Case Closed in Securities Dispute, Until New Evidence Is Uncovered

A Long Island couple who lost $5 million at the hands of Mark C. Hotton, the former stockbroker notorious for defrauding Broadway producers, is arguing that his employer, Oppenheimer & Company, withheld critical evidence during an arbitration hearing and should be held liable.

Securities lawyers say that disputes over the production of evidence take place regularly and that the failure to turn over documents is an all-too-common problem in arbitrations. Rarer is a smoking-gun document that surfaces after the fact, as appears to be the case with Oppenheimer and Mr. Hotton.

Mr. Hotton made headlines in 2012 for defrauding the producers of the Broadway play “Rebecca” by collecting fees and commissions for lining up financing with an investor who did not exist. He pleaded guilty to money laundering and two counts of fraud last July and is being held in the Metropolitan Detention Center in Brooklyn, awaiting sentencing on May 9.

Separate from the “Rebecca” fraud, Mr. Hotton, who was known as “Hollywood” at his Oppenheimer branch, where he worked for a little more than three years, is accused of stealing millions of dollars from his brokerage clients. Despite a regulatory record of six- and seven-figure investor complaints against him, Mr. Hotton attracted no media attention until after he was accused of bilking about $60,000 from the “Rebecca” producers.

Two of his clients, Louis and Donna Pitch, filed a claim with the Financial Industry Regulatory Authority against Mr. Hotton and Oppenheimer in December 2009. Two days before the hearing was to begin in February 2011, Mr. Hotton filed for bankruptcy, leaving Oppenheimer as the sole respondent.

The arbitrators ruled early last year that the Pitches were entitled to recover only half of their losses. In the course of 69 hearings over 22 months involving the couple, Oppenheimer had argued that it had been properly supervising Mr. Hotton, who worked at the firm from November 2005 to January 2009. The firm said in a post-hearing brief in December 2012 that there was no evidence that it had been negligent in hiring, investigating or retaining Mr. Hotton and that it had properly supervised him in his dealings with the Pitches. Any claims about Mr. Hotton’s transgressions “came to Oppenheimer’s attention after he left,” the firm told Bloomberg News in October 2012.

That turned out to be false.

Five months after the arbitrators’ decision, the Pitches’ lawyer, Timothy J. Dennin of Northport, N.Y., opened a computer disk that was sent to him during the discovery phase of a separate case against Oppenheimer and found a letter from the Securities and Exchange Commission that discussed Mr. Hotton’s improper trading.

On Dec. 14, 2007, the S.E.C.’s Office of Compliance Inspections and Examinations had written to Oppenheimer’s chief compliance officer, Allen Holeman, to inform the firm that it had not properly supervised Mr. Hotton. He had traded improperly in 11 of his clients’ accounts, the agency said.

That evidence would have “completely demolished” the firm’s defense that it had not been aware of problems with Mr. Hotton, the Pitches said later. But the letter had not been produced in 2010, after the Pitches requested “all documents, regulatory correspondence, and/or communications with the S.E.C.” concerning Mr. Hotton for the previous five years.

By the time the letter was discovered, the period for asking a court to vacate their Finra award had expired, prompting the Pitches to make an appeal last December to Finra that it consider punitive damages in addition to the award.

Lawyers are often suspicious that they have not received all the documents they asked for during litigation, but it’s unusual for an aggrieved investor to uncover conclusive evidence after a case has been decided.

Securities lawyers say that disputes over discovery are a regular occurrence. The failure to produce documents “has always been a pervasive problem in Finra arbitrations,” said Jason Doss, president of the Public Investors Arbitration Bar Association, an association of lawyers who represent investors.

An Oppenheimer lawyer, William E. Mahoney Jr., argued in a letter to Finra on Feb. 7 that it would be “clearly inappropriate” for Finra to take a fresh look at the Pitches’ case and asked the authority to decline their request for monetary sanctions, punitive damages and legal fees. But on March 24, Finra wrote to Mr. Mahoney to inform him that his request had been denied. On April 18, Oppenheimer filed a complaint in New York State Supreme Court, asking that the Pitches’ December 2013 request be dismissed.

Mr. Dennin said that he learned during a discussion with a Finra official this month that it had opened a preliminary inquiry into the Pitches’ complaint. A Finra spokeswoman, Michelle Ong, said that she could not comment on the existence of any inquiry but that “we are aware of the allegations in this matter and are currently reviewing them.”

Oppenheimer declined to comment specifically on the discovery issue.

Oppenheimer and other brokerage firms have been sanctioned and fined in the past for withholding documents during arbitrations and investigations.

In 2007, Finra settled a case with Morgan Stanley DW, the bank’s broker-dealer subsidiary, after the firm falsely told investors during arbitration that it could not produce email records because they had been destroyed during the Sept. 11 attacks. It turned out, though, that the firm still had millions of emails. After a settlement with Finra, 2,100 investors shared a pool of $9 million financed by Morgan Stanley to compensate for the withheld evidence.

In 2004, Finra censured and fined Salomon Smith Barney, Merrill Lynch and Morgan Stanley DW for failing to produce documents in 20 arbitration cases from 2002 to 2004. In a separate action against a smaller firm, Finra threatened fines as high as $5,000 a day if it did not comply with a panel’s discovery orders.

Oppenheimer itself has been sanctioned in the past for failing to produce documents. It agreed to pay a $1 million administrative fine in a settlement with Massachusetts in 2007 for conduct that included “false and misleading” statements related to the production of emails during an investigation.

It paid another $1 million fine the same year for “knowingly, or at a minimum, recklessly” sending flawed data to Finra’s predecessor, NASD, according to the firm’s Finra records.

Mr. Dennin said that Oppenheimer was still withholding evidence. He received only two pages of a longer version of the 2007 letter in which the S.E.C. described Mr. Hotton’s unlawful trading. Mr. Dennin requested that Oppenheimer provide the balance of the letter but says he has not received it.

It was only a fluke that he wound up obtaining the S.E.C. letter at all, Mr. Dennin said. “If I didn’t have these other clients, this would never have come to light.”

This post has been revised to reflect the following correction:

Correction: April 24, 2014

An earlier version of this article misspelled the name of a brokerage firm fined by the Financial Industry Regulatory Authority in 2004. It is Salomon Smith Barney, not Solomon Smith Barney.