Financial Advisor IQ (May 30, 2019) - Morgan Stanley relies on flawed legal arguments in its attempt to “shoehorn” a client into Finra arbitration, according to a brief filed by the client, Nirav Babu.
Earlier this year, the wirehouse filed a lawsuit pending in a federal court in Maryland to compel Babu to defend claims in a Finra arbitration proceeding initiated by two of its other customers.
In a brief filed this month, Babu argues that Morgan Stanley cannot compel him into the arbitration, and its attempt to do so doesn’t belong in federal court because the wirehouse failed to first exhaust administrative remedies at the SEC.
“[N]o amount of mere rhetoric by counsel can cure that fact,” writes Babu’s lawyer, Jacob Frenkel, a member of the Washington, D.C. law firm Dickinson Wright.
In making its arguments, Morgan Stanley’s lawyers ignored a 22-year-old ruling in another one of its own cases before the SEC, Frenkel writes.
Previously, Babu’s lawyer told the court that an improperly-supervised Morgan Stanley employee defrauded the wirehouse’s other two customers who filed their complaint against the wirehouse with Finra.
“Morgan Stanley may not try and deflect to a nonparty and Finra nonmember culpability for a complete breakdown of Morgan Stanley’s supervision of its financial advisor … Morgan Stanley may not use the fact that Mr. Babu happens to have an unrelated account at Morgan Stanley to force him to defend an arbitration in which he holds no interest,” Frenkel wrote in a briefly previously described in FA-IQ.
For its part, Morgan Stanley asked the court to issue a default judgment against Babu, forcing him to arbitrate the claims at a Finra hearing because he is a customer who signed an arbitration agreement.
“It’s a Herculean effort. Morgan Stanley is up against a lot in this case. I think it’s a stretch,” says Thomas Lewis, an attorney with the Lawrenceville, N.J.-based Stevens & Lee, who represents both FAs and their employers. If Morgan Stanley prevails, however, it could “wave this” in other courts nationwide, Lewis says.
Morgan Stanley first filed a lawsuit against Babu in January, laying out its unusually circuitous legal theory. The theory, if successful, may permit wirehouses to force customers into arbitration under an even greater number of circumstances than presently allowed under Finra rules. With his motion, Babu also asked the court to dismiss Morgan Stanley’s lawsuit.
In May 2018 Darrell and Karen Newcomb — who are no longer customers of the wirehouse — lodged a complaint against it with Finra. In their complaint, the Newcombs alleged that Sumitro Pal — a Morgan Stanley financial advisor at the time — “improperly convinced them” to wire $4 million to a Wells Fargo account owned by DH Investments LLC. Babu founded and owned DH Investments, according to the Morgan Stanley complaint.
According to Morgan Stanley’s complaint, Babu received $4 million illegally transferred from the account of the Newcombs.
But Babu’s lawyer stresses the Newcombs “do not make any allegations” against Babu and “do not accuse him of any involvement in their transaction whatsoever, much less any wrongdoing.” The Newcombs have not filed claims against Babu or DH Investments, Babu’s earlier motion states.
Pal, the Morgan Stanley financial advisor identified by the Newcombs as responsible for the decision to transfer the funds, worked for the wirehouse from 2004 until 2018 — his entire career. His BrokerCheck profile records that he faced a number of customer complaints — including two which led to settlements of more than $120,000.
In February 2018, prior to the Newcombs filing their Finra complaint, Pal died suddenly at the age of 37, according to a published obituary.
In response to the couple’s Finra complaint, Morgan Stanley denied the Newcombs’ allegations. In its Finra-filed answer, Morgan Stanley included a third-party complaint against Babu. In response, Babu asked Finra to dismiss Morgan Stanley’s complaint against him. In early January, Finra agreed it did not have jurisdiction over the dispute between Morgan Stanley and Babu.
But in its pending federal lawsuit, Morgan Stanley argues that because of the customer agreements he signed, Babu is required to arbitrate disputes with the wirehouse. According to Morgan Stanley’s lawsuit, Finra noted in its ruling dismissing its complaint against Babu that it would allow its submission based on a court order requiring such arbitration take place.
Morgan Stanley also alleges that if a misappropriation of $4 million took place, Babu — and not the wirehouse — would have been the one engaged in the misappropriation of the Newcombs’ funds.
Morgan Stanley also alleges the Newcombs “fully authorized” the transfer of the funds, so Morgan Stanley had no reason to believe it was illegitimate.
The Newcombs could not be reached for this story.
“It’s kind of amazing that Morgan Stanley would go to court and show this in public documents. It blows the lid off an extremely embarrassing episode. To have $4 million transferred to a Wells Fargo account is a black eye to Morgan Stanley,” Andrew Stoltmann, a Chicago-based plaintiff lawyer and a director and past president of the Public Investors Arbitration Bar Association, told FA-IQ previously.
“This presents a unique situation. It presents the issue of whether or not you can force someone to arbitrate a claim that has nothing to do with their accounts but based on the mere fortuity of the person being a customer,” Bradley Bennett, a former head of Finra enforcement who practices law in Washington, D.C., and usually defends broker-dealers, told FA-IQ previously.
If Morgan Stanley prevails, such a ruling would “significantly broaden the scope” of its customers’ arbitration pacts and “permit unrelated third-party claims into the Finra arbitration regime,” Babu’s lawyer writes in the most recent brief. “That decision will have a broad and wide-ranging impact on customer investment accounts across the United States,” he adds.