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Archive for the ‘Financial Services and Banking Litigation’ Category

SEC Issues Risk Alert Regarding Broker-Dealers and Investment Advisers’ Privacy Practices and Compliance with Regulation S-P

Posted on: April 22nd, 2019

By: Jennifer Lee

On April 16, 2019, the U.S. Securities and Exchange Commission (“SEC”) issued a Risk Alert summarizing the findings from the examinations of broker-dealers and investment advisers’ privacy practices and compliance with Regulation S-P.

Regulation S-P, 17 C.F.R. § 248.30, was enacted to protect the privacy of customers and their information. It has three major components:

  1. Firms are required to provide their customers with a copy of their privacy policies and procedures at the initial outset of the relationship and also on an annual basis.
  2. Firms are prohibited from sharing customers’ nonpublic information with unaffiliated third parties unless the customer is given prior notice regarding such practices.
  3. Firms must inform customers that they have a right to opt-out of the firm’s data sharing practices with unaffiliated third-parties and provide a method in which customers can opt-out.

During the examinations, which spanned over the course of the past two years, the Office of Compliance Inspections and Examinations (“OCIE”) found common deficiencies in firms’ compliance with Regulation S-P. The OCIE found that some firms did not provide customers with the initial and/or annual privacy policies and procedures. In other instances, the privacy policies and procedures were inadequate to satisfy the requirements under Regulation S-P. For example, the policies and procedures failed to identify the precautions taken to ensure the integrity of customers’ information.

Even when firms gave the required notices and had satisfactory written policies and procedures on the books, the OCIE often found that such policies and procedures were not actually being implemented and firms’ practices diverged from the written policies and procedures. Customers’ personally identifiable information (“PII”) were sent via unencrypted emails and left in unsecured physical locations, firm employees had customer information on unsecured personal devices, and outside vendors were not vetted on their cybersecurity and privacy practices.

These findings are unsurprising because often when a new set of privacy or cybersecurity regulations is introduced, companies will invest an incredible amount of time and resources to develop policies and procedures that comply with the new requirements. Usually, most of this work is done by the COO or Chief Information Security Officer (“CISO”). However, it does not and cannot stop there as most enforcement actions and customer actions are brought based on the firm’s failure to implement its policies and procedures.

To reduce the risk of enforcement and customer actions, firms must ensure that the policies and procedures in its books are put into practice. This requires buy-in from everyone at the executive level—from the CEO to the CMO—and cooperation from multiple departments in the firm that may not necessarily work closely with each other on a regular basis. In addition, firms should shift their perspective on compliance with Regulation S-P and other privacy or cybersecurity regulation. It is not a one-off event. Instead, it should be seen as an active and on-going process that requires constant training and monitoring.

If you have any questions regarding your firm’s compliance with Regulation S-P or other privacy and cybersecurity regulations, please contact Jennifer Lee at [email protected].

Plaintiffs’ Burden to Establish Punitive Damages: Farmers & Merchants Trust Co. v. Vanetik

Posted on: April 18th, 2019

By: Jennifer Weatherup

A recent decision from the California Court of Appeal has outlined the requirements for establishing a defendant’s financial condition as a prerequisite to an award of punitive damages, and has further emphasized that it is the plaintiff’s burden to provide a comprehensive picture of the defendant’s financial condition in support of a punitive damages award.

In Farmers & Merchants Trust Co. v. Vanetik, Plaintiff F&M Trust, who was the trustee and administrator of a pension plan, sued Defendants Yuri and Tony Vanetik[1] for breach of contract and fraud. F&M Trust claimed that the Vanetiks made several false statements and representations, which induced it to acquire stock in their company. At trial, the jury found the Vanetiks’ liable, and F&M Trust was awarded over $3 million dollars in punitive damages from the Vanetiks.

The Court of Appeal struck down this award because F&M Trust failed to present sufficient evidence of the Vanetiks’ financial condition. Because punitive damages are intended to punish wrongdoing and deter future misconduct, juries must consider three elements when determining an appropriate punitive damages award: (1) the wrongfulness of a defendant’s conduct, (2) the amount of compensatory damages, and (3) the defendant’s wealth. Wealth must be considered in order to determine whether a particular award is significant enough to punish that particular defendant.

As the Vanetik Court observed, a plaintiff wishing to impose punitive damages on a defendant must present evidence that provides a “balanced overview” of their financial condition. Thus, a plaintiff cannot cherry pick details relating to a defendant’s assets while failing to present evidence of liabilities or encumbrances on their property. Because F&M Trust only presented circumstantial evidence of the Vanetiks’ income, failed to determine whether Tony Vanetik’s home was subject to a lien or even owned by Tony, and failed to consider the Vanetiks’ liabilities, the Court found that there was insufficient admissible evidence to support a punitive damages award.

The Court further rejected F&M Trust’s claim that they should be excused from their failure to present evidence of the Vanetiks’ financial conditions because Defendants did not produce that evidence. Prior caselaw does provide that punitive damages may be awarded without evidence of a financial condition if a plaintiff’s failure to produce evidence is the result of the defendant’s failure to comply with discovery obligations. However, the plaintiff bears the burden of showing that the lack of evidence was the defendant’s fault, and F&M Trust failed to satisfy this burden.

As the Court noted, F&M Trust never filed a motion for pretrial discovery into the Vanetiks’ financial condition, even though a plaintiff must obtain a court order before conducting discovery into a defendant’s financial condition. Similarly, the trial court did not order the Vanetiks’ financial condition before the punitive damages portion of the trial. Thus F&M Trust’s failure to produce sufficient evidence of the Vanetiks’ financial condition is not excused, and the punitive damages award must be stricken.

The Vanetik case provides useful authority for professionals and other defendants who are facing a substantial punitive damages award, as it demonstrates the extent to which plaintiffs bear the burden of establishing defendants’ financial condition, and emphasizes the need for plaintiffs to present a complete picture of defendants’ finances, rather than relying on selective, incomplete, or circumstantial evidence.

If you have any questions or would like more information, please contact Jennifer Weatherup at [email protected].

[1] Plaintiff also sued the Vanetiks’ attorney. The Court separately found that the attorney could not be found liable for conspiracy.

FINRA Seeks To Simplify Non-Party Discovery

Posted on: April 9th, 2019

By: Greg Fayard

In January 2019, the Financial Industry Regulatory Authority (FINRA) proposed changes to its rules to give non-parties more time to respond to discovery requests and witness orders from arbitration panels. Currently, non-parties only have 10 calendar days from service by U.S. mail to respond or object to document subpoenas or witness/document production orders. Often times, the person responsible for responding to the non-party subpoena or arbitration order receives the subpoena or order after the 10 days have elapsed. When that happens, the non-party has waived its opportunity to object to the subpoena or order, subjecting it to potential sanctions or disciplinary action. To avoid such prejudice to non-parties, FINRA is recommending changes to its rules to give non-parties 15 calendar days (instead of 10) upon receipt (not service) of the order or subpoena. Receipt will include overnight mail, overnight delivery service like FedEx, hand delivery, e-mail or facsimiled documents. Importantly, under the proposed rule changes, service of discovery requests on non-parties by U.S. mail would be excluded. Lastly, FINRA seeks to codify rule changes to reflect how it currently processes and informs arbitration panels regarding non-party objections to subpoenas and orders.

The purpose of FINRA’s proposed rule changes is to provide better due process to non-parties, eliminate the problem of delays with U.S. mail, and to codify FINRA’s current protocols for non-party discovery.

The FINRA rules impacted by the proposed changes are 12512, 12513, 13512 and 13513. The new rules have to be approved by the Securities and Exchange Commission. If approved, FINRA will announce an effective date of the rule changes in a future regulatory notice.

If you have any questions or would like more information, please contact Greg Fayard at [email protected].

SEC Holds Public Forum as Part of Increasing Efforts to Regulate Digital Assets, Cryptocurrency Exchanges, and ICOs

Posted on: March 28th, 2019

By: Jennifer Lee

The Securities and Exchange Commission will be hosting a public forum on distributed ledger technology and digital assets in Washington DC on May 31, 2019. This is a part of the SEC’s increasing efforts to regulate cryptocurrency exchanges and initial coin offerings (ICOs) that have been proliferating unchecked until very recently.

Since digital assets are still an emerging concept, regulators, such as the SEC and the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of Treasury, have been struggling to figure out how the existing regulatory framework applies to cryptocurrencies, exchanges, and ICOs. However, as established financial institutions, such as Fidelity, begin to enter the digital asset space, the SEC has ramped up its efforts to ensure that companies are aware of and are in compliance with all applicable laws and regulations. Depending on the nature of the services provided, companies may be subject to the Securities Exchange Act of 1934, Bank Secrecy Act, and states’ money transmitter licensing statutes.

The push for more oversight over cryptocurrencies comes at the heels of high-profile scandals involving cryptocurrency exchanges and ICOs that left consumers and investors alike with nothing but questions after losing their fiat and digital currencies.

The very first incident involved Mt. Gox, a bitcoin exchange based in Tokyo, Japan that operated between 2010 and 2014. Cryptocurrency exchanges allow its users to exchange fiat currency (e.g., U.S. Dollars) into cryptocurrency and provide digital wallets for users to store their cryptocurrency. At its heyday, it was handling over 70% of all bitcoin transactions worldwide. However, it ran into a host of problems in 2013 continuing on to 2014 until it stopped operations and filed for bankruptcy. During the litigation that ensued, it was revealed that Mt. Gox somehow lost approximately 750,000 of its customers’ bitcoins, valued at around $473 million at that time.

More recently, in February 2019, the cryptocurrency exchange QuadrigaCX announced that it was missing approximately $145 million in digital assets. Its executives, consumers, and law enforcement are in a frenzy to determine what happened to the missing digital assets as the only person who had access was QuadrigaCX’s founder Gerry Cotten, who had passed away the month prior.

These incidents are not limited to cryptocurrency exchanges, especially as ICOs have become more popular in recent years. ICOs are similar to IPOs in the sense that investors can buy a stake in a particular cryptocurrency (referred to as a token), but unlike IPOs, a token’s value is not tied to the value or performance of an underlying company. In November 2018, the SEC settled charges against professional boxer Floyd Mayweather Jr. and singer/producer DJ Khaled for failing to disclose payments they received for promoting investments in ICOs. This suggests that despite the decentralized nature of cryptocurrencies and ICOs, the SEC has assumed jurisdiction over the space and its players.

Accordingly, broker-dealers and investment advisory firms looking to get involved in the digital asset space, including operating cryptocurrency exchanges, providing trading platforms for cryptocurrencies, or facilitating ICOs, must ensure that they are in compliance with all existing laws and regulations that govern traditional financial transactions and investments.

For more information or to inquire about the firm’s services related to digital currencies, please contact Jennifer Lee at [email protected].

Latest FINRA Rules to Regulate Expungement Actions

Posted on: February 19th, 2019

By: Margot Parker

FINRA recently announced its approval of enhanced training and guidance for arbitrators hearing expungement requests, an issue under increasing scrutiny as over 90% of such actions are currently granted. The proposal is now under review by the SEC and represents a step toward making it more difficult for brokers to have customer complaints expunged from their public records. The proposed rules also include a ban on compensated non-attorney representatives (NARs) from representing clients in FINRA arbitrations, as part of another step to strengthen the arbitration process.

While a ban on NARs has been widely supported, critics of the expungement process believe more should be done to take the burden away from customers to fight expungement actions. FINRA states that it shares these concerns. To reduce the high volume of expungements in the past, it codified a rule stating: “expungement is an extraordinary remedy that should be recommended only under appropriate circumstances.” With these recent steps, we may continue to see changes in the regulation of FINRA expungement actions in the near future.

If you have any questions or would like more information, please contact Margot Parker at (310) 937-2066 or [email protected].