RiesbergLaw - Forethought Wins
Barbara J. Riesberg

The Bureau of National Affairs, Inc.  By Phyllis Diamond

Arbitration

Memphis, Tenn.-based Morgan Keegan & Co. Inc. must pay more than $250,000 in compensatory and punitive damages to a Florida couple whose money it invested in a now failed Connecticut hedge fund that funneled its assets to Bernard L. Madoff Investment Securities, a Financial Industry Regulatory Authority arbitration panel directed March 3 (In re Arbitration Between Lieberman and Morgan Keegan & Co. Inc., FINRA, Case No. 10-00009, 3/3/11).

The panel concluded that the brokerage “did very little due diligence on the hedge fund in question and certainly did not perform substantial due diligence,” as the firm’s own procedures require for alternative investment products.

Rather, the panel cited “clear and convincing evidence that … Morgan Keegan was grossly negligent,” and that accordingly, it “fraudulently misrepresented the risk of this investment” to its customers, who lost their entire investment with the firm.

Investment Objectives.

Specifically, claimants Jeffrey and Marisel Lieberman charged the firm and one of its registered representatives, Julio Almeyda, with investing all of the money in their accounts with Greenwich Sentry LLP, a Madoff feeder fund. They sought to hold the firm liable for fraudulent misrepresentation, breach of fiduciary duty, and negligence, and for Tennessee and Florida statutory violations.


“[A]t the end of the day, as a FINRA-regulated institution, the brokerage was required to do due diligence on unregulated investments, and hedge funds are not regulated,” Miami attorney Barbara Riesberg said.


In its decision, the panel noted that in a 2009 memo to financial advisers and branch managers, Morgan Keegan’s compliance department directed that before recommending a hedge fund to a client, advisors must review the client’s new account form to ensure that the investment is suitable. “The memorandum also goes on to say that if the account is predominantly composed of this investment …, ‘speculation’ should be one of the primaryobjectives.”

Red Flags.

In this case, however, the panel noted that the Liebermans’ new account form indicated that speculation “was the last (not primary)” of their investment objectives. The Liebermans, who had less than a year’s experience in options and other investments, such as hedge funds, also testified to that effect.

Concluding that the firm did little due diligence regarding the investment, the panel said that among other deficiencies, Morgan Keegan admittedly failed to request an audit report on BLMIS, which implemented the fund’s investment strategy and served as sole custodian of the hedge fund’s assets. Doing so, according to the claimants’ expert, “would have led to Red Flags,” the panel wrote. It also said the brokerage “did not even produce any evidence of any follow-up review to indicate ongoing monitoring required as part of its due diligence.”

For these and other reasons, the panel ordered Morgan Keegan to pay $200,000 plus interest in compensatory damages; $50,000 in punitive damages; $14,000 in various in hearing fees; and $300 representing the non-refundable portion of the initial claim filing fee.

However, the panel dismissed the Liebermans’ claims against Almeyda, who it said “was not aware of the lack of due diligence performed by his firm and did not know that his representations to [the LIebermans] as to the level of risk were false and misleading.”

Due Diligence Obligation.

In a telephone conversation, Miami attorney Barbara Riesberg, who represented the Liebermans, said her clients “are extremely pleased with the decision. “Professionally,” she added, “it’s very exciting because this is not a common theory,” inasmuch as the alleged wrongdoing was “two steps removed” from Madoff–i.e., from Madoff to the fund to Morgan Keegan.

Riesberg emphasized that “[l]iability was based upon Morgan Keegan’s failure to perform substantial due diligence, as opposed to holding Morgan Keegan liable for Madoff’s fraud. … However, at the end of the day, as a FINRA-regulated institution, the brokerage was required to do due diligence on unregulated investments, and hedge funds are not regulated.”

Riesberg acknowledged that the arbitrators’ decision was unusually detailed, “which may be one reason the award generated a lot of interest” in the press. Another reason, she speculated, is that the panel awarded punitive damages, a relatively rare occurrence. “We got everything we asked for,” Riesberg stated. She said the next step is to go to court to seek attorneys’ fees based on the panel’s conclusion that the brokerage violated Florida law governing securities transactions.

Riesberg added that the defendants argued “that ‘nobody knew Madoff was a fraud.’ Whether they did or didn’t,” she stated, “it doesn’t absolve them of the duty to do due diligence.”

“We disagree with the panel’s findings in this case and plan to appeal the award,” a Morgan Keegan spokesperson told BNA.

The arbitration panel included two public arbitrators, Bernard A. Becker, the presiding chairman, and David M. Levine; and one non-public arbitrator, Bernard (Bob) L. Loring. Morgan Keegan and Almeyda were represented by Reva D. Campbell, Greenebaum Doll & McDonald PLLC, Louisville, Ky. The Liebermans were represented by Barbara J. Riesberg, RiesbergLaw, Miami.