Securities Industry Commentator by Bill Singer Esq

In October 2013, brokers Nicholas Webb and Thad Beversdorf were fired by their employer, Jefferies & Company, Inc. ("Jefferies"). They decided to challenge their termination, and, as their employment contracts with Jefferies demanded, they filed their claims in the Financial Industry Regulatory Authority's ("FINRA") arbitration forum. FINRA required them to sign an "Arbitration Submission Agreement," which they did, and their dispute with Jefferies proceeded in arbitration for the next two-and-a-half years. They withdrew their claims before a final decision was rendered. Under FINRA's rules, that withdrawal constituted a dismissal with prejudice. 

After the arbitration failed, Webb and Beversdorf sued FINRA in the Circuit Court of Cook County, Illinois, alleging that FINRA breached its contract to arbitrate their dispute with Jefferies. They faulted FINRA for a number of things, including failing to properly train arbitrators, failing to provide arbitrators with appropriate procedural mechanisms, interfering with the arbitrators' discretion, and failing to permit reasonable discovery. They sought damages "in an amount in excess of $50,000" and a declaratory judgment identifying specified flaws in FINRA's Code of Arbitration Procedure. FINRA removed the dispute to federal court, where it moved to dismiss on multiple grounds, including arbitral immunity. The district court held that FINRA was entitled to arbitral immunity and dismissed the suit. Webb and Beversdorf appeal this judgment.

The parties cast this case as one about arbitral immunity, which is the ground on which the district court dismissed the complaint. It turns out, however, that the case is really about federal jurisdiction. We asked the parties to submit supplemental briefs on this question, and they both contend that subject matter jurisdiction exists. Their strongest argument is grounded in the diversity statute, but the amount in controversy requirement presents an obstacle: the complaint satisfies it only if Illinois law permits the plaintiffs to recover their legal expenses from the underlying arbitration, this suit, or both. We conclude that while Illinois law permits the recovery of legal fees as damages in limited circumstances, those circumstances are not present here. 

FINRA found that Fifth Third failed to ensure that its registered representatives obtained and assessed accurate information concerning the recommended VA exchanges. It also found that the firm's registered representatives and principals were not adequately trained on how to conduct a comparative analysis of the material features of the VAs. As a result, the firm misstated the costs and benefits of exchanges, making the exchange appear more beneficial to the customer. By reviewing a sample of VA exchanges that the firm approved from 2013 through 2015, FINRA found that Fifth Third misstated or omitted at least one material fact relating to the costs or benefits of the VA exchange in approximately 77 percent of the sample.  For example:

• Fifth Third overstated the total fees of the existing VA or misstated fees associated with various additional optional benefits, known as riders.
• Fifth Third failed to disclose that the existing VA had an accrued living benefit value, or understated the living benefit value, which the customer would forfeit upon executing the proposed exchange.
• Fifth Third represented that a proposed VA had a living benefit rider even though the proposed VA did not, in fact, include a living benefit rider.

FINRA found that the firm's principals ultimately approved approximately 92 percent of VA exchange applications submitted to them for review. However, in light of the firm's supervisory deficiencies, the firm did not have a reasonable basis to recommend and approve many of these transactions. 

The evidence at trial showed that, from December 2012 through July 2015, Kyes worked with John Holdaway, 73, of Sandy, Utah, to defraud the Japanese investors through a business that they referred to as "Money Management Strategies," or MMS.  Kyes and Holdaway told the investors their money would be invested in high-speed trading programs with historical returns of well over 100% annually.  Kyes and Holdaway also told investors that their investments would be safe, in part because their principal investment would never leave the bank accounts into which the funds were sent, and that instead, MMS would draw a credit line secured by their funds and use that to fund trading.  Kyes and Holdaway further explained that any trading losses would be borne by MMS.  Based on the representations of Holdaway and Kyes, these investors wired money to bank accounts in Northern California controlled by Holdaway and Kyes.  The Japanese investors sent approximately $6.8 million to Holdaway and Kyes during the scheme.

The evidence at trial demonstrated that, in reality, Holdaway and Kyes did not invest the money as promised.  Instead, they spent the money themselves, used it to fund Ponzi-type payments back to investors, spent the money to pay back prior creditors to whom they owed funds, and spent it on gold-related businesses.  In addition, Holdaway and Kyes told investors that they were receiving distributions or returns on their investment.  To back up their claims, Holdaway and Kyes created and sent to investors fake documents, including phony account statements and forged letters from an accountant.  Holdaway, with Kyes's knowledge and participation, also sent emails to investors under fake names, to give the appearance that multiple people worked for Holdaway and Kyes, and lied about traveling to Europe or elsewhere to work on their investments.  

From 2001 through 2012, Cranney solicited money from people with whom he had personal and business relationships and represented that he would invest their money in an investment fund or a retirement plan he said he managed. However, instead of investing the money, Cranney spent his victims' savings and retirement on his own bills and debts to fund his declining health and nutrition products distributorship. To carry out his scheme, Cranney created shell companies that he named specifically to sound like investment funds. He also set up a sham Employee Stock Ownership Plan to convince victims to transfer their IRA and 401k retirement funds to him. Cranney's scheme ultimately collapsed in early 2012 when he could not obtain new investment money and initial investors began demanding return of their funds.

• Securities Industry Commentator
• Bill Singer