Securities Arbitration Commentator

April 19, 2017

Roth Law Firm Wins Big Securities Arbitration

NICKLIN v. C.L. KING & ASSOCIATES, INC., FINRA ID #15-01121 (New York, NY, 4/5/17). This is the second Award to issue in a dispute between investment advisor Bill Nicklin of NBS Advisors, LLC (“NSB”) and NSB’s clearing broker, C.L. King (“CLK”), and, as in the earlier-concluded case, the pleadings shed much light on what would otherwise be an opaque set of claims and defenses. C.L. King v. Nicklin, FINRA ID #12-02927 (NYC, 11/25/15) (reported in SAA 2016-46), involved CLK’s successful effort to collect a $13 million debit balance in Nicklin’s margin account and a defense based on the same allegations as those here. This case likewise resulted in a complete victory for CLK on the claim. The Complaint states that the claimants, members of the Nicklin family and associated entities, “were fraudulently induced to open and maintain accounts” with CLK, that CLK “breached service and option agreements with the claimants and breached a Service Agreement with a non-party to which Claimants were third-party beneficiaries.” The pleadings, taken together, detail a long-standing relationship between CLK and Nicklin as portfolio manager of NSB.

Claimants’ Story

Nicklin pursued a highly successful strategy of maintaining long positions in small- and micro-cap stocks, while hedging against the market risk with short call positions on broad market indices. In 2009, CLK entered into a Service Agreement with NSB, under which the former provided custodial services for the latter’s customers, and CLK encouraged NSB’s plans to grow during their relationship. CLK should have known that NSB’s option hedging strategy would cause short call debt to grow as the business grew, but it never disclosed the risk that a failure by CLK to increase its net capital to accommodate this debt would force liquidation of holdings in NSB customer accounts, depressing the value of those holdings.

In late 2011, encouraged by CLK and sensing a market upswing, Nicklin increased his customers’ long positions, “accompanied by a commensurate increase in short call liabilities.” CLK complained specifically about debit balances in two particular accounts, but Nicklin determined that they posed no problem and began to suspect that the real issue was CLK’s own financial difficulties. In fact, CLK’s former president, King, had used a CLK proprietary trading account to purchase certain securities from clients of King’s RIA, which the SEC found caused CLK’s net capital to decline in 2012. As a result, CLK put pressure on NSB’s customers to sell securities, beginning in January 2012 and terminated the Service Agreement on March 14. CLK also tried to find buyers of securities to be sold in forced liquidations from NSB customer accounts.

Respondent’s Story

CLK “fully understood that under NSB’s Strategy a substantial increase in the long market value of the stock positions in 2011 … required a comparable in the strategy’s “coarse hedge,” i.e., additional short index options had to be written” (emphasis in the original), but Nicklin increased the hedge, ordinarily 20% of equity, to 43% of equity by February 2012, during a bull market, greatly increasing the margin debt. Also contributing to the problems were market forces that drove down the value of NSB’s long positions and cash withdrawals from the two large accounts about which CLK expressed concern. The SEC did not allege any impropriety in King’s use of the CLK proprietary trading account, but only in the related disclosures and vetting process, nor did King’s use of the account have any impact on CLK’s capital. In fact, CLK never had any financial difficulties; its concern was the regulatory risks from the large margin debts.

CLK terminated the Service Agreement on March 14, 2012 only after unsuccessfully urging NSB to reduce its debit balances. By mid-April, “further price declines had moved some accounts from house calls to NYSE calls” that “have strict deadlines and serious consequences.” Under applicable industry regulations, CLK had no choice but to close out any losses by May 15, 2012. Its earlier margin calls were too small to impact prices and it went to great lengths to avoid negatively impacting prices when it closed out the positions, attempting to arrange a private sale of the long positions and, when it could not find another buyer, CLK’s current president, Candace Weir, bought them on her own account at a fair price and significant loss to herself.

(ed: *CLK’s allegations about Weir’s purchase of NSB’s long positions does not address any of the claims in this case, but did address an allegation by Nicklin in the prior case. There, in his Statement of Answer, he claimed that Weir forced the margin liquidation in order to purchase the stock because she realized it would be profitable. Nicklin did not re-allege that claim in its Statement of Claim here, but CLK nevertheless took the opportunity to rebut it. **C.L. King was represented in the arbitration by Richard Roth of The Roth Law Firm, New York City, and Chris Robertson, Seyfarth Shaw (Boston). Mr. Roth commented on the Panel’s decision: “By the Award, the Panel confirmed, as have other panels, that C. L. King acted at all times merely as a custodial firm….) (SAC Ref. No. 2017-15-01) 

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