FINRA Pre-Hearing Brief (Fictional Names)

FINRA Pre-Hearing Brief (Fictional Names)


Claimant, Trusting Victim, (“Claimant” or “Claimant Victim”), by and through her undersigned counsel, hereby files this pre-hearing brief, wherein she states as follows:

A.  The Claimant is an elderly retiree.

She resides in Trustworthy, Texas and Blue Lakes, Minnesota (depending on the season). Timid, frail, and risk-averse, Claimant was in search of an investment product characterized by safety and stability that generated a reasonable level of income.  With an eye toward appealing to Claimant’s conservative goals and objectives, Super Huge Financial Corp. (“Super Huge”) personnel portrayed the Stellar Mutual Fund (“Stellar Fund” or “Fund”) as a splendid investment that was tailored to her priorities.  Embracing half-truths and distortions, they concealed the true characteristics of the Stellar Fund while shamefully taking advantage of the admirable, respected reputation the firm then maintained.  Propelled, in part, by their own self interests, Sticky Stockbroker (“Stockbroker”) and his Super Huge colleagues pursued this regrettable, dishonest course of action in July 2015 notwithstanding their knowledge of Ms. Victim’s elderly status and her upcoming retirement.[1]

As framed by Super Huge and Stockbroker, the Stellar Fund constituted a magnificent “blue chip” asset, the safety of which was unparalleled. Tellingly, however, there was a wide, deep chasm separating the true features of that fund from the fictional portrayals that had been so artfully crafted.  On a realistic level, the Stellar Fund had become rancid in many respects.  Indeed, the Fund had been so thoroughly transformed with the passage of time that it could scarcely be compared to the Stellar Fund which was originally constructed.  And by July 1, 2015, Stellar Fund Executives had inexplicably steered the Fund into an untenable situation; it was virtually devoid of investment grade securities.  Viewed in that light, the Stellar Fund was miles apart from the accolades Stockbroker deceptively conferred upon it. The exercise of even a modicum of integrity would have precluded the employment of such sales tactics. Unfortunately, however, Respondents exhibited little regard for the welfare of Ms. Victim. And, on July 21, 2015, they persuaded her to purchase $750,000 of Stellar Fund securities. Several months later, the market value of Stellar Fund securities plummeted.

Fueled by concern over this tragic state of affairs, Claimant felt helpless. She could scarcely bear the losses that were then unfolding. Nonetheless, Respondents urged her not to sell. But, with her retirement party drawing near, Claimant soon decided that a sale constituted a necessity. Sickened by the catastrophic state of affairs that was forced upon her at such an advanced age, Claimant ultimately sold the Stellar Fund, recognizing a loss of nearly $500,000. [2]


B.  Respondents

Materiality: Misrepresentations and Omissions of Material Facts

As set forth above, Respondents misrepresented and omitted facts that were material to the Claimant’s decision to purchase Stellar Fund, along with her subsequent decision to continue holding those securities.[3]

The U.S. Supreme Court has held that in the securities context, an omitted fact is to be deemed material if there is a substantial likelihood that, taking into account all of the surrounding circumstances, it would have assumed actual significance in the deliberations of a reasonable investor.  Basic, Inc. v. Levinson, 485 U.S. 224 (1988).  See also Berreman v. West Publishing Company, 615 N.W. 2d 362 (Minn. App. 2000) (referencing materiality standards set forth in Basic). See also Lutheran Brotherhood v. Comm’r. of Revenue, 656 N.W2d 375 (Minn. 2003).  Under Minnesota law, the knowing concealment or nondisclosure of a material fact is actionable as fraud where, as here, there was a duty to disclose.[4]  Klein v. First Edina Nat’l Bank, 293 Minn. 418, 420 (1972) (holding that “[o]ne who stands in a fiduciary relation to the other party to a transaction must disclose material facts.”).[5]

Given the nature of the labels and characterizations Super Huge applied to registered professionals working on its behalf, the existence of a fiduciary duty is scarcely subject to debate.  Minnesota Statute 45.026 is dispositive; the breadth and reach of that provision leaves no room for any good faith argument on that front.  Among other things, section 45.026, subd. 1(b) specifies that a “financial planner” (a fiduciary) encompasses those who are portrayed as a “financial counselor,” an “investment counselor,” or a “financial consultant,” or such person is referenced through the use of a similar designation or title. Extending the analysis further, Section 45.026 subd. 2 goes on to expressly state that “financial planners” – as defined in the aforementioned flexible and elastic sense – “have a fiduciary duty to persons for whom services are performed for compensation” (e.g., Ms. Victim).  As an additional matter, Respondents maintained concrete disclosure obligations under separate Minnesota statutory provisions.  In that regard, Minnesota Statute 80A.01 operated so as to create a duty to disclose.  An analysis of Minnesota Statute 80A.03 yields the same result; it likewise gave rise to a full disclosure obligation.  Equally important is the recognition that regardless of whether Section 80A.03 is predicated on a finding of scienter, a showing of mere negligence satisfies the requirements of subparts (b) and (c) of Section 80A.01.[6]  See Sprangers v. Interactive Techs., 394 N.W.2d 498, 503 (Minn. App. 1986), review denied (Minn. Nov. 19, 1986).[7]

Minnesota common law also imposes a separate duty to disclose, in that, Respondents maintained superior knowledge and Claimant placed her confidence in them.  In accordance with Minnesota common law standards, these dynamics coalesced so as to place the relationship solidly within the fiduciary realm.  Pursuant to long-standing principles of Minnesota law, “[a] fiduciary relationship exists ‘when confidence is reposed on one side and there is resulting superiority and influence on the other; and the relation and duties involved in it need not be legal but may be moral, social, domestic, or merely personal.’”  Toombs v. Daniels, 361 N.W. 2d 801(Minn. 1985), quoting Stark v. Equitable Life Assurance Company of the United States, 285 N.W. 466, 470 (Minn. 1939).  In sum, “the fiduciary relationship has two characteristics: superiority of knowledge of one party and confidence reposed by the other.”  Vacinek v. First Nat’l Bank, 416 N.W. 2d 795, 799 (Minn. App. 1987).

On a related front, the SEC has also made it clear that full disclosure obligations stem from due diligence, “know your security” principles. In that regard, the SEC has specified that broker-dealers and their registered representatives must conduct a reasonable investigation of any recommended security and then disclose to potential investors material facts about which they are, or should be, aware.  See, e.g.Richard J. Buck, 43 S.E.C. 998, 1006 (1968), aff’d sub nom. Hanly v. S.E.C., 415 F.2d 589, 596 (2d Cir. 1969). Recognizing that a “reasonable investigation” serves as a predicate to a “reasonable basis,” those in the securities industry must undertake critical analysis and careful scrutiny of the information concerning the security they are recommending.  In re Sky Scientific, Initial Decision Rel. No. 137, at 26 March 5, 1999.  See also District Business Conduct Committee for District 5, No. C05960041 (NBCC Oct. 10, 1999) (emanating from former Rule 2110 “is the duty to make a reasonable investigation before making representations about securities.”).  

Prominently situated among the universe of material facts that must be disclosed are the “adverse interests” of the broker-dealer or registered representative, such as an economic inducement that could influence a recommendation to purchase, sell or hold the security.  William Jackson Blalock, 52 S.E.C. 77 (1994); Gordon Wesley Sodorff, Jr., 50 S.E.C. 1249, 1256-1258; Gilbert A. Zwetsch, 50 S.E.C. 816, 818 (1991); In the Matter of Michael A. Niebuhr, 60 S.E.C. Docket 2923, 2931 (1995); NASD Notice to Members Nos. 96-32 (May 9, 1996) and 96-50 (July 1996).  Federal court decisions likewise require brokers to refrain from self-dealing and to fully disclose benefits they expect to derive from the course of action they recommend. [8]


Fraudulent Inducement


Respondents misrepresented the fundamental character of the Fund. Notwithstanding the ostensible depth of their purported good faith assurances, the Stellar Fund lacked the pivotal qualities they accented.    Given the unenviable position they now occupy.[9] Respondents may attempt to reduce their liability by pointing to isolated statements in a prospectus that contradicted marketing materials and representations articulated by Super Huge and Stockbroker.[10]  However, the SEC, and numerous state and federal courts, have found that the delivery of a prospectus does not cure a fraud or “license broker-dealers or their salesmen to indulge in false or fanciful oral representations to their customers.”  Ross Securities, Inc., 41 S.E.C. 509, 510-511 (1963).  See also Persons Deemed Not To Be Brokers, Exchange Act Rel. No. 20943, at 10 (May 9, 1984) (expressing agreement with conclusion articulated in “Special Study of Securities Markets” by finding that “[n]o amount of disclosure in a prospectus can be effective to protect investors unless the securities are sold by a salesman who understands and appreciates both the nature of the securities he sells and his responsibilities to the investor to whom he sells.”).  Similarly, NASD/FINRA, through Notice To Members 94-16 (March 1994), stated that “oral representations by sales personnel that contradict the disclosures in the prospectus or sales literature may nullify the effect of the written disclosures and may make the member liable for rule violations and civil damages to the customers that result from such oral representations.”  See also McCoy v. Goldberg, 748 F. Supp. 146, 152 (S.D.N.Y. 1990) (“After luring plaintiff into ignorant reliance, defendants cannot now avail themselves of the doctrine of constructive knowledge” of the offering memorandum);[11]  Halperin v. eBanker, Inc., 295 F.3d 352, 357 (2d Cir. 2002) (noting that it is the “total mix of information” provided to the investor that is reviewed to determine whether the investor was misled).

In this case, there can be little doubt that the prospectus, when viewed in its entirety, was highly misleading. Extending the analysis further, it seems clear that the “total mix of information” Claimant received from the Respondents misrepresented both the nature and the risk of the Stellar Fund.[12]


  1. Negligence Per Se

“As the SEC has noted, the securities industry ‘presents a great many opportunities for abuse and overreaching, and depends very heavily on the integrity of its participants.’” Dep’t. of Enforcement v. Patel, No. C02990052, at 11 (NAC 2001).  “A broker-dealer, by holding itself out as a securities professional with special knowledge and ability, impliedly represents that it will deal fairly, honestly, and in accordance with industry standards with the public investor.”  In re Kevin Eric Shaughnessy, Exchange Act Rel. No. 40244, at 3 (July 22, 1998).  See also In re Thomas Kocherans, Exchange Act Rel. No. 36556 (finding that “[p]articipants in the securities industry must take responsibility for compliance with regulatory requirements and cannot be excused for lack of knowledge, understanding or appreciation of these requirements.”).

In accordance with well established principles of law, FINRA Rules, together with a broker-dealer’s internal rules,[13] serve to establish the duty of care owed by a brokerage firm.[14]  Without a doubt, investors residing in Minnesota (and throughout the country) are principal beneficiaries of the rules and regulations that have been established by FINRA.  To that end, FINRA has specifically stated that its “mission . . . is to regulate securities markets for the ultimate benefit and protection of the investor.”  NASD Manual, at 151 (2000). As part of its investor protection function, FINRA “writ[es] and enforce[es] rules and regulations for every single brokerage firm and broker in the United States;” it carries out those functions and many others, to “[s]afeguard the investing public against fraud and bad practices.” FINRA: “Get to know us,” at 2 (2009).       Taking all pertinent factors into account, it goes without saying that Respondents operated within the context of an intensely regulated industry requiring strict obedience to applicable laws and standards.[15]  Equally clear is the unwavering recognition that Claimant, and similarly situated investors, served as key beneficiaries of the demanding regulatory dynamics that were put in place as a means of achieving investor protection – which stands as an essential element of overall national prosperity.  See United States v. Naftalin, 441 U.S. 768, 776 (1979) (noting that “frauds perpetrated upon either business or investors can redound to the detriment of the other and to the economy as a whole.” (emphasis added).[16]  Viewed in that light, application of time-honored Minnesota law necessitates a determination that Respondents be held accountable under negligence per se principles.  Succinctly put, a negligence per se analysis is applicable when the following two part test is met:  “(1) ‘the persons harmed by [the] violation [of a statute] are within the intended protection of the statute’ and (2) ‘the harm suffered is of the type the [statute] was intended to prevent’” (brackets in original). Duxbury v. Spex Feeds, Inc., 681 N.W. 2d 380, 390 (Minn. App. 2004), review denied (Minn. Aug. 25, 2004), quoting Alderman’s Inc. v. Shanks, 536 N.W. 2d 4, 8 (Minn. 1995).  So solid is the extent to which negligence per se serves as a fundamental tenet of Minnesota jurisprudence that the Minnesota Supreme Court has expressly noted that “[a] long line of Minnesota cases establishes that violations of regulations or ordinances that are adopted pursuant to statutory authority[17] can result in negligence per se.” Shanks, 536 N.W. 2d at 8.  Conceptually, it must be understood that “[t]he statute or ordinance imposes a fixed duty of care, so its breach constitutes conclusive evidence of negligence” (emphasis added).  Id., quoting Pacific Indemnity Co. v. Thompson-Yeager, Inc., 206 N.W. 2d 548, 558-59 (Minn. 1977).  Celebrated scholars have observed that “‘[o]nce the statute [or rule] is determined to be applicable . . . a majority of the courts hold that the issue of negligence is thereupon conclusively determined . . . .’”  Shanks, at n.6, quoting Prosser and Keeton on the Law of Torts, Section 36, at 229-30 (5th ed. 1984).

            FINRA Rule 2010 requires that “[a] member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” Building upon those principles, it was incumbent on Super Huge financial consultants to serve the firm’s customers “with honesty and integrity by putting their interests first and foremost.” “Registered Representatives & Other Industry Professionals,” at 11, (NASD 2000).  See also Id., at 20 (addressing securities industry personnel and specifying that “[y]ou have a legal and moral obligation to place the interests of your customers above all else, particularly your own financial interests.”). In this case, Super Huge and Stockbroker enthusiastically recommended the Stellar Fund.  In reality, however, the Fund did not even come close to possessing the qualities Respondents attributed to it. Among other things, an investment in the Fund carried far more risks than Respondents disclosed.

As an additional matter, it must be recognized that since Respondents held themselves out as professionals with superior knowledge and skill, they were required to exercise the degree of skill that a reasonably prudent member of that profession would use in like circumstances.[18]


Based on the foregoing legal and equitable authority, along with the evidence to be presented at the final hearing, Claimant requests that this Arbitration Panel award her full compensatory damages, plus interest, costs and attorneys’ fees; and impose significant punitive damages upon Respondents.  Claimant also respectfully requests that the Panel provide her with all other relief to which she is entitled.


Respectfully submitted,




Attorney for Claimant

1  FINRA, together with federal and state regulators, have made it clear that they “view the protection of senior investors as a top priority.” Protecting Senior Investors: Compliance, Supervisory And Other Practices Used By Financial Services Firms In Serving Senior Investors, at 18 (SEC, OCIE; NASAA, and FINRA Sept. 22, 2008).  See also FINRA Regulatory Notice 07-43 (Sept. 2007) (emphasizing that with respect to senior investors, “[l]iquidity often takes on added importance.  And, depending on their particular circumstances, seniors and retirees may have less tolerance for certain types of risk than other investors.”).

[2] Clearly, “investment fraud hurts seniors more than any other group, because when seniors lose their life’s savings, they lack the time to rebuild a nest egg.”  Protecting Senior Cititzens from Investment Fraud, Congressional Testimony of SEC Chairman Christopher Cox, at 2 (Sept. 5, 2007).


[3] Notwithstanding the pivotal character of the underlying misrepresentations, a Rule 2010 violation may readily occur in the absence of “a finding of materiality”.  Dep’t. of Enforcement v. Goritz, C1000037, at 6 (OHO Jan. 3, 2001).  Similarly, “[a] misrepresentation may violate Conduct Rule 2010 even when there is no finding of intent to mislead.” Id.  (discussing former Rule 2110).


[4] To state a cause of action for fraudulent misrepresentation under Minnesota law, the victim must establish that he or she acted in reliance on the misrepresentation.  Spiess v. Brandt, 41 N.W.2d 561,565 (Minn. 1950).  However, it is a “well-established rule that in a business transaction the recipient of a fraudulent misrepresentation of a material fact is justified in relying upon its truth, although he might have ascertained its falsity had he made an investigation” (emphasis added).  Id., at 566.


[5] Federal standards are in accord.  Along those lines, a “duty to disclose arises when one party has information ‘that the other [party] is entitled to know because of a fiduciary or other relation of trust and confidence between them’” (brackets in original).  Chiarella v. United States, 445 U.S. 222, 228 (1980).  See also Affiliated Ute Citizens v. United States, 406 U.S. 128, 152-54 (1972).  On a related note, “[t]he NASD has previously held that Conduct Rules 2110, 2120 and SEC Rule 10b-5 are each ‘designed to ensure that sales representatives fulfill their obligation to their customers to be accurate when making statements about securities’” (emphasis added). Dep’t of Enforcement v. WaddellNo. C05000021, at 17 (OHO May 14, 2001).


[6] Minnesota Statute 80A.76 became effective on August 1, 2007.  Section 80A.76(b) imposes liability upon a seller of securities

if the person sells a security by means of an untrue statement of a material fact or an omission to state a material fact necessary in order to make the statement made, in light of the circumstances under which it is made, not misleading, the purchaser not knowing the untruth or omission and the seller not sustaining the burden of proof that the seller did not know and, in the exercise of reasonable care, could not have known the untruth or omission.


[7] Similarly, liability may also be imposed under Minnesota law based upon the tort of negligent misrepresentation.  Consistent with the observations that have been made by the Minnesota Supreme Court, where “‘a person represents as true material facts susceptible of knowledge to one who relies and acts thereon to his injury, the one making the representation cannot defeat recovery by showing that he did not know his representations were false or that he believed them to be true.’”  Lewis v. Citizens Agency of Madella, 235 N.W.2d 831 (Minn. 1975), quoting Sweeden v. Sweeden, 134 N.W.2d 871, 875 (Minn. 1965).  Accordingly, negligent misrepresentation liability may be imposed “even where the statement was not intentionally made, or was a mistake.”  Id.  See also Bonhiver v. Graf, 248 N.W.2d 291, 298-99 (Minn. 1976). Briefly stated, the tort of negligence is committed when there “is a failure to discharge a legal duty to the one injured.” Rasmussen v. The Prudential Ins. Co., 152 N.W.2d 359 (Minn. 1976). See also Hudson v. Snyder Body, Inc., 326 N.W.2d 149, 157 (Minn. 1982).  Taking these principles into account, it is readily apparent that half-truths can readily trigger liability even if there is no evidence of an intent to deceive. “One who speaks must say enough to prevent his words from misleading the other party.” First Edina Nat’l. Bank, 196 N.W.2d 619, at 622.


[8] See Prawer v. Dean Witter Reynolds, Inc., 636 F.Supp.  642, 644 (D. Mass. 1985); and Leib v. Merrill Lynch, Pierce, Fenner & Smith, 461 F.Supp. 951, 953 (E.D. Mich. 1978).


[9] Respondents are in an unenviable position, in the sense that although they went to great lengths to encourage investor trust and admiration, they are essentially claiming that their deceitful practices would not have encountered success if they had not been viewed in such an honorable light.  When faced with such a tortured claim in the past, the Minnesota Supreme Court has caustically discarded it.  See Davis v. Re-Trac Mfg. Corp., 149 N.W.2d 37, 39 (Minn. 1967) (discussing situation where deceptive scheme has achieved success, and concluding that “the party whose misstatements have induced the act cannot escape liability by claiming that the other party ought not to have trusted him.”).


[10] Under the circumstances, it is readily apparent that the underlying prospectus contained inaccurate and incomplete information.  Moreover, it goes without saying that Respondents possessed a due diligence duty, wherein they were required to make a reasonable investigation to assure themselves that the representations made in the Fund’s prospectus were accurate and complete.  See, e.g., In re Brown, Barton & Engel, 43 S.E.C. 43 (1966) and In re Amos Treat & Co., Inc., 42 S.E.C. 99 (1964).


[11]  Although New York law is typically less favorable to investors than the law applicable to this case (Minnesota law), this New York court recognized the “real world” dilemma that would result if a de facto “license to cheat” was conferred upon firms handing out a prospectus.


[12] Even if Ms. Victim’s elderly status had not compromised her ability to “fend for herself,” the decline in the price of Stellar Fund would not have put her on notice of Respondents’ fraudulent conduct.  See Betz v. Trainer Wortham, 504 F.3d 1017, 1026 (9th Cir. 2007) (“It is well settled that poor financial performance, standing alone, does not necessarily suggest securities fraud . . .”); La Grasta v. First Union Securities, Inc., 358 F.3d 840 (11th Cir. 2004) (“. . . precipitous fall in corporation’s stock price did not, by itself, put investors on inquiry notice.”).


[13] Super Huge was required to “establish, maintain, and enforce” its own internal rules and requirements.  Those internal standards had to be designed so as to provide for conformity with federal statutes and rules; Minnesota statutes and rules; and FINRA rules.


[14] The weighty internal supervisory rules broker-dealers are compelled to enforce have operated so as to leverage the resources of regulators, the effect of which has engendered a greater sense of safety and integrity, thereby heightening investor confidence in the capital markets. See  SG Cowen Securities Corp.Exchange Act Release No. 34-48335 (Aug. 14, 2003), citing, Smith Barney, Harris Upham, & Co., Exchange Act Release No. 34-21813 (March 5, 1985) (noting “that the ‘responsibility of broker-dealers to supervise their employees by means of effective, established procedures is a critical component in the federal investor protection scheme regulating the securities markets’)”.


[15]  Consistent with the teachings of the SEC, “the supervisory obligations imposed by the federal securities laws require a vigorous response even to indications of wrongdoing. Many of the Commission’s cases involving a failure to supervise arise from situations where supervisors were aware only of ‘red flags’ or ‘suggestions’ of irregularity . . . .” In re John Gutfreund, Exchange Act Release No. 34-31554, at 14 (December 3, 1992).


[16] See also Naftalin, 441 U.S. at 775-76 (analyzing legislative history behind federal securities law and concluding that Congress enacted such legislation “to restore the confidence of the prospective investor in his ability to select sound securities; to bring into productive channels of industry and development capital which has grown timid to the point of hording; and to aid in  providing employment and restoring buying and consuming power.”).


[17] FINRA rules are adopted pursuant to statutory authority vested in the SEC under Section 19(b) of the Securities Exchange Act of 1934.  Pursuant to Section 19(b)(1), a proposed FINRA rule change cannot become effective in the absence of SEC approval.  See General Bond & Share Co. v. S.E.C., 39 F.3d 1451, 1457 (10th Cir. 1994) (examining rule making requirements applicable to self-regulatory organizations, and concluding that “‘[n]o proposed rule change shall take effect unless approved by the Commission . . .’”).


[18]  In accordance with Minnesota law, Super Huge and Stockholder served as the antithesis of order takers.  Under circumstances of this sort, they are “generally in the business of supplying information for the guidance of [their] . . . clients.”  Safeco Ins. Co. v. Dain Bosworth Inc., 531 N.W.2d 867, 873 (Minn. App. 1993).


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