In March 2003, I purchased $80,000 of Franklin New York Tax-Free A shares for my 70+-year-old client, who wanted to hold them long-term and was eligible for the $50,000 breakpoint. She didn't need the income (as evidenced by her reinvestment of dividends) and was very happy with the investment.
Then, the bank branch in which I originated her account was transferred from me. In November, I was shocked to see her account at a zero balance. The new rep in the branch used my rep ID to sell the shares at a loss of more than $3,000. Then he deposited the funds into her bank account and bought a fixed annuity with a six-year surrender schedule. He circumvented the anti-churning detection systems by removing the funds from the brokerage account. The client cut a check to the annuity company. When I asked my branch manager to take the sale out of my rep number and have the client sign the proper documentation, she agreed to note what happened in the file, but I'm not satisfied. What can I do?
Act with caution as you rectify this situation. Your interests and those of your former client are not necessarily the same. You want to ensure that she was treated properly, but you also need to protect yourself.
From the facts you provided, it does not appear that you have any obligations to notify your former client or anyone else of your concerns. While you feel morally compelled to help her, you were not a party to these transactions and may not have sufficient information to properly judge them. They may actually be suitable. Also, in the course of attempting to save your former client, you could instigate a claim by her against yourself, your colleague and your firm. If violations have occurred, you might also fall into the role of whistle-blower against your colleague and your firm.
First, disassociate yourself from these transactions as simply and quietly as possible. Then worry about your former client. Since your manager was unreceptive to your plight, you will have to go higher up. Your firm may have an ombudsman with whom you can speak confidentially. If that leads to a dead end, contact your compliance officer.
Remember, however, that the information you provide may or may not be confidential. Hopefully, you will find support for your situation as you work your way up the chain of command.
If internal mechanisms fail you and your former client files a claim, seek expungement. Under limited circumstances, NASD Rule 2130 allows registered representatives to erase histories of disputes with customers from the CRD system. This rule was recently narrowed to fortify the integrity of the CRD system, but your situation appears to fit well within the modifications. They provide for expungement for registered representatives who were not involved in the alleged investment-related sales-practice violation.
Under the new rule, you will have to file a request to a court of competent jurisdiction and name the NASD as a party. NASD Notice to Members 04-16 explains the procedures for seeking a court-ordered expungement. You can also contact the NASD Registration and Disclosure Department at nasdr.com/3400_filing_online.asp.
In whatever steps you take, be cautious and deliberate. Copy all written communications and keep records of all of your interactions. Once you have successfully protected yourself, then you can ascertain what further action, if any, to take on behalf of your former client.
Law Offices of Anthony V. Trogan
West Bloomfield, Mich.
With respect to the alleged churning, the NASD defines churning as excessive trading or the trading of an account for the purpose of increasing commissions, rather than to further the customer's investment goals. (See nasdr.com.) Generally, the following must be established in a churning claim: excessive trading, the broker's control over the account and the intent to defraud or disregard for the client's interests.
In the classic churning case, the assets have been excessively turned over generating commissions. Turnover ratio is generally calculated by dividing the purchases made during a time frame by the average equity invested during that period. However, this formula is not conclusive proof of churning and must be viewed in conjunction with the goals of the client. Both from a regulatory and litigation standpoint, the annuity recommendation would likely not amount to a classic churning case.
Regarding your responsibility for transactions entered under your production number, nondocumented and nonapproved “sharing” of production numbers likely runs afoul of company policy. You may be subject to discipline if you participated willingly. However, if you can prove you did not initiate the transactions and that you brought the transactions to management's attention, your exposure will be greatly reduced. Note that a claimant's attorney will seek to impose responsibility on you irrespective of the fact you did not participate in the transaction.
Finally, when an employee believes management to be nonresponsive, everything should be documented. Management's decision to document the event by placing a note in the customer's file would be appropriate. However, a prudent course of action would be for you to write a letter to management, with a copy to the associated person who transacted the trade, to confirm you did not participate in the transaction. Retain a copy of this letter for your records and request a copy be maintained in your personnel file. Such written documentation will be invaluable in the event of a regulatory inquiry or customer complaint.
In short, ensure that relationships with clients are formally terminated, maintain written records of transactions and interactions and scrutinize your activities as would a regulator or arbitration panel.
Jennifer Woods Burke
Lubiner & Schmidt Cranford, N.J.
Ethical Rep is a monthly feature in which more than 30 prominent securities attorneys, experts and law school professors help Rep. readers deal with work-related ethical quandaries. Have you encountered a situation at work that makes you uncomfortable? Are you confused about how your responsibilities to clients might change as regulations continue to evolve? Drop a line to Rep.'s contributing editor, Ann Therese Palmer, and our group of experts will help you work through the problem.
The Ethical Rep.
249 West 17th Street, Third Floor
New York, N.Y. 10011-5300
Fax: (913) 514-3890.