A beleaguered John Thomas Financial broker, Scott Levine, was granted a moment of reprieve earlier this month, thanks to a bankruptcy filing on May 13.
After incurring multiple customer complaints related to his former firm, which was expelled by the Financial Industry Regulatory Authority Inc. in October 2013, bankruptcy protections afforded by federal law have frozen five customer complaints in which he was named and which carry damage claims that could total nearly $5 million.
Mr. Levine, who faced claims related to unsuitable investments, churning and private placements, continues practicing at his new broker-dealer, IAA Financial.
Attorneys who represent investors said that the situation is indicative of an unintended consequence of Section 362 of the Bankruptcy Code, which freezes litigation and administrative actions and is designed to help those who face financial emergencies maintain their livelihood and get back on their feet. Instead, it could be allowing some brokers to remain the business too long with customer complaints discharged in bankruptcy court or left open indefinitely.
“Bankruptcy can be used to manipulate things,” said Jacob Zamansky, an attorney for investors at an eponymous law firm. “The interesting issue is, why would a broker be able to continue practicing and earning a living under Finra as a Finra- registered person” if they file for bankruptcy to avoid debts to customers.
Finra rules require that a bankruptcy filing be reported within 30 days and a disclosure be made on the broker's public BrokerCheck report. But Mr. Zamansky said Finra should consider taking more immediate action including heightened supervision or suspension when bankruptcy occurs amid legitimate customer claims against the broker.
Instead, those complaints remain marked as “pending” under BrokerCheck. Arbitrators make no decisions with respect to such claims until the order that freezes legal action against the broker is lifted by a bankruptcy judge. Some complaints, such as Mr. Levine's, go back several years.
Finra does not disclose the number of brokers who have filed for bankruptcy, but statistics from the Certified Financial Planner Board of Standards Inc. show that as many as 49 CFP certificants filed for bankruptcy in 2011 in the aftermath of the financial crisis — compared with one in 2008.
Many brokers have legitimate reasons for filing for bankruptcy. It's not clear how many brokers are filing for bankruptcy with customer complaints pending because Finra does not disclose those numbers.
So far in 2014, however, there have been five awards issued in which the arbitrators noted that the claims against a broker had been stayed in light of a bankruptcy filing, according to a review of Finra awards.
Donald J. Gunn Jr. of International Assets Advisory, a sister firm of IAA Financial, filed for bankruptcy last October.
Mr. Gunn is a founder and former president of defunct brokerage firm GunnAllen Financial Inc. The firm, in which Mr. Gunn had a controlling interest, filed for bankruptcy in April 2010, according to Finra records. GunnAllen had been shut down a month before for not meeting capital requirements.
Last June, Mr. Gunn was the subject of a $250,000 customer complaint related to “excessive and unnecessary concentrated positions in volatile penny stocks,” according to his BrokerCheck report. He has denied the allegations and is requesting expungement.
“I have been a registered rep. since 1986. I have never had a personal customer complaint,” Mr. Gunn wrote in an e-mail.
“I was named in the June complaint because I was listed as a joint representative on the account. I had virtually no contact with the customer. Finra conducted an inquiry into the circumstances of the complaint and it was closed with no finding.”
He wrote: “Like many other financial services companies, GunnAllen did not survive the financial crisis. As a result my income and net worth dropped dramatically.
“My wife of 23 years filed for divorce. The weight of the resulting legal expenses, alimony demands and accumulated personal debt left me no choice but to file for personal bankruptcy,” Mr. Gunn wrote
“I continue to serve my clients with honesty, and to the best of my ability.”
Accusations around the sale of penny stocks are usually discharged because they are considered contractual claims against the broker, according to David Shaev, an attorney with Shaev & Fleischman who has worked with brokers who filed for bankruptcy.
Unless claims against a broker involve criminal allegations of fraud, they will usually end up being discharged by the bankruptcy court, he said.
“A bankruptcy stay is a very powerful tool that stays all actions against the debtor … with very few exceptions,” Mr. Shaev said. “And the creditor had best be careful.”
A Finra spokeswoman, Michelle Ong, declined to comment on whether the regulator had placed either Mr. Levine or Mr. Gunn on heightened supervision or had considered enforcement action.
A request for comment from Mr. Levine was returned by IAA Financial's in-house legal counsel, Kevin Carreno, who is also a part owner of the firm. Mr. Carreno said that the firm's policy did not allow brokers to comment for articles. He said he was “not aware of Finra inquiring about anything concerning Mr. Gunn or Mr. Levine.”
He declined to comment on whether the firm had taken action to place them under heightened supervision.
“Why would we?” he said. “If you filed for bankruptcy, would your employer place you under heightened supervision?”
The firm has to be careful because federal law prohibits firms or brokers from taking retribution for a bankruptcy filing, he added.
When it occurs after multiple customer complaints, bankruptcy should be grounds for termination of a state securities license in most cases, according to Joseph Borg, director of the Alabama Securities Commission.
“For multiple complaints, I'd probably terminate them anyway without the bankruptcy,” he said. “It's generally my rule that if there are bankruptcies and there are customer complaints, I'm going to be terminating those licenses.”
But bankruptcy law presents challenges for Mr. Borg as well.
Under federal bankruptcy law, for example, some brokers may be able to claim their state license as a property right, so it could not be revoked on account of a bankruptcy. Mr. Borg said he sometimes waits until the license comes up for renewal the following year and denies the request if he cannot find a charge with which to revoke the license sooner.
Finra usually follows suit if he files to terminate a broker's license, Mr. Borg said.
To take action on its own, Finra would have to file a separate case through its enforcement division based on charges unrelated to the bankruptcy. A broker that has customer complaints for fraud, for example, is less likely to be able to postpone action through bankruptcy. Finra's enforcement division also reviews all claims when they are filed with Finra dispute resolution.
For lesser complaints, however, that enforcement may take too long, said Jenice Malecki, an attorney who represents investors through an eponymous law firm. She said she has brought an arbitration case related to a broker who since filed for bankruptcy but remains licensed by Finra. She decided to name the broker or the firm in the arbitration claim so that her case would not be frozen, and her client could still have a chance to win damages.
“I think that it goes more to the lack of resources at Finra to follow up with every potential complaint,” Ms. Malecki said. “And that lack of resources obviously allows brokers like this sometimes to stay in the business.”
Often when customer complaints are resolved, which can be years after the bankruptcy filing, brokers may only have to pay a small portion of the total damages under the final bankruptcy order, and victims often have little recourse unless that broker had insurance, she said.
“Even if there is an enforcement action, they will fight and fight and fight to leave it open rather than have something close,” she said. “They can work as long as possible knowing that at some point they're going to get banged out of the industry and not have to pay anybody anything.“