Ron Vaerewyck was making his way through the convention floor at the annual World Money Show in Orlando, Fla., in February 2008 when he stopped by the booth for Reef Securities of Richardson, Tex.
The brochures for Reef’s private placements in the energy industry showed an impressive track record, Mr. Vaerewyck said. By May, after a phone pitch from a Reef broker, he had made the first of several investments that would total $90,000.
After receiving an initial payment in the range Mr. Vaerewyck had expected, though, Reef’s distributions dropped from monthly to quarterly to zero. Mr. Vaerewyck, his wife, and seven other investors wound up suing Reef.
And then, much to their surprise, Reef countersued.
“They said we’d be liable for their legal expenses,” which could have been $400,000 or more, Mr. Vaerewyck said. “That’s a pretty significant piece of change for a group of retired individuals.”
Like Mr. Vaerewyck and the other Reef customers, investors who lose money in private placements face a new obstacle when they take their cases to arbitration before the Financial Industry Regulatory Authority, or Finra, as they are required to do in any dispute. The brokers they have sued are suing them back, accusing them of reneging on indemnification agreements.
The practice, which can intimidate investors already reeling from investment losses, is not widespread. About half of the at least two dozen scattered examples come from one brokerage firm — Berthel Fisher & Company, based in Marion, Iowa. But lawyers who represent investors say it could dissuade the public from making claims against brokers if the strategy were to catch on with other financial products.
“Every brokerage firm out there would do it if they thought they could get away with it,” said Michael D. Kennedy, a lawyer at the White Law Group in Chicago, who represented Mr. Vaerewyck and the other investors who were sued by Reef.
Brokers require customers to agree to take disputes to Finra’s industry-run arbitration, rather than court, before they will open an account. Finra records show only 13 examples of firms countersuing customers based on the language in an indemnification clause, according to an analysis by the White Law Group. But not every case is recorded in Finra’s database because many settle before a hearing, making it hard to know exactly how often brokers use the strategy.
Joseph C. Peiffer of the law firm Peiffer Rosca Wolf Abdullah Carr & Kane in New Orleans said he was stunned when Berthel countersued an investor he is representing in a Finra case. “I thought, ‘Could the firm really be saying they can do whatever they want because my client signed a private placement memorandum?’ ”
Michelle Ong, a Finra spokeswoman, said by email that indemnification clauses did not shield firms from their legal and regulatory obligations to comply with federal securities laws and Finra rules. “The use of any clause or tactic designed to intimidate or keep a customer from exercising his/her right to proceed in arbitration would violate Finra conduct rules and we may investigate the use accordingly,” she said.
Private placements provide fodder for countersuits because investors must sign documents that say they indemnify the issuer and its agents for any losses, lawyer fees and case costs in the event the investor makes a misrepresentation. Investors also agree in writing that they are sophisticated and understand the risks of the investment.
Berthel Fisher seized on the language in those documents to bolster two counterclaims against 32 investors from Midwestern states who had lost all of the money they had invested in a private placement in a cellphone company. Berthel won both cases last year. The investors said they had been pitched the product by Berthel brokers who had an obligation to sell them a suitable investment. In their complaints filed with Finra, they contend that Berthel employees told them the investment was a “sure thing,” “no lose” and carried little risk.
The firm, though, said it was entitled to legal fees and other compensation because the investors had lied when they signed a document saying that they were sophisticated and understood the product. They did that “with the intent to trick Berthel Fisher,” the firm said in responses to two investor claims.
“The investors make representations to buy these things” and have a legal obligation to be truthful, said Vincent D. Louwagie, a Minneapolis lawyer who represented Berthel in both hearings.
Mr. Louwagie said the subscription agreements did not let brokers off the hook for everything. Brokers remain obligated to recommend suitable investments and not to mislead investors, he said.
Mr. Peiffer, whose case before Finra is in the discovery phase, said letting them off the hook was “exactly what Berthel was saying” in the counterclaim against his client.
Lawyers who represent investors say the countersuit strategy is an improper interpretation of the language in the documents investors sign. “The investor has signed a contract with the issuer, not the broker,” said Alan Rosca, who is working on the case against Berthel with Mr. Peiffer. It would make no sense for a customer to take advice from a broker who had no responsibility to sell an appropriate investment, Mr. Rosca said. “You expect a broker to recommend something that’s good for you.”
More vital, they and other plaintiffs’ lawyers argue, the tactic is contrary to public policy. In a brief to Finra arbitrators in May, the Reef investors, who won their case in July, said, “Indemnification clauses are not designed — and should not be used” to protect brokers who sell unsuitable investments.
Through a spokesman, Reef’s lawyer on the case, Elizabeth L. Yingling, declined to comment.
Lawyers for plaintiffs say countersuits based on indemnification are a potent strategy because customers are frightened by the demands for damages and to pay legal costs.
“Most of the time, these people have lost a lot of money and they say, ‘Gee, I could lose more,’ ” said Gail E. Boliver, a lawyer in Marshalltown, Iowa, who lost two cases in which he represented clients who were countersued by Berthel. “That’s the intent of it.”
Mr. Louwagie said the tactic was not meant to scare customers but “to give us an opportunity to make additional arguments to the arbitrators.” Berthel has made counterclaims against private placement customers about “a dozen times,” Mr. Louwagie said. Of those cases there was only one that the firm did not “either settle or win,” he said.
In February, Finra fined Berthel $775,000 for supervisory failures related to its sales of alternative investments. Among Finra’s findings was that Berthel had not enforced suitability standards for sales of some of its alternative products. One of the firm’s brokers, described but not identified in the settlement with Berthel, is in prison for stealing money from his clients. Mr. Peiffer’s firm is representing an investor who did business with that broker.
Mr. Vaerewyck, the former Reef customer, said countersuits were a bullying tactic. “They figured, ‘We will just ram this down these little people’s throats and scare the hell out of them,’ ” he said. “I think their ploy was that we would back off.”
It would send a bad message to investors if arbitrators began to accept the indemnity argument, Mr. Peiffer said. If Berthel and others are right, he said, “it gives brokers license to do anything they want.”