Securities and Investment


Pioneering through the morass of securities law can be quite overwhelming for investors and lawyers alike.  Federal and state statutes are reasonable starting references, as usual, but merely scratch the surface of what governs whom.  The financial services industry is much larger than products sold or services rendered by or through the New York Stock Exchange, the American Stock Exchange, the National Association of Securities Dealers (NASDAQ) exchange or any other stock exchange, and its regulation is similarly and necessarily vast.  Finding civil liability on those providing negligent or fraudulent financial planning, investment advice or brokerage services requires a much deeper and thorough understanding of securities and investment law.  Alas, a guiding light.


    Many types of professionals offer services for a fee to provide financial planning and investment advice.  The various specialties of professionals include at least the following:

  • Attorneys
  • Accountants
  • Financial Planners (certified, non-certified or other species of self-designated professionals)
  • Advisors or Consultants
  • Estate Planners
  • Medicare and Medicaid planners
  • Insurance and Annuity Brokers
  • Insurance Underwriters
  • Intermediaries
  • Stock Brokers
  • Broker-Dealers
  • Registered and Non-Registered Investment Advisors
  • Investment Advisor Representatives
  • Chartered and Non-Chartered Financial Analysts, Advisors, or Consultants
  • Registered or Non-Registered Investment Representatives
  • Sales Agents.

When it comes to personal finance, many people seek and rely on these types of individuals for advice, or even to manage their money directly.  Unfortunately, such individuals often abuse their positions of trust and cause financial harm to their clients.  Whether the misconduct of these so-called professionals involves misrepresentations, omissions, solicitation or sale of unsuitable products, churning, breach of fiduciary duty, fraud, conflict of interest, bad advice or mere negligence, victims must often turn to the governmental agencies or courts to seek a remedy.  The problem, of course, is determining where and how to file such action (federal court, state court, administrative agencies); and then, how to win.


     Congress has enacted generic laws to protect individual investors from fraudulent practices.  The Securities Exchange Act of 1933 and 1934 created liability in civil enforcement actions, administrative proceedings and private actions.  Section 10, codified as 15 U.S.C. § 78j, and promulgated under federal regulations as 17 C.F.R. § 240.10b-5, made it unlawful for any person to employ, directly or indirectly, manipulative and deceptive devices to defraud public investors.  This is commonly referred to simply as Rule 10b-5, and it provides as follows:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

  1. To employ any device, scheme, or artifice to defraud,
  2. To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or
  3. To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the purchase or sale of any security.

The term “security” is defined broadly, and has been interpreted by the courts to encompass nearly any instrument remotely related to an investment.  Reves v. Ernst & Young, 494 U.S. 56, 110 S. Ct. 945 (1990).  Rule 10b-5 expands the federal statute to prohibit all types of fraud, including misrepresentation.  Liability requires proof of scienter; i.e., that the defendant intended to deceive or defraud the investor.  Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976).  However, this may be satisfied under circumstances where the defendant acted recklessly.  Sundstrand Corp v. Sun Chemical Corp, 553 F.2d 1033 (7th Cir. 1977).

15 U.S.C. § 78t specifically holds controlling persons, and those who aid and abet, jointly and severally liable for any violation.  See Harrison v. Dean Witter Reynolds, Inc., 79 F.3d 609 (7th Cir. 1996)(upholding controlling person liability of broker-dealer where employees executed “Ponzi scheme” to defraud investor).  However, actions must be filed within one year after discovery of the facts constituting the violation and within three years of the violation itself. 15 U.S.C. § 78aa-1.

The federal Racketeering Influenced Corrupt Organizations Act (“RICO”), codified under 18 U.S.C. § 1961, et seq., also provides civil remedies for criminal acts of fraud and misrepresentation within the securities arena.  Liability requires proof of an agreement between two or more defendants to maintain an interest or control of an enterprise, or to participate in the affairs of an enterprise, through a pattern of racketeering activity, and that each defendant agreed to commit at least two predicate acts to accomplish their goals.  Id.  Victims are entitled to treble damages, including costs and reasonable attorney’s fees.  18 U.S.C. § 1964.  But see Vicom, Inc., v. Harbridge, Merchant Services, Inc., 20 F.3d 771 (7th Cir. 1994)(RICO plaintiff must allege that he was injured by reason of the use or investment of the racketeering income and not simply that he was injured by the racketeering activity itself).

Lawsuits alleging violation of any federal law may be commenced in federal court, pursuant to 28 U.S.C. § 1331.


     State statutes governing securities, formerly known as Blue-Sky laws, were intended to supplement the federal laws for the protection of public investors.  In many respects, the Wisconsin Uniform Securities Law, codified under chapter 551 of the Wisconsin Statutes, generically mirrors federal law.  Wis. Stat. § 551.41 provides nearly identical language as Rule 10b-5 in its prohibitions against fraudulent practices.  Wis. Stat. § 551.42 prohibits market manipulation, while Wis. Stat. § 551.43 is directed at broker-dealer activities.  Violators of these statutes are subject to civil liability for compensatory damages, attorney fees and costs, under Wis. Stat. § 551.59.  Likewise, investors are subject to a three year statute of limitations.  Wis. Stat. § 551.59(5); Gieringer v. Silverman, 539 F. Supp. 498 (E.D. Wis. 1982).

The statutes are supplemented by the Wisconsin Administrative Code in chapter Department of Financial Institutions – Securities.  These regulations impose licensing and registration requirements and procedures for broker-dealers, investment advisors and investment advisor representatives.  Wis. Adm. Code ch. DFI – Sec. §§  4.05 and §§ 4.06 establish rules of conduct and prohibited business practices for broker-dealers, while §§ 5.05 and §§ 5.06 do the same for investment advisors and investment advisor representatives.  The regulations mandate particular action by broker-dealers, such as the distribution of a prospectus on a security immediately upon inquiry or solicitation.  Wis. Adm. Code ch. DFI – Sec. § 3.03.

Wisconsin has its own version of the federal-type RICO Act, known as the Wisconsin Organized Crime Control Act (“WOCCA”), and codified under Wis. Stat.§ 946.80 – 946.88.  Racketeering activity is defined to include the attempt, conspiracy to commit, or commission of any of the fraudulent practices prohibited under Wis. Stat. § 551.41 – 551.44.  Civil remedies for violation of WOCCA include double damages, attorney fees and costs, and punitive damages where appropriate.  Wis. Stat. § 946.87(4).

Fraudulent representations or statements by a financial advisor in connection with the solicitation of a security entitles one who detrimentally relies on that statement to recover any pecuniary loss, together with attorney fees and costs.  Wis. Stat. § 100.18.  See also Winkelman v. Kraft Foods, Inc., 2005 WL 171334, 2005 WI App 25,  ___ Wis. 2d ___, ___ N.W. 2d ___ (Ct. App. 2005)(upholding an arbitration award of attorney fees and costs, pursuant to Wis. Stat. § 100.18).

While securities are broadly defined, some insurance instruments do not qualify, and hence are not governed by the same laws.  For example, not all annuities are considered securities for regulatory purposes.  Associates In Adolescent Psychiatry, S.C. v. Home Life Ins. Co., 941 F.2d 561 (7th Cir. 1991)(flexible annuity is not subject to registration and is not therefore a security); Peoria Union Stock Yards Co. Retirement Plan v. Penn Mut. Life Ins. Co., 698 F.2d 320 (7th Cir. 1983)(variable annuity may be a security).  The NASD has nevertheless determined that variable annuities are indeed subject to its jurisdiction and rules because owners necessarily assume certain investment risks.  NASD Notice 96-86: Sales of Variable Contracts Subject to Suitability Requirements.   Due to heightened complaints of impropriety regarding the solicitation and sale of variable annuities in recent years, the NASD and Securities and Exchange Commission have sharpened their supervision of such investments with stern warnings to members, investor alerts and news releases.  See NASD Notice 99-35: Responsibilities Regarding Sales of Variable Annuities; NASD Notice 00-44: Responsibilities Regarding Sales of Variable Life Insurance; NASD Notice 04-45: Proposed Rule Governing the Purchase, Sale, or Exchange of Deferred Variable Annuities; NASD Investor Alert: Should You Exchange Your Variable Annuity? (2/15/00); NASD Investor Alert: Variable Annuities: Beyond the Hard Sell (5/27/03); NASD News Release re: Enforcement Actions on Sales of Variable Annuity and Life Ins. (12/5/01); NASD News Release re: Prohibited Variable Annuities Sales (1/29/04); NASD News Release re: Fines for Violations Involving Variable Annuity Transactions (5/20/04); NASD News Release re: Deceptive Market Timing in Variable Annuity Transactions (6/1/04); Joint SEC/NASD Report: Broker/Dealer Sales of Variable Ins. Products (6/20/04).

Nevertheless, annuities remain subject to many of the same general prohibitions governing securities under State insurance laws.  Wis. Stat. § 628.34 prohibits unfair insurance marketing practices, including misrepresentations about a product.  Moreover, Wis. Stat. § 628.347 mandates that annuity sales to senior consumers satisfy the same suitability requirements imposed by the NASD.  And, to be sure, the Wisconsin Administrative Code also imposes certain disclosure requirements and marketing prohibitions.  See Wis. Adm. Code ch. INS § 2.07, 2.15 and 2.16.

Wisconsin’s insurance laws apply to both insurance agents and “intermediaries”, as defined by Wis. Stat. § 628.02(1)(a)as one who does or assists another in doing any of the following:

  1.  Solicits, negotiates or places insurance or annuities on behalf of an insurer or a person seeking insurance or annuities; or
  2. Advises other persons about insurance needs and coverages.

Wis. Stat. § 628.03(1) requires all intermediaries to be licensed.  Controlling person liability may exist under Wis. Stat. § 628.03(1) where an unlicensed person is permitted to act as an intermediary in Wisconsin.

Likewise, commission splits between unlicensed intermediaries constitute a violation of Wisconsin insurance law.  Wis. Stat. § 628.61(1) states as follows:

No intermediary or insurer may pay any consideration, nor reimburse out-of-pocket expenses, to any natural person for services performed within this state as an intermediary if he or she knows or should know that the payee is not licensed under s. 628.04 or 628.09.  No natural person may accept compensation for service performed as an intermediary unless the natural person is licensed under s. 628.04 or 628.09.

Unlawful commission splits also provide foundation for a claim of an improper business exchange under Wis. Adm. Code ch. Ins. § 6.66(3), which mandates appropriate licensure before forwarding business to a listed agent.

A plaintiff may commence a lawsuit in state court alleging violations of state statutes and regulations.  Assuming there is not complete diversity of citizenship between the parties (or, if there is, the damages do not exceed $75,000), the case will not be removable to federal court.


     The National Association of Securities Dealers (“NASD”) has created the largest dispute resolution forum in the United States.  All stockbrokers and broker-dealers must be members of the NASD, and are subject to its jurisdiction.  Therefore, most disputes with investors are required to be arbitrated under its procedural and substantive rules.

The NASD has promulgated rules governing its members, many of which mirror federal and state laws concerning fraudulent activity. The rules are readily findable as part of the NASD Manual Online.  See NASD Rule 2120 (prohibiting use of manipulative, deceptive or other fraudulent devices).  However, its most applicable and relevant rule concerns the ubiquitous concept of suitability.  NASD Rule 2310: Recommendations to Customers (Suitability) provides as follows:

  1. In recommending to a customer the purchase, sale or exchange of any security, a member shall have reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer as to his other security holdings and as to his financial situation and needs.
  2. Prior to the execution of a transaction recommended to a non-institutional customer, other than transactions with customers where investments are limited to money market mutual funds, a member shall make reasonable efforts to obtain information concerning:
    1. the customer’s financial status;
    2. the customer’s tax status;
    3. the customer’s investment objectives; and
    4. such other information used or considered to be reasonable by such member or registered representative in making recommendations to the customer.
  3. For purposes of this Rule, the term “non-institutional customer” shall mean a customer that does not qualify as an “institutional account” under Rule 3110(c)(4).

NASD members must carefully abide by the letter of this rule, which normally requires written documentation of their efforts.  New and updated account forms are supposed to identify the customer’s financial and tax status, risk tolerance, investment experience and objectives to adequately ensure that investments are suitable for the particular customer.  There is no “one size fits all” investment; meaning each customer requires individual attention and consideration.  Joint SEC/NASD Report: Broker/Dealer Sales of Variable Ins. Products, p. 9 (6/20/04).  When no such documentation exists to prove the member fulfilled his/her obligation under the suitability rule, the law implies a rebuttable presumption that a violation occurred.

On the other hand, even where a new account form documents a customer’s investment objectives and risk tolerances, the customer may prevail by showing the inaccuracy of such information.  Many times, a stockbroker will complete a new account form haphazardly, without really knowing the customer.  The New York Stock Exchange has a rule similar to the NASD suitability rule, called the “Know Your Customer” rule.  All NYSE Rules are available online.  NYSE Rule 405: Diligence as to Accounts, provides as follows:

Every member organization is required through a general partner, a principal executive officer or a person or persons designated under the provisions of Rule 342(b)(1) to:

  1. Use due diligence to learn the essential facts relative to every customer, ever order, every cash or margin account accepted or carried by such organization and every person holding power of attorney over any account accepted or carried by such organization and every person holding power of attorney over any account doing so, the broker must consider the risk of any particular investment recommendation or strategy employed.

This rule sets a standard for all financial and investment advisors to exercise due diligence throughout the relationship with a customer.

The NASD places ultimate responsibility for persons associated with its members on the members themselves; i.e., the broker-dealers and financial institutions are responsible for their employees and agents.  NASD Rule 3010 provides that “[f]inal responsibility for proper supervision shall rest with the member.”  Members must have in place written supervisory procedures to ensure their employees are fulfilling their obligations under the rules, toward the NASD and the public.  Members establish offices of supervisory jurisdiction (“OSJs”) to search for red flags, such as missing or incomplete new account forms, or stated objectives out of line with stated risk tolerances.  Where an investor has suffered a loss due to unsuitable investments, the member may be ultimately liable for failure to supervisor its employees.

Unsuitable investments can also be much more surreptitious.  Account forms may accurately reflect investor sentiment, yet be unsuitable.  For example, a broker may ask an elderly investor whether he wants his money to grow; and, of course, the investor will answer affirmatively.  The broker will then identify the investment objective as “growth” (a term of art in the securities industry, meaning the investor is willing to assume some risk for a higher return) without having discussed the other possible objectives, such as preservation of capital or income.  Often unbeknownst to the investor, he has been pegged as one looking for higher returns at the expense of higher risk, when more conservative values had truly been desired.  When OSJs review the documents and investments, there are no red flags to get their attention.  Proof of the unsuitable nature of the investments must come from the investor’s testimony about his actual investment experience, objectives and risk tolerance.  Brokers will rely on the account form documentation for their defense, but where the investor is unsophisticated and unfamiliar with the terms of art, such a defense is not fail-safe.  When brokers fail to discuss this trade-off to allow the investor to make an informed decision, they may be subject to an NASD claim for unsuitability.

The NASD has also promulgated more specific rules governing the conduct of its members.  Most of these rules fall under the general tenet and “fundamental responsibility” of “Fair Dealing with Customers”.  NASD Rule 2310-2.  The following activities are deemed to “clearly violate this responsibility for fair dealing”: (1) recommending speculative low-priced securities; (2) excessive trading activity; (3) trading in mutual fund shares; (4) nondiscretionary or unauthorized trading; (5) forgery; (6) nondisclosure of material facts; and (7) misrepresentation.  NASD Rule 2310-2.  These violations often overlap and can be proven in conjunction with the more general allegation of unsuitability.

The NASD has enacted its own Code of Arbitration Procedure to govern its extremely high volume of cases.  Investors must file a Uniform Arbitration Submission Agreement with a Statement of Claim outlining the relevant facts, allegations and remedies sought.  NASD Rule 10314(a).  There is a six year statute of limitations for NASD arbitration.  NASD Rule 10304.  Once filed, the respondent-member must file an Answer with any counter- or cross-claims within 45 days.  NASD Rule 10314(b).  The parties then select a panel of three arbitrators from a list of candidates.  NASD Rule 10308.  The discovery process requires parties to then voluntarily exchange information, pursuant to the NASD Discovery Guides, within 30 days.  NASD Rule 10321.  These guides provide lists of documents that are presumptively discoverable by both sides.  The parties must fully disclose the identity of all witnesses and documentary evidence at least 20-days before the arbitration hearing.  NASD Rule 10321(c).  This is known as the “20-day exchange” rule.  The arbitration panel will then hear the case and issue a written decision, which is binding on the parties, and made publicly available.  NASD Rule 10330.  The panel has authority to award compensatory and punitive damages, and attorney fees and costs to either party, and such awards are subject to extremely narrow review by the courts.  Winkelman v. Kraft Foods, Inc., 2005 WL 171334, 2005 WI App 25, ___ Wis. 2d ___, ___ N.W. 2d ___ (Ct. App. 2005); Mastrobuono v. Shearson Lehman Hutton, Inc., 514 U.S. 52, 115 S.Ct. 1212 (1995).

Most, if not all, of the above information, rules, procedures, notices, and news is accessible from the NASD website  It is a very useful tool for lawyers, and a great resource for the investing public.


    Not all misconduct in the financial services industry can be neatly categorized or juxtaposed with a precise governing statute, rule or regulation.  When promulgated laws fall short, the common law will usually step in.  The most common example is ordinary negligence.  So long as the defendant had a duty to act or refrain from acting in some manner, and the breach of that duty caused financial harm to the plaintiff, an action may be brought for negligence.  A company’s own policies, or any number of various industry standards, may be used to prove the defendant failed to exercise the requisite standard of care toward the plaintiff.

Other common law theories of liability include conversion or misappropriation of property, strict liability misrepresentation, breach of contract, and even civil conspiracy.  A civil conspiracy in Wisconsin is defined as “a combination of two or more persons acting together to accomplish an unlawful purpose or a lawful purpose by unlawful means.”  The essence of a conspiracy is a combination or agreement to violate or disregard the law.  Wis. JI-Civil, 2800.  Principals have been held liable in the financial services industry for the fraudulent acts of their agents, and even third parties, under a civil conspiracy theory.  See Matthews v. New Century Mortgage Corp., 185 F. Supp. 2d 874 (S.D. Ohio 2002); and Williams v. Aetna Finance Company, 83 Ohio St. 3d 464, 700 N.E.2d 859 (Ohio 1998)(finding the defendant companies liable under civil conspiracy theory for the fraudulent acts committed by third persons because their loans to such third parties were integral to the furtherance of the fraudulent scheme).


    Despite what ostensibly appears to be an excessive reach of overlapping laws and regulations governing the securities industry, significant and woeful loopholes actually remain.  This is because a large percentage of persons who offer financial advice for a fee fall between the cracks of governmental regulations, and are for all practical purposes unregulated.  They can often set up shop, hold themselves out as experts in the field with little or no training or licensing credentials, and advertise with impunity, without ever violating any laws.  Investors should be wary of anyone purporting to offer investment advice, especially those without proper credentials, licensure and affiliations with recognized and accredited firms or institutions.

Those who feel they have been duped, defrauded or taken advantaged of should consult with an attorney knowledgeable in securities law.  Just as each investor profile is unique, so is each potential claim, and warrants individualized attention and consideration.  A lawyer can pull the facts together with the law to determine whether a claim has merit, and then decide which avenue to pursue for recourse.