More than a Decade after bond he sold started going bad, former Wedbush Securities Inc, broker Michael Farah finally cashed in, winning more than $4 million from his former employer last month.
It’s a rare case, not only because of the size of the award and the years it took to win it, but also because of the Farah’s claim: that his erstwhile employer should compensate him for income he lost when clients who invested in the bad bonds dropped him as their money manager.
But it’s a type of case likely to become much more common brokerages continue to carry exotic investment products that aren’t easily understood by investors or even by the average broker, said Sam Edwards, a partner at a Houston securities law firm.
“This is a relatively novel concept and one I think you’re going to see a lot more of,” Edwards said. “You’ll see a wave of cases with brokers suing firms when one of their products blows up.” Last month, a panel of arbitrators at private watchdog organization Financial Industry Regulatory Authority, or Finra, ordered Wedbush to pay Farah $1.3 million for loss of income, plus attorney fees and punitive damages that came to a total $4.3 million.
Wesley Long, Wedbush’s head of private client services, disputed Finra’s decision. “We wholeheartedly disagree with the ruling and are currently reviewing our options,” Long said in an emailed statement. The firm declined further comment.
Farah’s claim against Wedbush, first brought in 2005, was that the firm told him that certain mortgage-backed bonds – some backed by loans on mobile homes – were among the safest investments, said Farah’s attorney, Philip Aidikoff at Beverly Hills law firm Aidikoff, Uhl & Bakhtiari.
“Mike was told these were good, stable, fixed-income investments,” Aidikoff said. “This is an example of a broker relying on what he’s told about a product by his firm.”
The bonds Farah sold started to lose value as early as 2003. At that time, Farah said he managed client assets of $100 million. But as the bonds soured, clients lost or pulled out $60 million, leaving Farah with fewer clients and less income. He left Wedbush in 2005 and sued the company for lost income. Many of his clients and former clients did the same, on Farah’s advice.
In his claim to Finra, Farah alleged the company misrepresented and omitted important information about the bonds and that his clients and he lost money as a result.
Wedbush denied those allegations and instead charged that Farah was responsible for making bad recommendations to his clients. What’s more, the firm wanted him to pay more than $9 million in settlements and Finra awards already paid by the firm to Farah’s former clients who sued over the mortgage bonds.
Finra’s arbitrators don’t explain the reasoning behind their decisions. Aidikoff noted, however, that Farah got nearly everything he asked for from Finra.
“The panel’s message was pretty clear,” Aidikoff said. “They were very concerned with the way Mr. Farah had been treated by the firm.”
Products and Punishment
It’s common for investors to sue brokerages after losing money, but less common for brokers themselves to do so. Edwards, the Houston attorney, said he expects more brokers will follow Farah’s lead, a natural reaction to the changing business of investment management.
Years ago, brokers and brokerages made their money by executing stock trades, and many cases that went to Finra involved brokers or firms who allegedly “churned” their clients’ account, executing unnecessary trades to increase commissions.
But Edwards said he sees fewer churning cases today. As the Internet has made stock trading cheaper for individual investors, many firms have had to look elsewhere for commissions. So they’ve been creating and selling new types of investment securities, such as the collateralized mortgage obligations that got Farah and Wedbush in trouble.
“Where they make their money is in developing products,” Edwards said. “And you’re going to find more and more cases where you have products that blow up. I tell people all the time: I’ve become a product liability lawyer.
”Edwards argues that brokers have to rely on their parent firms to analyze exotic investment products, and that such analysis is one of the reasons brokers pay fees to their firms.
Edwards said the Farah case shows brokers can successfully take on their firms if they can show that investment products are marketed as safe but turn out risky.
“That’s what this case proves to me,” he said. “There are instances where brokers are victims as much as the customers. That’s a good story to tell.”
Farah’s case is also noteworthy because Finra arbitrators ordered Wedbush to pay $1.4 million in punitive damages. Such damages have come in less than 5 percent of Finra cases, according to a study published by Cornell University Law School.
Jonathan Schwartz, a Marina del Rey securities lawyer who also works as a Finra arbitrator, said such damages are usually awarded only when there’s been egregarious wrongdoing.
“The punitive damages are very interesting,” he said. “You have to have an angry arbitration panel to get that kind of damages. There must have been something Wedbush or their lawyers did, or something that was found out. Some dreadful facts must have come to light.”