Wells Fargo’s appeal of bombshell 'fraud' ruling in FINRA case casts harsh spotlight on regulators

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Wells Fargo’s battle against a blistering court ruling that it rigged the investor dispute process in a secret pact with Wall Street’s self-regulator has unleashed a wave of new problems for the bank — and for its overseers.

The financial institution appealed on Feb. 23 a bombshell decision by a Georgia judge that the big bank and an outside lawyer working for it “committed fraud” on regulator FINRA, rigging its arbitration system to favor brokers over customers in disputes. The Financial Industry Regulatory Authority oversees the brokerage industry and is tasked with protecting investors and the integrity of markets.

Wells Fargo’s appeal of the judge’s ruling last month “has opened a Pandora’s box of negative consequences” for the Wall Street bank and its overseers, said Scott Silver, a securities lawyer in Coral Springs, Florida. Silver, who co-chairs the securities and investment fraud group at the American Association for Justice, a nonprofit trade group and lobby, added that, “we’ve been discussing how shocking this is.”

It’s the latest unflattering look for America’s third-largest bank. But the case also casts an unpretty light on Wall Street’s watchdogs.

“FINRA has yet to offer any rational explanation of what happened,” Silver said.

The self-regulator, which is overseen by the SEC, is not an arm of the government but operates with its blessing.

In 2020, Wells Fargo reached a deal to pay $3 billion to settle a Justice Department criminal investigation and SEC probe of its fake accounts scandal, in which it opened more than 2 million accounts for customers without their approval. On Feb. 10, U.S. Sen. Elizabeth Warren, a frequent FINRA critic, and U.S. Rep. Katie Porter wrote to FINRA asking for details about the Georgia case, the arbitration process and interactions with Wells Fargo. Brokerages nearly always make their customers agree to resolve disputes through closed-door arbitration with FINRA.

Now the Georgia case is raising fresh scrutiny of the fairness of FINRA’s entire dispute-resolution process. It’s also prompting questions about the teeth in the first prong of the SEC's mandate — to protect investors.

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Michael Edmiston, a lawyer and president of the Public Investors Advocate Bar Association, whose lawyers represent investors in claims and lawsuits against financial firms, said that Wells Fargo “has to appeal. I mean, what does it look like if there’s a judicial finding of fraud by a brokerage firm? Bad.”

‘Go vicious’
The skirmish revolves around a Georgia state court lawsuit filed by two Wells Fargo customers against the bank in 2019. Customers Brian Leggett and a partnership sued to reverse their defeat in a FINRA arbitration claim they made against Wells Fargo Advisors over $1.2 million in losses on complex investments carried out by two Wells Fargo brokers. Leggett was ordered to pay the bank and one broker $83,600 to cover their legal fees and hearing costs.

“You don’t normally see wirehouses go after clients,” Edmiston said of the FINRA award. “To see a wirehouse go vicious on a client is surprising.”

The customers’ losses stemmed from trades made in shares of NXPI Semiconductors, a Dutch company, and call options on Amazon stock.

On Jan. 25, the customers got their wish when Judge Belinda Edwards of Fulton County Superior Court in Georgia vacated FINRA’s award to the bank. Wells Fargo and the outside lawyer, the judge’s order said, “committed fraud on the arbitration panel by procuring perjured testimony, intentionally misrepresenting the record and refusing to turn over a key document.” Securities lawyers said that it’s almost almost unheard of for a judge to call into question “the fairness of the entire FINRA process,” as the judge’s ruling said. Silver said that the ruling “is more serious for FINRA than for Wells Fargo.”

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A FINRA spokesman, Ray Pellecchia, said March 3 that the self-regulator had nothing new to add beyond a Feb. 18 statement that said the organization had hired an outside law firm to conduct an independent review over how it chooses arbitrators. FINRA president and CEO Robert Cook said in the statement that, “We take this matter very seriously. FINRA recognizes the importance of maintaining trust in the system and is committed to ensuring the DRS arbitration forum is operated in a fair and neutral manner.”

Securities lawyer Jacob Zamansky in New York said that “it’s unusual for FINRA to have an independent investigation, because it means their credibility is at stake.”

Credibility and confidence
Investors rely on a balanced and transparent process to handle their grievances against brokers they think have cheated them. “It’s supposed to be a neutral forum where neither side has a special advantage,” said Zamansky.

But court papers in the Georgia case allege that with Wells Fargo, the process is far from that.

To choose arbitrators, FINRA’s computers are supposed to randomly generate an unbiased list of potential candidates from which everybody has to agree on three persons. The customers in the Georgia case allege in court filings that two names thought to be critical of the bank were removed from the list at the request of Wells Fargo’s lawyer, Terry Weiss, all with the permission of FINRA, according to the judge’s ruling. Weiss, a partner at law firm Maynard Cooper in Atlanta, referred questions to Wells Fargo. Jackie Knolhoff, a spokeswoman for Wells Fargo Advisors, said that “As previously stated, we disagree with the decision and are proceeding with an appeal.”

The result of the judge’s ruling, Zamansky said, is that “in future FINRA arbitrations, you’re going to have customers who ask courts to ask, ‘was there any improper influence?’”

SEC’s role
As FINRA’s overseer, the SEC might find itself drawn in. “Where is the SEC oversight of FINRA?” Silver asked. “The issue here is a lack of confidence in the system.”

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Zamansky said that the securities regulator could impose “a huge fine to send a huge message that this is inappropriate conduct.” Calls and emails to the SEC were not returned.

What about Wells Fargo customers who reached settlements with the bank through FINRA in prior years? Zamansky said those investors will want Wells Fargo to review them. But Silver said that “there is not an easy path open to reopen all of these old cases” because investors typically agree not to sue a financial institution once FINRA has made an award in their favor.

In June, FINRA withdrew a criticized proposal that would have made it easier for brokers to clean up their regulator records on BrokerCheck by removing customer complaints. Expungements can make bad or contentious brokers look better to current and future customers. As part of the bank-friendly FINRA award in the Georgia case, two Wells Fargo brokers had their records in the matter expunged. “That is now suspect,” PIABA’s Edmiston said.