A hybrid RIA, $2M in cannabis fund losses and a search for responsibility

A brokerage that works with hybrid registered investment advisory firms is testing whether clients can pursue arbitration complaints against the broker-dealer for alleged fraud losses.

Albany, New York-based Purshe Kaplan Sterling Investments — which is known in wealth management as one of the largest "friendly" brokerages for financial advisors who have their own RIA — is seeking a restraining order and preliminary injunction in Salt Lake City federal court blocking a FINRA arbitration case against PKS for the conduct of a barred ex-broker. The clients, Carol and Jeff Thomsen, accuse PKS of negligent supervision, fraud and other violations of FINRA rules that caused them losses of $2 million stemming from their investments in a private cannabis fund pitched by their advisor, Adam E. Nugent. In court filings earlier this month, attorneys for PKS argued that the Thomsens may not pursue claims against the brokerage because they invested through Nugent and his RIA, Foresight Wealth Management.

"The Thomsens presumably will argue that since they purchased their Agronomic investments [the allegedly fraudulent cannabis fund] from Nugent and his firm Foresight, and for approximately 15 months Nugent happened to be an 'associated person' of PKS, then they were 'customers' of PKS under FINRA Rule 12200," PKS said in a Jan. 2 motion for a temporary restraining order. "That argument attempts to connect dots that were never meant to be connected. An 'associated person' of a FINRA member can wear many, unrelated hats. The person can have an independent advisory company, like Nugent had Foresight. It is axiomatic that if an investor does not purchase any goods or services from the FINRA member, that investor is not a 'customer' of the FINRA member simply by purchasing goods or services from the 'associated person' acting on behalf of their own independent company."

Industry publication Financial Advisor Magazine first reported the case. Representatives for PKS, which has denied the Thomsens' allegations, didn't respond to requests for comment. Neither Nugent nor Foresight replied to inquiries about the case.

The Thomsens' attorney, Gana Weinstein Managing Partner Adam Gana, published an article in 2022 for the University of California, Davis Business Law Journal on the supervisory responsibilities of brokerages for outside investment advisory services of dually registered brokers.

"If the investments are made through the RIA, you absolutely and unequivocally have to arbitrate all claims associated with that disclosed outside business activity," Gana said in an interview. "It shouldn't stand any chance of success because they're in the wrong."

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The dual nature of hybrid RIAs

The hybrid structure of RIAs that use their own advisory firm while registering with a brokerage such as PKS often proves attractive to teams that have a small sliver of commissionable business — even though the dual affiliations can get into murky territory for some industry regulations and clients trying to understand the setup, said Jonathan Kurta, the founding partner of Kurta Law, which is also representing the Thomsens.

"The whole thing's confusing," Kurta said. "Why are there two separate systems here?"

Hybrid RIAs offer flexibility and growth potential for advisors and some of the largest wealth management firms, with many outsourcing part of the compliance role to the advisory teams as third-party offices of supervisory jurisdiction. Companies like PKS have paid substantial sums in regulatory cases involving the conduct of brokers, though. In addition to settling a FINRA case last month accusing PKS of failures in the pitching of scandal-plagued GPB Capital products, the firm notably paid more than $13.5 million between 2017 and 2019 in fines, restitution and settlements with a Native American tribe over sales of other alternative investments.

FINRA rules state that "the duty to supervise the outside business activities of member firm associated persons is unambiguous and applies to customers and 'or the public,'" Arbitration Insight's Louis Straney, a former regulator who often serves as an expert witness, said in an email about the PKS case.

"For matters associated with brokerage firms, it has been my experience that challenging venue delays resolution of the dispute and ultimately results in the civil court remanding the claim back to the dispute resolution process of FINRA," Straney said.  "Even if the court decides to hear the case, the standards established by regulators such as the SEC and FINRA are most often considered as the standards of care."

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The clients' allegations

Last February, Nugent and Foresight settled the Securities and Exchange Commission's fraud case alleging he raised $19.5 million from 80 clients for limited partnership interests and promissory notes in cannabis investments through a fund called Agronomic Capital. They misused assets in the fund, broke partnership agreements, misrepresented how they would use the investment proceeds and failed to disclose conflicts of interest, according to the SEC. Besides Nugent's acceptance of a bar from the industry, he and the RIA agreed to pay more than $3 million in disgorgement, penalties and interest.

The SEC case covered the period between March 2018 and December 2019, and Nugent was affiliated with PKS from March 2017 to June 2018, according to FINRA BrokerCheck. The Thomsens, who are in their late 60s, invested in Agronomic in June 2018, according to their November 2023 arbitration claim, which PKS included in its federal court filing. 

"Mr. Nugent was simultaneously registered as a registered investment advisor and operated an investment advisory practice, Foresight Wealth Management, with the full knowledge and approval of [PKS]. It was through his affiliation with [PKS] and Foresight that Mr. Nugent marketed and sold investments in Agronomic to the [Thomsens] and other customers," according to the statement of claim. PKS "approved Mr. Nugent's participation in Agronomic. Incredibly, despite having actual knowledge of Agronomic's activities, [PKS] failed to adequately investigate the same and safeguard its customers, including the [Thomsens]."

Their arbitration claim alleges that PKS breached FINRA rules about unsuitable investments, supervision, fraud, contract agreements, the fiduciary duty and the failure to warn, as well as the Utah Securities Act. An answer in the arbitration from PKS is due Jan. 18, but the firm "denies any and all liability," according to its filing.