The Financial Industry Regulatory Authority's arbitration panel raised its credibility in the securities industry when it imposed a hefty penalty on a unit of Ameriprise Financial Inc., Securities America, for its role in selling an elderly woman private placement notes from Medical Capital Holdings, industry professionals say.
The panel's decision also sent a signal to broker-dealers that financial advisers should perform much more thorough due diligence on the soundness of companies issuing certain securities before allowing investors to participate in risky investments.
The decision stemmed out of arbitration held during a dozen hearings in Los Angeles last November and December. In a $1.2 million resolution handed down on New Year's Eve, the Finra arbitration panel effectively backed up claims that Securities America had breached its fiduciary duty to Josephine Wayman, the claimant. It also found that Securities America violated industry rules, failed to properly supervise one of its brokers and intentionally and negligently misrepresented facts related to the sale of private placements from Medical Capital.
"The award was based on the specific facts of this investor's case, and we disagree with the outcome," Janine Wertheim, the chief marketing officer for Securities America, said Tuesday. "Securities America does not believe it acted inappropriately in the sale of these investments."
Medical Capital was a lending company that provided financing to financially troubled hospitals, nursing homes and other health care facilities. It secured unpaid bills from those facilities, called receivables, then sold interests to investors in the form of private placement notes.
Securities America relied on financials that were internally reviewed, but not independently audited, Joshua Waldman, an attorney at Burkhalter Kessler Goodman & George, an Irvine, Calif., law firm that represented the claimant, said in a phone interview Tuesday.
That kind of due diligence makes it difficult for an investor or other outside party to confirm whether the receivables are available to secure the notes. "There have been some other receivable businesses in the not-too-distant past that turned out to be Ponzi schemes," Waldman said.
Finra held Securities America and Randall Ray Talbott, the financial adviser named in the arbitration, liable for $734,118. That represents the amount that the claimant, Josephine Wayman, invested in the private placements. Other amounts include a $250,000 award for punitive damages, and the rest covered legal and procedural fees.
Wayman's attorneys say the decision was also significant because of the punitive award.
Daniel Kessler, an attorney for Burkhalter Kessler, said Wayman was about 80 years old when she invested in the Medical Capital notes between 2006 and 2008. Aside from the Medical Capital notes, she invested very conservatively and had not invested in anything remotely risky since the 1980s.
"This panel thought a lot about the knowledge of Securities America in coming down with that ruling," Kessler said. "I think it increases its credibility in this industry by giving awards like this under these circumstances."
The decision also drove home the message that securities brokers need to fulfill due diligence obligations to investors, especially when the investments involve structured products. "Conflicts of interests, and misrepresentations and omissions are coming to light," Peter Mougey, the president of the Public Investors Arbitration Bar Association, said Tuesday. "This is clearly sending a message that this conduct is not condoned and stuff has to be cleaned up. I am seeing more and more of those types of awards. It is not business as usual in Finra arbitrations."
The Finra arbitration ruling is the latest wrinkle in the ongoing legal battle between Securities America and various oversight bodies concerning the Medical Capital private placements.
Regulators from Massachusetts and Montana have accused Securities America of subpar due diligence on Medical Capital's debt, and want to hold the broker-dealer responsible for investor losses.
Massachusetts authorities filed a complaint in January 2010, saying it withheld material information from advisers and investors about the heightened risks associated with the Medical Capital debt.
In August 2010, the Montana's commissioner of securities and insurance followed with a similar complaint. Securities America was one of more than 40 broker-dealers that sold the Medical Capital Holdings notes, according to press reports. The Montana complaint, however, claimed it was responsible for selling $697 million, or 37%, of all Medical Capital notes nationwide since 2003.
Hearings in Massachusetts began Sept. 30, 2010. Although there is no telling when they will wrap up, company executives expect a decision in January or February.
It was unclear at press time when proceedings might begin on the Montana charges.
Medical Capital has its own problems, too.
The Securities and Exchange Commission charged Medical Capital and two of its executives with securities fraud in July 2009, and the company has since been placed in receivership, because the SEC says it failed to make interest and principal payments on almost $1 billion of notes.