June 25, 2021
If you run afoul of FINRA, you may be given the opportunity to enter into a regulatory settlement without admitting or denying the facts. Frankly, that's a deal that most respondents should jump at. Perhaps acknowledging that some who settle would like to offer their side of things in the published Acceptance, Waiver and Consent document, FINRA allows respondents to attach a Corrective Action Statement, which is supposed to be a "statement of demonstrable corrective steps taken to prevent future misconduct. Respondent understands that he may not deny the charges or make any statement that is inconsistent with the AWC in this Statement." BrokeAndBroker.com publisher Bill Singer is no fan of the Corrective Action Statement. He almost never recommends the option. He regularly argues against it. In a recent FINRA AWC, Bill takes the opportunity to show why FINRA's policy is misguided and inconsistent.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, John C. Braddock submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted.
In the Matter of John C. Braddock, Respondent (FINRA AWC 2020065347501)
The AWC asserts that John C. Braddock was first registered in 1986, and by 2012, he was registered with Lakeridge Capital Inc. As alleged in part in the FINRA AWC:
Beginning in September 2018, Braddock solicited prospective investors to purchase equity interests in a private placement or Company A, whose business purpose was to export beverages from the United States to foreign markets. Braddock, who was Company A's founder, chairman, and CFO, prepared the private placement memorandum for the offering, which was reviewed and approved by Lakeridge Capital. Braddock distributed the private placement memorandum to numerous prospective investors, some of whom became Lakeridge Capital customers. As set forth below, the. private placement memorandum contained two types of negligent misrepresentations or omissions of material fact.
First, the private placement memorandum flailed to disclose that Braddock had declared bankruptcy in June 2017 and entered into a debt reorganization and repayment plan that was confirmed in April 2018, prior to when Braddock began soliciting investors. His bankruptcy (which remained pending throughout the private placement offering) was a material fact that should have been disclosed to investors, given the other statements in the private placement memorandum about his financial background. For example, the private placement memorandum stated that Braddock had "over 35 years" of financial and business experience and, together with his partners, had "engaged in over $2 billion" of financial and fundraising transactions. Given such statements, Braddock's recent bankruptcy was a material fact that should have been disclosed to investors,
Second, the private placement memorandum negligently misstated that another company owned and controlled by Braddock (Company B) had invested approximately $1.13 million of "earnings." including approximately $280,000 of "working capital," in Company A. In fact, Company B had not invested any cash in Company A. The "earnings" and "working capital" reflected, instead, Braddock's estimate of the value of work that Company 13 had performed prior to Company A's formation, which Braddock. believed were of value to Company A's business. Characterizing the value of such work. as "earnings" and "working capital" was misleading because it gave investors inaccurate information; specifically, that Company A had more liquid capital to operate its business than was the case.
In accordance with the terms of the AWC, FINRA found that Braddock violated FINRA Rule 2010 and imposed upon him a five-month suspension from associating with any FINRA member in all capacities. The AWC asserts that no monetary sanction was imposed upon Braddock in consideration of his June 5, 2017 Chapter 13 bankruptcy petition that is pending.
Corrective Action Statement
The Braddock AWC includes a provision under "III. OTHER MATTERS" that states:
D. Respondent may attach a Corrective Action Statement to this AWC that is a statement of demonstrable corrective steps taken to prevent future misconduct. Respondent understands that he may not deny the charges or make any statement that is inconsistent with the AWC in this Statement. This Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA.
Respondents in a settled disciplinary action may submit a Corrective Action Statement and/or a Mitigation Statement to NASD Regulation. This article clarifies the NASD policies regarding such Statements.
A Letter of Acceptance, Waiver and Consent (AWC) permits a respondent in an NASD Regulation disciplinary action to settle the matter prior to the filing of a formal complaint. A Corrective Action Statement may be attached to the AWC, which is filed with the SEC and available to the public, provided such statement is: (1) limited to demonstrable steps taken to correct a problem associated with the disciplinary action; (2) generally no longer than 2-3 pages; and (3) contains the following legend:
This Corrective Action Statement is submitted by the Respondent. It does not constitute factual or legal findings by NASD Regulation, Inc., nor does it reflect the views of NASD Regulation, Inc., or its staff.
Separately, respondents may submit a Mitigation Statement for consideration by NASD Regulation and the National Adjudicatory Council. Generally, such Statements are used to describe mitigating circumstances surrounding the violation for the decision maker to consider in its review of the terms of a settlement. Unlike Corrective Action Statements, Mitigation Statements are not attached to the AWC or public order.
Respondents may also settle a matter after the complaint is filed by submitting an Offer of Settlement. While both Corrective Action and Mitigation Statements may be submitted to NASD Regulation in connection with Offers of Settlements, these Statements are not attached to the final Order Accepting the Offer of Settlement, which is filed with the SEC and available to the public.
NASD Regulation will not accept Corrective Action or Mitigation Statements that deny the allegations or are inconsistent with the findings in the settlement. . .
Respondent Braddock submitted to FINRA a Corrective Action Statement, which states:
The following Statement of Corrective Action includes demonstrable steps taken by the Respondent to correct the alleged violations in the AWC.
Respondent, whose business was adversely affected at the time by cancer treatments and a divorce, declared bankruptcy on June 5, 2017, and entered into a debt reorganization and repayment plan that was confirmed on April 2, 2018. Debts under the repayment plan have approximately one year remaining of the five year term and are currently 80% repaid. While the Respondent timely disclosed his bankruptcy to Lakeridge Capital in July 2017, Lakeridge Capital failed to make the required disclosure to FINRA through CRD until February 2019, despite repeated written notices by Respondent on July 4, 2017, July 5, 2017, September 14, 2017, and February 6, 2019. Respondent's bankruptcy has been disclosed on BrokerCheck since at least mid-February 2019 and was disclosed in the private placement memorandum as of March 14, 2020 when Respondent resumed capital-raising activities.
In multiple places in the private placement memorandum, the "earnings" and "working capital" were described as investments to build a "financial bridge" between the United States and foreign markets and "an international infrastructure, marketing, client, and investor network from 2006-2019." Respondent did not describe these terms correctly because they reflected, instead, Respondent's sunk costs by Company B for the benefit of Company A. On March 14, 2020, Respondent corrected this deficiency in a revised private placement memorandum by describing Company B's "earnings" and "working capital" as sunk costs and, on December 8, 2020, further defining sunk costs as capital invested by Company B on behalf of Company A and that, subject to an accounting and reconciliation overseen by Company A's Board of Directors, Company B retains the right to recoup some or all of its sunk costs from gross revenues of Company A.
This Corrective Action Statement is submitted by the Respondent. It does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff.
Bill Singer's Comment
As set forth in the AWC, FINRA alleges that
Beginning in September 2018, Braddock solicited prospective investors to purchase equity interests in a private placement or Company A . . . [and Braddock had] prepared the private placement memorandum for the offering, which was reviewed and approved by Lakeridge Capital.
. . .
First, the private placement memorandum flailed to disclose that Braddock had declared bankruptcy in June 2017 and entered into a debt reorganization and repayment plan that was confirmed in April 2018, prior to when Braddock began soliciting investors. . . .
Going by FINRA's allegations and timeline, Braddock declared bankruptcy in June 2017; and in September 2018, he began soliciting investors for the investment via the PPM that had been approved by Lakeridge Capital but which did not disclose the bankruptcy.
Braddock's Corrective Action Statement alleges in part that:
Respondent, whose business was adversely affected at the time by cancer treatments and a divorce, declared bankruptcy on June 5, 2017, and entered into a debt reorganization and repayment plan that was confirmed on April 2, 2018. . . . While the Respondent timely disclosed his bankruptcy to Lakeridge Capital in July 2017, Lakeridge Capital failed to make the required disclosure to FINRA through CRD until February 2019, despite repeated written notices by Respondent on July 4, 2017, July 5, 2017, September 14, 2017, and February 6, 2019. Respondent's bankruptcy has been disclosed on BrokerCheck since at least mid-February 2019 and was disclosed in the private placement memorandum as of March 14, 2020 when Respondent resumed capital-raising activities.
As set forth in the Corrective Action Statement, Braddock asserts that the 2017 bankruptcy was engendered by the adverse impact of cancer treatments and divorce. Moreover, Braddock asserts that he "timely disclosed" his bankruptcy to Lakeridge Capital by July 2017 but the firm "failed to make the required disclosure to FINRA through CRD until February 2019." Additionally, Braddock argues that his bankruptcy was disclosed since February 2019 on BrokerCheck and apparently on a revised/amended PPM by March 2020.
If we go by FINRA's allegations in the AWC, Braddock was charged with failing to disclose his bankruptcy in the version of the PPM that was reviewed and approved by Lakeridge Capital, and which was shown to potential investors. If we go by Braddock's assertions in his Corrective Action Statement, Lakeridge knew in July 2017 that he had filed for bankruptcy and, somehow, that the brokerage firm had failed to timely disclose his bankruptcy to FINRA/CRD. As set out in the AWC,
FINRA's and Braddock's fact patterns don't mesh.
FINRA's case against Braddock was that from September 2018 to April 2021, he had prepared and distributed a PPM that negligently misrepresented and omitted facts relevant to an investment in a private placement. Braddock's Corrective Action Statement asserts that he was not negligent because he had informed Lakeridge Capital by July 2017 of his bankruptcy and that the firm had failed to timely notify FINRA.
Braddock isn't directly raising in his Corrective Action Statement any role taken on by Lakeridge Capital in the drafting of the PPM, which is truly the core issue underlying FINRA's charges. In fact, Lakeridge does not appear to have had any such drafting role -- it's involvement was in reviewing the PPM per its obligation to authorize Braddock's outside activity and anticipated solicitations. Rather than directly address that core allegation, Braddock has raised unrelated issues about whether Lakeridge Capital timely filed a disclosure about his bankruptcy. We got apples. We got oranges.
Braddock's Corrective Action Statement does not seem to be limited to a "statement of demonstrable corrective steps taken to prevent future misconduct." Although Braddock's statement does not "deny the charges" in the AWC, it does strike me as making a somewhat inconsistent statement. Notwithstanding my concerns and reservations, FINRA accepted Braddock's Corrective Action Statement and published it as part of the AWC.
I am no fan of Corrective Action Statements and rarely, if ever, advocate their use. Given that the premise of an AWC is a settlement made without admitting or denying the findings, I don't understand why anyone would voluntarily submit a statement that typically make admissions of facts and findings; promises to correct situations that have not necessarily been acknowledged or admitted to; and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal. If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it.
Some think that a Corrective Action Statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. As with any post-game analysis, it's just not going to change the score. Moreover, if during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in your statement, or, it is alleged that you failed to implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission.
Some settling Respondents submit a Corrective Action Statement
that details a proposed or in-place supervisory scheme at a current FINRA member firm -- which takes on the trappings of a proposed scheme of enhanced supervision of a statutorily disqualified individual attendant to the filing of a FINRA Membership Continuance Application
(the "Form MC-400") http://brokeandbroker.com/PDF/MC400.pdf. I find that such a written proposal is an ill-advised practice because most AWC Respondents are merely suspended and fined and are not subjected to any further regulatory constraints after their time is served and the dollars paid. If FINRA wants to impose specific supervisory conditions upon a settling Respondent or require the submission of an undertaking by the registered rep or member firm, then so be it. On the other hand, why any member firm would draft an extensive list of compliance Do's and Don'ts to which a suspended rep would be subjected upon his or her return to production baffles me. Frankly, I'm old school: Don't volunteer anything and don't answer questions that weren't asked.
I appreciate that some employers/member firms think that memorializing an enhanced scheme of oversight for a settling registered person or member firm provides a hedge against future misconduct, but I don't agree with that premise. If a firm harbors such concerns about a particular associated person that the member feels compelled to memorialize in a FINRA settlement agreement an extensive, proposed supervisory protocol, then maybe that firm should terminate the individual. Similarly, if the firm intends to retain an outside, independent compliance consultant to redress in-house compliance failures, much of what needs to be reformed is likely stated at length in the AWC -- why restate the obvious or commit to steps that may prove unattainable?
And one last thing to mull over before you submit a Corrective Action Statement, just imagine what some customer's lawyer will do with that published list of proposed corrective actions if an associated person or the firm engages in future disputed conduct. A savvy Claimant's lawyer will cite the language in the AWC and will then cite your undertakings in the Corrective Action Statement. Wait and see how quickly a skilled lawyer will demonstrate that the firm promised "this" and swore it would do "that" but that was all lies -- and the brokerage firm will continue to dishonor its regulatory promises and compliance obligations unless you send it a strong message in the form of compensatory damages with the added kick of punitive damages. Yeah, I know, when I put it like that, it doesn't sound so good. Trust me, it will be put like just like that.