When settling a FINRA investigation, the Staff drafts a letter of Acceptance, Waiver and Consent (AWC) setting forth the terms of the settlement. In the AWC, FINRA routinely demands the settling party consent to the following restraint on speech:

“Respondent may not take any action or permit to be made any public statement, including in regulatory filings or otherwise, denying directly or indirectly, any finding in this AWC or create the impression that the AWC is without factual basis.”

A matter before the U.S. Supreme Court may upend FINRA’s use of a gag order.

Case In Point

On March 21, 2022, Barry Romeril filed a petition for writ of certiorari (Romeril v. Securities and Exchange Commission). Romeril asks the Court to consider whether First Amendment and due process rights are violated when the SEC forces a settling party to agree to a lifelong prior restraint barring any statement, however truthful, that even suggests that any allegation of the SEC is insupportable.

In 2003, Romeril settled an action initiated by the SEC. As part of the settlement and judgment, the SEC demanded a non-negotiable “consent” clause stating:

“Defendant agrees not take any action or permit to be made any public statement denying directly or indirectly, any allegation in the complaint or create the impression that the complaint is without factual basis.”

It is noteworthy that the SEC and CFTC systematically demand broad restraints on speech as a condition of settlement. See generally James Valvo, The CFTC and SEC Are Demanding Unconstitutional Speech Bans in their Settlement Agreements, Yale J. on Reg.: Notice & Comment Blog (Dec. 4, 2017). In so doing, settling parties are without defense in the court of public opinion.

Would FINRA Abide by an Adverse Ruling in Romeril?

If the Supreme Court accepts Romeril’s petition, the Court would determine the legality of the SEC’s gag order. Although the SEC’s gag order is identical in substance to FINRA’s gag order, FINRA is not a party to Romeril and it is unclear whether FINRA would abide by a ruling striking down the gag order.

FINRA goes to great lengths to proclaim that it is a “private entity” and not a “governmental body” bound by the U.S. Constitution. See e.g., D.L. Cromwell Inv., Inc. v. NASD Regulation, Inc. 279 F.3d 155, 162 (2d Cir. 2002). For example, in reliance upon this distinction, FINRA chooses not to recognize an individual’s right to invoke the Fifth Amendment privilege against self-incrimination in connection with on-the-record interviews. Nonetheless, FINRA does recognize certain Constitution-based rights. For example, in disciplinary proceedings, FINRA’s staff must turn over “Brady material” to the respondent (documents containing exculpatory material). See Dep’t of Enforcement v. Southeast Inv., N.C., Inc., 2019 FINRA Discip. LEXIS 23 *14 (NAC May 23, 2019) (interpreting FINRA Rule 9253).

Given that the gag order contained in an AWC mirrors the language within the SEC’s standard gag order, it would seem appropriate for FINRA to follow any guidance from the Supreme Court in Romeril.

Herskovits PLLC has a nationwide practice defending individuals and entities in FINRA investigations and disciplinary proceedings. Contact us at 212-897-5410.

FINRA’s enforcement program is big business.

In 2008, FINRA levied fines totaling $28 million. By 2016, that number jumped to $176 million. In 2008, FINRA ordered restitution payments to investors totaling $6 million. By 2015, that number jumped to $96 million.

Each year, FINRA initiates approximately 1,500 disciplinary actions against member firms and employees. FINRA’s Office of Hearing Officers resolves approximately 400 proceedings per year.

Although FINRA’s enforcement program is expansive, insufficient guidance is given to industry participants who choose to contest FINRA’s charges. This post sheds light on the nuts and bolts of FINRA’s disciplinary hearing process. Obviously, many enforcement matters involve complex issues of fact and law and require the assistance of a lawyer so be aware that this is basic information and no substitute for legal advice.

It is imperative that you consult an experienced FINRA-defense attorney to assess your exposure, if any and decide on the best strategy for your unique circumstance.

Overview

The lifecycle of a FINRA disciplinary proceeding follows a predictable path:

Pre-Complaint Investigation

This topic was covered in an earlier post.

Complaint – The Disciplinary Proceeding Officially Begins

A disciplinary proceeding officially begins when FINRA serves the Complaint. FINRA’s complaint is supposed to specify “in reasonable detail” the conduct which caused the rule violation. Once the Complaint is issued, the respondent has 25 days to file an Answer, which must admit, deny, or disclaim knowledge responsive to, each allegation in the Complaint (FINRA Rule 9215).

The Answer

Common issues with the answer relate to a Hearing Request, Insufficient Details in the Complaint and Default.

Hearing Request – FINRA Rule 9221

When filing the Answer, the responding party has the right to a demand a hearing (FINRA Rule 9221). Failing to request a hearing when filing your Answer may waive your right to demand a hearing.

Insufficient Details in the Complaint

You are permitted to file a “motion for a more definite statement.” A motion is simply a written request to obtain a ruling from the Hearing Officer. A motion of this type may be appropriate if the Complaint fails to provide enough detail for you to understand the charge against you and plan your defense.

Default

Failing to answer the complaint permits the Hearing Officer to issue a default decision.

Hearing Officer and Panel are Appointed

Soon after the Complaint is filed, FINRA’s Chief Hearing Officer appoints the Hearing Officer who will preside over your case. The Hearing Officer is employed by FINRA but strives to be impartial and conflict-free.

Hearing Officers play no role in the pre-complaint investigation and maintain independence from FINRA’s enforcement program. Biographies of FINRA’s Hearing Officers are available at finra.org. The function of the Hearing Officer is to resolve all motions and ensure that the proceeding is conducted fairly and efficiently.

Hearings are typically heard before a 3-person Hearing Panel. The panel is chaired by the Hearing Officer and includes 2 industry panelists who typically are drawn from FINRA’s District Committees.

Settlement Process (Prior to Complaint v After Complaint Issued)

The settlement process shifts once a Complaint has been issued. Prior to the issuance of a Complaint, settlement is documented with a Letter of Acceptance, Waiver and Consent.

After the Complaint has been issued, settlement occurs only through a written Offer of Settlement (FINRA Rule 9270).

An Offer of Settlement is presented to the Hearing Officer and must contain the following:

• A signature by the respondent
• Identification of the origin the disciplinary action
• Specification of the rules which were allegedly violated
• Specification of the facts or practices that the respondent engaged in to cause the rule violation
• A statement consenting to findings of fact and violations consistent with the terms of the Offer of Settlement
• A proposed sanction

The decision to submit an Offer of Settlement is a difficult one. If the Offer of Settlement is rejected, the Hearing Panel may assume that the person who submitted the Offer is guilty of the rule violation.

Offers of Settlement can be contested or uncontested. It is uncontested if Enforcement or Market Regulation agrees in advance to the terms of the Offer and is contested if they do not. Clearly, the odds of acceptance of the settlement offer increase greatly if the Offer is uncontested.

Settlement terms may also be reached by mediation through FINRA’s Office of Hearing Officers mediation program. If mediation is agreed to, the Chief Hearing Officer appoints a Hearing Officer (other than the Hearing Officer assigned to the case) to conduct the mediation.

Mediation is confidential, voluntary and non-binding, meaning that any party can choose to discontinue the mediation at any time. The mediation is typically conducted by telephone.

Initial Pre-Hearing Conference

At various points during the pre-hearing phase, the Hearing Officer may order the parties to attend a pre-hearing conference by telephone.

The initial pre-hearing conference is important because it sets a case management and scheduling order. Generally, the Hearing Officer will expect the parties to strictly adhere to each deadline in the scheduling order.

Deadlines typically set during the initial pre-hearing would include:

• Dates and location of the final hearing
• Deadline for parties to file motions for leave to permit expert testimony
• Deadline for parties to file motions for summary disposition pursuant to FINRA Rule 9264
• Deadline for the respondent to file a motion related to Enforcement’s production of documents under FINRA Rules 9251 and 9253
• Deadline for respondent to file a motion seeking to compel Enforcement to invoke FINRA Rule 8210 to obtain documents or hearing testimony from non-parties
• Deadline for parties to exchange proposed stipulations concerning relevant undisputed facts
• Deadline for parties to file pre-hearing submissions, including briefs, witness lists, exhibits lists, and proposed exhibits
• Deadline for parties to file objections to proposed witnesses or exhibits

Discovery

Discovery is the term used to describe the exchange of documents or information before trial. Litigants use discovery as a means to obtain documents or information needed to support their claims or defenses.

Discovery in the context of a FINRA disciplinary proceeding will likely feel decidedly one-sided.

Enforcement has vast powers to conduct an expansive investigation. In so doing, Enforcement obtains all the discovery it deems necessary before starting the disciplinary proceeding. They can obtain documents and testimony from any member firm or employee without your knowledge and without any practical limitation.

Once Enforcement or Market Regulation deems its investigation complete (meaning, once they obtain the documents and information they deem necessary to support its charges), the Complaint is filed.

Nevertheless, when defending a disciplinary action, you are not afforded anywhere near the same latitude to obtain documents or information which may support your defenses.

FINRA’s rules do require automatic disclosure by Enforcement or Market Regulation of the following categories of documents, provided the documents “relate to” the investigation which led to the disciplinary proceeding:

• Requests for documents or information issued pursuant to FINRA Rule 8210 and all responses
• Requests for documents or testimony not issued pursuant to FINRA Rule 8210 and all responses
• All transcripts and transcript exhibits
• Documents obtained from non-parties
• Documents containing “material exculpatory evidence,” meaning documents which may rebut FINRA’s charges of wrongdoing

Common Discovery Issues

The common issues in discovery, some quite different from traditional litigation, include those set out below.

Absence of Subpoena Power

In traditional litigation, you have the ability to subpoena documents or testimony from third-parties which may be critical to support your defense. However, in a FINRA disciplinary proceeding, you have no right to issue subpoenas for documents or testimony.

You can file a motion asking the Hearing Officer to order Enforcement to issue a Rule 8210 request to a member firm or its employees, but you should not assume the Hearing Officer will grant the request.

The motion must describe the documents, state why these documents are material, identify the efforts made to obtain the documents by other means, and state whether FINRA has jurisdiction over the custodian of the documents (FINRA Rule 9252).

Generally, the Hearing Officer will need to be convinced that, (1) the information sought is relevant, material, and noncumulative; (2) the requesting Party has previously attempted in good faith to obtain the desired documents and testimony through other means but has been unsuccessful in such efforts; and (3) each of the persons from whom the documents and testimony are sought is subject to FINRA’s jurisdiction.

Disputes Concerning Whether a Document “Relates to” Your Proceeding

Enforcement or Market Regulation is only required to produce documents obtained by FINRA “in connection with the investigation that led to the institution of proceedings.” This standard may invite abuse on the part of Enforcement because it is easy to claim that documents in FINRA’s possession were not obtained “in connection with” your investigation.

Generally, you will need something more than assumption to convince a Hearing Officer that documents withheld by Enforcement or Market Regulation were obtained “in connection with” your investigation.

Disputes Concerning Witness Interview Notes

A respondent is entitled to file a motion seeking “witness statements” (generally, a transcript of an “on-the-record” interview) for each witness that Enforcement or Market Regulation may call to testify.

A respondent may also file a motion seeking witness interview notes transcribed by a FINRA investigator.

For technical reasons, it is uncommon to obtain witness interview notes taken by a FINRA investigator.

Pre-Hearing Motions

Pre-hearing motions will generally concern:

• Motions for summary disposition (FINRA Rule 9264)
• Motions to obtain documents or testimony from members firm or employees (FINRA Rule 9252)
• Motions concerning the use of expert witnesses
• Motions concerning proposed witnesses, exhibits or areas of testimony

Pre-Hearing Submissions

Prior to the hearing parties must exchange Witness Lists, Exhibit Lists and file a Prehearing Brief. Below are some details on each.

Witness List

The parties are required to exchange witness lists. The list must disclose the name, address, telephone number, and current occupation of each prospective witness. The list must also briefly describe the substance and scope of the anticipated testimony.

Once the witness list is exchanged, either side can object to witnesses proposed by the opposing party.

Exhibit List

The parties are required to exchange proposed exhibits. The list must include a description of each exhibit and a brief statement indicating the purpose for which the document will be offered at the hearing.

The determination of which documents to use is labor intensive because Enforcement often produces thousands of pages of documents during discovery.

Once the exhibit list is exchanged, either side can object to exhibits proposed by the opposing party.

Pre-Hearing Briefs

Pre-hearing briefs are critically important. You are expected to provide a cogent narrative of the facts and apply the facts to the rules at issue.

This is often the first opportunity for the respondent to educate the Hearing Panel on your “view of the world.” Prior to this point, the Hearing Panel has only seen a one-sided presentation – the Complaint.

Drafting a persuasive pre-hearing brief requires skill and a great deal of effort. It is difficult to extract nuggets of information from thousands of pages of documents and weave that information into a persuasive fact pattern.

The Hearing

The hearing is conducted in a manner very similar to traditional litigation. The parties can make opening remarks. Then Enforcement or Market Regulation has its witnesses testify. Then the respondent has his witnesses testify.

The hearing will conclude with closing statements by the parties.

Trial strategy is well beyond the scope of this post. Suffice it to say, it requires a highly skilled lawyer to effectively question witnesses and elicit favorable testimony at a disciplinary hearing.

Post-Hearing Submissions

Hearing Officers may direct the parties to file proposed findings of fact and conclusions of law, or post-hearing briefs, or both. These, too, are labor intensive endeavors. A persuasive post-hearing brief provides a cogent narrative of the record (the record is comprised of witness testimony and documents received in evidence).

Conclusion

After the hearing concludes, the Hearing Panel typically issues the decision within 60-days. The parties do have certain rights to appeal an adverse decision, first to the National Adjudicatory Council, then to the SEC, and finally to a Federal Court of Appeals.

Disclaimer

This post is for general informational purposes only and is neither intended as, nor should it be considered, legal advice. Every fact situation is different and there is no substitute for qualified legal counsel which you should seek at the earliest possible moment as there are strict timelines in all areas of Securities Law.

Questions Concerning FINRA’s Disciplinary Process? Call Us. FINRA Defense and Securities Litigation is all We Do: 212.897.5410 or Email Us

In its quest for investor protection and market integrity, FINRA diligently seeks out firm representatives who are in violation of its strict rules. Recently, the regulatory authority decided to bar California-based Jim Jinkook Seol from the industry.

A former employee of Ameriprise Financial Inc.; Seol was found to have sold $100 million worth of EB-5, permanent residency-eligible, investments without disclosing the transactions to his employer.

The EB-5 visa program offers permanent residency to foreign nationals who invest between $500,000 and $1 million and create 10 jobs in a new business venture in the US. The program is especially attractive to wealthy individuals from emerging economies like China and India, and, as such, it holds an enormous profit potential for securities industry professionals.

Back in September 2011, while working for Ameriprise, Seol formed a company of his own, Western Regional Center (aka WRCI), to market EB-5 eligible investments to overseas investors.

He went on to travel to South Korea and China, where he was able to secure 200 investors. Each one of them contributed $500,000 to fund NextEra Energy Capital Holdings LLC’s Genesis Solar Energy Project, a solar power plant endeavor based in Riverside, California.

The total of WRCI-managed investments was $100 million. The deals earned Seol’s company $736,000 per year in management fees.

According to FINRA, “Seol intentionally concealed his WRCI activities from his employing firm in multiple instances by repeatedly lying to his supervisor and the compliance examiner that he had ‘no outside business activities, no outside employment, no outside board memberships, and no ownership interest in any legal entities.’ In addition, according to the decision, Seol claimed at the hearing that he did not believe the firm’s policy against outside securities transactions applied to his solicitations through WRCI because he did not understand the limited partnership interests sold to investors to be securities.”

FINRA’s hearing panel found Seol’s claims of ignorance to be “incredible” and described his conduct as “egregious.” In fact, FINRA has very clear rules about outside business activities for registered persons. Rule 3270 establishes that,

“No registered person may be an employee, independent contractor, sole proprietor, officer, director or partner of another person, or be compensated, or have the reasonable expectation of compensation, from any other person as a result of any business activity outside the scope of the relationship with his or her member firm, unless he or she has provided prior written notice to the member, in such form as specified by the member. Passive investments and activities subject to the requirements of Rule 3280 shall be exempted from this requirement.”

Jim Jinkook Seol has, nevertheless, appealed the hearing panel’s decision before FINRA’s National Adjudicatory Council (NAC). The appeal is currently awaiting a decision.

Seol no longer works for Ameriprise, as he was fired when the firm found out about his outside business activities and his failure to disclose them. According to Brokercheck, Seol is no longer a registered broker and he was “discharged for violation of company policy related to an undisclosed outside business activity.” The chances of his appeal being successful remain rather slim.

FINRA issued its summary of disciplinary actions reported for June 2012. Certain actions are noteworthy and are indicative of regulatory trends effecting broker-dealers and registered representatives.

Herskovits PLLC comments on the following regulatory actions:

Net Cap Violations

Freedom Investors Corp. (CRD #23714, Brookfield, Wisconsin), Joel ReidBlumenschein (CRD #1372334, Registered Principal, Pewaukee, Washington) and Gary Lee Gossett (CRD #1939514, Registered Principal, Spokane, Washington) – FINRA Case # 2010025132201

Findings:

Among other findings, FINRA found that the firm entered into a settlement with a customer that exceeded $15,000, and through its CCO, failed to timely disclose the receipt of the written complaint and the settlement to FINRA within 10 days. Furthermore, FINRA found that because the firm failed to accrue the liability resulting from the loss guarantee it made to the customer, its net capital was reduced. This resulted in it conducting a securities business without the required net capital for four months so that the firm’s books and records and Financial and Operational Combined Single (FOCUS) filings were inaccurate. The firm then failed to provide timely notice of its net capital deficiency to the Securities Exchange Commission (SEC) and FINRA.

Disposition:

Resolved by Offer of Settlement with a censure, fine and suspension for certain employees.

Analysis:

This matter highlights the importance of timely complaint reporting via Forms U4, U5 and in accordance with FINRA Rule 4530 (Reporting Requirements). Furthermore, this matter highlights FINRA’s ongoing effort to discipline members concerning net cap violations; here, resulting from the member’s “loss guarantee” to its customer. The “loss guarantee” arose from a peculiar circumstance in which a registered representative settled with a customer pursuant to an agreement which if, after a period of 18 months, the prior losses sustained in the account were not recovered, the firm would pay customer the difference plus 5% interest.

Anti-Money Laundering Violations

First Kentucky Securities Corporation (CRD #7524, Frankfort, Kentucky) and Frederick Jennings Kramer (CRD #2299599, Registered Principal, Owensboro, Kentucky) – FINRA Case # 2010021314101

Findings:

The Member’s 2009 independent AML test was inadequate because it was limited to the review of deposit slips for one branch office, rather than sampling different transactions at all branch locations. The findings stated that the test did not include a review of the firm’s AML procedures, nor did it include a review of the overall adequacy of the firm’s AML compliance program. Moreover, the test did not include a sample of all of the firm’s business lines, review of the firm’s AML training program and its customer identification program (CIP), and whether its representatives were complying with the CIP.

Disposition:

Resolved by Acceptance, Waiver and Consent with a censure and fine of $15,000.

Analysis:

AML continues to be an area of focus for FINRA. Here, FINRA fined the firm and the FINOP for the violations referenced in the AWC. This matter highlights that FINRA will enforce its AML Compliance Program Rule (FINRA Rule 3310) even as against small broker-dealers. Therefore, small broker-dealers would be well served to ensure that a procedure exists for independent testing (e.g., testing by a professional not employed by the firm) along with the annual certification by the CEO (Rule 3130).

Please contact Robert Herskovits, Esq. with any questions. (212) 897-5410. robert@herskovitslaw.com.