Big problems often arise from small problems -- it's the mushroom effect. How often have you found yourself in a mess that you never quite saw coming? When you trace your steps back to see where it all went wrong, you often come to rest at some mundane, innocuous moment. In an ongoing SEC administrative proceeding, Ground Zero appears to have been nothing more than a lawyer representing a brokerage firm and its employee during a customer arbitration. As it developed, the employee had engaged in some misconduct, which gave rise to allegations that the firm had failed to supervise her, which gave rise to the SEC initiating administrative proceedings against the firm. As that supervisory case makes its way through the SEC, lo and behold, the federal regulator seeks to disqualify the lawyer who represented both the firm and the employee during the customer arbitration -- the firm wants that same lawyer to defend it against the SEC's charges. Is the lawyer conflicted? Did the employee previously waive any future conflicts? Should the lawyer be allowed to cross examine his former client? All that and more shall be revealed on the pages of today's BrokeAndBroker.com Blog
Case In Point
In the Matter of Wedbush Securities, Inc. (Corrected Order Instituting Administrative Proceedings and Notice of Hearing, '34 Act Rel. No. 82954, Admin. Proc. File No. 3-18411 / March 27, 2018), the Division of Enforcement alleged under the heading "Summary":
1. Wedbush failed reasonably to supervise one of its registered representatives, Timary Delorme ("Delorme"), who engaged in manipulative trading activity of penny stocks over multiple years, as detailed below. Wedbush was aware of certain aspects of her activity in 2012 and 2013 but its supervisory policies and implementation systems failed reasonably to guide staff on how to investigate the activity. Specifically, in late 2012 and early 2013, Delorme's supervisors: (1) reviewed an email outlining her role in fraudulent transactions involving penny stocks; (2) received copies of two FINRA arbitrations filed by her customers outlining serious allegations of her role in their investments in the same penny stock issuers; (3) learned of a FINRA inquiry into her personal trading in one of those penny stock issuers; and (4) learned of a separate FINRA inquiry into the allegations underlying the customer arbitrations. Wedbush had no clear process for how to handle red flags of potential market manipulation.
Motion to Disqualify Counsel
Citing alleged conflict, Enforcement moved to disqualify Charles B. LaChaussee, Esq. from acting as counsel for Respondent Wedbush. In the Matter of Wedbush Securities, Inc. (Order Denying Motion to Disqualify Counsel, Admin. Proc. Rul. Rel. No. 5780, Admin. Proc. File No. 3-18411 / June 7, 2018) https://www.sec.gov/alj/aljorders/2018/ap-5780.pdf
Enforcement alleged that LaChaussee had played an integral role in Wedbush's allegedly deficient internal investigation into Delorme's conduct, and, further, that he had represented Delorme in connection with two customer arbitrations. In opposing the motion, Wedbush argued, in part, that LaChaussee had only represented Delorme in one arbitration, which Enforcement apparently has not challenged in its reply.
Accordingly, Enforcement argued that LaChausseee is conflicted because [Ed: footnotes omitted]:
(1) he may become a necessary witness at the hearing; (2) he may be taking an adversarial position to his former client, Ms. Delorme, and has not obtained a waiver of such conflict; and (3) he was an active participant in the events underlying the Division's claims.
Enforcement asked SEC Administrative Law Judge ("ALJ") Grimes to [Ed: footnotes omitted]:
disqualify LaChaussee from appearing as counsel for Wedbush. And if I do not disqualify LaChaussee, the Division asks that that I prohibit him from cross-examining Delorme because she is his former client whose position is adverse to Wedbush's position. It also requests that I enforce requirements in the California Rules of Professional Responsibility and the ABA Model Rules and require Wedbush to affirm in writing that it has been informed that LaChaussee's conduct is at issue and that his personal interests may limit his ability to fully represent Wedbush.
In taking under consider the motion to disqualify, ALJ Grimes acknowledges that such a legal maneuver is often deployed as a [Ed: footnotes omitted]:
tactical device to disadvantage a movant's opponent and the disruptive consequences that would flow from disqualification, courts tend to view such motions "with extreme caution," if not outright skepticism. A party moving to disqualify counsel thus bears "a heavy burden of proving" the grounds for disqualification.
Necessary Witness-- or simply the best?
In tackling Enforcement's assertion that LaChaussee be disqualified because of his role as a necessary witness, ALJ Grimes found that Enforcement had not carried its burden of proof [Ed: footnotes omitted]:
First, it does not claim that it will be prejudiced if LaChaussee testifies. Second, "[a] necessary witness is not the same thing as the ‘best' witness." Even if the Division has shown that LaChaussee is the best witness on the issue of Wedbush's response to allegations of fraud -- which it has not -- it has not shown that he is necessary, i.e., that the testimony he might provide is unavailable from any other source. Other than saying LaChaussee is necessary, the Division does not explain why. And given its burden, the Division's omission is fatal to this aspect of its motion.
Cross Examination Crossfire
In response to Enforcement's effort to deny LaChaussee the right to cross-examine Delorme, Wedbush argued that the cited previous arbitration representation was undertaken pursuant to a joint representation letter/ In that letter, Delorme allegedly had agreed that in the event a conflict developed between her and Wedbush such that members of the firm's legal department had to withdraw from further representation of her, that legal staff would be permitted to continue to represent the firm. Further, Wedbush asserted that LaChaussee's prior representation of Delorme involved claims about how she had handled her clients' accounts, and that those are not the issues before the ALJ and not relevant to the proceeding.
ALJ Grimes declined to guide his determination of the cross-examination issue solely by California Rules of Professional Conduct, as urged by the parties because he did not see the core matter before him as one involving a proceeding to determine whether LaChaussee had violated a state ethical rule. That aside, the ALJ opted to be guided by the ABA Model Rules of Professional Conduct as a more appropriate ethical policy statement, which he notes sets forth in ABA Rule 1.9(a):
A lawyer who has formerly represented a client in a matter shall not thereafter represent another person in the same or a substantially related matter in which that person's interests are materially adverse to the interests of the former client unless the former client gives informed consent, confirmed in writing.
Given the allegations in the OIP, ALJ Grimes concluded that it is not presently possible to conclude that Delorme's 2012 customer arbitration or any information LaChaussee learned in 2012 while representing her are irrelevant. Notwithstanding, given Rule 1.9's allowance for client waivers of conflicts, the ALJ denied Enforcement's motion and allowed LaChaussee's examination of Delorme subject to her and Wedbush's consent. In reaching that decision, ALJ Grimes acceded to Enforcement's request to [Ed: footnotes omitted]:
require Wedbush to affirm in writing that it has been informed that LaChaussee's conduct is at issue that his personal interests may limit his ability to fully represent Wedbush. But this is not a disciplinary proceeding. And at this stage, it is not clear that LaChaussee's "interests concerning his own conduct" may affect his representation of Wedbush. Nevertheless, the Commission's interest in protecting the integrity of the proceeding would be served by requiring a written waiver from Wedbush of any conflict or appearance of a conflict resulting from LaChaussee's prior representation of Delorme.
In making his final determination, ALJ Grimes succinctly sums up his ruling:
The Division's motion to disqualify LaChaussee is DENIED. By June 21, 2018, Wedbush or LaChaussee shall submit for in camera review, (1) the referenced joint representation agreement Delorme executed, and (2) evidence of Wedbush's consent in light of LaChaussee's prior representation of her. Alternatively, Wedbush may elect in writing by June 21, 2018, to have a counsel other than LaChaussee represent it in this proceeding.
Bill Singer's Comment
Readers of the BrokeAndBroker.com Blog know that I am a bit of a groupie when it comes to ALJ Grimes, who consistently drafts cogent decisions replete with content and context that render them compelling and accessible to both lawyers and laypersons alike. Today's Order Denying is merely another in a long line of such sterling examples.
There are some important takeaways from the Order Denying. First, the industry should pay attention to the role that the joint representation letter played -- and to the possible need to pen a written waiver of conflicts at some point in the future. Second, associated persons should also note that when they agree to a joint representation, they could easily find themselves on the receiving end of a blistering examination by someone who previously served as their lawyer and in whom they had placed confidence and trust. As such, stockbrokers, traders, and sales assistants should carefully consider the wisdom of simply signing off on a joint representation. In keeping with that advice, brokerage firms should also consider the potential for disqualification of a favored lawyer who was placed in the role of representing both the firm and its employees. As I am apt to tell many a client, "it never becomes a problem until it becomes one."