The Financial Industry Regulatory Authority has barred former stockbroker Michael Rappa of Roseville, California from the securities brokerage industry after finding that Rappa solicited investors to purchase promissory notes issued as part of a Ponzi scheme perpetrated by the Woodbridge Group of Companies LLC (“Woodbridge”), which have since filed for Chapter 11 bankruptcy. According to FINRA’s findings, “Rappa sold $2,731,287 in in the fund’s notes to investors, some of whom were customers of his member firm.” At the time of the investments, Powell was registered with Foresters Equity Services.
Customers of Rappa and/or Foresters who invested in Woodbridge may have claims against the brokerage firm. To prevail on a claim against the firm, the customers will likely have to demonstrate that the firm either knew or should have known about Powell’s unlawful conduct. See McGraw v. Wachovia Securities, L.L.C., 756 F. Supp. 2d 1053 (N.D. Iowa, 2010) and in As You Sow v. AIG Financial Advisors, Inc., 584 F. Supp. 2d 1034 (M.D. Tenn. 2008).
In McGraw, two brokerage firms asked the court to dismiss claims relating to investment transactions that a broker at the firms had recommended on the grounds that the transactions were outside the scope of the broker’s employment with the firms. The court denied the firms’ motion as to substantially all of the plaintiffs’ claims and reasoned in pertinent part as follows:
[L]ack of notice or approval of a representative’s particular outside activity or private securities transaction does not relieve a firm of its duty to monitor or investigate a representative’s outside activities or private securities transactions. . . . The court agrees that the plaintiffs have generated genuine issues of material fact that “sufficiently suspicious” circumstances here may have placed the defendants on notice that Lovegren was engaged in improper conduct as to them, giving rise to a duty to monitor and investigate Lovegren’s outside activities or private securities transactions.
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Specifically, the McGraws have generated genuine issues of material fact that . . . they received documentation of and other communications about their purported “investments” with Lovegren sent from Lovegren’s offices and company e-mail accounts at SCI/Wells Fargo or A.G. Edwards/Wachovia.
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Thus, they have generated genuine issues of material fact that employees and agents of the defendants either knew of Lovegren’s “outside” business activities and private securities transactions with the plaintiffs or should have discovered those activities from proper monitoring of incoming and outgoing correspondence and payments to and from Lovegren at his offices at SCI/Wells Fargo or A.G. Edwards/Wachovia, but they neither monitored, investigated, nor discovered Lovegren’s misconduct
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Thus, the court concludes that, notwithstanding that there is no documentation that Montross ever had an account with A.G. Edwards/Wachovia, and Pestka was no longer a client of A.G. Edwards/Wachovia when she invested in Lovegren’s fictitious investment in “Bond Management,” all of the plaintiffs may nevertheless have been owed a duty by A.G. Edwards/Wachovia and/or SCI/Wells Fargo to monitor and investigate Lovegren’s activities, and that the defendants may have breached that duty by failing to monitor, discover, or investigate Lovegren’s outside activities and private securities transactions.
In As You Sow, the court also denied a motion to dismiss filed by a FINRA member firm that was sued in connection with unapproved outside sales. The court reasoned in pertinent part as follows:
Stokes’s duty was to complete securities transactions in accordance with securities laws and NASD rules. To that extent, the acquisition and disposition of Plaintiffs’ assets were within the actual scope of Stokes’s duties as the Defendants’ agent. Federal courts that have held that broker-dealers are liable under principles of respondeat superior where their affiliated agents steal client’s money. See Henricksen v. Henricksen, 640 F.2d 880, 887 (7th Cir.1981), cert denied, 454 U.S. 1097, 102 S.Ct. 669, 70 L.Ed.2d 637 (1981); Alvarado v. Morgan Stanley Dean Witter. Inc., 448 F.Supp.2d 333 (D.P.R.2006). A contrary rule would cause injury unfair to the investing public.
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Broker dealers may not enjoy the benefits of their relationships with affiliated agents without discharging their supervisory duties, including the supervision of private securities transactions. Significantly, the NASD defines “private securities transaction” as a transaction “outside the regular course or scope” of the affiliation. Rule 3040(e) (emphasis added). A private securities transaction is therefore not outside the scope of the affiliation, but simply outside the “regular” or primary scope. Consistent with these principles, the Sixth Circuit has held that “a dispute that arises from a firm’s lack of supervision over its brokers arises in connection with its business,” even when the investor had no accounts with the firm. Vestax Securities Corp. v. McWood, 280 F.3d 1078, 1082 (6th Cir. 2002). For this tort [negligent supervision], numerous courts have ruled that broker dealers may be held liable under the common law for negligently supervising their registered representatives, even on dealings with investors who had no accounts with the firm.
FINRA’s enforcement division regularly brings actions against member firms for supervisory failures where the member firms have failed to detect “red flags” of broker misconduct. In FINRA Department of Enforcement v. Metlife Securities, Inc., et al, a firm was sanctioned for failing to detect an employee’s involvement in the misappropriation of customer funds. The findings of fact stated in pertinent part as follows:
As a result of the Respondents’ deficient supervisory systems and procedures for email review, numerous emails that contained indications of misconduct by representatives escaped detection. For example, during the relevant period, two MSI registered representatives engaged in undisclosed outside business activities and private securities transactions without detection by MSI, although the misconduct was reflected in more than 100 separate emails that were sent or received during that period using MSI assigned email addresses. It was ultimately revealed that one of those registered representatives had participated in numerous private securities transactions to raise capital for real estate development companies that he owned, controlled, or had contracted with, and that the representative had misappropriated nearly $6 million from his customers.