BROKER-DEALER DISPUTE OF THE WEEK
The summary below appeared in a recent Securities Litigation Alert.

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Stone v. Chicago Investment Group, LLC, No. 11 C 51, 2011 U.S. Dist. LEXIS 149153 (N.D. Ill., 12/29/11). 1934 Act: Securities Exchange Act of 1934 * FRCP: Federal Rules of Civil Procedure (Rule 4(m)) * Service of Process (“Summons – Time Limit for Service”) Misrepresentations/Omissions * Timeliness Issues (Statute of Limitations). In light of the Supreme Court’s Merck decision, 7th Circuit case law that the statute of limitations for Exchange Act claims begins to run when plaintiffs are on “inquiry notice” is no longer good law.

Plaintiffs purchased “investment promissory notes” issued by two real estate development companies. In their complaint asserting claims for securities fraud under the Exchange Act, the Illinois Securities Law and Illinois common law, plaintiffs allege defendants Chicago Investment Group and broker Alan Birkley made false and misleading statements to them regarding the safety of and rate of return on the notes. Defendants move to dismiss on statute of limitation grounds. The Court denies the motion. Under the Supreme Court’s 2010 Merck decision, the requirement that a claim for fraud under the Exchange Act be brought within two years after the discovery of facts constituting the violation does not depend on when plaintiffs were on “inquiry notice,” as previously held by the Seventh Circuit. Rather, the limitations period begins to run only when plaintiffs “know, or with due diligence should know, the facts underlying the alleged violation.” In contrast, the three-year limitations period under the Illinois Securities Law begins to run when plaintiffs are on inquiry notice of a possible violation. Under either standard, however, plaintiffs’ claims are timely. The fact that the original notes were not paid at the end of 2007 when due did not trigger the running of the limitations period, especially since plaintiffs were provided with replacement notes with a 2008 maturation date. Nor did the failure to pay the notes in 2008 trigger the running of the limitations period. The mere fact of an investment loss does not provide plaintiffs with facts showing a violation, particularly as to the scienter requirement. Similarly, plaintiffs were not on inquiry notice of fraud more than three years before they filed their claims under the Illinois Securities Law. Again, the mere fact that the investments were not performing as represented is not sufficient to trigger the running of the limitations period, especially given that defendants were providing plaintiffs with reassurances regarding the investments and voluntarily replaced the 2007 notes with 2008 notes. Accordingly, defendants’ motion to dismiss on limitations grounds is denied. 

(J. Komie) (EIC: It seems the value of a statute of limitations defense has been seriously discounted by the Merck decision and this Opinion provides a good demonstration of that fact.) (SLC Ref. No. 2012-04-10, 1/23/12)

ARBITRATION ITEM OF THE WEEK

MERRILL PAYS $1 MILLION FOR ARB BREACH: While we suspect FINRA would take the position that all arbitration rules are conduct rules, it is true that some Code provisions are substantive, not procedural, and bear an importance that warrants enforcement when violations occur; the requirement placed upon members to arbitrate disputes is of that character. That policy was made apparent by FINRA’s announcement, in a News Release, dated January 25, 2012, that it was imposing a fine of $1 million on Merrill Lynch for purportedly circumventing the arbitration requirement. Back in 1996, the New York Stock Exchange sanctioned broker-dealer McLaughlin Piven for requiring its trainee brokers to sign agreements that expressly waived the SRO rule requirements regarding arbitration (NYSE Rule 347) and agreed to litigate any disputes under the contract in the New York state courts (7 SAC 9&10(11); SEC Rel. No. 34-38076). Merrill’s approach was somewhat more subtle. There was no mention of an arbitration waiver in the agreements, which were extended to 5,000 brokers on Merrill’s sales force after the merger with Bank of America. The forgivable loans that the brokers received, as part of a retention drive known as the Advisor Transition Program (ATP), were structured so that the lender was not Merrill, the FINRA member, but a non-member affiliate, Merrill Lynch International Finance, Inc. (MLIFI). Thus, an undertaking to litigate disputes in the New York state courts permitted MLIFI to pursue loan defaults, without any obligation to arbitrate. FINRA charged this device was a subterfuge, in findings made pursuant to a Letter of Acceptance, Waiver and Consent, signed by Merrill, without admitting or denying. The money for the loans did not come from MLIFI’s coffers, but were provided by the parent company of the two affiliates. In the AWC, FINRA concludes that Merrill’s actions violated Rule 13200(a) of the Industry Code and IM 13000, which provides that a failure to submit a dispute for arbitration, as the Code requires, may also be considered a violation of Rule 2010, “conduct inconsistent with just and equitable principles of trade…. By structuring the ATP program to allow the Firm to avoid complying with its obligation to arbitrate disputes with its associated person, Merrill Lynch violated FINRA Rule 2010.” Merrill also violated these rules by pursuing collection of amounts due from brokers under the promissory notes in court actions rather than in arbitration proceedings. Merrill filed more than 90 collection actions in the New York courts during the period January through November 2009. In a “Corrective Action Statement” attached to the AWC, the Firm states that “Merrill Lynch and MLIFI stopped pursuing ATP collection actions to New York state court in January 2010, and will not do so in the future.”

(ed: *The price of violating the arbitration requirement has gone up – McLaughlin Piven was fined $15,000. **We question the underpinning assumptions behind this alleged legal gambit – just looking at the arbitration side, the “win rate” statistics and the recovery percentages in promissory note cases have been historically in the 90% or greater range. The rule change permitting expedited promissory note procedures under FINRA Rule 13806 was approved in June 2009 (SEC Rel. No. 34-60132). What’s the problem?) (SAC Ref. No. 2012-04-01, 1/25/12)

 

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