Securities Law Blog

In an effort to create more clarity for financial services firms surrounding the use of social media networks, the Financial Industry Regulatory Authority (FINRA) released a Regulatory Notice on January 25, 2010 entitled “Guidance on Blogs and Social Networking Web Sites”.

While the industry regulator does not codify any direct actions that need to be taken by financial firms, they do make several suggestions that could protect a firm’s liability when communicating over the internet. Organized in a Question and Answer format, FINRA sheds light on potential compliance issues and offers possible policies and procedures that firms could adapt in order to deal with supervisory and recordkeeping responsibilities.

The main message for firms throughout the Notice seems to be, if you plan on using it, you better be able to supervise it, we don’t care how or what you use to do it but it better be done and it better be done right.

Some key points in the Notice:

*If a firm communicates or allows its employees to communicate through social media sites, it is the firm’s responsibility to keep records of communications that relate to “business as such”. Firms need to ensure that associated personnel using social media sites for business purposes are adequately supervised, have necessary training in such activities, and do not present undue risk to investors.

*Requirements set forth by Federal securities laws and FINRA rules may be triggered when registered representative’s communications include recommending specific investment products. Additional disclosures should be made available to the customer to prevent any skepticism that a firm’s associate was misleading in anyway. FINRA suggests that firms should prohibit all interactive electronic communications that recommend a specific product unless a registered principal has previously approved the content.

*For static information, which could include profile, background or wall information, on social networking sites that are established by the firm or a registered representative, a registered principal of the firm must approve all information before it is posted. It is advised that these approvals also be documented.

*For interactive electronic communication, it is not required to have a registered principal’s approval, but it still must be supervised by the firm. FINRA suggests that firms adopt supervisory procedures similar to those used for electronic correspondence. It is up to the firm to develop policies that address communication liability and ensure that they are “reasonably designed to ensure that interactive electronic communications do not violate FINRA or SEC rules”.

*It is also the firm’s responsibility to prohibit personnel from engaging in business communication on social media sites that are not subject to firm’s supervision, and to take disciplinary action if firm policies are violated.

The overall goal of the Notice is to protect investors from misleading representations and allow firms to take part in the benefits of social media while effectively and appropriately supervising their associated persons’ involvement with these sites.

Scott Rothstein pled guilty on January 27, 2010 to federal charges that he ran a $1.2 billion Ponzi scheme. Rothstein, a disbarred attorney and founding partner of the South Florida law firm Rothstein Rosenfeldt Adler, was charged with wire fraud, money laundering, conspiracy and racketeering. The career of one of Florida’s most flamboyant attorneys thus ends in the collapse of yet another massive fraud.

Rothstein’s scheme was operated by using faked legal statements. He attracted investors by promising huge returns on investments in legal settlements he claimed would pay out over time. Prosecutors say most of the settlements never even existed, and that Rothstein operated the Ponzi scheme using money from new investors to pay old investors. Rothstein also offered investments in short-term business loans that offered large financial returns, most of which never existed as well.

The Rothstein Rosenfeldt Adler law firm is heavily linked to the founder’s Ponzi scheme. In a single year the firm earned $8 million but somehow paid its 150 employees $18 million in salaries. According to Assistant U.S. Attorney Alison Lehr, the additional $10 million came from the operation of funds produced by the Ponzi scheme.

Also under investigation are 50 of the 70 attorneys formerly employed with Rothstein Rosenfeldt Adler, and the Florida Bar is examining possible irregularities involving client trust accounts. Along with former Rothstein associates, bankers and any others who may have been involved could face criminal charges, according to published reports.

Following Rothstein’s December 1st arrest, several investors filed lawsuits in an attempt to get their money back, one case demanding more than $100 million in damages.

Authorities are seeking to recover millions of dollars that Rothstein and his wife donated to charities and close to $400,000 contributed to local political parties and candidates, in order to help repay dozens of cheated investors. Some of Rothstein’s extravagant assets are also being seized including two dozen homes, 20 exotic cars, three boats, numerous bank accounts, and over 300 pieces of jewelry.

With sentencing set for May 6, Rothstein could face a maximum sentence of 100 years in federal prison and at least $1.5 million in fines.

Increasing numbers of complaints from investors concerning sales of private placements has brought more cases against brokerage firms involved in selling private placement or Regulation D offerings. The representatives marketing these offerings are also being singled out by defrauded investors.

In the U.S. District Court in Boise, Idaho, a group of investors have filed a lawsuit against their adviser, Bradley Hofhines, and his firm, Summit Retirement Advisers LLC. The claimants allege that Hofhines failed to disclose that returns from investments in Provident Royalties LLC securities were not in fact profits generated by investments in oil and gas properties but instead were a Ponzi-esque mixture of investor funds and proceeds of later offerings.

The lawsuit also names affiliates of Hofhines, including Securities America Inc., the firm’s broker-dealer, as well as Ameriprise Financial Inc., which owns Securities America Inc. The broker-dealer and its parent company could be liable for failure to supervise the representative. While the degree of participation of each party has yet to be uncovered, Securities America has been named in two other lawsuits related to private placements gone askew.

In Hofhine’s statement, he claimed to have done the right thing when selling the Provident shares.

“I will say that I sold the product properly, given the information I had and the due diligence that was performed on this company,” Hofhine stated. “I certainly had no way of predicting or uncovering the alleged intentional fraud at Provident, nor how the economic collapse has magnified the problems.”

Another major bump in the road for Hofhine and Securities America is that they allegedly sold Provident securities to more than 35 non-accredited investors. Typically most investors who buy private placements or ‘Reg D’ offerings must be considered ‘accredited’; individuals with more than $1 million in assets.

Securities America’s executive vice president and chief marketing officer, Janine Wertheim, commented by saying “Each private-placement transaction of this type is reviewed on an individual basis to determine accredited investor status and requires evidence of eligibility to purchase the product.”

Now less than two months later, Securities America finds itself in more hot water, this time with the Massachusetts Securities Division.

The complaint charges that the broker-dealer misled investors when it sold them private-placement securities. It alleges that when it sold promissory notes issued by Medical Capital Holdings Inc. as private placement securities totaling $697 million, Securities America made “material omissions and misleading statements”. The broker-dealer is also said to have disregarded due-diligence recommendations to share financial information with investors.

Securities America sold 37% of the estimated $1.7 billion in notes from 2003 to 2009 issued by Med Cap. More than 60 Massachusetts investors bought approximately $7.2 million of the notes sold by Securities America, according to the Securities Division.

The Massachusetts Securities Division is seeking a cease and desist order and an administrative fine against Securities America, as well as restitution for all Massachusetts investors who bought the notes.

This case comes at a time when the Financial Industry Regulatory Authority (FINRA) is stepping up its efforts to investigate more and more allegations of misconduct arising from the sale of ‘Reg D’ private placements.

James Shorris, executive vice president and executive director of enforcement at FINRA, stated that the industry regulator will be continuing to focus their attentions on whether the brokers made any misrepresentations during a sale, whether they performed due diligence with the products sold, and whether firms adequately supervised sales of the products. FINRA will also be taking into consideration the suitability of the sales made to customers.

The collapse of Bernard Madoff’s estimated $65 billion dollar Ponzi scheme in 2008, was the precursor to the “Year of the Ponzi” in 2009. Defrauded investors saw an estimated $16.5 billion dollars disappear as more than 150 pyramid schemes unraveled, according to the Associated Press analysis of scams in all fifty states. Madoff’s very public decline brought a heightened public awareness and increased scrutiny to Ponzi schemes. But he wasn’t the only securities fraudster who made headlines.

Following the breakdown of Ponzi schemes nationwide, there was a drastic increase in federal securities fraud investigations opened in 2009. The FBI alone increased its securities fraud investigations by 1,750 from 2008. The Securities and Exchange Commission (SEC)’s Ponzi scheme investigations now make up 21 percent of the SEC’s enforcement workload. The Commodity Futures Trading Commission more than doubled its amount of civil actions in Ponzi cases this past year.

In its continuing effort to avoid being burned by another major Ponzi scheme, the SEC is developing new investigative units to improve its enforcement. A major focus will be to encourage companies and individuals to cooperate more closely in providing information, and to better analyze tips and complaints the SEC receives. The cooperation efforts will include similar incentives that have been used by the Justice Department in its criminal investigations. Included in these incentives will be written cooperation agreements under which SEC attorneys recommend leniency for parties providing information in their proposals to the SEC commissioners.

With the surge of federal fraud investigations in 2009 and those that date back to the credit crisis in 2007, an increase in federal prosecutions of financial crimes is expected to follow in 2010.