(CN) - Waterford Investment Services Inc. must arbitrate investors' claims that one if its associates conned them into a Ponzi scheme even though he wasn't an employee of the company at the time, the 4th Circuit ruled.
Although George Gilbert wasn't a Waterford employee, a three judge panel sitting in Richmond, Va. found the company could have exerted enough control over his actions to make him an "associated person" of the firm under the arbitration rules of the Financial Industry Regulatory Authority.
In 2005, as a financial advisor at Waterford's sister firm Community Bankers Securities, Gilbert talked several members of the Bosco family into investing in two securities offered by CBS.
By 2009 the Bosco's had lost over $1 million with Gilbert and filed claims against him, CBS and Waterford alleging misrepresentation and failure to disclose the risk involved with their investment.
That same year the Securities and Exchange Commission began an investigation of CBS, Waterford, their corporate parent AIG Inc. and majority shareholder and chief of all three firms Nicholas Skaltounis, alleging that they were running a Ponzi scheme selling new shares and promissory notes to pay off earlier investors and support day-to-day operations.
While the claims were before FINRA, CBS ceased operations. Most of its associates, including Gilbert, and half of its customers migrated to Waterford.
Waterford asked a federal district court to dismiss it from the FINRA arbitration claims arguing that it had no control over Gilbert's actions before he was an employee.
The district court denied Waterford's motion finding that the overlap in management structure, employees and even office space between CBS and Waterford meant Waterford had the opportunity to influence Gilbert's actions which was sufficient to include it in the FINRA action.
So close was the relationship between to the two firms - shared office space, most of the corporate officers, same majority shareholder - the district court found the Waterford was mere continuation of CBS taking on all of its assets and liabilities.
On appeal Wateford didn't deny the cozy arrangement of the firms but argued that each had its own chief compliance officer rendering Waterford without the power to influence Gilbert.
Affirming the district court's decision, Circuit Judge Dianna Gribbon Motz said separate compliance officers didn't remove the possibility that Waterford could have controlled Gilbert's actions.
"Waterford's focus on the separate role of one position in the two firms, no matter how persistent that focus, simply does not eliminate the overlapping roles and actions of numerous other high-level officers and directors with powerful positions in both firms."
"The definition of 'associated person' is broad, allowing for a representative, like Gilbert, to be an associated person of a member firm whenever he is 'directly or indirectly ...controlled by a member,'" Judge Motz said quoting FINRA rules.
Motz agree with the district court that Waterford could have exerted both types of control. Directly through a compliance manager who worked for both firms and indirectly through CBS' chief compliance officer who reported to the man in charge of both firms.
"There simply is no reasonable inference to be made that CBS's Chief Compliance Officer, who happened to be unaffiliated with Waterford, was the only CBS employee who could exercise control over Gilbert's activities," Motz wrote.
Given undisputed evidence of overlap between the firms, and federal presumption in favor of arbitration, Motz concluded the investors could compel Waterford to arbitrate their claims.