On Jan. 9, an arbitrator for the Financial Industry Regulatory Authority, or FINRA, awarded customers of a brokerage firm compensatory damages of roughly $55,000 for breach of fiduciary duty, negligence and breach of contract in the course of a bond sale.

In addition, the customers were awarded almost $15,000 in prejudgment interest.

The customers, the claimants in the arbitration, were Zane Gubman and Karen Gubman in their capacities as co-trustees of the Gubman Revocable Trust and co-trustees of the Sidney Cohn Life Insurance Trust. The respondent was brokerage firm The GMS Group LLC.

According to the Award, which came with an explained decision, the GMS broker who handled the bond transactions had a duty to deal fairly with the customers when making the sales. Fair dealing requires, among other things, that the firm do reasonably thorough research into the terms and creditworthiness of the products it offers, that the firm convey all this information to its brokers and that the brokers make sure customers are given all pertinent information.

This duty of fair dealing and due diligence is found in the FINRA Rules as well as the rules of the Municipal Securities Rule making Board.

Arbitrator Awards Damages

The FINRA arbitrator awarded damages resulting from the claimants’ investments in Main Street Natural Gas Inc. Gas Project Revenue Bonds, Series 2008A.

The Main Street Bonds were complex in nature. The bond purchaser’s money went through the Main Street Natural Gas Inc. to Lehman Commodities, a unit of Lehman Bros, a once-prestigious investment bank that failed spectacularly in 2008.

Lehman Commodities was then obligated to purchase gas to be delivered to Main Street Natural Gas Inc., which would distribute the gas to municipalities and others for 30 years. The revenue from the gas sales was to be used to pay the bond holders and the payments of principle and interest were guaranteed by Lehman Bros. This meant that the bond holders were exposed to the default of both Lehman Commodities and Lehman Bros., the Award said.

Arbitrator Declines Damages

The arbitrator declined to award damages sought by the claimants’ related to their investments in a series of Washington Mutual 4% Notes, however, finding that the claimant had been reasonably informed as to those transactions.

The Award was unevenly split between the two trusts for which the Gubmans served as co-trustees, with the Gubman Revocable Trust receiving about $41,000 compensatory damages plus and prejudgment interest, and the Sidney Cohn Life Insurance Trust receiving about $29,000.

Firm & Broker Failed in Their Duty to Inform

In this case, the FINRA arbitrator found that the brokerage firm and the broker who interacted with the claimants failed in their duty to reasonably inform the claimants about the Main Street Bonds

The claimants made it clear before the transactions that they were relying completely upon the expertise of the broker and the firm and they were not interested in doing research on their own, according to the Award.

Therefore, to fulfill their duty the broker and the firm needed, at a minimum, to apprise themselves of: 1) the opinions of the three major rating agencies as to the bonds’ credit risks 2) the facts and terms of the bonds they were proposing for sale 3) general market conditions 4) and the risk of default.

The evidence gathered in the FINRA arbitration showed that the management and analysts at the firm, as well as the broker in question, were either in possession of this data or able to ascertain this data for both the Main Street Bonds and the Washington Mutual Bonds before the bonds were sold to the claimants.

In her explained decision, the FINRA arbitrator said the underlying principle of law was that brokers may not make material misrepresentations regarding the product being sold. Most pertinent here, material misrepresentations include omissions as well as false affirmative statements.

If the broker knew there was a risk of a default by some involved party other than the issuing entity, or knew that a particular market condition might adversely affect the value of bonds, that broker was obligated to convey this information to claimants so they could make an informed decision.

The claimants were always open to any information brought to them by the broker and always bought the bonds suggested by the broker, the Award said. The evidence showed, however, that in the case of the Main Street Bonds, the claimants may well have declined to purchase them if had they been told everything that that firm and the broker knew or should have known.

The evidence also showed that claimants exercised their own judgment when fully informed, even if it conflicted with the broker’s recommendations. For instance, the claimants decided to sell the bonds despite the broker’s suggestion that they hold onto them. After the claimants became fully informed about market trends, they judged that the bonds might lose further value, according to the Award.

The arbitrator also held that the firm could not insulate itself from liability through the belated production of a prospectus informing claimants of the risks of default.

“An initial omission of facts could not be cured in this manner,” the Award said.

The Main Street Bonds were a new issue and the evidence shows that the claimants’ exposure to a default by Lehman Bros., who were participants in the offering and guarantors, was clear. Although the three major rating agencies rated the bonds as investment grade, by the time they were offered for sale to the claimants in August 2008, Lehman Bros.’ credit worthiness had been downgraded.

The broker testified that at the time of the Main Street Bond sale, he knew the market was concerned about Lehman’s ratings, the Award said. The broker testified that it was his general practice to advised customers about market concerns and downgrades, but he said if could not remember if he informed the claimants. The claimants testified that they were never given this information.

Moreover, the claimants said that they had relied upon the fact that the offering was guaranteed by what they perceived to be a prestigious firm, the Award said.

While the broker did provide basic information to the claimants on the bonds’ rate, term, issuer, guarantor and maturity date, he failed to provide vital risk-of-default information about Lehman Bros. the Award said. Therefore, the arbitrator concluded that the firm and the broker failed to provide claimants with all the information they needed to make a decision regarding the Main Street Bonds. The arbitrator held this was a negligent omission, and not done with the intent to defraud.

Guiliano Law Firm

The practice of Nicholas J. Guiliano, Esq., and The Guiliano Law Firm, P.C., is limited to the representation of investors in claims for fraud in connection with the sale of securities, the sale or recommendation of excessively risky or unsuitable securities, breach of fiduciary duty, and the failure to supervise. We accept representation on a contingent fee basis, meaning there is no cost to unless we make a recovery for you, and there is never any charge for a consultation or an evaluation of your claim. For more information contact us at (877) SEC-ATTY.

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