The Wolf of Wall Street Meets Regulation Best Interest: Who Wins?
Background
Many people know about Jordan Belfort, the Wolf of Wall Street. Possibly from seeing the movie of that name. He made his fortune by aggressively marketing penny stocks, many of them fraudulently, to retail customers.
Many are also aware of the SEC’s recently adopted Regulation Best Interest. That rule requires a brokerage firm or its personnel making a recommendation to a retail customer to act in the best interest of the customer as well as mitigate or disclose various conflicts of interest.
Could Belfort have survived, and even prosper, under Regulation Best Interest? Possibly “Yes.”
The Flaw
Regulation Best Interest applies to “recommendations” but does not define that term. The SEC says recommendation means what it means under the rules of the self-regulatory organizations. The applicable rule is FINRA Rule 2111 (Suitability). But that rule does not define what a recommendation is.
Instead, FINRA has issued a number of Regulatory Notices setting forth the tests it would apply in determining whether a communication or series of communications constitutes a recommendation. They are all facts and circumstances driven, i.e. there is no definitive answer. These are:
a) Given the content, context and manner of presentation, could the communication be viewed as a call to action; would it reasonably influence an investor to trade a specific security or group of securities ;
b) The more individually tailored the communication is to a particular customer or targeted group of customers about a specific security or group of securities, the more likely it is a recommendation; and
c) While an individual communication may not be a recommendation, a series of communications may be a recommendation when considered in the aggregate.
The Test
Would the following conversation be a recommendation?
Belfort: Hello. My name is Jordan Belfort. I am with Dowe Cheatem and How, a broker-dealer registered with the SEC. Our business is acting as a market-maker or dealer, buying and selling low priced speculative stocks. We trade for our account in these stocks because you can make more money with a low priced stock than with a high priced blue chip. We trade stocks based on price movements- i.e. the likelihood they will go up or down and not based on the merits, value or worth of the company. We make no recommendations.
Your name was given to me as an astute investor. So i wanted to tell you about “Flying Widget”, a stock we are actively trading. Some of our customers have bought and sold this stock at a great profit. Others have bought and are holding in light of the rapid price rise. We just bought a block of “Flying Widget” from a customer who bought it a few weeks ago at $3.00 and sold it to us at $5.00.
How many shares can I put you down for?
Customer: Can you tell me something about this company, its trading history, etc.Jordan: No. As I said we don’t follow the company; we trade based on price movement of the stock, and we make no recommendations. So how many shares would you like?
Question
Is this conversation a “recommendation” under the FINRA standards? Is it a recommendation as defined in the dictionary? How would a judge rule?
Contact
Please feel free to call or email me (Office 212 455 0476; Cell 914 646 8035; email msimkin@securitiesregslawyer.com) with any comments or questions.
September 2019