In 2010, the Financial Industry Regulatory Authority ("FINRA") investigated its member firm Marquis Financial Services, Inc., Marquis' associated person/officer/control person Gregory Evan Goldstein, and the firm's employees in connection with purportedly suspicious penny stock trading. During the investigation, FINRA apparently learned that since at least 2005, Goldstein had been operating Wall Street At Home.com, which the regulator characterizes as an outside consulting business. FINRA asserts the following relationships:
At a January 9, 2012, On-The-Record interview ("OTR"), FINRA staff asked Goldstein about his Wall Street at Home activities, to which he testified that he did consulting work by conducting "due diligence" to determine whether companies were "viable." Apparently, FINRA believed that Goldstein had failed to disclose his outside business activity in violation of FINRA Rule 3270. Notwithstanding his responses to various queries, FINRA asserts that Goldstein declined to:
After the interview, FINRA sent a Rule 8210 request to Goldstein demanding that he respond to the three requests noted above plus information/documents showing the compensation that he and/or Wall Street at Home had received. Through counsel, Goldstein refused to respond asserting that FINRA did not have the authority to require an associated person to produce documents relating to a third party.
On March 13, 2012, pursuant to Rule 9552: Failure to Provide Information or Keep Information Current, FINRA staff issued a Notice of Suspension to Goldstein that would become effective unless he complied with the Rule 8210 requests by April 6, 2012. In response, Goldstein requested an expedited hearing on the matter.
In a decision dated January 4, 2013, a hearing panel found that FINRA had jurisdiction to seek information regarding Goldstein's outside business activities for purposes of Rule 8210 because:
As a result of the above findings, FINRA ordered Goldstein to reply to all outstanding Rule 8210 information requests within twenty-one days of the date of the decision. Goldstein was warned that his further non-compliance would result in his suspension from associating with any member firm in any capacity. Moreover, if Goldstein did not fully comply with the requests within three months of the decision, his suspension would automatically convert to a Bar and he would be fined $50,000.
On January 22, 2013, Goldstein filed an application for review with the Securities And Exchange Commission ("SEC") together with a motion to stay the imposition of sanctions. In the Matter of the Application of Gregory Evan Goldstein For Review of Action Taken by FINRA (Securities And Exchange Commission, Order Denying Stay, '34 Act Release 68904; Admin. Proc. File # 3-15183, February 11, 2013).
In considering the request for a stay, the SEC noted that in addition to it's obligation to consider the impact of the requested stay upon the public, Goldstein had the burden to demonstrate the likelihood that:
In addressing those considerations, Goldstein argued that he was likely to succeed on the merits of his appeal. Goldstein cast FINRA's objectionable demands as part of an impermissible fishing expedition - one in which the self-regulatory organization ("SRO") improperly sought his production of documents and information about an unrelated third party and violated his due process rights. Goldstein asserted that without a stay, FINRA's sanctions would irreparably injure him because it would prevent his continued securities industry employment, which he has enjoyed for many years.
While agreeing that FINRA's Rule 8210 scope is not unlimited, the SEC pointedly characterized the SRO's requests to Goldstein as "not even close to those limits." Further, the SEC rejected Goldstein's depiction of FINRA seeking information from an unrelated third party and, in contradistinction, viewed the dispute through the prism that Goldstein was an associated person who had acknowledged being in possession, custody and control materials sought. The SEC dismissed the effort to portray Wall Street at Home an unrelated third party - the federal regulator saw the firm as being closely tied to both Goldstein and Marquis.
In noting that FINRA had recently amended its Rule 8210 to embrace the standard of "possession, custody or control," the SEC determined that Goldstein satisfied one or more of those three prongs. To the extent that Goldstein was arguing that FINRA was precluded from making such a demand pertaining to records of an unrelated third party, the SEC rejected that premise.
SIDE BAR: What's all this fuss about possession or custody or control? In The Matter of the Application of Jay Alan Ochanpaugh For a Review of Disciplinary Action Taken by NASD (Securities and Exchange Commission Opinion, Exchange Act Release No. 54363, Aug. 25, 2006), the NASD barred Ochanpaugh for failing to produce copies of checks drawn on the account of a church with which he was associated in alleged violation of NASD Rule 8210.
In declining to produce the demanded checks, Ochanpaugh asserted that the checks were the church's property, that the church was not an NASD member, and, accordingly, NASD had no right to them. Further, the church's leadership relied on their First Amendment rights and their obligations under their covenant, and refused to violate their members' privacy by producing the checks.
On appeal, the SEC set aside the Bar and hearing costs. In reaching that decision, the SEC found [footnotes omitted]:
[T]he Articles identify Ochanpaugh's authority, as president, to control all aspects of Wisdom Mission's operations, and the signature card suggests that Ochanpaugh may be a person with some control over Wisdom Mission's account. On the other hand, NASD had evidence that, as a matter of practice, Ochanpaugh did not in fact have absolute control over Wisdom Mission. He was not free to release confidential information about members on his own. Ochanpaugh testified without contradiction that he was a pastor and counselor who was insulated from any contact with Wisdom Mission's financial operations and who was not permitted to open bank correspondence delivered to his post office box. The letters from Grell and Juergens corroborate Ochanpaugh's testimony. Because NASD has not established that Ochanpaugh does possess and control the requested checks, we need not address whether possession and control suffice to make the requested checks "books, records, and accounts of' Ochanpaugh for purposes of Rule 8210.
Because we find that NASD did not establish that its request for copies of checks drawn against Wisdom Mission's checking account was within the scope of its authority pursuant to Rule 8210, we do not find that Ochanpaugh violated that Rule by failing to produce the checks, and we set aside this proceeding and NASD's order barring Ochanpaugh and assessing costs against himů
The SEC yet again admonished, as it has often done so in the past, that non-compliance with FINRA's Rule 8210 demands "subverts" the SRO's ability to regulate. In characterizing the Goldstein investigation, the SEC portrayed FINRA as seeking information related to potentially serious securities violations, including selling away, front running, market timing, and fraud - and the federal regulator also added that Goldstein had failed to report his outside business activity at Wall Street at Home in apparent violation of Rule 3270. Taking those factors into consideration, the SEC perceived the risk of harm if it allowed Goldstein to continue participating in the industry pending his appeal.
In the end, the SEC denied the requested stay and directed Goldstein to what it deemed the most expedient resolution of the suspension and asserted harm: Comply with FINRA's requests before the deadline of February 15, 2013. Reduced to its basics, the SEC didn't view Wall Street at Home as an entity "unrelated" to Goldstein and found that Goldstein evidenced possession, custody, or control of the documents sought by FINRA.
Bill Singer's Comment
The SEC recently approved amendments to FINRA Rule 8210, and those changes will become effective on February 25, 2013. In general, Rule 8210 is a powerful tool in FINRA's arsenal as a regulator because it essentially gives the SRO unfettered right to inspect and copy the books, records, and accounts of member firms, associated persons and other persons over whom it has jurisdiction. As codified in the new version of the rule, FINRA has the right to demand the production of documents in the "possession, custody or control" of firms and persons subject to its jurisdiction.
As such, an entity or individual subject to FINRA's jurisdiction may have to provide records that they have the legal right, authority or ability to obtain upon demand - even if that document is not in the subject's possession or custody. If the subject of the demand has "control" of the document sought, that may be sufficient for FINRA to insist it be produced, regardless of the nature of the third party where the document resides. Bottom line, the SRO asserts that all aspects of the relationship between a broker-dealer and its associated persons are potentially subject to Rule 8210 demands.
A controversial aspect of the amended Rule 8210 is that it grants FINRA the ability to serve a demand on the attorney for a member firm, associated person or person subject to FINRA's jurisdiction. If FINRA staff or an adjudicator knows that a firm, associated person or person subject to FINRA's jurisdiction is represented by counsel regarding the matter in question, notice of a Rule 8210 request will be provided to counsel rather than to the client. This proposition puts the onus on the subject entity or individual to clearly and timely indicate to FINRA when they are being represented by an attorney.
I would urge all FINRA member firms and associated persons to read and then re-read FINRANotice to Members 13-06: FINRA's Information and Testimony Requests / SEC Approves Amendments to Rule 8210 / Effective Date: February 25, 2013. Here is the amended rule with new language underlined:
8210. Provision of Information and Testimony and Inspection and Copying of Books
(a) Authority of Adjudicator and FINRA Staff
For the purpose of an investigation, complaint, examination, or proceeding authorized by the FINRA By-Laws or rules, an Adjudicator or FINRA staff shall have the right to:
(1) require a member, person associated with a member, or any other person subject to FINRA's jurisdiction to provide information orally, in writing, or electronically (if the requested information is, or is required to be, maintained in electronic form) and to testify at a location specified by FINRA staff, under oath or affirmation administered by a court reporter or a notary public if requested, with respect to any matter involved in the investigation, complaint, examination, or proceeding; and
(2) inspect and copy the books, records, and accounts of such member or person with respect to any matter involved in the investigation, complaint, examination, or proceeding that is in such member's or person's possession, custody or control.
(b) through (c) No Change.
A notice under this Rule shall be deemed received by the member or currently or formerly registeredperson to whom it is directed by mailing or otherwise transmitting the notice to the last known business address of the member or the last known residential address of the person as reflected in the Central Registration Depository. With respect to a person who is currently associated with a member in an unregistered capacity, a notice under this Rule shall be deemed received by the person by mailing or otherwise transmitting the notice to the last known business address of the member as reflected in the Central Registration Depository. With respect to a person subject to FINRA's jurisdiction who was formerly associated with a member in an unregistered capacity, a notice under this Rule shall be deemed received by the person upon personal service, as set forth in Rule 9134(a)(1). If the Adjudicator or FINRA staff responsible for mailing or otherwise transmitting the notice to the member or person has actual knowledge that the address in the Central Registration Depository is out of date or inaccurate, then a copy of the notice shall be mailed or otherwise transmitted to:
(1) the last known business address of the member or the last known residential address of the person as reflected in the Central Registration Depository; and
(2) any other more current address of the member or the person known to the Adjudicator or FINRA staff who is responsible for mailing or otherwise transmitting the notice.
If the Adjudicator or FINRA staff responsible for mailing or otherwise transmitting the notice to the member or person knows that the member or person is represented by counsel regarding the investigation, complaint, examination, or proceeding that is the subject of the notice, then the notice shall be served upon counsel by mailing or otherwise transmitting the notice to the counsel in lieu of the member or person, and any notice served upon counsel shall be deemed received by the member or person.
(e) through (g) No Change.
***Supplementary Material ***
.01 Books and Records Relating to Investigations. This rule requires FINRA members, associated persons and persons subject to FINRA's jurisdiction to provide FINRA staff and adjudicators with requested books, records and accounts. In specifying the books, records and accounts "of such member or person," paragraph (a) of the rule refers to books, records and accounts that the broker-dealer or its associated persons make or keep relating to its operation as a broker-dealer or relating to the person's association with the member. This includes but is not limited to records relating to a FINRA investigation of outside business activities, private securities transactions or possible violations of just and equitable principles of trade, as well as other FINRA rules, MSRB rules, and the federal securities laws. It does not ordinarily include books and records that are in the possession, custody or control of a member or associated person, but whose bona fide ownership is held by an independent third party and the records are unrelated to the business of the member. The rule requires, however, that a FINRA member, associated person, or person subject to FINRA's jurisdiction must make available its books, records or accounts when these books, records or accounts are in the possession of another person or entity, such as a professional service provider, but the FINRA member, associated person or person subject to FINRA's jurisdiction controls or has a right to demand them.
In a vacuum, you might say that this is all so much legal mumbo jumbo - the legalese that few understand and far too many don't care about. Why do these changes matter? Why should you be concerned or troubled by FINRA's attempt to expand its apparent jurisdiction to materials in the hands of third parties. Well, how about I let the SEC's own words in Goldstein deliver a far more chilling frisson than I could:
[G]oldstein also appears unlikely to succeed on his due process claims because, as FINRA correctly observes, FINRA is not a state actor and is required only to "provide a fair procedure for the disciplining of members and persons associated with members."
You got that? Is that clear enough for you? There is no due process at FINRA. No . . . Due . . . Process. Because FINRA is not a governmental actor it is not subject to federal or state due process. Of course, geez, how nice that FINRA cites to so many federal and state rules and statutes in its proceedings and appeals.
And how nice that FINRA arrogates to itself the convenience of service on legal counsel in lieu of its member firms or associated persons - apparently without first confirming that such a relationship exists. Frankly, I can't wait to see the challenges on appeal to such service when the law firm previously represented a client but not presently; or there is an ongoing fee dispute and the law firm refuses to communicate with the SRO; or the associated person wasn't exactly informed that his or her employer had designated its in-house or outside counsel to accept service for the employee.
What if FINRA demands production of you joint tax return but your spouse doesn't want to disclose his/her confidential financial information?
What if you don't have possession or custody of records such as old phone bills, old bank statements, etc. but FINRA insists that you fill out a form authorizing the copying by and the release from the entities where you did business?
What if, you know, somehow, a federal or state agency that can't obtain certain third-party documents from you because of your due process rights gets a gander at the materials in FINRA's possession?
Ahh . . . so now you understand what's at stake here.