Banned brokers represent investors in FINRA arbitration despite rule to contrary
Few advisors may be aware that brokers who have been banned — and even those with criminal pasts — may represent aggrieved investors in arbitration forums run by the Financial Industry Regulatory Authority.
None of these representatives are licensed to practice law, yet FINRA says it will decide whether to allow so-called non-attorney representatives to continue in this role.
The fact that FINRA has long permitted this practice points to "one of the essential problems with arbitration," says Amanda Werner of Americans, arbitration campaign manager at Financial Reform and at Public Citizen. "You don't have the traditional protections of the legal system. I think it definitely shows FINRA is not doing a good enough job."
FINRA, a self-regulator run by the firms it oversees, says its mission is "to protect America’s investors." It closed a two-month comment period last month about the role that non-attorneys and their firms should take in its dispute-resolution forum.
A FINRA spokesman declined to comment on questions about brokers who represent investors in arbitration even though they have criminal records or have been banned from the securities industry. He said the regulator looks forward to reviewing the comments submitted by the public.
While attorneys are subject to stringent ethical requirements, non-attorney representatives can operate more freely, for example, by cold-calling clients, a practice forbidden for attorneys.
Some ex-brokers with long disciplinary histories have built second careers taking cases at lower rates than lawyers charge. Although FINRA prohibits brokers who have been banned from the industry from representing investors, at least one continues to handle high caseloads, and others offer their services through proxies, according to a study by the Public Investors Arbitration Bar Association.
Non-attorneys "are a real and growing menace to investors in the FINRA arbitration forum," says Andrew Stoltmann, president of PIABA. These investors can be twice victimized, he says: After losing money at the hands of their investment advisor, they might pay fees for poor representation in cases where awards cannot be collected.
Non-attorney representatives should be banned from FINRA arbitration, contends the PIABA report, which was authored by Stoltmann and association board member David Neuman in response to FINRA’s request for public input.
Some critics contend PIABA is acting out of self-interest to widen the pool of clients for its own members.
"Anecdotal stories, emanating primarily from PIABA members about certain [non-attorney firms'] alleged misbehavior, is tiny compared to the extraordinary horror stories about attorneys taking people's money, making promises and then failing to perform," says Richard Sacks, founder of Investor's Recovery Service, a non-attorney firm in Novato, California. His comments were published on FINRA's website.
Sacks was banned from the securities industry more than 20 years ago, according to BrokerCheck. In at least half a dozen regulatory cases against him, he was found to have overcharged clients, created a record of fictitious trades and breached client fiduciary duties, according to BrokerCheck.
After being fined thousands of dollars, Sacks wrote on one of the cases that the "sanctions [imposed on him] were exceptionally severe, unfair and totally inconsistent with other penalties."
However, when FINRA adopted a rule in 2007 preventing banned brokers from representing clients in arbitration, Sacks sued the SEC, which oversees FINRA, and prevailed in an appeal before the Ninth Circuit in San Francisco California, in 2011. That victory allowed him to continue representing investors in FINRA arbitration, partly because he had been doing so for years before the regulator adopted the ban.
Between 1991 and 2014, Sacks filed more than 1,300 claims on behalf of investors with FINRA or its predecessor, the NASD, according to his letter published on FINRA’s website. Sacks did not respond when asked for his firm's track record on those cases.
Sacks says the PIABA study is motivated by "attorneys looking to eliminate their competition, particularly in light of the extremely low number of customer complaints filed at FINRA over the past few years." In 2017, 3,137 arbitration cases were filed, compared with 3,681 cases for 2016, while 2009 saw upward of 7,000, according to FINRA.
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Stoltmann called Sacks’ criticisms of the PIABA study "nonsense."
Another founder of a non-attorney firm, Mitchell Markowitz of Stock Market Recovery Consultants, lost his insurance adjuster's license after pleading guilty in federal court in Newark, New Jersey, in a $1 million insurance scam involving costume jewelry. He was sentenced to 180 days in jail followed by five years’ probation, according to a 2004 report by New Jersey prosecutors.
The PIABA study found that Markowitz’s firm handled 61 FINRA arbitration cases between 2013 and 2016. That does not include settlements, which aren't entered into the public record. Some of the awards produced "disturbing" results in which arbitrators dismissed investors’ claims, the study says. Markowitz did not respond to requests for comment.
The controversy about investor representation goes to the heart of ongoing questions about whether FINRA is truly protecting investors.
Recently, concerns have been raised about the deep industry ties among FINRA's board members, the regulator's practice of allowing brokers to wipe their public records clean of disciplinary histories, and allegations that FINRA may have acted at the behest of JPMorgan Chase in retaliating against a whistleblower.
The fact that FINRA permits its firms to require that clients submit to private arbitration to resolve conflicts with brokers or their firms remains controversial. Binding arbitration prevents investors from taking their claims to court, where proceedings are open to public scrutiny and where claimants are typically represented by attorneys.
"There are no rules of professional conduct applicable to [these] firms' activities," FINRA wrote on its website, noting that they are not subject to malpractice insurance requirements or licensing boards, and no supervisory body is in place to police their activities.
Clients for at least one non-attorney firm went public in its defense. About 10 people identified as customers of Cold Spring Advisory Group in New York City posted letters on FINRA's website. Cold Spring is owned by Michelle Ottimo, the wife of a former broker, Louis Ottimo, who acts as a consultant to the firm even though FINRA barred him from the industry in 2015, the PIABA study says. Neither Michelle nor Louis Ottimo replied to requests for comment.
Donnie Pate, the 60-year-old founder of a used car and truck dealership in Tallahassee, Florida, wrote that Cold Spring did "a great job" on his case, even though he has yet to recover any money. Pate says he suffered losses of $152,000 on a $183,000 death benefit from his late wife's life insurance policy. He added that he paid his former broker $91,000 in commissions and fees for managing the money.
"I was overjoyed when the award came down in our favor only to find out after 30 days [that his broker] filed for bankruptcy and we received nothing," Pate wrote in the letter.
"Mr. Pate's experience is not isolated," said Neuman, the PIABA board member.
"Cold Spring was involved in 27 arbitration awards, 19 of which were 'zero' awards for the client,” Neuman said via email. “In the eight cases in which Cold Spring 'won' something for the client, only one was successful against a brokerage firm that was still in business, and only one other award was against a broker who stayed in the securities industry. Out of the other six awards, [they] were against brokers who left the industry or a defunct brokerage firm."
If Pate paid a large retainer upfront, "this is a big problem," Neuman said. "For the investor, it's throwing good money after bad."
Pate did not respond to questions about his case. Jennifer Tarr, who handles arbitration cases for Cold Spring, did not disclose the amount of the retainer. She did say that “because of [Cold Spring's] continued support in the case, Mr. Pate is slated in the Chapter 13 to get back over $65,000. If a broker files Chapter 13 bankruptcy, it is possible to recover for our clients.”
Numerous commenters on FINRA's website noted that it’s difficult to assess the role that non-attorney firms in FINRA play given that the regulator has not released statistics about their conduct. One of the commenters, William A. Jacobson, director of the securities law clinic at Cornell University Law School, urged FINRA to do so, adding that attorney misconduct in arbitrations also is common.
"Without substantial evidence of the scope of inappropriate conduct by [non-attorney] firms, we believe that this policy ensuring that investors with small claims have representation warrants maintaining some use of [such] firms," he wrote.
If FINRA continues to allow them, Jacobson and others said the regulator should consider adopting stricter rules, such as allowing people who are not attorneys to only take cases with less than $100,000 in losses, to limit the magnitude of any harm.
At the same time, it would be "reasonable," he added, to prevent those with a criminal history from taking part in any way.