Securities America filed a request Friday in U.S. District Court to be removed from a Financial Industry Regulatory Authority arbitration involving clients of a company it acquired in 2016. The clients named both that company, Foothill Securities, and Securities America as respondents in a $600,000 claim seeking compensation for a poor investment recommendation made before the acquisition.

At issue is whether Securities America, a La Vista, Neb.-based broker-dealer in the Osaic group, should be called before Finra in this matter at all, according to the company’s complaint, filed in the District of Nevada. When the company purchased Foothill, it acquired most, but not all, of the firm’s assets, and the acquisition agreement included phrasing that absolved Securities America of any debts or obligations that might arise from Foothill’s operations before the sale, according to the filing.

The claimants in the Finra case, however, disagree, asserting that as the successor entity in the acquisition, which provided continuity for Foothill’s business, Securities America inherited Foothill’s liability for a broker’s recommendation of an investment that went south.

“Handling the acquisition as an asset sale does not relieve a firm of liability,” said Adam J. Weinstein, an attorney with New York law firm Gana Weinstein and one of the attorneys representing the claimants. “Otherwise, firms could just do that every once in a while and wipe the slate clean.”

Regardless of the outcome in this case, the nuance of liability for pre-acquisition investment activity is something advisory firms should be paying attention to if they plan to grow through acquisitions, said Leila Shaver, an attorney and founder of My RIA Lawyer in Alpharetta, Ga.

Officials at Securities America could not be reached by the time this story was filed. The firm is seeking an injunction enjoining the Finra arbitration against it from going forward, a declaration that the dispute is not arbitrable, the award of attorney’s fees and other costs associated with its defense and any other relief the U.S. District Court considers just and proper.

A Terrible Accident, A Compelling Complaint
The clients making the claim are Christopher J. Phillips, the Angela Marie Mobley Trust, the Larry Mobley Living Trust and the Debra Demasi Trust. The claimants originally went before a Finra panel naming Foothill Securities as the respondent in their quest to recover $600,000 they say they lost because of an inappropriate recommendation by their Foothill broker, Lance Taylor Knight.

But because Foothill became a defunct company following its acquisition, the clients moved to add Securities America as a respondent in a second amended statement of claim earlier this month. Knight was not named as a respondent.

One of the claimants, the Angela Marie Mobley Trust, was established to invest settlement money that its namesake, Angela Marie Mobley, received following a car crash she survived at age 7 that left her permanently cognitively impaired. The money was intended to provide for her care throughout her life.

Phillips, an attorney, was named trustee, and it was through him that Mobley and her siblings, Debra Demasi and Larry Mobley, were introduced to Foothill and to broker Knight, the statement of claim said. At the time of the introduction, Phillips had already relied on Knight for about 20 years as his personal financial advisor.

The claimants say that even though the trusts were for the welfare of the beneficiaries, Knight recommended that Phillips sign documents to invest in a non-traded real estate investment trust called the Hospitality Investors Trust, or “HIT,” also known as the ARC Hospitality REIT. The claimants described this as “a low quality, high-cost, and high-risk alternative investment that paid Mr. Knight a 7% commission.” They added that the REIT had a history of managerial troubles and should never have been considered an appropriate investment. It eventually went bankrupt in 2021, the suit said.

In all, the Angela Marie Mobley Trust invested $300,000 in Knight’s REIT recommendations, while the Larry Mobley and Debra Demasi trusts invested $100,000 each; Phillips also invested $100,000. All of this money was lost, the Finra claim said.

The claimants alleged a breach of fiduciary duty, a lack of suitability, fraudulent or negligent material representations, violations of various Finra rules, failure to supervise and breach of contract.

The claimants requested the Finra panel award them compensatory damages of $600,000 or what a well-managed account would have performed, pre- and post-judgment interest, attorney’s fees, expert fees, forum fees and punitive damages.

Protection Begins With New Contracts And Burying The Old Firm
In general, liability does continue to exist when firms merge or are acquired, Shaver said, adding that an acquirer can’t simply say it’s not responsible. “That’s not really enough,” she said. “But there are things you can do to protect yourself in an acquisition if you have a plan. And the first thing? Have a plan!”

According to Securities America’s district court filing, it acquired some of Foothill’s assets and incorporated some of the firm’s brokers, but not the claimants’ assets and not Knight as a broker.

However, Securities America did take possession of Knight’s registration for a 24-hour period as part of a bulk transfer of Foothill’s registered reps.

“As a result, his registration was moved to SAI [Securities America] overnight, when it was moved again to the firm with which he was contracted as a registered representative,” the Securities America filing said. “Mr. Knight never worked for SAI, never opened up any accounts at SAI, did not move assets to SAI and entered no agreements with SAI.”

According to BrokerCheck, Knight’s registration with Foothill ended December 8, 2016, his registration with Securities America ended December 9, 2016, and his registration with his next firm, M.S. Howells & Co., began December 13, 2016.

It’s this overnight registration that Shaver said may be the Achilles’ heel for Securities America.

“That probably was a mistake if it was over a 24-hour period,” she said. “That signals a compliance team that’s not well informed as they’re doing the acquisition.”

If one firm is buying another, she said, the game plan should be pretty straightforward, with professional liability insurance or errors and omissions insurance put in place or a clawback on price to adjust the value of the business based on future litigation.

“Go to an insurance company and look at purchasing a policy to cover past conduct so if there is any serious litigation you have some coverage to cover defense costs,” she said. “If there is pending arbitration, put money in an escrow account.”

But most important, create a clear break between the old firm and the new, bigger company.

“If you’re buying an entity, shut down that entity. Really create a break between the old entity and the new firm,” she said. “As soon as the acquisition closes, immediately send out brand-new contracts. You let clients know the entity is being shut down, they’re being transferred to a new firm, and they have a limited time to sign the new contract or they’ll be moved off the master roster.”

The plan, she continued, needs to set the stage for newly signed contracts quickly and efficiently.

“Reps will complain it’s so much paperwork and takes so much time, but I think that’s bull****,” Shaver said. “If you’re exposed to a six- or seven-figure lawsuit, it’s worth taking the time to do it. When a client files that lawsuit, everyone wishes they had those signed contracts. Shoulda, coulda, woulda.”

On the plus side, the firms that are successful moving 98% to 99% of their book are the ones that embrace the challenge, meeting clients where they are, she said.

“That means sending out couriers to clients who don’t use email,” Shaver said. “And if they’re still not responsive, get rid of them. The likelihood of lawsuit with clients who are unresponsive is high. How can you make sure if you’re still making suitable recommendations if you haven’t talked to a client in three years?

“This is an opportunity to purge liability,” she concluded. “Your risky clients are your problem children.”

As for Securities America, Shaver said that if the firm ends up in Finra arbitration, the deciding factor in any award would be that Securities America had enough interaction with the claimants to make them think they were Securities America clients.

“The Finra panels aren’t looking to be equitable,” she said. “They’re looking to do what’s fair. It’s not usual for them to go beyond the letter of the law.”