A Stockbroker s Guide to Regulatory Investigations (2 nd Edition, 2012) Understanding regulatory examinations and enforcement actions.

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2 A Stockbroker s Guide to Regulatory Investigations (2 nd Edition, 2012) Understanding regulatory examinations and enforcement actions. Joel R. Beck, Esq. The Beck Law Firm, LLC 1

3 A Stockbroker s Guide to Regulatory Investigations (2 nd Edition, 2012) Copyright Joel R. Beck This work is licensed under the Creative Commons Attribution-No Derivative Works 3.0 United States License. To view a copy of this license, visit or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA. 2

4 Table of Contents About the Author 5 Foreward Regulatory Exams = Serious Matters 8 Part One FINRA Examinations and Actions Chapter 1 Overview of Examinations 12 Chapter 2 The FINRA Exam Process 18 Chapter 3 Rule 8210 and Jurisdiction Issues 25 Chapter 4 Informal Disciplinary Actions 31 Chapter 5 The Formal Action Process An Overview 35 Chapter 6 Pre-Complaint Settlement / AWC 42 Chapter 7 No Settlement = Litigation An Overview of the FINRA Hearing Process 48 3

5 Chapter 8 Settlements after the Complaint The Offer of Settlement 57 Chapter 9 Appeals and Calls for Review 61 Chapter 10 Other Considerations 65 Part Two SEC Matters Chapter 11 SEC Matters 69 Part Three - State Securities Commission Matters Chapter 12 State Examinations and Enforcement Activities 72 Conclusion 76 4

6 About the Author Joel R. Beck is a lawyer and founder of The Beck Law Firm, LLC in metro Atlanta, Georgia. Joel s practice primarily focuses on financial markets law, representing firms and brokers across the country in regulatory matters, arbitration cases, and providing general legal advice relating to compliance issues for brokerdealers and registered investment advisors. Joel also works as a consultant to other attorneys representing clients in securities regulatory matters and has testified as an expert witness in securities-related cases, and worked as an independent consultant for a broker-dealer to satisfy undertakings imposed by the SEC. Prior to opening The Beck Law Firm, LLC, Joel worked at NASD (now known 5

7 as FINRA) for ten years, including six years as an attorney in the Enforcement Department. There, Joel litigated cases involving penny stock fraud, misrepresentations and omissions of material facts, unsuitable recommendations, unauthorized trading, forgery, supervision, selling away, conversion of funds and other violations. In addition to working as an attorney in the Enforcement Department, Joel also worked as an examiner in the Member Regulation Department, and as a paralegal in Enforcement at NASD. Now, in addition to securities regulation and compliance matters, Joel s practice also includes criminal defense (including white collar type matters relating to the financial markets), basic estate planning for individuals, and small business law, including business formations and operations, contracts, agreements, and the day to day legal needs of a small business owner. Joel earned his BBA at Georgia Southern University and his JD at John Marshall Law School, 6

8 Atlanta, where he graduated with honors and was a recipient of the West Publishing Company Award for Academic Excellence. In November 2005, Joel was designated a Certified Regulatory and Compliance Professional (CRCP) by the NASD Institute and the Wharton School of Business at the University of Pennsylvania. He no longer maintains that designation as active, focusing his continuing education efforts in a variety of other areas. In March 2010, and again in March 2011, Law & Politics and the publishers of Atlanta Magazine named Joel as a Georgia Rising Star lawyer in securities litigation. Joel is a member of the State Bar of Georgia. 7

9 Foreword Regulatory Examinations = Serious Matters. If I were to try to come up with a catchy title or subtitle to this short book, it might be Oh S*&#! because that s the reaction I think many brokers have when they receive a notice from a regulator asking for information or informing them that they are under investigation. Perhaps you received a letter from a FINRA examiner, or maybe your compliance officer or branch manager has asked you for information in response to a regulatory inquiry. Or, maybe a client has filed a complaint against you and you are expecting to hear from the regulators. Whatever the reason you re interested in learning more about these matters, you should understand that regulatory examinations, whether conducted by FINRA, the SEC, or a 8

10 state securities regulator, are serious matters because disciplinary actions resulting from these examinations can have a significant impact on your career. Sanctions for violations of industry rules and regulations, or federal or state securities laws may result in: a censure, fines being assessed against you, orders to pay restitution to customers, a suspension from working in the industry for a number of days to years, or an outright bar from being associated with a broker-dealer. Further, the regulatory actions taken against you may become reportable on your Form U4 and made available to the public through press releases and announcements by regulators. These actions can result in your broker-dealer terminating your employment or your independent contractor agreement, can make it more difficult to join another broker-dealer in the future, can make it more difficult to be registered with the states, and can make your practice and advice less appealing to existing or potential clients. Further, it is possible that a 9

11 disciplinary action can have collateral consequences in other areas, including licensing for insurance, investment advisor, mortgage and other areas. As a result, brokers must treat regulatory examinations as serious matters. In this short book, I ll share with you the basics of regulatory examinations, focusing primarily on exams and regulatory actions initiated by the Financial Industry Regulatory Authority (FINRA ), as I believe that more representatives are likely to face FINRA matters than matters involving other regulators. But, I ll also share some information on SEC and state exams and actions as well. Why did I write this book? It s simple. I believe there is a lot of information that a broker under investigation needs to know. They should understand the process they are in, what some of the steps involved are, and what the possible outcomes might be. As the old saying goes, forewarned is forearmed. The more solid 10

12 information you have, the better your decision-making process can be. While I believe that this book contains very useful information, please understand that this book is not a substitute for competent, experienced legal advice. This book simply seeks to educate you about these types of investigations and highlight issues and outcomes that might apply in your situation. Put simply, if you need legal advice, you need to consult a lawyer. And if you need legal advice relating to regulatory investigations, you owe it to yourself, and your career, to consult with a lawyer experienced in these areas. All information in this ebook is believed to be accurate at the time it was written, but there are no guarantees of such accuracy and the author and publisher assume no responsibility to update and maintain this ebook. 11

13 Part One - FINRA Examinations and Actions Chapter 1 Overview of Examinations From both my time as a securities regulator and now in the private practice of law, I ve been involved in hundreds (if not thousands) of regulatory examinations. In private practice, I often represent individual brokers and firms that are involved in an investigation or examination (these words are used interchangeably) by FINRA or other regulators. Many times, I find that brokers don't understand the role that FINRA plays, what their own responsibilities and obligations are, and what can come about as a result of a FINRA examination. We ll cover these items in this section, beginning with some 12

14 background on FINRA, and the types of examinations that they may initiate. FINRA is not a part of the government and FINRA examiners won't throw you in jail for some type of violation of industry rules and regulations. FINRA is a self-regulatory organization and all broker-dealers doing business with the public are members. Pursuant to their membership in the organization, brokerage firms, and the brokers working for them, agree to abide by industry rules and regulations, including FINRA rules, and agree to be subjected to FINRA's jurisdiction in disciplinary actions. These disciplinary actions are civil in nature, and are not criminal matters (FINRA matters are civil; there are federal and state law enforcement agencies that investigate securities violations and, if appropriate, criminally prosecute violators). The distinction of FINRA as a nongovernment regulator is important because under the current state of the law you don't have certain rights with 13

15 FINRA that may exist with the SEC or a state regulator (think of the 5th amendment right against selfincrimination for more information see the chapter on Rule 8210). FINRA conducts routine exams of broker-dealers to check for compliance with industry rules and regulations. These routine examinations generally follow a cycle that results in a firm being inspected once every year, two years, or three years, depending on the type of business the firm does, its size, and its perceived risk to the markets and the investing public. The scope of these examinations are very broad with examiners making sure that the firm is operating with sufficient capital, is adequately supervising its employees and business operations, and has proper internal systems and controls in place. Examiners also focus on more mundane elements, like making sure a firm displays a SIPC sign on its premises in the manner prescribed by industry regulations. 14

16 In addition to these routine exams, FINRA also conducts cause (think for cause ) examinations based on information that it receives that indicate that there might be a rule violation. For example, an examination may be started based on information from a Form U4 or U5 disclosure, a Rule 4530 report, a customer complaint, an arbitration claim, a referral from an arbitration panel, or information received from another regulator or law enforcement agency. Sometimes exams are initiated based upon information received from a competing broker or broker-dealer employee in the form of a regulatory tip. These cause exams typically focus on sales practice matters involving allegations of unauthorized trading, unsuitable recommendations, misrepresentations or omissions, selling away (private securities transactions), participating in undisclosed outside business activities, forgery, theft or conversion of funds, and other unethical behavior. 15

17 Information that FINRA obtains in its exams is generally not publicly available, but brokers and firms should be aware that FINRA might share certain information with other regulators, as well as with law enforcement agencies. Further, the exam file may be subject to a subpoena in civil litigation, including customer-initiated arbitration claims. For these reasons, it is wise to consult with legal counsel when facing a regulatory exam, particularly in cases where the broker may have participated (intentionally or not) in criminal misconduct, or where there may be a serious risk of civil litigation by investors or others who may have been damaged as a result of the broker s conduct. As discussed later with regards to Rule 8210, while failing to cooperate with FINRA will typically ultimately result in an individual being barred from working in the industry, such option may be the chosen strategy when faced with other criminal or civil actions or claims. 16

18 Various departments within FINRA conduct examinations, including Member Regulation, Enforcement, and Market Regulation. Member Regulation typically is responsible for the routine examinations of firms, but it, as well as Enforcement, also conducts cause exams focusing on sales practice violations of firms and brokers. Enforcement will typically be involved in larger-scale investigations covering a wide range of issues or other cause exams, and Market Regulation is the primary department for conducting exams relating to the operation of the markets, and trade reporting compliance, etc. While many exams conducted by FINRA do not lead to no disciplinary action being taken, or only an informal (and non-public) type of action, firms and brokers cannot tell at the outset of an examination what the end result will be. As such, it is best for a broker to treat all examinations as serious matters. 17

19 Chapter 2 The FINRA Exam Process Most of the regulatory exams that result in disciplinary actions against individual brokers result from cause exams and relate to sale practice issues, disclosure (Form U4) issues, or the broker s other activities (such as outside business activities). Whatever the type of violation being investigated, the process the examiners use remains basically the same. At the outset of the exam, the regulators generally know little about the activities or conduct being investigated. The examiner s first step is usually to send a written request for information to the broker-dealer and another one to the broker, seeking basic information on the complaint or other disclosure. These initial requests letters 18

20 often simply ask for the broker to provide a written response to the allegation. The request letter to the firm usually seeks a written narrative of the complaint or other disclosure and the firm s findings, and may also seek copies of relevant documents, including correspondence with the customers involved, account records such as statements and new account forms, and other relevant items. After obtaining this initial information, examiners review the documents and information received to determine whether the issue is one over which FINRA has jurisdiction, may indicate a potential rule violation, and meets other thresholds for FINRA to continue reviewing the matter. Historically, FINRA does not conduct examinations into conduct that it considers too old (perhaps older than two years) unless that conduct is egregious. Examiners use a variety of investigative methods to conduct their examination, but the vast majority of information gathered comes about as a result of written 19

21 letters. Letters seeking information and documents, and responses to specific questions are frequently sent to firms, brokers, and other involved persons associated with brokerdealers. Oftentimes a letter to a broker seeking information will ask the broker to respond with a signed, written statement, responding to specific questions. It is commonplace for a broker to receive two, three, four or more such letters. In addition to writing letters, examiners may conduct telephone interviews with brokers, managers, compliance department employees, customers, and others to obtain additional information. These interviews are considered to be informal interviews, but brokers must be cautious nonetheless, as what they say can certainly be used against them. In most cases that lead to a disciplinary action, the examiners and/or attorneys for FINRA will request that the broker or other associated persons of the firm meet with the regulators for an on-the-record interview 20

22 ( OTR ). These OTRs are very similar to a deposition in a civil court case as the witness is sworn in to tell the truth, the interview is recorded by a court reporter, and a transcript of the interview is prepared. Usually, when FINRA staff seek to take testimony with an OTR, they believe that it is likely that the case will result in some type of disciplinary or enforcement action, though that will not be communicated to the broker. Since brokers are allowed to have legal counsel appear at the OTR with them, a wise broker will obtain legal counsel to help prepare for the OTR, for the OTR itself, and for any forthcoming enforcement action. Sometimes there may be two OTRs of a broker during the course of an examination; FINRA is not limited to just one interview with an individual. Once the examiners believe that they have gathered all of the relevant information, documents, and other evidence, a report of examination will be prepared by the examiner(s) and submitted to a supervisor. That supervisor 21

23 will review the report and the evidence obtained, and then make a recommendation to close the file without action, to pursue some type of informal disciplinary action, or to pursue a formal disciplinary action, or to resolve the matter with a combination of these items. A more senior manager generally reviews the supervisor s recommendation and then the exam is closed, or informal or formal disciplinary action is pursued (or a combination of those). While this is a short chapter and the process of the examination seems simple enough, it does not mean that a regulatory examination will be completed quickly. To the contrary, the examination will likely take many months, and it is not unusual for an examination to take over a year to be completed. Of course, those cases that are deemed more serious may be completed more quickly than many routine types of examinations. The good news, however, is that, until a Wells letter or phone call is issued to the broker officially putting he or she on notice that the staff 22

24 intends to pursue a disciplinary action against him or her, no disclosure of the regulatory examination is required to be made on the broker s U4. One final point relating to the exam process: FINRA does not have jurisdiction over people that are not affiliated with the securities industry. Since FINRA cannot require or compel the cooperation of these folks, such as customers, some examinations go nowhere due to a lack of customer cooperation, if such cooperation is necessary to establish the existence of a violation. Brokers should not attempt to persuade a customer not to cooperate with the regulators, because such persuasion can be found to be a violation of FINRA rules, for which the broker or firm can be sanctioned. This holds true for settlement agreements with customers to resolve customer complaints or arbitrations. FINRA expressly prohibits any settlement agreements from restricting the customer s ability to communicate with and cooperate with any regulator. 23

25 Likewise, brokers must also be wary of settling a complaint with a customer without approval of their firm, as FINRA can sanction brokers for settling away from the firm. 24

26 Chapter 3 Rule 8210 and Jurisdiction Issues A question I am frequently asked relates to FINRA Rule 8210, with brokers wanting to understand whether they have to comply with requests for information from the regulator. The short answer to that question is no, but there may be significant consequences for not doing so. The standard sanction for failing to respond to information requests or requests for testimony is a bar from the industry, meaning that the person is no longer eligible to be registered or even associated with a broker-dealer. So, while a broker does not have to respond to FINRA, he or she will almost certainly be kicked out of the industry for such failure. And importantly, that type of disciplinary action may have an impact on the broker s future 25

27 employment prospects, as well as on licenses for other activities, such as an insurance license, investment advisor registration, mortgage license, etc. Put simply, Rule 8210 is essentially FINRA s version of a subpoena. FINRA is not a part of the government and it therefore does not have subpoena authority, but Rule 8210 comes close. The rule requires that a broker-dealer firm, and registered and associated persons, and persons subject to FINRA s jurisdiction, cooperate in a regulatory examination and provide information in writing, electronically, or orally, including testimony, when requested by FINRA staff. Should a broker choose not to comply with the request, he may be suspended through an expedited proceeding, and, as a result of a disciplinary proceeding, he may be barred from association with any broker-dealer in any capacity for the failure to respond, in addition to other sanctions. 26

28 As I ll discuss in a later chapter, FINRA is different than other regulators. Because the other regulators (the SEC and the states) are the government, a broker can usually, where appropriate, assert his or her right against self-incrimination and elect not to answer certain questions from those government regulators where the misconduct may have criminal ramifications. But, because FINRA is not the government, such 5 th amendment protections do not apply, and a broker who refuses to answer questions or provide information to FINRA on these grounds can be sanctioned and barred from the industry. Nevertheless, in certain cases it may be preferable for a broker to not cooperate with FINRA if he is facing criminal charges, as the statements and information he provides FINRA can be subpoenaed or requested by law enforcement agencies, or FINRA may make a criminal referral to such agency and provide them with information it obtains. The decision on whether to cooperate with securities regulators while facing 27

29 possible criminal exposure is a complicated one that should always be made with the advice of legal counsel experienced in these matters, only after reviewing the facts and circumstances of the broker s particular situation. One more point on 8210: It is a violation of Rule 8210 to provide misleading, untruthful or outright false information to the regulators, and may brokers have been sanctioned for lying to the regulators. Sometimes, the sanctions for lying to the regulators is worse than the sanction for other violations identified during the investigation, leading to more significant, and needless, sanctions against the broker. And, if the untruthful information is provided to FINRA in the context of a sworn statement, it is possible that the broker could face criminal charges for perjury. Another question I often get about regulatory examinations is that of jurisdiction, and how that relates to 28

30 a former broker who is now out of the securities industry. Article V, Section IV of FINRA s Bylaws provides for FINRA s jurisdiction over formerly registered and associated persons. Pursuant to the Bylaws, a person is subject to FINRA s jurisdiction for purposes of Rule 8210 requests and disciplinary proceedings for two years following the effective date of termination of the broker s registrations (or termination of the association with a broker-dealer in the case of associated persons). Note that the effective date of termination may be after the date that the broker ceases working for a firm, because the firm has to have a reasonable amount of time to file a Form U5 disclosing the broker s departure. There s another wrinkle with respect to the two-year period of retained jurisdiction as it relates to a formerly registered person. If the broker s U5 is amended during that two-year period in a manner that discloses new, actionable conduct, the two-year period starts over. So, under this bylaws provision, it is 29

31 technically possible for FINRA to maintain jurisdiction over a formerly registered broker for almost four years, if an amended U5 is filed just shy of two years of the broker s departure from the firm. Because many persons, including regulator staff, misunderstand these technical jurisdiction provisions, if a broker has been out of the industry for about two years and is dealing with an examination or disciplinary action, he or she should consult with experienced legal counsel about the jurisdiction issue. 30

32 Chapter 4 Informal Disciplinary Actions In the old days at NASD, once the examination was completed and a recommendation had been made to pursue informal disciplinary action, the broker could expect one of two possibilities: a Letter of Caution or a Compliance Conference. Both of these mechanisms were methods to take disciplinary action against the broker in an informal fashion. It is informal in the sense that it is not reported on a broker s U4, is not made publicly available at that time, and does not impose any sanctions against the broker. It is essentially a private admonishment or censure by the regulators, wherein the broker is informed of the alleged 31

33 improper conduct, and is required to affirm that he understands, and will endeavor not to engage is such improper conduct again. Now, with FINRA (postconsolidation of NASD and NYSE Enforcement), it seems that the terms letter of caution and compliance conference have been replaced with one term for an informal action: the Cautionary Action. Typically, with the Cautionary Action, the FINRA staff sends the broker a letter explaining that they have completed the examination, and has concerns about the broker s compliance with industry rules. The letter will specify the rule believed to have been violated, and perhaps specify the reasons for such violation. Sometimes the letter requests that the broker submit a letter in reply acknowledging that he has received the letter, understands the regulator s concerns, and will work to ensure that no additional violations of the rules occur in the future. Sometimes no such reply is requested. The matter is 32

34 generally closed once the Cautionary Action letter has been sent, and, if applicable, once the broker has submitted the reply, unless the staff is also pursuing some additional items through formal action as well. In more serious cases, the staff may require the broker to come to a FINRA office for a meeting, where they will orally explain the findings of their examination to the broker, relay their concerns about the broker s compliance with industry rules and regulations, and admonish the broker to follow the straight and narrow path of full compliance with the rules. At the conclusion of these meetings, the broker may be requested to send in a letter acknowledging the concerns that were addressed and articulating any steps that the broker may take to ensure a repeat of the violation does not happen. From a broker s perspective, if an examination is not going to be closed without action, then it is preferable 33

35 for the disciplinary action to be informal, and resolved through a Cautionary Action. But not all types of violations will be considered appropriate for informal action, and certainly the more serious violations will never be handled in this fashion. One final note on informal action: the regulator keeps up with its informal actions. So, when a broker engages in the same improper or unlawful conduct in the future, you can expect the informal disciplinary action to be brought up at a disciplinary hearing, showing that the broker was placed on notice to cease the misconduct. 34

36 Chapter 5 The Formal Action Process An Overview Once the examination has been completed, and a recommendation that formal disciplinary action be pursued, the examination is then often turned over to lawyers working for FINRA, generally in either the Enforcement or Market Regulation Departments (if these departments did not actually conduct the examination). The lawyer will typically review the file and the recommendation to ensure that the examiners have obtained all of the necessary evidence and information, and if not, may request that the examiner staff continue in its evidence gathering. Once the file is determined to be essentially complete, the lawyer 35

37 will likely contact the broker with a phone call or letter, or both. Oftentimes, the FINRA lawyer will contact the broker (or his lawyer) advising him or her that FINRA intends to take a disciplinary action against the broker for a violation of FINRA rules or certain other industry rules, regulations or laws. A general description of the rules or laws alleged to have been violated will be provided, and the broker will be invited to make a submission to FINRA providing it with any additional information or documents not previously provided, and to present an argument as to why the FINRA staff should not proceed with a disciplinary action. This process is called the Wells process, named after Senator John Wells who chaired a Congressional committee in the early 1970s charged with reviewing the enforcement activities of the SEC. Senator Wells committee recommended that the SEC provide notice to prospective respondents of charges being 36

38 considered by the SEC staff. The SEC adopted such practice, as did many SROs such as FINRA. The Wells notification is significant. Once the broker receives the Wells notification advising he or she that FINRA intends to proceed with disciplinary action against the broker, the broker has an obligation to amend the Form U4 to disclose that the broker is under investigation. Additional disciplinary charges can be made against the broker for not updating the U4, or not timely updating the U4. The Wells notification will generally give the broker a few weeks to respond by submitting a Wells submission to FINRA, or to speak with the FINRA lawyer about settling the case before a disciplinary complaint is filed against the broker. A Wells submission is typically a written argument as to why it is not appropriate, not necessary, or both, for FINRA to pursue the proposed 37

39 action against the broker. The submission may provide FINRA with additional information and evidence it did not obtain during the course of the examination that might tend to show that the broker did not commit the violation, or that the violation is not as serious or significant as the regulators believe, among other things. Any Wells submission sent in by the broker (or his lawyer) will be reviewed by the FINRA lawyer and his or her supervisor, and, if they still intend to move forward and issue a disciplinary complaint, the submission will also be reviewed by staff in the independent Office of Disciplinary Affairs (ODA). ODA must approve the issuance of all disciplinary complaints (as well as settlements) by either the Enforcement or Market Regulation departments. The question of whether to submit a Wells response in any particular case cannot be answered in the context of this short book. The answer depends on the case, what has been provided during the course of the 38

40 examination and the posture of the parties at that point in time, among other things. My experience and observation over the years is that Wells submissions are generally not successful at persuading the regulators not to pursue a disciplinary action. They may be successful in altering the action by changing a rule or law alleged to have been violated, or in reducing the number of charges being pursued. And they may also be successful in providing rationale and support for more reasonable settlement terms if the parties have discussed settling but are still far apart on terms. Ultimately, whether to submit a response to a Wells letter will be determined by the facts and circumstances of the particular case. And in making that decision, it is important to understand that such submission is not a confidential settlement agreement and that it might be used against the broker by the regulator, or by civil claimants if the submission is produced pursuant to a subpoena. 39

41 If, after receiving a Wells response, the regulators determine not to pursue formal disciplinary action, they may either close the examination without action, or proceed with informal disciplinary action as discussed in a previous chapter. If they are proceeding with formal action, the broker can either settle the matter or stand up and fight. The broker can answer a disciplinary complaint and request a hearing, and have a hearing before a hearing panel. The panel will hear the evidence and make a determination as to whether the broker committed the alleged violations, and if so, determine the appropriate sanctions. The hearing panel decision is not necessarily the end of the case, as there are avenues to appeal the decision. One final note on formal disciplinary actions: if the broker chooses not to participate in the process, the process will continue, and a default decision can be issued against the broker, subjecting the broker to sanctions. Simply closing your eyes and ears and pretending that the action 40

42 does not exist doesn t stop it from moving forward. Because it is incredibly difficult (if not impossible) to reverse a default decision entered against you, the time to deal with the matter is when it is ongoing. 41

43 Chapter 6 Pre-Complaint Settlement / AWC Oftentimes brokers will settle a proposed disciplinary action with FINRA before a formal disciplinary complaint has been issued. These settlements are done through a Letter of Acceptance, Waiver and Consent (AWC) in which the broker neither admits nor denies the allegations, but agrees to the imposition of findings of facts and of violations, and to the imposition of negotiated (to some extent) sanctions. Once finalized, the AWC completely resolves the matter, and pursuant to the terms of the AWC, FINRA will not come back later and bring another action alleging violations based on the same conduct as described in the AWC. 42

44 Many brokers who settle through AWCs do so to avoid the uncertainties of going through the hearing process, thereby accepting a known resolution of the matter through the AWC. Others settle because they believe they have no choice, as they are not able to retain counsel to represent them, and don t want to fight the matter themselves. Others simply settle because they simply don t care anymore as they are no longer working in the securities industry and don t plan on returning to the field. Whatever the reason, there are pros and cons to settling any case. Before agreeing to settle a proposed action through an AWC, a broker should understand the nature of the charges being settled, the type and quality of the evidence against the broker that the regulator might have, and the actual repercussions of entering into a settlement. For example, a regulatory body may seek to settle charges against a broker that make findings that the broker 43

45 committed fraud, or committed violations in a willful manner, among other things. Because these types of findings can have significant impact on the broker, it is important to understand exactly what conduct, and how charged. It is also important to understand what evidence the regulator has that might tend to show the broker committed the violation, and understand the quality of that evidence. It may be that a regulator seeks to settle a case that it believes in, but does not believe that it can win at hearing, if the case went to hearing. As such, brokers and their lawyers must consider the unique facts and circumstances of their case, as well as what the regulators have to prove, and how, before agreeing to settle. Finally, a broker should understand the actual repercussions of entering into a settlement. While a broker may not care about working in the securities industry again, 44

46 the broker should understand that a disciplinary action might have an impact on an ability to work in other fields, especially fields that require licenses such as insurance, mortgages, and others. And, the broker must understand that the nature of the findings made in the settlement can greatly impact the situation. Take for example a broker that is charged with willfully failing to amend his Form U4 to disclose a reportable item. While the sanctions in a settlement may include a small fine and a very short suspension, the fact that the violation was alleged to have been done in a willful manner results in the broker being statutorily disqualified from working with a broker-dealer. So, in effect, the short suspension is essentially a bar, unless the broker is able to obtain special authorization from FINRA and the SEC to be associated with a brokerdealer. Because there can be collateral consequences beyond the simple appearance of the settlement, brokers 45

47 should engage hiring experienced counsel to guide them through this process. Procedurally, once the broker and FINRA staff agrees on a settlement, the FINRA lawyer drafts the AWC. Once the broker signs it and returns it to FINRA, it must be approved by the prosecuting department (Enforcement or Market Regulation), and then reviewed and approved by the Office of Disciplinary Affairs pursuant to delegated authority from the National Adjudicatory Council. If ODA approves the settlement, then the matter is settled and it is resolved according to the terms of the AWC. Sometimes, however, a settlement will not be approved by ODA. In those cases, the FINRA lawyer will likely advise the broker as to the changes required for the AWC to be acceptable to ODA, and the broker can agree to those terms, or can refuse and instead opt to litigate the matter. 46

48 A final note on AWCs: Some folks are under the misguided impression that by settling early, they get a discount on sanctions, meaning that they might expect to receive more significant sanctions if they fight the matter and go to a hearing. Certainly sometimes the sanctions at hearing are harsher than what a broker might have settled for, but not always. And, many times a broker can obtain more favorable results in terms of sanctions (if found to have violated the rules as alleged by the regulator.) So, brokers who can stomach going through the hearing process may fare much better than by settling out early. 1 1 I ve tried hard not to resort to using footnotes in this book. But I just have to do it here on the concept that sometimes pays to fight the regulators. I ve had success for clients obtaining lower sanctions by litigating and going through a hearing, as opposed to taking the settlement terms offered by FINRA Enforcement. Other lawyers have had this same success as well from time to time. You can also find some articles written along the lines that it sometimes pays to fight the regulators. Note, however, that while I agree that it sometimes pays to fight the regulators, that does not mean it always pays to fight the regulators. As the gambler teaches us, you got to know when to fold em as well. 47

49 Chapter 7 No Settlement = Litigation An Overview of the FINRA Hearing Process Not all brokers settle proposed charges against them through an AWC for a variety of reasons such as a desire to clear their names, the inability or unwillingness to agree to sanctions demanded by the regulators for a settlement, or to simply avail themselves of the litigation process to be able to continue to work for a period of time. Generally, should there not be a settlement reached immediately following the Wells letter, then FINRA will seek to file a formal disciplinary complaint against the broker before FINRA s Office of Hearing Officers. (Note: In some cases, the Complaint may allege more serious misconduct or charges 48

50 than what was proposed to settle the matter; the staff is not limited to charging the broker only with the charges it was willing to settle.) Procedurally, the FINRA lawyer will go through a similar process to get approval to file a Complaint as he or she does to get an AWC approved. The prosecuting department (Enforcement or Market Regulation) will review the matter and determine that it believes that it has sufficient evidence to support a rule violation, and ODA must approve the issuance of the Complaint. Once the Complaint is filed with FINRA s Office of Hearing Officers, a notice that the complaint has been filed, along with a copy of the complaint, is mailed to the broker at his or her CRD address, and any other address for which FINRA believes is a valid address. The notice provides a due date for the broker to file an answer, sets forth information relating to the possible location of the hearing, 49

51 discovery of certain information, and other technical information. The broker can then file an answer to the complaint, admitting or denying the allegations, and can also request a hearing. If an answer is filed and a hearing is requested, the Hearing Officer assigned to the case will conduct a prehearing conference with the parties and schedule the case. Scheduling includes deadlines for discovery issues, filing of pre-hearing briefs and motions for various things, and scheduling the hearing itself. The schedule issued by the Hearing Officer will govern the proceeding, and the parties must seek the Hearing Officer s permission to deviate from it. The Hearing Officer, an employee of FINRA, serves as the chairperson of the Hearing Panel that will judge the case at hearing. Two other hearing panelists serve on the panel as well. These other panelists generally 50

52 come from a Regional Committee that consists of folks from the industry (typically principals of firms) elected by the member firms. A respondent in a disciplinary proceeding is entitled to discovery in the case, and is generally allowed to inspect and copy the documents and information in the investigative file that led to the issuance of the complaint. A respondent is not entitled to all of FINRA s documents in the case as some things may be excluded under the Rules. Unlike a civil court case, however, discovery is only one way, and Enforcement or Market Regulation do not have the right to obtain discovery from the respondent (though there may be investigative letters issued under Rule 8210 seeking information or facts relating to certain affirmative defenses or facts that a respondent might raise in his or her answer). 51

53 In the course of moving forward to a hearing, various motions might be filed by either side of the case. Common motions include motions to allow witnesses to testify at hearing via telephone instead of in person, as well as motions in limine that seek to have the Hearing Officer rule on evidentiary issues before the hearing. Other motions might seek to disqualify a Hearing Officer or hearing panelist, seek to obtain additional discovery or more information on the Complaint, or motions by the FINRA staff seeking summary disposition (seeking to resolve the mater without hearing, or to at least resolve the issue of liability for the violations). Shortly before the hearing occurs, the parties will exchange witness lists, exhibit lists and proposed exhibits, as well as file prehearing briefs outlining their arguments about the evidence of the case, the applicable law and what findings the hearing panel should make after hearing all of evidence and testimony. 52

54 The hearing itself is less formal than a trial in a courtroom, does not follow court rules and procedures, but generally operates in the same fashion. The FINRA attorney will make an opening statement, followed by an opening statement from the respondent s lawyer. FINRA will then call its witnesses, typically including the FINRA examiner who investigated the case, customers and others, to testify about the facts supporting the allegations in the Complaint and to introduce and testify about exhibits that FINRA seeks to introduce against the respondent. The respondent or his or her counsel has the opportunity to cross-examine these witnesses. Following the completion of the FINRA staff s case, the respondent is also given the opportunity to call witnesses to testify, for the respondent to testify himself, and for the respondent to offer exhibits as evidence in the matter. Likewise, the FINRA attorney will also have the opportunity to cross-examine any witnesses who are called to testify on behalf of the respondent, and 53

55 the respondent himself, if he testifies. Unlike most court cases, the hearing panelists might also ask questions of the witnesses at any time, and sometimes have many questions for the witnesses, especially the broker. Following the testimony of the witnesses and the presentation of evidence, the lawyers will make their closing arguments and ask the panel to make findings in favor of their respective client, to find the that FINRA proved or failed to prove the allegations against the broker, to impose a certain level of sanctions, or to otherwise rule as they argue. From there, the hearing panel will meet to determine how they wish to rule. In many cases they may make their decision right away, but that decision is not immediately communicated to the parties. Instead, the Hearing Officer will draft a written decision outlining the charges, the respondent s answer, the evidence and testimony presented, and the legal basis for the panel s 54

56 ruling. It is common for the decision to be issued many months after the hearing is concluded. Once the hearing panel decision is issued the matter is closed, and the sanctions (if any) imposed by the panel will become effective, unless either side appeals the case, or the case is called for review by the National Adjudicatory Council (see subsequent chapter for discussion of appeals/calls for review). The final result is reported on the broker s U4 and is made publicly available. One final note on timing: The process is lengthy. After the complaint has been issued, the hearing might not be held for six months to a year or more, depending on several factors including the complexity of the case, the number of respondents, the availability of witnesses and the schedules of the hearing officer and the parties. Then, after the hearing is held, it may take several more months before the hearing panel releases a written decision. So, including 55

57 the hearing process with the examination itself, the whole regulatory matter might reasonably take one and a half to two years or more to conclude. 56

58 Chapter 8 Settlements after the Complaint The Offer of Settlement While brokers often settle the regulatory charges before a Complaint is filed, not all do. Of those who don t, many will settle the matter after the Complaint has been filed, but before the matter goes to a hearing. These postcomplaint settlements are resolved in similar fashion to the pre-complaint settlements (AWC). The post-complaint settlements are made through the broker submitting an Offer of Settlement. Like an AWC, these offers are made without the broker admitting or denying anything, but agreeing to the entry of an order showing that the broker committed the 57

59 violations as alleged in the Complaint and imposing sanctions. The broker agrees to waive the right to go to a hearing and to settle the matter allowing FINRA to make findings of fact and of violations consistent with those in the Complaint. Typically, the offer is negotiated with the prosecuting FINRA department (Enforcement or Market Regulation) and the parties have a good idea that the sanctions will be approved by FINRA once it is submitted and worked its way through the approval process. One advantage to settling through an offer of settlement is that the broker gets to take advantage of the discovery process and can see and understand the evidence gathered against him or her in the regulatory examination. The broker and his attorney can perhaps then better weigh and consider the evidence, the possible outcomes at hearing, and make a more informed choice as to whether it is better to settle or go to hearing. The disadvantages of this strategy include additional costs in legal fees, as well 58

60 the risk that the regulator might have issued a complaint against the broker containing additional charges that might not have been made if the matter was settled through an AWC. Procedurally, if the offer has been negotiated with the prosecuting FINRA department, the approval process for the offer is the same as that of the AWC. Only if the offer is approved will an order accepting the offer be issued, thereby closing the disciplinary action. The broker also has the ability to submit a contested offer of settlement. Under this rule, the broker submits the offer, agreeing to the entry of findings of fact and of violations, and the imposition of sanctions. However, Enforcement or Market Regulation opposes the offer, typically due to sanctions that the department believes are insufficient. Under Rule 9270, the contested offer, along with its opposition, is then submitted directly to the hearing 59

61 panel. If the hearing panel accepts the offer, it goes to the National Adjudicatory Council for approval, and must receive such approval before it can be fully accepted by FINRA. This mechanism, while allowed under the rules, is rarely used and not readily embraced by hearing panels, which may be more inclined to hold a full hearing to determine the appropriateness of resolving the case on those terms. One final note on settlements: Part of the their appeal is the broker maintains the ability to have a final order issued that specifically says that in settling the matter, the broker neither admitted nor denied the allegations against him. If you go to hearing, you lose that opportunity. For some, this fact is an important consideration. 60

62 Chapter 9 Appeals and Calls for Review Suppose you take your case to hearing, and you get a victory either getting the charges against you dismissed, or having what you consider to be reasonable and appropriate sanctions imposed against you as opposed to what you perceive as more harsh sanctions sought by the FINRA staff. You decide not to appeal, and Enforcement (or Market Regulation) doesn t appeal either. Seems like the matter is over, and everyone can go on with their business. Not necessarily. In the civil court world, if neither party appeals a court decision, the case is over. An appeals court will not decide that it wants to review the matter and force the parties through an appeal that neither wants. That system makes sense. But that s not how the FINRA system works. 61

63 FINRA s National Adjudicatory Council (the NAC) is the regulator s appellate-level body. The NAC can decide that it wants to review the case and force the parties through an appeal. Cases can be called for review to consider the hearing panel s findings as to violations, as well as its imposition of sanctions. During the course of this review the NAC can modify, reverse or affirm the hearing panel s decision, turning the broker s victory into a defeat. Like the civil court system the broker can appeal a hearing panel decision, as can the prosecuting FINRA staff. These appeals are heard by the NAC. And, as with the call for review system, the NAC can modify, reverse or affirm the hearing panel s decision. The process before the NAC, whether it is the result of a call for review or an appeal by a party, is also lengthy, and a basic appeal or call for review may take many months or a year or more to be completed. Generally 62