FINRA and Smarsh Prevail In Spoliation Case

December 28, 2015

This is an update of "FINRA Named As Defendant In Case Alleging Altered Electronic Files" (BrokeAndBroker.com Blog, April 24, 2015) and "FINRA Moves To Dismiss Spoliation Claims" (BrokeAndBroker.com Blog, May 5, 2015).

FINRA Named As Defendant 
In Case Alleging Altered Electronic Files

The April 24, 2015, BrokeAndBroker.com Blog discussed a civil Complaint filed in the United States District Court for the District of Columbia ("DDC") involving the somewhat esoteric legal issue of "spoliation," the alleged destruction or alteration of evidence. Although that doesn't necessarily sound like a riveting story, consider the fact that the federal lawsuit under consideration names as one of the Defendants Wall Street's self-regulatory organization, the Financial Industry Regulatory Authority ("FINRA"). 

Case In Point

In the federal lawsuit of Thaddeus J. North and Mark P. Pompeo, Platintiffs, v. Smarsh, Inc. and Financial Industry Regulatory Authority/Department of Enforcement (Complaint, DDC, 15-CV-00494, April 6, 2015), Plaintiffs North and Pompeo seek damages and relief against Defendants Smarsh and FINRA for spoliation, tampering and destruction of evidence and to prevent use of such spoliated and tampered evidence in federal proceedings.

NOTE: Defendants in a civil lawsuit are presumed innocent unless and until proven guilty by a preponderance of the evidence in a court of law.

SMARSH Retained To Archive

The DDC Complaint alleges that from 2008 to August 2011, Plaintiff North was registered as the Chief Compliance Officer with Southridge Investment Group, LLC and thereafter, until January 2013, with Ocean Cross Capital Markets, LLC. As further explained in the DDC Complaint [Ed: yellow highlighting provided]:

[In] January 2013. Mr. North and approximately half of the registered representatives from Southridge became registered with Ocean Cross when Southridge came under investigation by FINRA and other regulators who were investigating a hedge fund managed by the owner of Southridge and an alleged tip about a business relationship between LK,1 who was registered with Southridge and TC,2 a statutorily disqualified person. Mr. North is a respondent in FINRA Enforcement Disciplinary Proceeding No. 2010025087302 involving Southridge ("Southridge Proceeding") and Disciplinary Proceeding No. 2012030527503 involving Ocean Cross ("Ocean Cross Proceeding"). In both Disciplinary Proceedings Mr. North was accused of failing to review sufficient electronic correspondence; in the Southridge matter he was also accused of not detecting and reporting the business relationship between LK and TC.  

4. Plaintiff Pompeo is an individual who resides in Massachusetts. Mr. Pompeo was registered as a securities broker with Southridge from January 2010 to September 2011 and subsequently registered with Ocean Cross from September 2011 to September 2012; his business for the firm involved sales and marketing. He was charged with FINRA rule violations in an August 16, 2013 pursuant to FINRA Examination No. 20120305375.3  

Smarsh's Role

In order to satisfy regulatory requirements for the storage/review of electronic communications, Southridge and Ocean Cross purportedly contracted with Defendant Smarsh to preserve exact and unchangeable copies of internal and external electronic communications for all registered representatives of the firms. As asserted in the DDC Complaint:

14. FINRA does not require that broker-dealers use specified systems or companies to satisfy SEC and FINRA rule requirements for the storage and review of electronic communications; Southridge and Ocean Cross complied with their regulatory duty of preserving electronic communications by contracting with Smarsh to (a) use proper care to preserve by commercially responsible methods exact, unalterable, non-rewriteable, and non-erasable copies of each firm's registered representatives' domain emails, Bloomberg messages and other electronic correspondence in a permanent file for the Relevant Period, (b) provide access to that database of ESI for compliance review, and (c) maintain an accurate electronic record that documents ESI compliance reviews. See supra para. 5.

. . .

21. Smarsh handled the Ocean Cross domain set-up and provided instructions to registered representatives for the transition from Southridge to Ocean Cross for setting up their various electronic and handheld devices with specific IP addresses that enabled Smarsh to preserve all internal and external firm and Bloomberg domain electronic communications. 

22. Even though Bloomberg, LP maintains a permanent archive or "vault", for its customers' messaging, e.g. email communications and "chats", additional set-up time and protocols were necessary to have Smarsh preserve copies of registered representatives' Bloomberg communications at both Southridge and Ocean Cross. Bloomberg required Smarsh to obtain written authorization from LK, a user ID and password to allow daily file transfer protocol ("FTP") for Bloomberg email and instant messaging to Smarsh from a site separate from Bloomberg's communication system. 

23. In addition to preserving the ESI, Smarsh had a duty to place the ESI, from both the firm domain email systems and Bloomberg in an accessible, searchable database to which Mr. North and others with supervisory and compliance responsibilities would have access in order to satisfy and perform the duty of reviewing internal and external electronic communications.

FINRA Exams

Sometime in 2010, FINRA was conducting examinations and issued Rule 8210 letters demanding information and documents from Southridge and Ocean Cross. At that point, the member firms allegedly were relying upon Smarsh to provide archived electronic materials to the self-regulator.  

As will likely be more fully developed during motion practice and/or at trial, what was asked for, what was maintained, and what was produced by the firms became points of dispute. More critically, individuals were questioned by FINRA staff during on-the-record interviews and among the exhibits put before the witnesses were some of the electronic materials now at issue. Consider these allegations in the DDC Complaint:

 34. In the course of FINRA examination(s) and various 8210 letter requests for information that began in 2010, the Southridge and Ocean Cross firms arranged for Smarsh to deliver the firms' electronic communications records directly to FINRA, because the 8210 letters demanded delivery of electronic communications in "a special format", e.g. .pst. CEO Schloth stated under oath before Enforcement attorneys and investigators, " . . . when you guys request something, we just don't want to screw it up in terms of download. So we just ask SMARSH [sic] to do it. That's generally what - - the best way to do it." Excerpts from Schloth On the Record Interview ("OTR") (In the Matter of Southridge) dated February 9, 2012 p. 89, ll. 2-9,marked Exhibit 1. As a result, Smarsh delivered Southridge and Ocean Cross ESI directly to Enforcement according to FINRA Rule 8210 requests throughout the Relevant Period.  
 . . .  

37. Beginning in November 2013 Enforcement delivered CDs/DVDs to Mr. North containing ESI alleged to be exact copies of the database of emails received directly from Smarsh and upon which it based its disciplinary actions against Mr. North and Mr. Pompeo.  

38. The CDs/DVDs contained predominantly electronic communications for many if not all firm members, scans of documents obtained from the firms, and copies of OTR interviews in the Southridge and Ocean Cross Proceedings conducted by Enforcement of Messrs. North and Schloth in April 2012 and LK in September 2011 and August 2012 in the Disciplinary Proceedings. Mr. North and LK had not retained counsel to attend their respective OTRs.  

39. During the OTRs the witnesses were shown exhibits purporting to be printed copies of email communications, which exhibits created unexplainable confusion in the witnesses: Mr. North did not remember seeing or reviewing any of the emails represented in the exhibits shown to him in OTRs; and while being shown a series of emails in one OTR, LK remarked, " - - you know this is deceiving. This isn't true." See Excerpts from LK OTR (In the Matter of Southridge) dated September 13, 2011 p. 183, ll. 3-4, marked Exhibit 2.  

Pompeo Settled


As explained in Footnote 3 to the 
DDC ComplaintPlaintiff Pompeo asserts that he had settled FINRA's regulatory allegations only after he was shown emails during an on-the-record interview -- and Pompeo now alleges that he was unaware that those emails had been spoliated. The implication and inference of such an allegation is that a witness is now arguing that his testimony was based upon a form of deceit in that he was asked questions about documents that were not "original" in the form placed before him.

SIDE BAR: The following December 2013 FINRA Disciplinary Notices were published concerning Pompeo [Ed: yellow highlighting provided]:

Mark Peter Pompeo (CRD #1897147, Registered Supervisor, Hull, Massachusetts) submitted a Letter of Acceptance, Waiver and Consent in which he was fined $5,000 and suspended from association with any FINRA member in any capacity for 10 business days. Without admitting or denying the findings, Pompeo consented to the described sanctions and to the entry of findings that he participated in the offer and sale of a private placement offering at his member firm. The findings stated that as part of his sales efforts, Pompeo periodically sent emails to current and prospective investors providing updates and information on the company. The emails constituted a communication with the public as defined by NASD Rule 2210(a), and Pompeo's emails contained various false and misleading statements. The suspension was in effect from November 18, 2013, through December 2, 2013. (FINRA Case #2012030527502)

Schloth Settled

During the relevant times cited in the DDC Complaint, non-party William E. Schloth ("Schloth") was Southridge's and Ocean Cross's the Chief Executive Officer ("CEO"), and General Securities and Financial Operations Principal. In July 2009 CEO Schloth hired non-party LK, whom he directly supervised at Southridge and Ocean Cross.  Schloth had interviewed and allegedly determined not to hire TC in June 2009 due to the purported cost and regulatory procedures that would have been necessary if TC were hired by the Southridge firm. Schloth asserts that in August 2009, he had discussed TC's status with FINRA's manager of Statutory Disqualification Regulatory Operations in August 2009.

SIDE BAR: The following February 2013 FINRA Disciplinary Notices were published concerning Schloth:

William Edward Schloth (CRD #2644188, Registered Principal, Fairfield, Connecticut) submitted an Offer of Settlement in which he was fined $20,000 and suspended from association with any FINRA member in any principal capacity for 22 months. The fine must be paid either immediately upon Schloth's reassociation with a FINRA member firm following his suspension, or prior to the filing of any application or request for relief from any statutory disqualification, whichever is earlier. Without admitting or denying the allegations, Schloth consented to the described sanctions and to the entry of findings that he was the principal at his member firm responsible for supervising a registered representative. The findings stated that Schloth knew that the representative had a business arrangement with a non-registered and statutorily disqualified individual. Schloth failed to implement a system to appropriately supervise, or otherwise monitor, the representative and the individual's relationship to ensure that the representative was not aiding and abetting the individual to participate in the securities business despite his non-registered and statutorily disqualified status. The findings also stated that Schloth did nothing to adequately supervise this relationship. Schloth did not independently verify the representative's representations to him, that she was not facilitating trades for the individual or paying him for a commission-driven business. Schloth did not review the Service Agreement of the individuals, of which his firm was aware of and had approved. Schloth did not request from the representative her business' general ledger or bank statements, or copies of the non-registered individual's business invoices issued to the representative's business. The findings also included that while Schloth represented to FINRA that following the examination of the firm he periodically requested and reviewed the representative's business general ledgers and the non-registered individual's business invoices, at no point did he do anything else to independently verify the scope of her relationship with the individual or his business, or otherwise follow up on any red flags that should have put him on notice to heighten or otherwise alter his supervision of the representative. Schloth did not independently contact her brokers, traders or public customers to inquire whether the non-registered individual was involved in the trading activity.The suspension is in effect from September 16, 2013, through July 15, 2015. (FINRA Case #2010025087302)

William Edward Schloth (CRD #2644188, Registered Principal, Fairfield, Connecticut) submitted a Letter of Acceptance, Waiver and Consent in which he was fined $20,000 and suspended from association with any FINRA member in any principal capacity for six months. The fine must be paid either immediately upon Schloth's reassociation with a FINRA member firm following his suspension, or prior to the filing of any application or request for relief from any statutory disqualification, whichever is earlier. Without admitting or denying the findings, Schloth consented to the described sanctions and to the entry of findings that as CEO, chief financial officer (CFO) and FINOP of the firm, Schloth handled all investment banking responsibilities at the firm, including interactions with current and potential banking clients, conducting due diligence on possible investment banking deals to be sold by the firm and supervising any private placement transactions. The findings stated that Schloth was responsible for the firm's WSPs; however, he was not the firm's CCO or municipal securities principal. Schloth failed to conduct adequate due diligence on a firm private placement offering and failed to ensure that the firm established, maintained and enforced an adequate supervisory system, including WSPs, addressing due diligence of private placements. The findings also stated that Schloth was the registered principal responsible for the supervision of all firm registered representatives when a registered representative sent an email regarding a private placement offering to current and prospective investors. The email, which Schloth reviewed and approved, constituted a communication with the public and contained various false and misleading statements. The findings also included that Schloth failed to ensure that the firm established, maintained and enforced an adequate supervisory system, including WSPs, addressing, inter alia, municipal securities, safeguarding customer information and the retention of business-related communications. The WSPs were not tailored to address the needs of the firm's business and they provided little useful guidance as to what reviews and other supervisory steps were required by firm personnel. Schloth also failed to enforce certain firm procedures, including those requiring the firm to contract with its clearing firm to provide material disclosures to customers prior to purchasing a municipal security, relating to the inspection of the firm's branch offices and regarding the use of personal email addresses for sending business related emails. The suspension is in effect from September 16, 2013, through March 15, 2014. (FINRA Case #2012030527501)

Spoliation Allegations

The DDC Complaint asserts the following:

41. In April 2014, LK purchased access to her entire Bloomberg vault for the Relevant Period, which a computer technologist downloaded from a secure FTP website managed by Bloomberg, for the purpose of comparing the contents of the Bloomberg vault to the ESI allegedly preserved by Smarsh and purporting to be Bloomberg messages and to determine why the ESI appeared to be spoliated and, if possible, to determine the circumstances under which such spoliation occurred.

42. LK's Bloomberg vault contained over two hundred twelve thousand (212,000) emails and a few thousand chats of various types in extensible markup language ("XML") for the Relevant Period.

43. The electronically stored records initially produced by Smarsh in the Southridge Proceeding and delivered by Enforcement in late 2013 contained less than sixty thousand (60,000) records in .pst format, allegedly emails attributable to LK and her sister-assistant; the email records for LK and produced by Smarsh in the Ocean Cross Proceeding contained fewer records purporting to be LK's emails than LK's Bloomberg records for the comparable period of time.  

44. The spoliation observed by the computer technician retained in March 2014 included tens of thousands of emails with language added to sender line descriptions, the substitution or insertion of inaccurate sender and recipient names, formatting and time differences, lost and incomplete content, and multiple copies of the same communication in different formats; further, because Mr. North was familiar with the large number of email communications for the Southridge and Ocean Cross firms, it appeared that tens of thousands of  6 LK was also a co-respondent in the Southridge Proceeding.  
 . . .  

46. In a Declaration dated July 30, 2014, Dustin Sachs, Managing Consultant with Navigant Legal Technology Solutions, confirmed the findings of the computer technician that certain CDs/DVDs delivered by Enforcement contained permanent read errors and certain anomalies, formatting and content differences existed in the data produced by Smarsh that were not present in the original source emails from the Bloomberg accounts of LK and TC.  
 . . .  

55. In February and March 2015, Berryhill Computer Forensics, Inc. ("Berryhill") examined the data allegedly preserved by Smarsh and ultimately delivered by FINRA to the parties in the disciplinary proceedings against Messrs. North and Pompeo; Berryhill determined the following: My conclusion, based on the evidence I have examined to date, is that FINRA has been massively misled by Smarsh. The data produced by Smarsh has been altered and manipulated to the point of being nearly unrecognizable when compared to the original source data. Among the many problems I have observed are date and time stamps that have been altered, sender and recipient header information changed, and body content altered or deleted. Overall, these give a misleading and false impression of the facts in this case. The errors and other problems I have highlighted in this report are not occasional occurrences found in only a few messages. They are examples among hundreds of thousands of systematic and widespread failures in how Smarsh has collected, processed and produced the data for which they are supposed to be a neutral third party repository.  See Declaration of Jon Berryhill dated March 2, 2015 ¶ 5, marked Exhibit 8.  

56. Berryhill further concluded:  

The scope of spoliation of the emails is so broad that no information produced through Smarsh can be deemed reliable. This would include not only the header information and content of any message or groups of messages, but also any reports or summaries derived from or referencing those messages. The multiple and repeated failures of Smarsh's processes leave me with no confidence in anything they produce. (Emphasis added.)  Id. ¶ 24.  

57. Regarding the CDs/DVDs produced on October 15, 2014, Berryhill continued:  The flawed processing by Smarsh has led to even the most fundamental of errors in identifying evidence data types. Ms. Miller provided to me two DVDs identified as  FINRA production no. 2010025087302, discs 1 and 2. These two discs contain more than 9GB of data saved in PST format in 8 separate files. It was represented to me that FINRA was told by Smarsh that these two discs, produced by Smarsh, contained some 190,000 instant messages recovered from the Bloomberg archives, but that had some how been previously "overlooked."  

. . .

This XLM data appears to be in the same format, with the same XML tags as all the other Bloomberg messages. I see nothing to indicate they are in any way "instant messages." All of the messages I have observed from these two DVDs are consistent in format . . . I do note that in this case, as with all the other instances of Bloomberg XML data being converted to PST format, that a substantial amount of information has been added that gives a false and misleading impression of the nature and form of these messages. In Smarsh's processing, produced on the PSTs, they have added to the beginning of each (approximately 190,000) message body the text "BB Message". This text does not appear in the originals.  Id. ¶¶ 20-21.  

Much Ado About Nothing
  

The DDC Complaint acknowledges that FINRA's view of the spoliation issues raised by Plaintiffs is, essentially, much ado about nothing:

60. In both the Southridge and Ocean Cross matters, Enforcement claims that spoliation is irrelevant as to the content of the emails and whether or not sufficient email review was conducted; therefore, at no time since bringing concerns about spoliation to the attention of Enforcement in February 2014 and again in July 2014, have either Smarsh or FINRA investigated the claims and explained how and why multiple non-native format versions of email files exist in the records delivered by Smarsh or the spoliation evident in the form of added language, altered time and date formats, lost and incomplete content, and the absence of more than half of the data that should have been preserved by Smarsh in an unalterable, nonrewriteable, and non-erasable format.  .

Wrongful Action By FINRA

In making their case, Plaintiffs North and Pompeo asserted four counts against Smarsh and two counts against FINRA's Enforcement Department:  

COUNT I -SPOLIATION OF ELECTRONICALLY STORED INFORMATION BY SMARSH (Intentional Spoliation)  

COUNT II - SPOLIATION OF ELECTRONICALLY STORED INFORMATION BY SMARSH (Spoliation by Gross Negligence)  

COUNT III - SPOLIATION OF ELECTRONICALLY STORED INFORMATION BY SMARSH AND ENFORCEMENT (Negligent Spoliation)

COUNT IV - INJUNCTIVE RELIEF AS TO SMARSH AND ENFORCEMENT

In offering the bases for their claims, Plantiffs assert in the DDC Complaint:

93. Enforcement's instructions to convert ESI to a certain format breached the duty to deliver ESI in native format as to substantial portions of ESI, e.g. Bloomberg messaging, were a proximate and contributing cause of spoliation to the ESI, resulted in the foreseeable harm of unwarranted disciplinary actions against Plaintiffs, the failure of evidence to defend against such actions, damage to their reputations, loss or reduction of employment and income, and caused them to incur attorneys fees, court costs, and the costs associated with proving the spoliation, all in amounts to be proven at trial.

. . .

98. In this case, a computer technician, a consultant from Navigant, and Berryhill  independently concluded that pervasive spoliation to ESI allegedly preserved by Smarsh  occurred; at no time did Plaintiffs handle or process the ESI, therefore, Messrs. North and  Pompeo are likely to prevail on the merits of their claim for injunctive relief.  

99. Both Messrs. North and Pompeo suffered irreparable harm when each experienced loss of employment, reduction in wages, and or loss of professional reputation due  to unwarranted and unfounded claims made by FINRA against each, which claims are based  substantially if not exclusively on ESI spoliated due to Smarsh's intentional or grossly negligent  or other negligent handling.  

100. Irreparable harm in the form of unwarranted legal actions will continue to occur  as long as FINRA or any other third party or entity can use or make available for use in  Enforcement and other legal proceedings any ESI processed and spoliated by Smarsh during the  Relevant Period due to Smarsh's intentional or grossly negligent or negligent mishandling.  

101. Neither FINRA nor Smarsh will suffer harm if injunctive relief is granted because it is unlawful to knowingly use corrupted evidence in federal proceedings.  

102. The public interest is furthered by injunctive relief that will prohibit FINRA's use  of spoliated ESI in federal proceedings against Messrs. North and Pompeo because it is unlawful  to knowingly use false or corrupted evidence in federal proceedings; the public interest is better  served by preventing and providing sufficient sanctions for the use of spoliated, false or  corrupted evidence in federal proceedings.  

103. Messrs. North and Pompeo have no adequate remedy at law (a) as long as Smarsh uses protocols and processes that spoliate electronic communications, denies that spoliation occurred, and is willing to testify falsely about its business and performance of its duties; and (b) as long as FINRA contends that spoliation of ESI is irrelevant to lawful defenses to claims and proceedings predominantly, if not entirely, dependent upon spoliated ESI, while using spoliated  evidence in proceedings to advance monetary and non-monetary sanctions that cause permanent and irreversible harm.  

THEREFORE, Plaintiffs pray for:  

a. Judgment against Smarsh and findings that Smarsh agents and or employees  intentionally or with gross neglect spoliated the electronic files used in federal proceedings;  
b. Judgment against Smarsh and findings that Smarsh agents and or employees  negligently spoliated the electronic files used in federal proceedings;  
c. Judgment against FINRA and findings that FINRA agents and or employees negligently contributed to the spoliation of the electronic files used in federal proceedings;  
d. Judgment against one or both defendants to each for present and future lost wages, in the amounts of one million eight hundred twenty-six thousand dollars ($1,826,000) for
Mr. North and one million one hundred twenty-five thousand dollars ($1,125,000) for Mr.  Pompeo, plus costs and allowable attorneys fees;  
e. Judgment against Smarsh for punitive damages based upon economic and other  applicable damages due to Smarsh's intentional conduct or gross neglect in processing ESI  during the Relevant Period;  
f. For permanent injunction, enjoining Defendant Smarsh, and its agents, servants, ;and employees, and all persons acting under, in concert with, or for them from actions and  methods that spoliated the ESI described herein, and enjoining delivery of the spoliated records  described herein to others for use in pending and any future litigation involving Plaintiffs;  
g. For permanent injunction, enjoining Defendant FINRA Enforcement, and its agents, servants, and employees, and all persons acting under, in concert with, or for them from  using the ESI and records described herein and spoliated by Smarsh in pending and any future  Enforcement or other FINRA related litigation involving Plaintiffs . . .

READ the Full DDC Complaint

FINRA Moves To Dismiss Spoliation Claims

FINRA Motion To Dismiss

On April 29, 2015, Defendant FINRA filed a Motion to Dismiss the Complaint. As set forth in FINRA's Memorandum of Points and Authorities In Support of the Motion to DismissAs set forth in the self-regulatory organization's Memorandum in Footnote 2

This is not the first time Mr. North and his counsel have prematurely and improperly sought to enjoin these FINRA disciplinary proceedings. On December 10, 2014, in an action styled "In re Thaddeus J. North", United States Court of Appeals for the D.C. Circuit, Case No. 14-1274, Mr. North filed an "Emergency Petition for Mandamus, Temporary and Permanent Injunctive Relief, and Stay of Proceedings Before the Financial Industry Regulatory Authority." The Petition challenged the determinations of two separate FINRA Hearing Officers in the FINRA cases regarding the same allegedly spoliated records at issue in the current Complaint, and sought to permanently enjoin the FINRA cases. The next day, on December 11, 2014, the Appeals Court Ordered that the Petition be denied finding that mandamus relief was not warranted. See December 11, 2014 Order, attached as Exhibit 1.

Further, FINRA argues that dismissal is compelled for the following reasons:

  1. This Court lacks subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1) and 12(h)(3) because the Exchange Act provides the exclusive judicial remedy for complaints arising from FINRA disciplinary proceedings and requires Plaintiffs to exhaust their administrative remedies. 15 U.S.C. § 78s, 78y; See Marchiano v. NASD, Inc., 134 F.Supp.2d 90 (D. D.C. 2001); see also McGinn, Smith & Co.. Inc. v. FINRA, 786 F.Supp. 2d 139, 146 (D. D.C. 2011).
  2. FINRA "is absolutely immune from suit for the improper performance of regulatory, adjudicatory, or prosecutorial duties delegated by the SEC." In re Series 7 Broker Qualification Exam Scoring Litigation, 548 F.3d 110, 114 (D.C. Cir. 2008). No court has ever allowed tort claims to proceed against FINRA related to its enforcement duties under the Exchange Act.
  3. Neither the Exchange Act, nor any provision of the federal securities laws expressly provides for a cause of action against an SRO like FINRA for acts or omissions in connection with its regulatory duties. See, e.g., In re Series 7 Broker Qualification Exam Scoring Litigation, supra, 548 F.3d at 115 ("The elaboration of duties, allowance of delegation and oversight by the SEC, and multi-layered system of review show Congress's desire to protect SROs from liability for common law suits").
  4. Even if such a claim were viable, Plaintiffs fail to state a claim of "negligent spoliation" claim against FINRA. See Cook v. Children's National Medical Center, 810 F.Supp. 2d 151, 155 (D. D.C. 2011); see also Holmes v. Amerex Rent-A-Car, 180 F.3d 294, 297 (D.C. Cir. 1999).
Non-Existant Tort

In substantively addressing the spoliation claims, FINRA's Memo asserts that:

[T]he crux of the negligent spoliation claim against FINRA is that it somehow "contributed to" the spoliation of emails maintained by Smarsh solely because FINRA requested those emails "in a "special format", e.g. ".pst." Complaint, ¶34. Specifically, the Complaint alleges "Enforcement also had a duty to avoid spoliation to ESI, however, by and through its agents and employees, FINRA negligently contributed to the spoliation during the examination and investigations of Southridge and Ocean Cross by requiring that electronic communications be converted and delivered in .pst format, non-native to Bloomberg communications and certain other email programs." Complaint, ¶92. Not only does this paragraph seem to plead the nonexistent tort of "contribution to spoliation", but on its face fails as FINRA had no duty to request emails in native format. FINRA did not own, maintain, or control these emails. As a regulator, FINRA made a routine request to the firms' email vendor to obtain emails in .pst file format.

Requesting emails in ".pst" format is far from "special" as Plaintiffs contend - rather, it is usual and customary: "Email is not typically produced in native file format because the extraction of individual emails from a large database containing other emails requires conversion of the file format into a near-native format." 1-37A Moore's Federal Practice - Civil § 37A.43(1) (3d ed. 2015). "Collections of entire sets of emails, often stored in networked servers, can be extracted in a PST or NSF format, i.e., file extensions.pst or .nsf." Id. at § 37A.43(2). Like FINRA, the SEC also often requests emails in .pst file format. See Division of Enforcement, Enforcement Manual, §3.2.6.2.3 ("Format for Electronic Production of Documents to the SEC") specifically provides that SEC staff may accept emails in .pst file format.10 FINRA owed no duty to Plaintiffs to request data from their firms' email vendor in a native file format. Even if the allegations of the Complaint could be considered, Plaintiffs' negligent spoliation claim against FINRA is so untenable that it fails as a matter of law.

Pages 24 - 25 of FINRA Memorandum

READ the Full-Text:

On December 4, 2015, DDC dismissed the Complaints against Defendants Smarsh and FINRA pursuant to its Opinion ("DDC Opinion") in Thaddeus J. North and Mark P. Pompeo, Platintiffs, v. Smarsh, Inc. and Financial Industry Regulatory Authority/Department of Enforcement (Opinion, DDC, 15-CV-00494, December 4, 2015). As noted in the "Conclusion" to the DDC Opinion:

For the foregoing reasons, the Court will grant both FINRA's Motion to Dismiss, Dkt. 6, and Smarsh's Motion to Dismiss, Dkt. 9, and deny Plaintiffs' Motion for Orders to Produce Digital Records for Examination, Dkt. 28. In sum, the Court finds that it has no general or specific jurisdiction over Smarsh. Accordingly, the Court will dismiss the Complaint against Smarsh without prejudice for lack of in personam jurisdiction. With respect to Plaintiffs' negligent spoliation claims against FINRA, the Court finds that TRAC divests the Court of jurisdiction to entertain Plaintiffs' prayer for injunctive relief. Moreover, since Plaintiffs are unlikely to succeed on the merits of their claim and it is unclear that they will suffer irreparable harm as a result of the continuation of the FINRA proceedings, the Court finds that transfer to the D.C. Circuit is not in the interest of justice. The Court will dismiss Plaintiffs' claim for injunctive relief against FINRA without prejudice for lack of subject matter jurisdiction. The Court also holds that FINRA is absolutely immune for its regulatory and prosecutorial acts and, thus, will dismiss Plaintiffs' claim for monetary relief against FINRA with prejudice. A memorializing Order accompanies this Memorandum Opinion.

Pages 32 - 33 of the DDC Opinion

Irreparable Harm Standard

The DDC Opinion tackles the issue of whether Plaintiffs successfully advanced the required demonstration of "irreparable harm" in order to provide the foundation upon which a transfer of the case to a federal Court of Appeals or the imposition of an injunction could be predicated. 

In tackling the unusual request to have the district court case transferred to a federal Court of Appeals, the Court explained that:

The Exchange Act establishes a mandatory process for resolving FINRA disciplinary actions. Marchiano, 134 F. Supp. 2d at 92. That process does not contemplate the involvement of federal district courts. Id. at 92, 94-95. The D.C. Circuit has clearly held that "where a statute commits review of agency action to the Court of Appeals, any suit seeking relief that might affect the Circuit Court's future jurisdiction is subject to the exclusive review of the Court of Appeals." Telecommunications Research and Action Center v. F.C.C., 750 F.2d 70, 75 (D.C.Cir.1984) (TRAC)). Pursuant to TRAC, a district court does not have jurisdiction to review or enjoin FINRA's disciplinary actions if: (1) the relevant statute "commits review to the Court of Appeals"; and (2) "the action seeks 'relief that might affect the Circuit Court's future jurisdiction.'" Marchiano, 134 F. Supp. 2d at 93 (quoting TRAC, 750 F.2d at 75). Both factors are satisfied in the instant case.

Pages 23 -24 of the DDC Opinion:

In addressing the broader application of the "irreparable harm" standard, the DDC Opinion concludes that:

With respect to the issue of irreparable harm, Plaintiffs do not allege that there is a risk of further spoliation. Mr. Pompeo already settled the allegations against him by entering into an AWC with FINRA and the merits hearings in the Southridge and Ocean Cross Proceedings against Mr. North have already concluded. Also, Mr. Pompeo does not explain how he would be irreparably harmed if the Court does not enjoin the pending proceedings against Mr. North. In terms of concrete damages, Plaintiffs complain that they have incurred significant litigation expenses in responding to FINRA's disciplinary proceedings. Nonetheless, "courts have uniformly recognized that '[m]ere litigation expense, even substantial and unrecoupable cost, does not constitute irreparable injury.'" McGinn, Smith, 786 F. Supp. 2d at 147 (quoting Renegotiation Bd. v. Bannercraft Clothing Co., 415 U.S. 1, 24 (1974)). They also allege without specificity that FINRA's alleged negligent spoliation has resulted in retribution, as well as loss of gainful employment and professional reputation. See Compl. ¶¶ 62, 64-65. The Court recognizes that these damages could rise to the level of irreparable injury. However, FINRA has not issued a final disciplinary action against Mr. North and some of the charges in the Southridge and Ocean Cross Proceedings -- i.e., whether Mr. North reviewed sufficient electronic correspondence as required by securities laws and regulations -- have nothing to do with the content of the spoliated ESI. Therefore, it is unclear how enjoining FINRA from using spoliated ESI against Mr. North would avoid the alleged harms.

Page 29 of the DDC Opinion

Abolute Immunity

In upholding FINRA's "absolute immunity," DDC sets forth some of its considerations and conclusions:

exclude expert testimony and reject the spoliation allegations as irrelevant were nothing more than evidentiary decisions, subject to appeal.11 Accordingly, FINRA was acting within the scope of its delegated adjudicatory authority. See FINRA's MTD, Ex. 2 (FINRA Rule 9263) at 3. Finally, the Complaint does allege that FINRA was misled by Smarsh and negligently relied on spoliated ESI to pursue the underlying enforcement actions against Plaintiffs. Compl. ¶¶ 90-103. Nonetheless, at the very most, these allegations only show that FINRA failed to properly perform its delegated functions. Since FINRA is "absolutely immune from suit for the improper performance of . . . [its] duties," Plaintiffs cannot defeat immunity in the instant case. In re Series 7, 548 F.3d at 115 (affirming the dismissal of a tort action against FINRA for admitted mistakes committed while administering a securities licensing exam). Plaintiffs' claim for monetary relief will be dismissed with prejudice.

Pages 31 - 32 of the DDC Opinion

READ the FULL TEXT DDC Opinion