Industry News

RIA takes dispute with Fidelity to the Supreme Court

Plaintiffs claim firm filed a suspicious activity report to conceal its own wrongdoing

A defunct registered investment adviser and two former clients locked in a legal battle with Fidelity Investments are appealing their case to the U.S. Supreme Court.

The petition involves allegations by now defunct AER Advisors that Fidelity lent out shares of stock owned by the RIA’s clients, the father-and-son duo of William and Peter Deutsch, for purposes of short selling against the clients’ wishes in 2012.

Two lower courts have ruled in favor of Fidelity on the basis of a law that gives legal immunity to a securities firm that files a suspicious activity report, which Fidelity filed against AER.

“Fidelity put me out of business to cover up their fraud,” said Dave O’Leary, the founder and chief executive of AER before it went out of business in March 2013.

According to the petition, AER was operating as an RIA on Fidelity’s wealth central platform in 2011 when Mr. O’Leary introduced his “China Gold” strategy designed to take advantage of a widespread selloff of Chinese companies.

William and Peter Deutsch, founders of Deutsch Family Wine & Spirits in White Plains, N.Y., were aggressive investors trying to gain a controlling interest in China Medical Technologies, a Beijing-based maker of cancer-treatment devices.

In March 2012, after the Deutsches had accumulated approximately 13 million shares of China Medical, they received an email from Fidelity inviting them to participate in a “fully paid lending program,” which would involve allowing Fidelity to lend the stock to short-sellers for a fee.

Even though the lending program would have paid more than 7% annually for use of the shares, the Deutsches declined the offer since they are continuing to accumulate shares.

Despite their decision, the lawsuit alleges that between March and June 2012, Fidelity lent out nearly 1.8 million shares of the Deutsches’ China Medical stock to short sellers.

Not only were the Deutsches not paid for unwittingly lending out their shares, but in June of 2012, when they tried to move shares between their own accounts, Fidelity had to start recalling shares from short-sellers to replenish the Deutsch account.

When that effort failed to produce enough shares, Fidelity had to buy 1.2 million shares of China Medical on the open market, which drove up the price by nearly 200%, leading to a halt in trading by the Securities and Exchange Commission.

The sudden spike of a heavily shorted security is known as a short squeeze for the way it forces short-sellers to abandon positions to halt losses.

Despite owning more than a third of all China Medical shares and in the midst of a strategy to acquire more, on July 5, 2012 Fidelity filed a suspicious activity report, effectively accusing the Deutsches of influencing the stock’s sudden spike.

The Deutsches did not respond to a request for comment for this story.

Mr. O’Leary claims Fidelity filed the suspicious activity report to gain immunity for its own violations of securities lending practices and that the court should not grant immunity in this case. He claims lower courts have interpreted the immunity rule differently.

“Petitioners brought this action against Fidelity seeking redress for Fidelity’s fraudulent concealment of its own conduct, a cover-up of its illicit lending practices and market manipulation that created the short squeeze,” the petition states.

Even though the government investigations into AER Advisors, which were triggered by the suspicious activity report, were not prosecutable, they were enough to put AER out of business.

In response to a request for comment, Fidelity spokesman Vincent Loporchio emailed the following: “All of their claims were without merit, which is why the lower federal courts ruled in our favor.”