FINRA’s Office of Hearing Officers recently rendered a decision on an issue of first impression in Dep’t of Enforcement v. NYPPEX, LLC, et al., (Disc. Proc. No. 2019064813801). Enforcement charged FINRA member firm, NYPPEX, LLC, its former CEO, Laurence Allen, and its CCO, Michael Schunk, with numerous violations of FINRA rules. The charges stemmed from Respondents’ conduct in the wake of a temporary restraining order issued by a New York state court against Allen. Among other things, the order, obtained at the behest of the Office of the Attorney General for the State of New York (“NYAG”), enjoined Allen from engaging in securities fraud and violating New York’s securities laws. Enforcement took the position that the TRO rendered Allen statutorily disqualified from continued association with a FINRA member firm. Allen could have remained associated with the Firm if it applied for, and received, FINRA’s permission pursuant to FINRA Rule 9520. Allen’s supervisor, Schunk, however, purportedly let Allen continue as an associated person at NYPPEX for over a year without seeking a waiver from FINRA.

FINRA’s disciplinary proceeding was triggered by the ex parte TRO. After a two-year investigation, in December 2018, the NYAG commenced an action under Article 23-A of New York’s General Business Law, known as the Martin Act, against Allen and certain others. The NYAG applied on an ex parte basis for preliminary injunctive relief against Allen, NYPPEX Holdings, and others under Section 354 of New York’s General Business Law. The NYAG stated that a preliminary injunction was warranted because of the allegations of fraud and fraudulent practices by Allen and his refusal to produce documents or appear for testimony. In December 2018, the Supreme Court of the State of New York granted the NYAG the relief it sought and issued the TRO without hearing from Allen or NYPPEX. Allan was served with the Order in January 2019 and Schunk learned about it that month as well.

On December 4, 2019, the NYAG filed a complaint in the New York Supreme Court against NYPPEX, Allen and others (Index No. 452378/2019). In February 2020, the New York Supreme Court concluded a five-day hearing and issued a preliminary injunction prohibiting Allen and NYPPEX from, among other things, violating the Martin Act and from “facilitating, allowing or participating in the purchase, sale or transfer of any limited partnership interest in [the fund].” At this point in time, NYPPEX filed an MC-400 Application seeking permission for NYPPEX to remain associated with a disqualified person, Allen. FINRA Enforcement, however, argued that Allen became statutorily disqualified when the TRO was issued in 2018, more than a year before NYPPEX filed the MC-400 Application.

A person is deemed disqualified from continued association with a FINRA member firm if, among other things, such person “is enjoined from any action, conduct, or practice” specified in Section 15(b)(4)(C) of the Exchange Act. That section, in turn, includes a situation in which a person “is permanently or temporarily enjoined by order, judgment, or decree of any court of competent jurisdiction from . . . engaging in or continuing any conduct or practice in connection with any such activity, or in connection with the purchase or sale of any security.”

Once a member becomes aware that one of its associated persons is subject to a disqualification, the member is obligated to report the event to FINRA. The firm must amend the individual’s Form U4 within 10 days of learning of a statutory disqualifying event. The member firm then must either file a Form U5 terminating the individual’s association or file an MC-400 Application seeking to sponsor the association of the disqualified person. If the member firm neither terminates the individual nor submits an MC-400 Application, the member is ineligible to continue in FINRA membership.

In the case of NYPPEX and Allen, the respondents argued that the TRO did not cause Allen to be statutorily disqualified and they claimed that they relied on both in house and outside counsel in coming to that conclusion. Among other things, Respondents argued that the TRO did not subject Allen to statutory disqualification because it was issued ex parte and Allen had no “notice and opportunity to be heard.” The OHO noted that “[w]hether an ex parte temporary restraining order triggers a statutory disqualification appears to be an issue of first impression.” The OHO, however, had little difficulty in finding that the TRO was indeed an injunction that triggered statutory disqualification. The decision notes that nothing in the language of the Exchange Act requires notice and opportunity to be heard before an event is disqualifying. The OHO concluded, “[i]n sum, there is no basis to conclude that Congress meant to exclude an ex parte temporary restraining order from the operative provision.”

Finally, the OHO also rejected any advice-of-counsel defense because, “[r]eliance on advice of counsel is not relevant to liability if scienter is not an element of the violation.” The decision noted, however, that even when reliance on advice of counsel is not relevant to liability it may be considered as a possible mitigation of sanctions. In the present case, however, there seems to be little mitigation of the sanctions imposed. NYPPEX was expelled from FINRA membership, Allen was barred from the securities industry, and Schunk was fined $120,000, barred from acting in any principal or supervisory capacity and suspended from the industry three and a half years.

Similar to Enforcement, the NYAG likewise prevailed at trial. The New York Supreme Court found Allen and NYPPEX liable for assorted false and misleading statements and ordered disgorgement of nearly $7 million.

Herskovits PLLC has a nationwide practice defending investigations and litigation brought by FINRA and other regulators. Feel free to call us for a consultation at (212) 897-5410.

On December 16, 2019, FINRA released the AWC in Matter No. 2018060843801 (In re Molteni) [click here to read the AWC]. At first blush, the AWC seems to concern a garden variety violation in which the FA failed to amend his Form U4 to disclose two federal tax liens. This doesn’t seem to be the violation of the century, right? Even FINRA’s Sanction Guidelines suggest a regulatory slap on the wrist of a modest fine and 10 day suspension.

So here is where things get interesting. FINRA more or less sanctioned Molteni in accordance with the Sanction Guidelines. They hit him with a $5,000 fine and a 3 month suspension. However, FINRA also found that he “willfully” failed to disclose the federal tax liens. In the world of FINRA regulation, the word “willful” carries an awful lot of weight.

What does it mean to act “willfully”?

According to FINRA, a willful violation of the securities laws means simply that “the person charged with the duty knows what he is doing” and does not require that he also “be aware that he is violating one of the Rules or Acts.” Wonsover v. SEC, 205 F3d 408, 414 (D.C. Cir. 2000). A failure to disclose information on a Form U4 is willful “if the respondent of his own volition provides false answers on his Form U4.” Robert D. Tucker, Exchange Act Release No. 68210, 2012 SEC LEXIS 3496, at *41 (Nov. 9, 2012).

What are the implications of acting “willfully?

Here’s where FINRA drops the hammer. Under Section 3(a)(39)(F) of the Securities Exchange Act of 1934, a person is subject to statutory disqualification if, among other things, he “has willfully made or caused to be made in any application … to become associated with a member of a self-regulatory organization … any statement which at the time, and in light of the circumstances under which it was made, false or misleading with respect to any material fact, or has omitted to state … any material fact which is required to be stated therein.” 15 U.S.C. § 78c(a)(39)(F). Article III, Section 3 of FINRA’s By-Laws provides that a person subject to a statutory disqualification cannot become or remain associated with a FINRA member unless the disqualified person’s member firm applies for, and is granted by FINRA, relief from the statutory disqualification.

What are the implications of statutory disqualification?

So, although FINRA ostensibly suspended Molteni for 3 months, practically speaking, they barred him for life. Once an individual is subject to “statutory disqualification” that person cannot become or remain associated with a brokerage firm absent special permission from FINRA. You may ask, is it difficult to get “special permission from FINRA? If you asked that question, the answer would be “hell yes.”

If a brokerage firm wants to hire an individual subject to statutory disqualification, FINRA requires the member firm to complete a Membership Continuance Application (called an MC-400 application). If you’ve never seem one of those, click here. Basically, FINRA asks for a ton of information about the disqualifying event, information about how the firm will supervise the individual, and a lot of information about the firm itself. At the end of the day, firms don’t want a headache like this and I don’t blame them. Not only does the firm need to satisfy FINRAs demands in the MC-400 application but the firm also needs to participate in an “eligibility proceeding.”

Very few firms are willing to deal with the road-blocks associated with hiring a disqualified individual. For that reason, Molteni wasn’t suspended for 3 months. In reality, he was barred for life. And that is all because of the word “willful.”

Herskovits PLLC represents individuals and firms in defense of FINRA investigations and disciplinary proceedings. Feel free to view our practice area page here, or simply call us at 212-897-5410.