AER Advisors, Inc. v. Fidelity Brokerage Services, LLC
Posted on Categories Court Decisions, Securities Customers

By Paul J. Dubow

There is no good faith requirement in the provision of the Bank Secrecy Act that gives financial institutions immunity for voluntarily disclosing a possible violation of a law or a regulation to a government agency.

AER Advisors, Inc. vs. Fidelity Brokerage Services, LLC, No. 18-1884 (1st Cir., 4/17/19).

In 2009, AER, a registered investment advisor, joined Fidelity’s Wealth Central platform, giving it access to Fidelity’s investment technologies that AER relied upon when advising its clients. Under this program, Fidelity held the shares that AER’s clients purchased. Two of AER’s clients, William and Peter Deutsch, who owned millions of shares of China Medical Services, participated in the program. In March 2012, Fidelity offered the Deutsches the chance to participate in its “fully paid lending program” in which they would lend their China Medical shares to Fidelity for an interest based fee. The Deutsches declined the offer. Nevertheless, Fidelity chose to lend 1.8 million shares owned by the Deutsches to short sellers between May and June 2012. Fidelity profited from the loans, notwithstanding that the Deutsches were unaware of the transactions and received no compensation.

In June, Fidelity’s surreptitious lending triggered a recall obligation, because Fidelity loaned more China Medical shares than legally permitted. Fidelity issued recall notices for the shares, but only recovered 600,000. Instead, a short squeeze occurred, which drove the price of the stock up from $4 to $11.80. Fidelity was forced to buy 1.2 million shares on the open market. On July 5, Fidelity filed a suspicious activity report (SAR) with the Treasury Department’s Financial Crimes Network, accusing the Deutsches of manipulating the price of China Medical stock. The SEC halted trading in the shares on July 29 and commenced an investigation of AER and the Deutsches. The investigation was ultimately dropped, but not before AER and the Deutsches spent “hundreds of thousands” of dollars defending themselves and AER went out of business.

AER and the Deutsches filed suit against Fidelity in federal court, citing diversity jurisdiction, alleging an array of state law claims all based on the premise that Fidelity filed an SAR falsely accusing them of market manipulation. Fidelity claimed that it had absolute immunity from lawsuits alleging the filing of a false SAR and moved to dismiss the suit, citing a provision in the Bank Secrecy Act (BSA) that stated that “a financial institution that makes a voluntary disclosure of any possible violation of law or regulation to a government agency…. shall not be liable to any person…. for such disclosure.”

The motion was granted and the plaintiffs appeal, arguing that there is an implied good faith exception to the grant of immunity provided in the Act. The First Circuit affirms. Congress could have easily added a good faith requirement to the statute but did not. Moreover, a qualification on the immunity created by the BSA, such as a good faith requirement, poses practical problems, because it would create the risk of second-guessing and discourage disclosure. The risk that an unfounded or malicious filing would result in false charges is slight, since ordinarily the disclosures would, as a practical matter, be made to government authorities, who provide their own filter as to what investigations are pursued and made public. In addition, remedies other than private damage actions are available for willfully false reports, i.e., private sanctions such as employment termination and government penalties such as fines and imprisonment. Given this compendium of considerations, the BSA immunizes financial institutions even if their disclosures are unfounded, incomplete, careless, and even malicious, just so long as they identify “a possible violation” of law, something that Fidelity did here.

(P. Dubow) (EIC: We covered the District Court’s decision previously in SOLA 2018-36. We noted in that summary that the Deutsches sued Fidelity and National Finl. Svcs. in arbitration, seeking damages for lost opportunity and Fidelity’s handling of the account. The Panel denied the claims on damage grounds, while also providing its findings in full. Here’s an excerpt from the Award: “In essence, the firm appeared to be more focused on its own interests at the expense of accommodating those of its client or at minimum gaining a key understanding as to what the client’s intentions and interests were. Instead, the conclusion was reached that Deutsch and O’Leary were engineering a short squeeze and should be cut off from further purchases of CMED. By reason of the foregoing, the Panel finds in favor of Claimants on this equitable issue. However, as mentioned above, whatever Fidelity did or did not do would not have altered the failure of Claimants’ investment because the events that doomed the strategy were either external to Fidelity or internal to CMED.”)

(SOLA Ref. No. 2019-28-07)

NOTICE: The court decision synopsis published above represents an abbreviated description of the actual decision and is re-printed here for its educational value. The author's effort is to report concisely the substance of the decision or a selected portion of the decision; commentary or analysis is generally reserved for the italicized section at the bottom of the summary. Subscribers to SAC's Online Litigation Alert (SOLA), from which this synopsis is excerpted, have immediate access to the full decision, in addition to the synopsis. 

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