Category Archives: law

Stanford Ponzi Covered Up by NASD/FINRA’s Arbitrators: Part II

Fox Business has just came out with an interview with Stanford Financial whistleblower Layla Wydler, who was fired from Stanford Financial Group in 2002 when she refused to participate in what seven years later has been finally exposed by federal law enforcement authorities as a “massive Ponzi scheme.”

In 2000, Stanford offered Wydler, a top broker-dealer, a sizeable salary plus a signing bonus. In exchange, Wydler made a five-year commitment to Stanford and brought her valuable book of business with her.

Red Flags

Soon after starting, Wydler became suspicious. First, the Stanford “CDs” were actually administered as a hedge fund and invested in the money market. Consequently, “Stanford was paying about 3% more than everyone else in the world was paying on CDs without explaining how he could earn that return. … [H]ow can you do that, sell a product that you call a CD when it’s really not a CD?” asks Wydler.

Second, Stanford rebuffed requests for portfolio appraisals. “[W]e would never be able to get that from them because they would tell me it’s proprietary information. [There was] a lot of mystery,” says Wydler.

Third, much like Madoff, Stanford’s audits were done by “mom and pop” accountants. “[Standord’s] financials were not audited by a U.S. reputable account[ing] firm. [Instead,] it was done by an unknown firm in Antigua. To me, that was a red flag,” states Wydler.

Fourth, Stanford would claim the CDs were insured by Lloyd’s of London. “[B]ut that’s not what it was,” says Wydler. “It was just to cover the directors and employees in case of a lawsuit, and not the client accounts at all.”

Fifth, the Stanford headquarters building had a plaque stating “Member of SIPC.” This falsely implied the SIPC’s protection covered the CDs. “[I]t’s misleading,” states Wydler. “[Y]ou [would] see the SIPC sign, [and] you would imagine that everything was safe.”

Arbitration

After Wydler refused to sell the CDs, Stanford fired her. “[T]hey wanted me to pay back the promissory note that…was a part of the signing bonus that they gave me when they hired me,” says Wydler. Stanford took Wydler to arbitration before FINRA and sought in excess of $100,000.
Wydler counterclaimed wrongful termination, alleging the firing was punishment for refusing to participate in Stanford’s Ponzi scheme. “[I]n the arbitration, we asked for the documents that would have supported the claim,” i.e., portfolio appraisals and Lloyd’s insurance policies supposedly backing the CDs, says Wydler’s attorney, Mike Falick. “And we were turned down.” Not surprisingly, the arbitrators ruled against Wydler, awarding Stanford over $107,000. (Stanford eventually settled for an undisclosed amount.)

Subsequently, Wydler reported Stanford to the SEC. However, the SEC took no action for five years. “I think there was ineptitude on the part of the regulatory agencies,” states Falick. “NSAD [the predecessor of FINRA and the agency that was responsible for this arbitration] is a self-regulatory body…charged with making [sure] the broker dealers are operating fairly and legally. The SEC is charged with protecting people. I don’t think either one of them, given the opportunities that they had and the information that they had, did what they need to do to make that happen.”

The Hefty Price Tag of Arbitral “Efficiency”

When asked whether he could have subpoenaed the documents to crack the case in court, Falick answered, “If I could’ve gotten this case out of FINRA, the day that we had the discovery issue, when FINRA told me…’we’re not gonna allow you to get those documents,’…that day it would’ve happened.”

Instead of having her day in court, Wydler was forced into a Star Chamber arbitration and panel that denied her the opportunity to support her claims with discovery and to pay the criminal organization she tried to report $107,782. So thanks in part to NASD’s arbitrators, the fraud was allowed to continue for five more years until it finally collapsed under its own weight.

“I asked for the documents that would’ve proven her case and we were stonewalled by Stanford and we were told by FINRA that our document request was irrelevant,” says Falick. “[H]ad we gotten those documents, not only would Leyla have won her case, but maybe 30,000 people wouldn’t have lost their life savings.”

“[W]hen I left, I believe that there was about a billion dollar in the bank,” says Wydler. “[I]t ended at 7.2 billion.”

As an attorney, my advice to my clients is to refuse to participate in any binding arbitration unless they were aware of and understood what arbitration entails at the time they signed the contract containing an arbitration clause. Increasingly courts are recognizing that essentially businesses are using private arbitrators to shield them from the consequences of their lawbreaking, and refusing to enforce arbitration clauses.

Good work by Fox Business! Here’s the full interview and story.
(Note: the video did not play for me with Firefox but played fine with IE)

Here’s my first post on this case.

Ponzi-Scheme Whistleblower Ordered By Corrupt Arbitration Panel to Pay a Criminal Organization $107,782

Just how corrupt and pervasively dysfunctional is private arbitration in America right now?

Via Felix Salmon, the Financial Times reports that more than five years ago a lady by the name of Leyla Basagoitia who worked at the Ponzi scheme known as Stanford Financial quit her job and alerted the SEC and the NASD (now called FINRA) her suspicions about the criminal fraud going on.
Rather than having her day in court, instead Ms. Basagoitia was forced into a kangaroo arbitration and forced by the arbitrators to pay the criminal organization she tried to blow the  whistle on $107,782.

So in part because of NASD’s arbitrators, the fraud was allowed to continue for years longer until it finally collapsed on its own weight last month.

As the article notes:

Ms Basagoitia told an arbitration panel at the National Association of Securities Dealers in October 2003 that she suspected Stanford Group Company, one of Sir Allen’s key businesses, was “engaged in a Ponzi scheme to defraud its clients”, according to case documents. In 2007, the NASD became the Financial Industry Regulatory Authority.
In a nine-point critique, Ms Basagoitia pointed to many concerns cited last week by the SEC in its charges against Sir Allen’s businesses, including allegations about the lack of a credible auditor, mis-selling of products and the promise of consistently high returns that did not “correspond to the reality of the markets”.
Ms. Basagoitia’s allegations were denied by Stanford Group Company and dismissed by the dispute resolution panel. She was ordered to pay Stanford $107,782 in damages, in repayment of a loan advanced to her while an employee of the company.

Great work again by the Financial Times, in particular to reporters Robert Cookson and Michael Peel in London and Joanna Chung in New York.
PS: I had my moment in the famous pink pages of the Financial Times last year. Have a look at the end of this article.

FASB posts The Weston Firm’s comment letter on Proposed FSP FAS 140-e and FIN 46(R)-e

Big banks and financial companies have long gotten away with not disclosing clear and accurate valuations of many types of financial assets. When I heard that the Financial Accounting Standards Board was seeking comments on proposed stronger financial disclosure rules over one type of financial asset, “Variable Interest Entities,” I reviewed the changes and then wrote a letter in support.

As it turns out, my letter was the first of 31 to be submitted. The second letter was submitted by a leading independent accountant, Jack Ciesielski, who also offered his unqualified support for the FASB proposal.

He maintains a blog on accounting issues here: http://www.accountingobserver.com/blog/

After our two letters in support came a flood of opposition letters from such models of probity, foresight, and clear and forthright financial reporting as AIG, GMAC, Freddie Mac, Fannie Mae, MBIA, UBS, and Mortgage Bankers Association.

Links to all of the letters submitted to the FASB are here.

Fighting Back Against Illegal Arbitration Clauses in Condo Purchase Contracts

Quick Summary: In this post, Greg shows how arbitration provisions in condo purchase agreements violate California law and cannot be enforced.

In my cases representing real estate investors who want their new construction condo and house deposits back, I often encounter arbitration clauses. I have yet to see one that I think would hold up in court under California law.

One such reason is that the arbitration clauses encompasses not only the buyer’s right to a jury trial, but the buyer’s right to a specific form of statutory relief, such as attorneys’ fees or punitive damages. However, in pre-printed form contracts, both state and federal courts usually rule that arbitration agreements which prevent the plaintiffs from seeking a certain form of statutory relief are unconscionable, therefore unenforceable.

In a 1985 case over an arbitration agreement between a car manufacturer and a car dealership, the U.S. Supreme Court ruled “[b]y agreeing to arbitrate a statutory claim, a party does not forgo the substantive rights afforded by the statute; it only submits to their resolution in an arbitral, rather than a judicial, forum.” Mitsubishi Motors Corp. v. Soler Chrysler-Plymouth, 473 U.S. 614, 628 (1985). This means that if you are entitled to attorneys’ fees under a specific statute in a jury trial, you are equally entitled to attorneys’ fees under the same statute in an alternative forum.

Consequently, the California Supreme Court ruled that an adhesive arbitration agreement abridging an employee’s right to acceptable discovery, judicial review, cost limitations, and punitive damages in a wrongful termination action against her employer is “substantively unconscionable” and thus unenforceable. In the key California Supreme Court case of Armendariz v. Found. Health Psychcare Servs., ruled that California common law “disallows forms of arbitration that in fact compel claimants to forfeit certain substantive statutory rights.” Armendariz v. Found. Health Psychcare Servs., 24 Cal. 4th 83, 99-100 (Cal. 2000). The same rule was cited in three  recent federal cases: Gelow v. Cent. Pac. Mortg. Corp. Circuit City Stores v. Adams. See 279 F.3d 889, 893 (9th Cir. Cal. 2002); Ingle v. Circuit City Stores, Inc., 328 F.3d 1165, 1179 (9th Cir. Cal. 2003); Gelow v. Cent. Pac. Mortg. Corp., 560 F. Supp. 2d 972 (E.D. Cal. 2008).

Besides these common law rulings against arbitration, California’s statutory law also limits the use of arbitration. First, California Civil Code § 1668 states that “All contracts which have for their object, directly or indirectly, to exempt anyone from responsibility for his own fraud, or willful injury to the person or property of another, or violation of law, whether willful or negligent, are against the policy of the law.” In other words, a contract cannot give a developer carte blanche to break the law without facing the consequences.

Second, California Civil Code § 3513 says that “Anyone may waive the advantage of a law intended solely for his benefit. But a law established for a public reason cannot be contravened by a private agreement.” Attorneys’ fees, punitive damages, and other statutory remedies often have a public purpose, such as creating a disincentive for committing future wrongdoing. Consequently, the Ninth Circuit Court refused to enforce an arbitration agreement between a petroleum franchiser and a petroleum franchisee that failed to allow for attorneys’ fees and punitive damages, which were available under the Petroleum Marketing Practices Act. In the 1995 case of Graham Oil v. Arco Products Co., the court concluded that these remedies were “important to the effectuation of the PMPA’s policies.” Graham Oil v. ARCO Products Co. (9th Cir. 1995) 43 F.3d 1244.

Finally, the Armendariz court ruled that “[a]rbitration agreements that encompass unwaivable statutory rights must be subject to particular scrutiny.” Armendariz 24 Cal. 4th. This means that if your arbitration agreement limits your right to a specific form of statutory relief, it might not stand up to scrutiny in a court of law.

It is well known that arbitration, while a good alternative to litigation in many contexts, it drastically unfair when the participants are a regular person on one hand, and a giant corporation on the other. If you have a condo deposit and want a refund because you are unable or unwilling to close, do NOT agree to take the case to arbitration. With the assistance of an attorney experienced in condo contract litigation, take the case to court. At that point you can oppose the arbitration clause before a judge, who will hopefully rule in your favor on this issue.

Greg Weston is a graduate of Harvard Law School and experienced business attorney licensed in California and Florida. Mr. Weston’s San Diego-based practice focuses on representing individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com. Comments about the blog via e-mail are welcomed.

Can The Builder Sue Me To Close? California Law on Specific Performance in Residential New Contraction Contracts

If you have signed a contract to purchase new residential construction in California, such as a spec house or condo unit, but now do not want to actually close on the purchase, you might be wondering if there is a way the developer can force you to complete the purchase.

The answer, generally speaking, is no, the developer cannot force you to close. When a contract is breached (e.g., you don’t show up at closing), there are two types of remedies for the aggrieved party: damages (a court award of money) and specific performance (a court order compelling the breaching party to abide by the contract.)

Here is the rule, excerpted from a California State Court of Appeals case, on when specific performance is allowed:

Specific performance of a contract may be decreed whenever: (1) its terms are sufficiently definite; (2) consideration is adequate; (3) there is substantial similarity of the requested performance to the contractual terms; (4) there is mutuality of remedies; and (5) plaintiff’s legal remedy is inadequate.

Blackburn v. Charnley, 117 Cal. App. 4th 758, 766 (Cal. Ct. App. 2004).

In most cases requirements No. 4 and No. 5 cannot be met, making specific performance unavailable. Requirement No. 4 (“mutuality of remedies”) means the purchase agreement needs to give the buyer an equal remedy of specific performance against the seller in order for the seller to have such a right against the buyer. I have never seen a purchase contract that meets this requirement.

Requirement No. 5 (“plaintiff’s legal remedy is inadequate”) is more commonly phrased “no adequate remedy at law.” This means there has to be some reason why an award of money does not adequately compensate the seller for losses from the real estate buyer’s breach before the seller can compel you through specific performance to close.

The five requirements above are not either/or requirements. All five requirements must be met before a builder might be able to force someone who has contracted to purchase a property to close. While it is possible to think up a hypothetical where all five requirements will be met, in the real world such circumstances will rarely occur. And even if all the requirements are met, the buyer still has a number of other defenses. Remember, the rule is that if the five requirements are met, only then the judge may order specific performance. If the judge doesn’t feel doing so is fair, he or she may still decline decreeing specific performance.

Developers, whose lawyers have already explained the law to them, will often threaten a specific performance when a buyer refuses to close on a residential real estate purchase contract, hoping that buyers will be ignorant of this law.

Defaulting buyers should not be scared of this talk. California’s residential real estate law was specifically designed to shift a large part of the risk of a real estate downturn onto developers and off of home buyers and small scale real estate investors. If you have put down a deposit on a real estate deal, but now don’t want to close because of the drop in the real estate market or your own changed circumstances, it is a good idea to talk to a real estate lawyer to figure out what your options are. It is especially important that when you decide not to follow through on the purchase contract, you consult with a lawyer to take the proper steps to notify the developer and mitigate the developers damages.

Just don’t trust the self-serving statements made by your developer.

My fellow real estate law blogger Jared Beck has his own post on the law in Florida governing specific performance in real estate contracts.

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This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Greg Weston is an experienced business litigator licensed to practice law in California and Florida, and is a graduate of Harvard Law School. Mr. Weston’s frequently represents individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com.

Jingle Mail and 2nd Mortgages

I’ve discussed Jingle Mail several times, which is when a borrower owes more on his mortgage than his residential property is worth, and makes the rational decision to give the house back to the bank by mailing back the keys of the house to the bank.

I’ve been e-mailed and asked via blog comments on what the law is for jingle mail and second mortgages in California. The key question is “Can the banks come after me for the difference between the mortgage price and the market price of the house.”

Let’s have a look at how the law plays out under several typical situations.

In the following examples I use the shorthand “H” for homeowner and “B1, B2” for Bank 1, Bank 2, and so on.

Scenario 1

In 2006 H purchases his residence for $1,000,000. He pays for the house using funds from three sources: (1) a traditional first mortgage for $800,000 from B1; (2) an additional 5-year-ARM for $150,000 from B2; (3) a $50,000 down payment from H’s savings.

The value of H’s house, however, has now dropped in 2008 to $700,000, and he still owes $920,000 on his two mortgages. He decides to stop paying both of them, and the two lenders foreclose, and sell the house for $700,000 at auction.

Can either B1 or B2 go after H for their shared $220,000 loss on the mortgage?

Answer:

No. In this simplest scenario, the borrower is completely protected. He can walk away from his house, and the banks have no remedy other than foreclosing on the house. They cannot sue the borrower, and cannot go after his other assets. California provides no remedy for banks other than foreclosure on purchase money mortgages on residential real estate when the borrower lives in the house.

Scenario 2

H has two mortgages:

– 1st mortgage from B1 that he used to buy his house

– 2nd mortgage from B2 he took out a few months later.

H stops paying first mortgage to B1, which responds with a  non-judicial foreclosure of H’s house. After H moves out and the house is taken by B1, H stops paying his second mortgage to B2. Can B2 go after H’s assets in a judicial foreclosure?

Answer:

Maybe. It was B1’s decision, not B2’s, to proceed with a non-judicial foreclosure for the obvious reason that the slower and more costly judicial foreclosure process would not get it any better a result because the first mortgage was a purchase money mortgage.

But the 2nd mortgage was not for purchase money, so B2 does have a reason to prefer a judicial foreclosure because it could obtain a deficiency judgment. As the California Court of Appeal noted in In re the Marriage of Anthony and Charlotte Oropallo:

It is true that when the security of a second deed of trust is rendered valueless by a prior foreclosure, through no fault or action of the second lender, that lender for equitable reasons will ordinarily be permitted an action against the debtor on the second obligation.

Note, however, the qualifications the Court uses. It does not say “always” but instead says “ordinarily” may a 2nd non-purchase-money lender pursue a deficiency judgment against a borrower. Note also that the Court says a deficiency action “ordinarily” is allowed when the mortgage is rendered valueless “through no fault or action of the second lender.” The remedy is allowed not as a matter of law, but as a matter of equity, and a bank cannot receive the benefits of equity unless its own behavior was equitable.

H, however, might be able to argue that B2 was at least in part (if not mostly or entirely) for the foreclosure. Is B2 known for seeking out and writing mortgages based on inflated appraisals? Did the B2 target homeowners with poor credit, knowing that it could charge such homeowners higher interest rates and more fees? Did B2 actually verify the buyer’s income, or was it a no-doc loan that it bought from one of the dozens of now-bankrupt subprime brokers? Was B2 already equitably compensated for H’s default by charging and receiving above-market interest rates and a host of fees?

Scenario 2 is winnable by either party, or the decision could be split, with B2 being awarded a judgment for a substantial sum, but less than its full loss. In practice, if H puts up a spirited defense to B2’s lawsuit, H will probably either win the case early by

(1) showing a procedural defect in the foreclosure or B2’s pleadings

(2) or proving inequitable conduct on B2’s part.

Failing that, H will probably be able to convince B2’s attorneys to settle for a smaller sum than the amount he defaulted on.

Scenario 3

H buys his house with a mortgage from B1. Some time later, he takes out a second mortgage, again from B1. He then stops paying both mortgages and B1 forecloses on the house in a nonjudicial foreclosure. The sale of the house does not bring enough to pay off the first mortgage, much less the second.

Since the 2nd mortgage was not a purchase money mortgage subject to the protections of Cal. C.C.P. 580b, can B1 obtain a deficiency judgment for the second mortgage in a judicial foreclosure?

Answer:

No. In Simon v. Superior Court, 4 Cal. App. 4th 63 (1992), a bank tried to go after a borrower in a judicial foreclosure on the second non-purchase-money mortgage after it had already taken the property in a non-judicial foreclosure after a default on the first mortgage.

This is good news for homeowners who have a 2nd mortgage they took out later from the same bank they used for their first mortgage. In many cases a bank may not know the size of a deficiency until after it has already proceeded with a non-judicial foreclosure of the first mortgage. At that point, it is out of luck and will have to eat the loss with the 2nd mortgage (or, quite commonly, a HELOC on top of the first mortgage).

This article does not constitute legal advice or the formation of an attorney-client relationship, and is not for re-publication without express permission of the author.

Greg Weston is a graduate of Harvard Law School and experienced business attorney licensed in California and Florida. Mr. Weston’s San Diego-based practice focuses on representing individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com. Comments about the blog via e-mail are welcomed.

Residential Real Estate Purchase Contract Cancellation in California: Several relevant laws apply

California Civil Code 1675 is not the only arrow in the canceling house or condo buyer’s legal quiver, just the surest. As I discussed here and here, C.C. 1675 allows the buyers to get all but 3% of the purchase price back from their deposit, but other rules may allow them to recover their entire deposit.

Under California Civil Code 3275, a plaintiff suing a developer for a return of a purchase deposit can argue that even more of his deposit should be returned than the “all-but-3%” of C.C. 1675. To survive a buyer’s motion for summary judgment, the defendant is burdened with producing evidence that it has been damaged by at least as much of the deposit it wants to keep. For example, in Timney v. Lin, 106 Cal. App. 4th 1121 (1st Dist. 2003) a buyer who was unable to obtain financing and had to cancel his purchase agreement demanded and received his entire deposit of $31,250 returned. Judge Stevens of the California Court of Appeal wrote that because the defendants “produced no evidence in the trial court demonstrating they suffered any cognizable damages” or that “it was impracticable to estimate the amount of any damages” that California law requires judges to “assume there were no such damages.” With no damages shown, the court awarded the buyer his entire $31,250 deposit back.

Had the buyer only relied upon C.C. 1675 he would have been entitled to $20,281.25 of his $31,250 back, with the seller keeping $10,968.75, or 3% of the purchase price of $365,625. Thus two different laws allowed him to recover his deposit back, one a partial refund, one a full refund.

 

Greg Weston is a graduate of Harvard Law School and experienced business attorney licensed in California and Florida. Mr. Weston’s San Diego-based practice focuses on representing individuals and small businesses against large corporations, including cases involving condominium purchase agreements and other real estate investments. He can be reached at (619) 255-7098 or greg@thewestonfirm.com. Comments about the blog via e-mail are welcomed.