind it. So, make sure that the underlying investment or business is real. You can do your own due diligence if you don’t find anything. That’s the time to run away from this investment.

23:20 – NR

If the person who’s doing these kinds of Ponzi schemes is not a brokerage per se, are these still handled by FINRA and the normal matters that you handle? Even if it’s not, like I said, a typical brokerage firm?

23:31 – JZ

No, FINRA only involves Wall Street and smaller brokerage firms. You have to be a member of FINRA, to go there otherwise these Ponzi schemes are difficult, you’d have to sue them in court. And oftentimes somebody that does something like this has hidden their assets away, you know, put it in a relative’s name, or maybe has nothing left. Those are sad situations. Oftentimes, there’s, there’s no you know, pot to latch into, which is another reason not to really invest with somebody that’s not a registered firm or an investment advisor, because if your money’s gone, there may be no place to recover.

24:11 – NR

You’ve given a lot of information of how to protect oneself, but what should a person do if they find that they thought they did what they should do and they are a victim of fraud? What are the steps what what’s the proper course of action?

24:23 – JZ

Well, the first thing you need to do if you think you’ve been fleeced or put into an inappropriate investments, you know, contact a securities attorney, such as myself, they’re lawyers around the country that that do what we do. But start speaking to a lawyer because they’re familiar with the process. They can evaluate your case quickly. That’s probably the first thing you should do. Gather the gather the evidence, you know your monthly statements. If you have notes or emails, pull your case together and sit down with an investment fraud attorney to evaluate your case, but do it quickly because you know, the longer you wait, you may be barred if you wait too long statute of limitations and things like that, and the evidence can disappear. So jump on it, do it quickly and speak to a lawyer.

25:18 – NR

Should the person remove the money from brokerage firm or just leave it there? What is the safest option?

25:24 – JZ

I say talk to your lawyer about that. If it’s something you’re really worried about, yeah, let you know. If you think there’s, there’s stealing or declining in value. Maybe talk to another financial advisor, and get an accountant involved. But make that decision about what to do after you’ve consulted a professional like a lawyer. Or, you know, perhaps another advisor.

25:47 – NR

Is there any other steps a person can do to prepare aside from collecting their documents?

25:52 – JZ

You know, maybe talk to other customers who were involved. If somebody was on a call or meeting with you, you know, find out what their recollections are, but the key is basically to get those documents and get them to an attorney as early in the process as you can, that’s really the best thing you can do.

26:12 – NR

All right, Jake, well, you’ve certainly provided a lot of helpful overview, investment fraud tips and tricks here and I’m sure our listeners are really going to appreciate that. So, thank you, everybody. Thank you for listening to The Investment Lawyer Speaks. We’ll be back next time with more tips of some scams you should avoid and what to do if you find yourself a victim of investment fraud. Thank you, everybody. Thanks, Jake.

26:33 – JZ

Like you and anybody can check our websites Zamansky.com. We have a lot of tips and a lot of information on the website, so feel free to visit it. You can also send me an email from the website. jake@zamansky.com.

26:46 – NR

Wonderful, Jake. I’m sure that’s very helpful to our listeners. Thank you so much.