Pastore & Dailey successfully dismissed claims filed in Delaware bankruptcy court by one of the nation’s largest mineral mining companies. Pastore & Dailey represents an investment bank seeking a fee associated with $650 million in construction financing for the project. The mining company was attempting to avoid paying this fee by asserting that claims had been discharged in bankruptcy.
Tag: Security
Defeated Motion to Stay
On behalf of its sophisticated financial services client, Pastore & Dailey LLC recently defeated a Motion to Stay a New York Supreme Court action pending resolution of an ongoing arbitration. In denying the defendants’ motion for a stay, the court agreed with P&D’s arguments that the corporate defendants’ conduct in choosing not to participate in the arbitration, thus creating a complete separation of identity between the defendants in the court case and the respondents in the arbitration, could not be used as an excuse to stop the court proceedings until the arbitration was resolved.
Defeated Emergency Appeal to NYS Appellate Division
Pastore & Dailey recently defeated an emergency appeal to NYS Appellate Division (1st Dept.) by a client’s competitor in the financial services industry (including a FINRA member firm) on the trial court’s denial of its motion to stay our client’s lawsuit in NYS Supreme Court (New York County) against the competitor and its principals while a related FINRA arbitration was in process. (Our client is suing the competitor and its principals for tortiously interfering with our client’s contracts with its ex-employees, among other things.)
Should All Financial Advisors Bear the Obligations of Fiduciary Duty?
As of today, in the retirement and savings plan matters, money managers are not required to register as fiduciaries. The Department of Labor (“DOL”) is about to clarify the situation by wiping out the difference that exists between financial advisors and broker dealers in regard to their responsibilities in retirement advices.
A fervent debate is currently on regarding whether the fiduciary duty should be applicable to broker dealers. Under section 3(21)(A)(ii) of the Employee Retirement Income Security Act (“ERISA”), a fiduciary advisor is a person who “renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan … .” In other words, the fiduciary advisor has to act solely in another party’s interests. The main corollary of this principle, for the fiduciary, is to avoid any conflicts of interest between itself and its clients.
Recently, the United States Supreme Court clarified the scope of the fiduciary duty under ERISA – Tibble v. Edison International, No. 13-550 (U.S. 2015). The Supreme Court expressed that a fiduciary “has a continuing duty to monitor trust investments and remove imprudent ones. This continuing duty exists separate and apart from the fiduciary’s duty to exercise prudence in selecting investments at the outset.”
Some financial services providers do not seem concerned about the possibility of a higher standard – i.e., they already support these basic safeguards in their work policy. Others who are under the pressure of their executives demanding large profit-return, seem to “forget” some of these principles and claim that they will not be able to serve their clients or stay in business if such a rule came into effect.
Who Takes the Lead?
Although initially the Securities and Exchange Commission (“SEC”) regulated broker dealers and investment advisors, it has delegated a large part of its prerogatives related to the broker dealers to the Financial Industry Regulatory Authority (“FINRA”). Nevertheless, when investment advice and securities transactions are related to savings and retirement plans the DOL also has a say in the matter.
Industry groups have widely expressed their concerns with the idea of a fiduciary standard commitment for broker dealers. The fact that the DOL is conducting the project understandably makes the financial services industry skeptical as the connection between them and the DOL is much less privileged than with the SEC or FINRA.
Financial services providers would welcome a consistent and coordinated interpretation of this new standard by the DOL and SEC; divergence between regulators would not serve anyone and would confuse both providers and clients. Trustees believe the industry and investors would be better served if the SEC took the lead and the DOL incorporated the standard guidelines in its interpretation of ERISA.
The Crisis Aftermath
Investment advisors – who provide investment advices – undertake to strictly respect the fiduciary duty. The objectives and interests of their clients must be their priorities when they suggest securities acquisitions. Any conflict of interest must be avoided or at least fixed in the Clients favor.
As opposed to advisors, broker dealers – who only execute securities transactions – have so far not been required to follow the fiduciary duty principle. However, as they suggest the purchase of securities, they are held to submit suitable products to their clients in regard to their financial situation and investment objectives. However, FINRA “suitability” standard does not mean that the products sold must be the best in respect to the purchaser profile.
During the latest financial crisis, many people learned the hard way that, even though those brokers were managing their savings, they were not fiduciaries and, consequently, were not held by the fiduciary duty. Thereafter, Congress adopted the Dodd-Frank Wall Street and Consumer Protection Act, with the intent to have the SEC examine the need of a new uniform federal fiduciary rule both for brokers and advisors. The SEC did so, and in 2011 released that a uniform standard would be appropriate.
At the same time, the DOL – which enforces among others the ERISA – implemented its own set of regulations in this matter with the intent to put some safeguards in place regarding retirement and savings accounts. In its new regulations, it focuses mainly on the conflict of interest facet of the fiduciary duty in respect to retirement accounts.
Two Week Extension
In 2010, the DOL wished to expand the definition of Fiduciary Duty under the ERISA but, eventually, overwhelmed by the industry pressure, had to withdraw it. In February 2015, President Obama asked the DOL to move ahead on its fiduciary rule.
Although Senators from both sides asked the DOL to extend the comment period, arguing that the matter is too complex to be commented in 75 days, the latter extended the period only for two weeks. Rule makers bode that a longer extension of this period could be prejudicial for their project.
http://newoak.com/wp-content/uploads/Defining-Fiduciary-POV-F3.pdf
https://www.asppa.org/News/Browse-Topics/Details/ArticleID/4515
Investment Banking: How to Protect the Success Fee
The terms of the investment banking engagement letter are critical to the protection of the issuer in any deal. Often overlooked, however, is that the investment banker’s fee is often protected or lost by those same terms – particularly in small deals for micro-cap or under capitalized companies. Generally, an investment bank charges two different fees: the retainer fee, which has to be paid as soon as the banker starts his assignment, and the success fee, which has to be paid when the deal is closed.
Although the investment banker could waive this retainer fee in case of a surefire deal, it is usually a lump sum and oftentimes it is paid on a monthly basis. It can also be paid out at the beginning and might eventually be credited against the success fee.
The success fee, however, is most commonly a percentage of the final deal. Depending on the bank philosophy, the fee can be declining – e.g. the Lehman system – or the opposite, progressive, which can better incentivize the banker not to hurry in the transaction and motivate him to close a deal that exceeds the initial goals.
The time to pay the success fee is also a key point to be determined by the parties. It is evident that the bank wants to be paid at deal close and it should not be a problem with a cash sale. It can be much more complicated when the deal involve other payment options such as capital adjustments or deferred payments.
Often with smaller companies, there is a primary secured lender that has significant control over the issuer. When an investment banker is successful, and raises debt or equity, (or some combination thereof) the bank and banker are entitled to this fee. With a secured lender that controls the issuer in some form, or has the ability to foreclose on the assets, the investment banker is at risk if the bank is not paid at closing – if the deal is funded and sometimes thereafter the issuer faces economic trouble, the investment banker’s success fee can be swallowed up by a bankruptcy or asset foreclosure.
Thus, we propose that where practical, and where leverage allows, the investment bank insists that the secured lender or those lenders with the ability to foreclose and take the issuers assets, either indemnify, or better yet, guarantee the investment banker’s fee in the event that the issuer cannot pay it due to the actions taken by the lender.
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http://www.axial.net/forum/investment-banking-fee-structures/
http://thismatter.com/money/stocks/investment-banking.htm
http://www.axial.net/forum/how-to-structure-the-investment-banking-engagement/
http://www.lexology.com/library/detail.aspx?g=84675f88-e4c0-492e-8535-954518c0c7f5
High Frequency Trading Law
Recent Developments in High Frequency Trading Law
Last year the Federal Court of New York was stormed by investors alleging that exchanges, banks, and broker dealers created an unfair marketplace through high frequency trading (“HFT”). All suits were inspired by Michael Lewis allegations, author of the best-seller “Flash Boys: A Wall Street Revolt”, who argued that the stock market is rigged in favor of exchanges, big banks and high-frequency traders.
Case Dismissed
By dismissing a three class-action on April 30 – Lanier v. BATS Exchange Inc et al, Nos. 14-cv-03745, 14-cv-03865 (S.D.N.Y. 2015) – Judge Katherine Forest of the U.S. District Court for the Southern District of New York placed her imprint into the debate to know whether the Security Exchange Commission (“SEC”) is the only competent entity to receive a complaint involving exchanges.
Harold Lanier, the aggrieved investor who initiated the suit claimed that several major U.S. exchanges, including among others, NASDAQ, NYSE and BATS, scammed ordinary investors by selling faster access to market data to high-frequency traders and therefore broke their initial duty as market regulators. Furthermore, the claimant added that they violated the nondiscrimination and fairness provisions enclosed in the subscriber agreements issued by the exchange which details both parties’ commitments.
The plaintiff rightfully called into question the competence of the SEC as it formerly approved the practices of HFT. But according to the Federal Judge, the Exchange Act provides that any conflict should be brought before the SEC, as a two-tiered procedure is already in place in case of a violation of its rules by an exchange. In any case, if the aggrieved party seeks to go further, only Federal Court of Appeals can review the SEC order. The Judge contested anyway that the allegations of the agreement violation were sufficient to state a claim.
The market regulators “absolute immunity” question is nonetheless still unanswered as the case has not been followed up. Defendants argued that, as self-regulatory organizations, they should benefit an absolute immunity from civil lawsuits intended to get damages in connection with their regulatory responsibilities. Hence only the SEC should hear investors’ complaints.
Pension Funds Joined the Battle
The class action led by the City of Providence and Rhode Island – City of Providence, Rhode Island et al v. BATS Global Markets Inc et al, Nos. 14-cv-02811, 14-MD-2589 (S.D.N.Y. 2015) – is however still ongoing as the motions to dismiss laid recently were set aside by Federal Judge Jesse Furman. The State-Boston Retirement System and three other funds located in Stockholm, Alexandria and the Virgin Islands joined the battle. Here, in addition to public exchanges such as BATS, CHX, NASDAQ and NYSE, Barclays LX dark pool is also targeted by the plaintiffs.
As dark pools are private exchanges without either quotations or subscribers noticeable, only large investors can deal on these platforms. Alternative trading systems are more and more coveted by investors and their part of the market doubled in the last five years. Nowadays around a third of the trades are being conducted through dark pools in the United States.
Although individual investors should not have access to these venues, mutual or pension funds might. Therefore, individuals can be harmed indirectly in dark pools which are much more vulnerable to HFT predators than public exchanges. The plaintiffs will nonetheless have to demonstrate clear and specific damages to win their case, which in this complex and obscure market, will need a very high level of expertise.
Hazy Dark Pools
In July 2014, individual investor Barbara Strougo brought her grievances to the New York District Court – Strougo v. Barclays, No. 14-cv-05797 (S.D.N.Y. 2015) – against Barclays and its executives of covering up aggressive high frequency trading operations on their Barclays LX dark pool. In addition to that, she claimed that Barclays gave crucial non-public information to hostile traders.
In essence, Rule 10b-5 of Securities Exchange Act of 1934 deems illegal any behavior aimed to deceive people involved in securities transactions in an exchange. Would this mean that investors should be entitled to know the presence of HFT when trading in the venue? Indeed, if the exchange owner is aware about HFT predators, not to disclose it would be breaking the law. Knowing the potential risks of his or her investment is a fundamental right to any investor.
The rules that regulate dark pools depend whether they are registered as national securities exchanges or broker dealers and also about their activities and trading volume. If recognized as broker dealers, they perform under a different set of regulations than public exchanges and the Exchange Act is not applicable in the same way. As a result, the SEC review does not apply and complainants can head straight to district court.
Barclays’ dismissal bids were turned down by the Federal Judge as questions about the integrity of its alternative trading system are still unanswered. The Judge expressed her concern about specific misstatements – i.e., touting the safety of the LX platform while, on the other hand, allowing aggressive behavior.
Barclays maintains that it would deny access to any trader who operates aggressively on its platform but the plaintiff assure that the platform was infested by high speed traders who used their technology to make profit at the expense of common investors.
David Against Goliath
While big financial companies struggle against investors to defend themselves and try to minimize the impact of HFT on the market, Goldman Sachs is determined not to let go off anything against one of its former computer programmer. Serge Aleynikov left his employer to join startup Teza Technologies, bringing with him the trading algorithm he had set up while working there. The stolen code in question was initially an open source code barely modified under the pressure of the bank to reach quick results.
Notwithstanding that Mr. Aleynikov had been cleared of all federal charges after having spent one year behind bars, Manhattan District Attorney Cyrus R. Vance Jr. took over the case and filed and a new suit against the programmer – New York v. Sergey Aleynikov, No. 004447/2012 (N.Y.C. Crim. Ct.).
Here again, on the first step of the judicial procedure, Mr. Aleynikov was found somewhat guilty of stealing the codes –i.e., the jury, confused faced of the complexity of the matter, reached a mitigate decision founding him not guilty of unlawful duplication of computer-related material, guilty of unlawful use of secret scientific material and deadlocked on another unlawful use charge. Even though the conviction stands, he is unlikely to serve any more time in prison.
Although outlandish, the Aleynikov case is not isolated in the High Frequency Trading history. Other programmers were arrested by Mr. Vance to whom intellectual property theft should be seen as physical property theft.
The District Attorney to say: “When an employee takes software to create his own company, anybody would classify that as “stealing” or “theft”; under existing state law, however, stealing valuable printer toner out of an office supply closet is a more serious offense than stealing valuable computer source code.”
Jason Vuu, Glen Cressman and Simon Lu, all in their mid-twenties, were arrested and prosecuted on similar counts – People v. Simon Lu et al., No. 03869/2013 (N.Y.C. Crim. Ct.). Vuu and Cressman were former employees of the Dutch trading house Flow Traders. All three ducked prison for pleading guilty and were fined and put under probation.
Kang Gao, former analyst for hedge fund Two Sigma Investments was however sentenced ten months in jail – New York. v. Kang Gao, No. 00640/2014 (N.Y.C. Crim. Ct.) –, a time that he had already served waiting for his judgement.
http://www.law360.com/articles/646881/ex-goldman-coder-gets-split-verdict-in-2nd-ip-trial
http://www.theotcspace.com/content/stock-exchanges-call-dismissal-hft-lawsuit
http://www.wsj.com/articles/high-frequency-trading-leads-to-lawsuit-against-exchanges-1410192793
http://www.reuters.com/article/2014/11/04/us-highfrequencytrading-lawsuit-idUSKBN0IO1O420141104
http://dealbook.nytimes.com/2014/09/08/pension-funds-join-lawsuit-on-high-frequency-trading/?_r=0
http://www.law360.com/articles/649198/exchanges-win-dismissal-of-high-speed-trading-cases
http://www.nytimes.com/2015/05/02/business/dealbook/ex-goldman-programmer-found-guilty.html
http://www.law360.com/articles/624067/ex-flow-traders-worker-ducks-prison-for-source-code-theft
http://www.law360.com/articles/624573/ex-two-sigma-analyst-cops-to-ip-theft-faces-deportation-
FINRA Arbitration Not Always Mandatory
For the Moment, FINRA Arbitration with Customers is Not Mandatory, So Say Two Federal Appeals Courts
In August 2014, the Court of Appeals in the 2nd Circuit (i.e., NY and CT) joined its brethren in the 9th Circuit (i.e., CA, NV, OR, WA, MT, ID, AK and HA) in holding that a FINRA member firm and its customer may agree to settle disputes in court and not in FINRA arbitration. Meanwhile, the Court of Appeals in the 4th Circuit (i.e., MD, WV, VA, NC and SC) ruled the opposite in 2013 under similar facts. Resolution of this circuit split would have to come from the U.S. Supreme Court – not a certainty.
BACKGROUND:
FINRA Rule 12200 provides as follows:
Parties must arbitrate a dispute under the Code if:
- Arbitration under the Code is either:
(1) Required by a written agreement, or
(2) Requested by the customer; - The dispute is between a customer and a member or associated person of a member; and
- The dispute arises in connection with the business activities of the member or the associated person, except disputes involving the insurance business activities of a member that is also an insurance company.
[Emphases added.]
In 2013, the 4th Circuit rejected efforts by units of Citigroup and UBS (FINRA member firms) to block arbitration of auction-rate bond-related claims brought by Virginia-based Carilion Clinic. UBS Fin. Servs., Inc. v. Carilion Clinic, 706 F.3d 319 (4th Cir.2013). Carilion had hired UBS and Citigroup to underwrite and broker its auction-rate bond offerings starting in 2005. Carilion alleged that UBS and Citigroup misled Carilion by neglecting to mention that they had a practice of placing supporting bids in such auction, so as to prevent the failure of such auctions. When such auction markets collapsed in 2008 and the brokers withdrew their supporting bids, Carilion lost millions of dollars when it was forced to refinance its debt at much higher rates. Carilion filed statements of claim against UBS and Citigroup in FINRA arbitration in 2012, and UBS and Citigroup quickly filed in federal court to block same.
First, UBS and Citigroup effectively argued that Carilion was too sophisticated to be a “customer” under FINRA rules. The 4th Circuit disagreed, finding Carilion to be a “customer” under FINRA rules.
Next, UBS and Citigroup argued that the forum selection clauses in the agreements with Carilion clearly said that district court in New York City would be the forum for disputes under the agreement. The 4th Circuit held that FINRA arbitration rules mandating FINRA as the forum for disputes with customers trumped such forum selection clauses, especially since there was no specific waiver by Carilion of its right to arbitration.
In March 2014, the 9th Circuit essentially disagreed with the 4th Circuit’s holding in Carilion. In an auction-rate security case, the court held that “the forum selection clauses superseded Goldman’s default obligation to arbitrate under the FINRA Rules and that, by agreeing to these clauses, Reno disclaimed any right it might otherwise have had to the FINRA arbitration forum.” Goldman, Sachs & Co. v. City of Reno, 747 F.3d 733 (9th Cir.2014).
In August 2014, the 2nd Circuit followed suit in yet two more auction-rate security-related cases, and took the unusual step of stating “We thus disagree with the contrary conclusion reached by the Fourth Circuit in Carilion Clinic.” Goldman, Sachs & Co. v. Golden Empire Schools Financing Authority, No. 13-797-cv and Citigroup Global Markets Inc. v. North Carolina Eastern Municipal Power Agency, No. 13-2247-cv (August 21, 2014). The 2nd Circuit held that, “Under our precedent, the forum selection clause at issue in these cases is plainly sufficient to supersede FINRA Rule 12200.”
CONCLUSION:
These circuit splits mean that mandatory FINRA arbitration is alive and well in some parts of the country, but not others (including, as of August 2014, the important jurisdiction of New York). These decisions remind both firms and their clients not to gloss over the standardized template language at the end of their agreements, especially forum selection clauses and integration clauses.
What the courts do not mention (nor need to, for their purposes) is FINRA IM-12000, which essentially gives FINRA enforcement power to pursue any member firms that “fail to submit a dispute for arbitration under the Code as required by the Code.” FINRA IM-12000(a). It remains unknown as of this writing whether FINRA is investigating the above member firms for violations of FINRA Rule 12200, or will do so. Firms like the ones above that fight FINRA arbitration as a forum for disputes with customers, do so at their own peril.
Defeated Emergency Motion to Stay
Pastore & Dailey recently defeated an emergency motion by a client’s competitor in the financial services industry (including a FINRA member firm) to stay our client’s lawsuit in NYS Supreme Court (New York County) against the competitor and its principals while a related FINRA arbitration was in process. (Our client is suing the competitor and its principals for tortiously interfering with our client’s contracts with its ex-employees, among other things.)
Motion to Strike Victory
Pastore & Dailey recently succeeded in defending their client’s claims against a motion to strike in Connecticut Superior Court. Pastore & Dailey was successful on the majority of their counts, including fraud, multiple counts for breach of contract and breach of the covenant of good faith and fair dealing, CUTPA and breach of fiduciary duty. While most of Pastore & Dailey’s successful rulings came from the bench, the Judge did issue a written opinion as to the breach of fiduciary duty claims. Pastore & Dailey prevailed in arguing that their client, a co-owner and co-manager of a successful hedge fund, was in fact owed a fiduciary duty by the other co-owner/manager, despite their equal ownership interests. The court agreed with Pastore & Dailey’s arguments that the existence of a fiduciary relationship depends on several factors and simply because there is equal ownership does not preclude one party from operating as a fiduciary to the other in their management and control. Thus, the court allowed the breach of fiduciary duty claim to survive the motion to strike and remain a valid cause of action in the case along with the majority of their claims, including their most important claims.
Pastore & Dailey Wins Temporary Restraining Order and Preliminary Injunction for Financial Services Client
Pastore & Dailey successfully obtained a temporary restraining order and preliminary injunction in New York State Court for one of our clients. The client provides financial advisory services, including analysis and consulting related to Residential mortgage-backed securities, other securities, and other complex assets, to some of the largest financial institutions and law firms in the world. This dispute arose when a group of our client’s employees all resigned around the same time and together joined a new, competing venture just formed. The former employees have restrictive covenants in their employment agreements with our client not to solicit our client’s employees or clients, or use or disclose its confidential information and trade secrets. Recognizing the enforceability of those employment agreements, the Court issued a temporary restraining order and preliminary injunction to protect our client’s confidential information, trade secrets, employees, and client base pending the outcome of a Financial Industry Regulatory Authority (FINRA) arbitration our firm instituted on behalf of our client.