• July 17, 2023
• Financial Industry Regulatory Authority

The Wolper Law Firm filed an arbitration claim before the Financial Industry Regulatory Authority (“FINRA”) on behalf of clients who realized losses of nearly $750,000 in Silicon Valley Bank, First Republic Bank, Signature Bank and other financial sector securities recommended by Stifel, Nicolaus & Co., Inc. and Morgan Stanley.  The Financial Advisor responsible for the recommendations is Gregory (“Greg”) Sain.

The Allegations Contained Within the Arbitration Claim:

According to the claims filed by the Wolper Law Firm:

Financial Advisor Gregory Sain recommended that the customers transition their portfolio away from investment grade municipal bonds, which comprised more than 90% of their investments, and reinvest the proceeds in corporate bonds and preferred stocks within the financial sector.  There was further concentration of those assets within specific issuers, including Silicon Valley Bank (“SVB”), First Republic Bank and Signature Bank—three financial institutions that have either declared bankruptcy or have been seized by the federal government or its agencies in 2023

This case is about the over-concentration of Claimants’ accounts in corporate bonds and preferred stocks within the financial sector and further concentration of those assets within specific issuers, including Silicon Valley Bank (“SVB”), First Republic Bank and Signature Bank—three financial institutions that have either declared bankruptcy or have been seized by the federal government or its agencies in 2023.  The arbitrations remain pending.

Gregory Sain clearly ignored the express statements from the Federal Reserve over the last many years that rising interest rates were forthcoming.  As this occurred, it invariably caused the fixed income securities recommended to Claimants, which are interest rate sensitive, to decline in value.  Because many of the preferred stocks are perpetual in duration, there is no maturity date on which Claimants will receive a return of 100% of their principal, like with a municipal bond.  Moreover, because the securities have declined, Claimants cannot reallocate those assets without realizing a large loss.  The transformation of Claimants’ accounts from a municipal bond portfolio to a portfolio principally consisting of perpetual preferred stocks in the financial sector has created liquidity and duration risk that Claimants never had with municipal bonds and did not need at their stage of life.

Gregory Sain made bold representations to Claimants regarding the viability of Silicon Valley Bank, Signature Bank and First Republic Bank.  He also made affirmative representations regarding the safety and stability of the financial sector, in general.  After the collapse of the aforementioned banks, it took the federal regulators less than one month to conclude that the bank failures were not part of the normal course of market fluctuations.  Rather, the Board of Governors of the Federal Reserve stated that “Silicon Valley Bank (SVB) failed because of a textbook case of mismanagement by the bank” and the Federal Deposit Insurance Company (“FDIC”) concluded that “the root cause of [] [Signature Bank’s] failure was poor management.”  None of these factors were investigated by Stifel, Morgan Stanley or Gregory Sain at the time of the recommendations.

The Story of SVB, Signature Bank and First Republic

On March 10, 2023, SVB, regulators intervened and placed SVB into a bankruptcy/receivership process following an increase of customer withdrawals (i.e., a run on the bank).  Within one month of the SVB collapse, the Board of Governors of the Federal Reserve issued its Memorandum titled “Review of the Federal Reserve’s Supervision and Regulation of Silicon Valley Bank,” finding that “Silicon Valley Bank (SVB) failed because of a textbook case of mismanagement by the bank.  Its board of directors failed to oversee senior leadership and hold them accountable.”  The Memorandum concluded that SVB’s “board of directors and management failed to manage their risks”, causing “widespread managerial weaknesses, a highly concentrated business model, and a reliance on uninsured deposits.”  SVB had an inadequately unhedged portfolio of bonds and preferred stocks on its own books, which was mismanaged over the last several years as the Federal Reserve raised interest rates.  The bank announced in early March that it realized a $1.8 billion loss after selling some of its bond and preferred stock holdings at depressed prices in order to meet customer withdrawals.

Two days after the collapse of SVB, Signature Bank was seized by the New York State Department of Financial Services, who appointed the FDIC as a receiver to take control of the bank.  Within weeks, the FDIC issued a Memorandum, summarizing its findings regarding the collapse of Signature Bank.  The FDIC concluded that the “root cause of SBNY’s failure was poor management” exacerbated by the collapse of SVB and Silvergate Bank in California.  The FDIC further concluded that Signature Bank management “pursued rapid, unrestrained growth without developing and maintaining adequate risk management practices…did not always heed FDIC examiner concerns, and was not always responsive or timely in addressing FDIC examiner concerns.”  Notwithstanding the riskiness of the business practices identified by the FDIC, it noted that Signature Bank had an over-reliance on uninsured deposits and depositors in the cryptocurrency industry as a funding source for its business operations.  With the collapse of certain cryptocurrency platforms and when other customers began withdrawing these funds, it created a loss of liquidity, culminating in the collapse.

Several weeks later, on May 1, 2023, First Republic Bank collapsed, and regulators facilitated a fire sale of its assets to JP Morgan at deeply discounted prices.

The Standard of Care

Financial advisors have a legal and regulatory obligation to recommend only suitable investments that are appropriate for their clients’ needs and objectives. Their employing brokerage firm has a legal and regulatory obligation to supervise the Financial Advisors’ sales practices and dealings with clients. To the extent any of these duties are breached, the customer may be entitled to a recovery of his or her investment losses.

Reasonable basis suitability requires that a recommended investment or investment strategy be suitable or appropriate for at least some investors. Reasonable basis suitability requires an advisor to conduct adequate due diligence so that he or she can determine the risks and rewards of the investment or investment strategy.

Quantitative suitability requires a brokerage firm or financial advisor with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions – even if suitable when viewed in isolation – is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer’s account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.

Customer-specific suitability requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer’s investment profile. Among the criteria that a financial advisor must evaluate to satisfy his or her customer-specific suitability obligations include the investor’s age, tax status, time horizon, liquidity needs, and risk tolerance; a client’s other investments, financial situation and needs, investment objectives, and any other information disclosed by the customer should also be considered.

The Wolper Law Firm represents investors nationwide in securities litigation and arbitration on a contingency fee basis.  Matt Wolper, the Managing Principal of the Wolper Law Firm, is a trial lawyer who has handled hundreds of securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at (800) 931-8452 or by email at mwolper@wolperlawfirm.com.