BrokeAndBroker.com: A Man For One NASD Season

March 28, 2010

Timothy P. Pedregon, Jr. (Pedregon) worked as an examiner with the self-regulatory organization National Association of Securities Dealers, Inc. (NASD) from April 2003 until November 2004. According to an NASD Memorandum (Probationary Memo), Pedregon was placed on probation by NASD in June 2004 because:

Your overly aggressive approach has been brought to your attention in the past by your supervisor, your mentor, and at least one other co-worker . . . . The impact of your behavior has been considerable. By engaging in inappropriate and unprofessional conduct you have negatively impacted NASD's image as a fair and objective regulator. In addition, your conduct on the examination in question has provided the firm with the opportunity to complain about its treatment by NASD, causing resources to be diverted from investigating the serious apparent violations detected during the examination, to investigating and responding to the firm's allegations.

The Probationary Memo further noted that Pedregon had "used an obscene and derogatory term in reference to the firm [under examination] in the presence of firm employees," and that "at times during the course of the examination you conducted yourself in an overly aggressive manner."  

Bill Singer's CommentFrankly, NASD's response does not strike me as appropriate or professional. 

Pedregon had been given three "friendly" warnings by his supervisor, mentor, and co-worker during his first year on the job. Some would suggest that an immediate termination for cause was the proper reaction, or, at a minimum, at least a suspension. It seems to me that the probation would simply result in Pedregon seething, stewing, and waiting to get even with those NASD colleagues who ratted him out, and, eventually with NASD member firms that would once again come within his cross-hairs.

Complaints against regulatory staff by the regulated community are often dismissed as the disgruntled pettifoggery of malcontents; notwithstanding that the history of such allegations and their common themes have long raised legitimate concerns - albeit, concerns that the regulatory community chose to denigrate and deny. While regulators should be determinedly dogged in their investigations of misconduct, such zeal must remain within the bounds of propriety. 

Bullies tend to pick on defenseless little guys.  By encouraging an atmosphere of overly aggressive regulation, regulators unfairly single out the small fry as easy prey, while the big fish are left alone. We have recently seen the legacy of such misguided regulation involving Madoff, Stanford, Bear Stearns, and the whole Too-Big-To-Fail Gang.

From Bad to Worse  

Approximately five months after being placed on probation, for reasons not provided, Pedregon's employment with NASD ended in November 2004, . Following the cessation of his NASD employment, Pedregon was employed as a compliance officer at a FINRA member firm, which was his first and only registered role.

For several months in fall 2005, Pedregon conducted online conversations with a fourteen-year-old young woman whom he had not met in person. On November 9, 2005, he went to a hotel where he had arranged to meet the young woman. When he arrived, he was arrested by police officers who had been told about the intended meeting by the young woman's mother. The following day, he was discharged by the FINRA member firm where he had been employed as a compliance officer since November 2004.  

Indictment

Pedregon was indicted under Section 33.201(c) of the Texas Penal Code and subsequently pled guilty to two felony counts of online solicitation of a minor to meet with the intention of sexual contact.  In January 2007, a Texas court sentenced him to 180 days in county jail for each count, the sentences to be served consecutively. It also placed him on "community supervision," apparently a type of probation, for ten years. Pedregon was required, among other things, to perform 180 hours of community service at the rate of ten hours per month, report to a supervision officer, and register as a sex offender. Pedregon served the jail sentences and registered as a sex offender. As of January 22, 2009, he had completed two years of community supervision.

Court records show that additional community supervision requirements were added in June 2008. These include a requirement that Pedregon shall not reside at a location with or have access (either directly or indirectly) to a computer with a modem or any other device allowing access to the internet and shall allow inspection of his computer files, digital camera, cell phone and removable storage media.  He was further required to submit to internet, e-mail, and other electronic transfer of information monitoring at his own expense; a prohibition against accessing MySpace, Facebook, Craigslist, or similar personal ad web-page; and a requirement to abide by all monitoring rules and refrain from tampering with or attempting to disable the monitoring system. It is unclear why these requirements were added.

Statutory Disqualification

As a result of his January 31, 2007 felony conviction, Pedregon is subject to a ten-year statutory disqualification under the Securities Exchange Act of 1934 and FINRA's By-Laws. See, Section 3(a)(39)(F) of the Exchange Act, 15 U.S.C. § 78c(a)(39)(F); Art. II, § 4 of the FINRA By-Laws. As a statutorily disqualified person, Pedregon is not eligible to associate with a FINRA member firm without the consent of FINRA. FINRA By-Laws, Art. III, § 3(d). For details on Statutory Disqualification, visit http://www.rrbdlaw.com/STATDISQ/sdindex.htm  

PlanMember Application

In accordance with the Statutory Disqualification process, in July 2008, PlanMember Securities Corporation (PSEC) applied to Financial Industry Regulatory Authority, Inc. (FINRA) for consent to continue as a FINRA member if Pendregon became an associated person.  PSEC has been a member of FINRA and its predecessor, NASD, since 1983, and a member of the Municipal Securities Rulemaking Board since 2001. It sells mutual funds, municipal securities, variable annuities, limited real estate investment trusts, and limited partnerships; it also provides investment advisory services. At the time of its Membership Continuation Application (Form MC-400) to FINRA, PSEC had three hundred branch offices, with eighty-five principals and almost four hundred registered representatives.  

PSEC proposed that Pedregon serve as its compliance officer, with responsibilities for branch office examinations, trade and e-mail surveillance, customer complaint resolution, licensing and registration, and anti-money laundering and advertising review.

Supervisor CCO Murphy

PSEC's MC-400 provided that Pedregon would work in PSEC's Carpinteria, California office and would be supervised by PSEC's Chief Compliance Officer Daniel Murphy, who began working in the securities industry in 1993 (in sales) and then in compliance in 1995. He held various compliance positions at another firm for eleven years before becoming chief compliance officer of PSEC in March 2005. At the time of the application, Murphy supervised four individuals at the Firm. He has never supervised a statutorily disqualified individual. Murphy testified that Pedregon would be working "literally right at 15 feet outside of my office" and would not be meeting with clients or handling customer funds. Murphy further testified that although Pedregon's position as compliance officer would be "a level above a compliance specialist," Pedregon would not be managing anybody.

Proposed Plan of Special Supervision

PSEC submitted a proposed plan of supervision for Pedregon with its membership continuation application. For detailed examples of special supervisory plans, see, http://www.rrbdlaw.com/STATDISQ/sdindex.htm.  Although the MC-400 instructed PSEC to describe the proposed plan "in specific detail," PSEC's plan had only two elements:

  1. The supervisor [will meet] with [Pedregon] on a periodic basis to review his performance. This will entail a review of his performance in the areas assigned to him. The firm will keep a log of the findings of these meetings.
  2. All customer, representative or staff complaints pertaining to [Pedregon], whether verbal or written, will be immediately referred to the Director of Compliance. The supervisor will prepare a memorandum to the file as to what measures he took to investigate the merits of the complaint and the resolution of the matter. Documents pertaining to these complaints should be segregated for ease of review.
Murphy's Testimony

At the FINRA hearing, after Murphy had learned that FINRA Member Regulation staff found PSEC's proposed plan inadequate, Murphy orally elaborated on the plan, saying that Pedregon's e-mails would be subject to review, that Pedregon would have quarterly performance reviews, and that Murphy "could have one of my staff look at [Pedregon's] hard drive periodically." However, Murphy was willing to commit only to a general outline of a supervisory plan, stating that he "wasn't going to spend a lot of time on it" and "[didn't] plan on giving the detailed, the granular level" until he was sure that Pedregon would be joining PSEC because "I'm busy enough as it is."

When asked how the plan he described would differ from the supervision applicable to other PSEC employees who were not subject to statutory disqualification, Murphy said that other employees would not be subjected to hard-drive review, and that the review of Pedregon's e-mails would be more comprehensive. Murphy did not explain which of Pedregon's e-mails he would review, or how many he would review, or how he would select the e-mails to review.

At the hearing, Murphy was unable to recall details about a PSEC violation based on the failure to follow firm procedures for the review of an individual under heightened supervision. The violation occurred while Murphy was PSEC's chief compliance officer, and a 2007 letter of caution from FINRA noting the violation had been attached as an exhibit to a letter from Member Regulation outlining Member Regulation's recommendation on PSEC's application that was sent to Murphy only two weeks before the hearing.  

Bill Singer's Comment: From the jaundiced eye of a veteran regulatory attorney, I would have to infer from Murphy's alleged statements and conduct at the hearing, that he either was not prepared to attend the hearing and participate in a constructive manner; or, that he purposely desired to torpedo the application and extricate himself from what he may have deemed a no-win situation.  Without question, both of my hunches may well be wrong and off-base, but the responses are so bizarre given the normal answers at such a hearing, that you just have to wonder what was going on here.

Regardless of my suspicions, here are a few tips about testifying at a FINRA SD hearing. 

  1. Fully prepare for your testimony -- and anticipate some tough questions. 
  2. Fully review the background of the statutorily disqualified individual and fully familiarize yourself with your own firm's disciplinary history.
  3. Don't communicate with the FINRA SD hearing panel in a combative or dismissive manner 
  4. Never waive off the need to spend a lot of time crafting a supervisory plan for an SD individual. 
  5. Never say that you won't engage in a detailed consideration of the supervisory plan.
  6. Never tell a FINRA SD hearing panel that you're too busy to focus on the proposed supervision of an SD individual.
  7. Don't use the word "granular" at a FINRA SD hearing. 

Pedregon's Testimony

Pedregon had not begun counseling by the time of the hearing. Pedregon testified that the probation officer in Texas did not want him to begin counseling there if he would soon be moving to California to work for PSEC, because the counseling process was very expensive and California would not recognize the counseling provided to Pedregon in Texas. (Note: As of October 8, 2009, Pedregon had attended four court-mandated counseling sessions in a program that ordinarily requires about eighteen months to complete. His therapist reported that Pedregon had completed two of twenty-five relapse prevention tasks and that many of the identified goals of the program had not yet been addressed, due to the short time that Pedregon had been participating in the program.)

At the FINRA hearing, Pedregon apologized for the conduct that led to his felony convictions and stated that he held himself accountable for it. Pedregon explained that if he violated probation during his ten-year term, he would be sent to prison for ten years, and would not be given credit for the 360 days already served. Pedregon emphasized that this threat of consequences for a violation of probation made it especially important for him to be scrupulously attentive to maintaining the highest standards of conduct. Pedregon also testified to his dedication to the securities industry, the significance of his prior military service as a Marine, the tenacity he displayed as an NASD examiner, his appreciation of PSEC's willingness to hire him, and his eagerness to devote himself again to protecting investors' interests.

Bill Singer's Comment:  The "tenacity" that he displayed as an NASD examiner?  The "tenacity"??  Wow - talk about just not getting it! Why didn't Pedregon simply end his testimony with a stirring rendition of "Thank Heaven for Little Girls"? 

Post-Hearing Submissions

After the FINRA SD hearing, PSEC submitted a more detailed supervision plan, which explicitly stated that Pedregon would not maintain discretionary accounts, act in a sales representative capacity, meet with clients, or handle client funds. It named Murphy as Pedregon's primary supervisor and PSEC's Director of Human Resources, Angel Sugleris, as "interim supervisor" if Murphy was to be "on vacation or out of the office for an extended period."

The revised plan required Murphy to "periodically review Timothy Pedregon's electronic communications, branch examinations he conducts, his performance as an employee, and his internet activity," and to document and maintain records of those reviews; it also required Murphy to periodically review Pedregon's written correspondence. The revised plan required Pedregon to disclose details related to his probation to Murphy each month, and to notify Murphy immediately if he was in violation of any terms of his probation. The revised plan further specified that all complaints related to Pedregon were to be referred immediately to Murphy for review, and that Murphy was to maintain records as to his investigation and resolution of any such complaints. The revised plan also required Murphy to certify quarterly that Pedregon was in compliance with all the conditions of heightened supervision set forth in that plan.

FINRA Denies SD Application

FINRA denied PSEC's application.  FINRA noted that Pedregon was

  • only recently convicted of a very serious crime,
  • would be on probation until 2017, and
  • had not shown that he had successfully completed the counseling sessions that are a condition of his probation.

FINRA also found that Pedregon's actions, although not securities-related, were "deceptive," and that his misconduct was directed against a minor.  

Further, FINRA found that PSEC's proposed supervisory plan was inadequate. FINRA noted three specific areas in which the plan was lacking:  

1.      The plan did not specify how often Murphy's periodic reviews of Pedregon's electronic communications, branch examinations, internet activity, and written correspondence would take place;

2.      The plan did not provide for supervision of Pedregon while Pedregon was conducting branch examinations; and

3.      The plan provided for Sugleris to supervise Pedregon in Murphy's absence, although Sugleris was not qualified to supervise Pedregon. FINRA noted that Sugleris was registered only as an investment company/variable products limited representative and principal and was therefore not qualified to supervise Pedregon, who under the proposal would be registered as a general securities representative acting in the capacity of a compliance officer.


FINRA also questioned the likely rigor of Murphy's proposed supervision of Pedregon, finding that Murphy had not prepared adequately for the hearing and expressing concern that Murphy might not devote sufficient time and energy to supervising Pedregon. In particular, the SEC seemed troubled by Murhpy's inability to remember an incident (which was referenced in a 2007 Letter of Caution from FINRA) involving his failure to follow procedures when previously supervision an individual under heightened supervision.  

Although Pedregon did not disclose the fact that he had been jailed on any of the three successive Uniform Applications for Securities Industry Regulation and Transfer ("Forms U-4") that he submitted to PSEC in 2008, FINRA concluded that Pedregon "did not mislead the Firm or Member Regulation in this regard as the information about the two jail sentences was apparent from the copies of the two January 31, 2007 sentencing court orders that the Firm enclosed with its MC-400."

FINRA also found that NASD's Probationary Memo contained "disturbing" comments that did not reflect favorably on Pedregon's character and judgment or his ability to act professionally as PSEC's compliance officer. FINRA concluded that Pedregon's participation in the securities industry would present an unreasonable risk of harm to investors or the marketplace, and that the public interest would not be served by permitting him to associate with PSEC. It accordingly denied PSEC's application.

Bill Singer's Comment:  Has "silly season" started so early this year? 

Lemme see if I got this logic:  NASD has an examiner on board for about a year.  During that first-year of employment, three NASD staff members (his supervisor, mentor, and co-worker) warn this examiner about being overly aggressive.  When an incident occurs during which this same examiner apparently goes ballistic and engages in inappropriate and unprofessional conduct, NASD puts him on probation. Talk about a slap on the wrist.

How effective was the Probationary Memo?  How lasting and meaningful an impression did that document make upon Pedregon?  No reason for me to guess or put words in the former NASD examiner's mouth -- according to Pedregon, years later, he still believes that he merely exhibited "tenacity" when dealing with NASD member firms under his regulatory oversight. 

Amazingly, NASD's successor (FINRA) cites the Probationary Memo's disturbing and unfavorable comments about Pedregon's character and judgment, and ability to act professionally as a reason to deny his application.  Umm, just a point fellas -- apparently NASD didn't find the comments disturbing or unfavorable enough to immediately fire Pedregon, much less suspend him.  So how is it that the same set of facts in that Probationary Memo now outrage and shock you to the extent that you won't even register Pedregon?  You think, just maybe, that you FINRA folks might want to consider the absurdity of now waving that NASD Probationary Memo around as if it were some smoking gun?   

SEC Appeal

Following FINRA's denial of the MC-400 application, Pedregon appealed to the SEC. In the Matter of the Application of Timothy P. Pedregon, Jr. for Review of  Action Taken by the Financial Industry Regulation Authority, Inc. (Opinion of the Commission, Securities Exchange Act Rel. No. 61791 / Admin. Proc. File No. 3-13610, March 26, 2010).

FINRA Management's Interference Alleged

Pedregon alleged that FINRA senior management told his former co-workers at NASD (now FINRA) not to comply with his requests for letters of reference. By telling his former co-workers not to submit letters on his behalf, Pedregon claims that FINRA deprived him of his right to due process. Pedregon alleged that such interference violated FINRA Rule 9524(a), which permits a statutorily disqualified individual to submit "any relevant evidence" in an eligibility proceeding.

It is well established that the requirements of constitutional due process do not apply to FINRA because FINRA is not a state actor. See, e.g., D.L. Cromwell Invs., Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162 (2d Cir. 2002); Scott Epstein, Exchange Act Rel. No. 59328 (Jan. 30, 2009), 95 SEC Docket 13833, 13855, appeal filed, No. 09-1550 (3d Cir. Feb. 24, 1009); Charles C. Fawcett, Exchange Act Rel. No. 56770 (Nov. 8, 2007), 91 SEC Docket 3147, 3153-55; Mark H. Love, 57 S.E.C. 315, 322 n.13 (2004). The SEC found that Pedregon did not introduce facts sufficient to support his claim that FINRA management effectively prevented his former coworkers from submitting letters on his behalf.

The SEC found that Pedregon failed to introduce facts sufficient to establish that FINRA management deprived him of the right to submit relevant evidence in the form of letters from his former co-workers. Pedregon did not identify anyone who was allegedly involved in this conduct, either FINRA management or former co-workers. He did not provide details as to what such letters might have said or how they would have supported his cause. He did not provide evidence that co-workers would have written such letters if management had not intervened.

Bill Singer's Comment: Among the more jaw-dropping revelations that I make to clients is the fact that FINRA is not required to afford constitutional due process protections.  Notwithstanding that FINRA is often referred to as a quasi-governmental  actor (and often raises that shield when seeking to immunize its alleged prosecutorial-like conduct), to date, the courts do not see the incongruity of not requiring minimal quasi-governmental due process rights to subjects, targets, and respondents in self-regulatory proceedings. 

FINRA Bias

Pedregon contends that "inflammatory language" in FINRA's denial of his application shows that FINRA acted with prejudice. Pedregon cited the inappropriate scrutiny given to

  • FINRA's characterization of the seriousness of the felony,
  • his ongoing probation,
  • his questionable conduct during an NASD examination and the doubts about his character and judgment to which it gave rise,
  • his failure to show that he had completed probation or counseling, and
  • the inadequacy of PSEC's proposed plan of supervision. 

The SEC found no prejudice in FINRA's denial.

Immaterial Felony Conduct

Pedregon argued that the conduct that led to his felony convictions did not involve matters related to securities or finance and that this one legal matter should not reflect upon his entire industry career. He asserted that FINRA's denial of re-entry to persons convicted of felonies unrelated to the securities laws is "both unfair and unconstitutional." The SEC again noted that FINRA is not a state actor and is therefore not bound by constitutional limitations applicable to government agencies. Moreover, Congress, not FINRA, determined that felony convictions unrelated to the securities laws could preclude participation in the securities industry for a ten-year period, unless an SRO finds that such participation is in the public interest.

Recency of Conviction 

The SEC agreed with FINRA that

         The recency of Pedregon's conviction,

         The pendency of his probation through January 2017, and

         his failure to complete mandatory counseling militate against allowing Pedregon's re-entry into the securities entry at this time.

The SEC shared FINRA's concern about allowing persons serving probation to be associated with member firms. Because Pedregon has completed so little of the court-mandated counseling, he has done little to show successful rehabilitation. The therapist's progress report submitted by Pedregon rates his progress in therapy on thirteen factors, on a scale of zero (not applicable/unknown) to five (excellent). Pedregon received no rating higher than three, satisfactory, on any factor.

Inadequate Plan of Supervision

A supervisory plan for a person subject to statutory disqualification must provide for stringent supervision. For example, the SEC has stated that a supervisory plan lacks the necessary intensive scrutiny when the supervisor will not be in close, physical proximity to the statutorily disqualified person. Under PSEC's proposed plan, it appears that there would be no supervisor in proximity when Pedregon would be conducting branch office examinations, so Pedregon would not have the intensive scrutiny required because of his statutorily disqualified status. Other shortcomings pointed out by FINRA -- lack of specificity about the frequency of certain reviews and assignment of the unqualified Sugleris as Pedregon's supervisor in Murphy's absence -- were similarly troubling to the SEC. Although Murphy represented that he would develop a more detailed supervisory plan for Pedregon if Pedregon is permitted to associate with PSEC, the burden of proposing a suitable supervisory plan is on PSEC, and it cannot satisfy this burden by waiting until Pedregon is in the job to work out the details of the plan. The SEC agreed with FINRA that the supervisory plan was inadequate for the task.

The Role of Supervisor Murphy

The SEC also shared FINRA's concerns about whether Murphy would provide an appropriate level of supervision for Pedregon. The regulators believed that Murphy had devoted limited attention to structuring a supervisory plan for Pedregon. Although he elaborated on his original plan during and after the hearing, the plan remains vague and flawed. Moreover, Murphy's lack of commitment to thinking through these supervisory issues, as exemplified by his stated refusal to "spend a lot of time" working out the details of a supervision plan because he was "busy enough as it is," suggest that Murphy might not devote sufficient time and attention to supervising Pedregon.  

Pedregon's NASD Conduct

FINRA found that Pedregon's use of an obscene and derogatory term in reference to a firm under NASD examination in the presence of employees of the firm, and the indications that several of his colleagues considered his approach "overly aggressive," did not reflect favorably on Pedregon's character or judgment, or his ability to act professionally as PSEC's compliance officer. Pedregon argued that his examination of the firm uncovered various violations and irregularities, and that the firm was subsequently closed "because of Pedregon's attention to detail, investigative mentality, assertive approach, and steadfastness." He argued that rather than raising concerns about his conduct, his involvement in the examination should be viewed as demonstrating his commitment to the public interest.

The SEC found that FINRA appropriately concluded that Pedregon's behavior during the examination was questionable, even if his goals in conducting the examination were laudable. The SEC agreed that these facts are troubling, and that they further weigh against Pedregon's reentry into the securities industry as a statutorily disqualified person, especially when the proposed heightened supervision is inadequate. The SEC further observed that

Pedregon cites the examination that led to his being put on probation at NASD as evidence of his commitment to the public interest. As discussed, see supra note 34, we find that devotion to the public interest does not excuse Pedregon's "overly aggressive" approach and use of obscene language.


Footnote 40 (page 15 of SEC Opinion)

FINAL THOUGHTS  

Bill Singer's Comments: I would urge the regulatory community and the financial press to give far more consideration to the corrosive nature of overly aggressive, unprofessional regulation.  Please consider this memorable movie scene: 

WILLIAM ROPER: So, now you give the Devil the benefit of law!

SIR THOMAS MORE: Yes! What would you do? Cut a great road through the law to get after the Devil?

WILLIAM ROPER:
Yes, I'd cut down every law in England to do that!

SIR THOMAS MORE: Oh? And when the last law was down, and the Devil turned 'round on you, where would you hide, Roper, the laws all being flat? This country is planted thick with laws, from coast to coast, Man's laws, not God's! And if you cut them down, and you're just the man to do it, do you really think you could stand upright in the winds that would blow then? Yes, I'd give the Devil benefit of law, for my own safety's sake!


A Man for All Seasons (Columbia Pictures, 1966, play/screenplay Robert Bolt)