An irreverent Wall Street Blog
SEC Declines To Stay FINRA Bars Pending Appeal
March 11, 2015
Today's BrokeAndBroker.com Blog is
less about the facts in an underlying Financial Industry Regulatory Authority
("FINRA") regulatory case and more an examination of the mechanism by
which the self-regulatory organization's ("SRO's")
Bar is "stayed" pending an appeal to the Securities and
Exchange Commission ("SEC"). Although the appellate path from FINRA
to the SEC and ultimately the federal courts may hold out much promise, a
critical consideration for those who have been hit with long suspensions or
bars is whether they can continue to pursue their industry careers during the
pendency of the appeal. If a Stay of the challenged SRO sanctions is
not ordered by the SEC, individuals often find themselves unable to afford
ongoing legal representation with their financial lifeline cut or, in the
alternative, the winner of a Pyrrhic victory if they ultimately prevail on
their appeal but find that their book of business has evaporated during the
time it took to win a reversal or remand.
Case In
Point
On January 31, 2012, FINRA's
Department of Enforcement ("DOE") filed a Complaint against
Respondents William Scholander and Talman Harris, alleging, among other things,
that they had sold to their customers the securities of DEER, a Chinese
consumer products company listed on the NASDAQ, without disclosing to the
customers that they had previously received $350,000 from the company pursuant
to a consulting agreement. The complaint also alleged that the respondents had
engaged in outside business activities ("OBA") without disclosing
those activities to their member firm employer.
OHO
On August 16, 2013, a
Financial Industry Regulatory Authority ("FINRA") Office of Hearing Officers
("OHO") Hearing Panel Decision found Respondents William
Scholander and Talman guilty of two causes of
action:
- fraud in violation of Section 10(b) of the Securities Exchange Act of 1934, SEC Rule 10b-5, and FINRA Rules 2020 and 2010 and
- engaging in OBA without giving prior written notice to the firm that employed them, in violation of NASD Rule 3030 and FINRA Rule 2010.
The OHO
Decision dismissed a Third Cause of
Action alleging that Respondents violated NASD Rule 3110 and FINRA
Rule 2010 by causing a books and records violation is
dismissed.
For the fraud violation, FINRA
imposed upon each Respondent a Bar from associating with any
FINRA member firm in any capacity. For the OBA violation, FINRA would have
imposed upon each Respondent a $10,000 fine but declined to impose that
sanction in light of the Bar. FINRA
Department of Enforcement, Complainant, v. William
Scholander and Talman Harris,
Respondents (OHO
Decision, Disciplinary Proceeding 2009019108901, August 16, 2013).
NAC
On appeal to FINRA's
National Adjudicatory Council ("NAC"), that body affirmed the OHO findings and
sanctions. The NAC noted that a three-month suspension and a $15,000 fine per
respondent on the OBA charge would be deemed sufficient but declined to impose
such sanctions in light of the Bars. FINRA Department of
Enforcement, Complainant, v. William Scholander and Talman Harris,
Respondents
(NAC Decision, Disciplinary Proceeding 2009019108901,
December 29, 2014).
Oh, SEC,
Won't You Stay, Just A Little Bit
Longer
At this point, Scholander and Harris are each barred by FINRA after exhausting their
administrative remedies at the SRO. If they opt to pursue their next level of
appeals, namely, to the SEC, what happens if it takes the federal regulator a
year to adjudicate their appeal? What good would an ultimately favorable SEC
ruling do the respondents if, in the interim, they were out of business and
lost all of their clients? On the other hand, for the SEC to routinely
grant stays would be to potentially inflict bad actors upon the investing
public and, to a degree, become complicit in a game whereby appeals are filed
for no purpose beyond delaying the inevitable and potentially increasing the
list of victims.
SIDE BAR: For a fuller context of the underlying issues, here is the summary from the SEC:
FINRA made the following factual findings, which applicants do not dispute. Scholander and Harris entered the securities industry in the 1990s, and they worked together as partners at branch offices of various FINRA member firms since 2002. From March and May 2009, respectively, until February 2010, Scholander and Harris were associated with Seaboard Securities, Inc. During this period, applicants decided to acquire a broker-dealer and identified a prospective firm to purchase, which was then called Brentworth and Company, Inc.Applicants had longstanding business ties to two individuals, identified by FINRA as "Person 1" and "Person 2," who specialized in promoting the stocks of Chinese companies. In November 2009, while applicants were associated with Seaboard, one of the promoters organized a trip to China for Scholander and one of his associates. Scholander visited DEER's offices in China for approximately two hours. Before this trip, in 2008 and earlier in 2009, the promoters had promoted DEER's stock and the applicants had provided investment banking services, which are not at issue in this proceeding, to DEER regarding a private placement of the company's securities. But FINRA found that, during this trip and on conference calls with DEER, applicants provided only "very limited" services to DEER, including advice regarding the growth of DEER's business, its choice of an investment bank, and "what [DEER could] do to improve and appeal to the investors." On December 17, 2009, DEER wired a $350,000 fee for these services into a bank account that applicants had opened to assist in purchasing Brentworth.FINRA found that applicants used the $350,000 payment for various expenses connected to the purchase of their new broker-dealer, which they renamed First Merger Capital, Inc. and opened in February 2010. Applicants then left Seaboard and became associated with First Merger. FINRA found that, from February through November 2010, Scholander and Harris sold $961,852.68 in DEER securities to thirty-two First Merger customers. Scholander and Harris acknowledge that they did not disclose to these customers the $350,000 payment or their business relationship with DEER.. . .[I]n affirming the Hearing Panel's findings, the NAC found that "Scholander and Harris were among the primary beneficiaries of the $350,000 payment [from DEER]" and that their receipt of the payment was material information they were required to disclose to their customers.The NAC cited Kevin D. Kunz, in which the Commission found that the existence of a consulting agreement pursuant to which a broker received payments from an issuer whose securities the broker recommended to customers "would have been material to any prospective investor" because "[w]hen a broker-dealer has a self-interest (other than the regular expectation of a commission) in serving the issuer that could influence its recommendation, it is material and should be disclosed."2 The NAC found that applicants acted with the requisite scienter by acting "at least recklessly," stating that applicants' "ongoing business relationship with DEER gave them obvious conflicts of interest that had the potential to influence their decision of what securities to recommend to their customers." According to the NAC, the failure to disclose this information when recommending the securities was "a highly unreasonable omission that presented a danger of misleading customers."The NAC found that several aggravating factors applied to applicants' misconduct and that there were no mitigating factors. As a result, the NAC sustained the Hearing Panel's bar of both applicants in all capacities, which it found was an appropriate sanction "to remedy [applicants'] violations, protect investors, and deter others from engaging in similar misconduct."
Pages 2 - 3 of the SEC Order. In the Matter of the Application of Williaml Scholander and Talman Harris for Review of Action Taken by FINRA (Order Denying Stay, '34 Act Release 74437, Admin. Proce File 3-16360 / March 4, 2015).
On appeal to the SEC,
Respondents Scholander and Harris sought a Stay from the SEC
of the FINRA Bars pending their appeals. FINRA opposed the
requested Stays.
And now
a brief music interlude from Wall Street regulators Frankie Valli and The Four
Seasons:
3 Likelihoods and 1
Public Interest
The SEC's Stay Test
essentially
is composed of three "likelihood" considerations and one public
interest component. In considering the requested stay of the
Bars, the SEC offers
this [Ed: footnotes omitted]:
Page 3 of the SEC OrderANALYSISThe Commission considers the following in determining whether to grant applicants' motion for a stay: (1) the likelihood that movants will succeed on the merits of their appeal (2) the likelihood that movants will suffer irreparable harm without a stay (3) the likelihood that another party will suffer substantial harm as a result of a stay and (4) a stay's impact on the public interest. Applicants have the burden of establishing that a stay is warranted. For the reasons discussed below, applicants have not met this burden.
Upon review, the threshold to
obtain a Stay from the SEC is daunting. Those seeking that
relief must show a "likelihood" that they will succeed on the merits
of their appeal. Think about it. You've likely lost twice at FINRA --
at the OHO and NAC levels -- before appealing to the SEC and now you are
admonished that in order to secure a Stay, you have to show
that you will likely succeed on the merits of your appeal. Worse, there are
three additional considerations and they are all joined by an "and"
and not an "or."
The second prong of the SEC's
Stay Test is that you must show another likelihood that if
the Stay is not granted, that you will suffer
irreparable harm. Not just harm.
Irreparable harm -- as in if FINRA's
Bar is not stayed, you
will be harmed to such a degree that even if you were to win on
appeal, the damage of having left the Bar in place during the
appeal would be so devastating that even after a victory on
appeal, it would be a harm beyond undoing. We're talking lights out. Lock the
door behind you. Departure from a point of no
return.
The third
"likelihood" circumstance is whether the SEC will draw a negative
inference from the mirror-image of your situation: If the Stay is granted,
is there a "likelihood" that another party will suffer substantial
harm. Note that in this prong the harm is not "irreparable"
but a lesser standard of "substantial."
Last but certainly
not least, the SEC considers the impact upon the public of granting the
Stay. This is the so-called 'public interest"
mandate.
SEC Checks
Its Test
In parsing through
the Stay
Test,
the SEC determined that the Scholander and Harris had failed to show a
likelihood of success on the merits of their appeal. In reaching that
conclusion, the SEC characterized appellants' arguments as raising matters
previously posed to both the OHO and NAC without success -- and the SEC notes
that FINRA's prior decisions seem on sound footing. As many lawyers who handle
these types of appeals to the SEC know, you can't merely regurgitate your same
arguments at FINRA and expect that such an effort will make a strong showing
that this time, before the SEC, you're going to prevail on the merits. That
being said, you still have to go through that re-play in order to present your
appeal.
In further
eviscerating appellants' "likelihood of success on the merits"
burden, the SEC noted that Scholander and Harris had admitted their
non-disclosure of the agreement to their customers. Since the non-disclosure
was viewed as the guts of FINRA's case, that's a tough finding to overcome. On
the other hand, appellants claimed that their non-disclosure was not
material. They further asserted that even their duty to disclose wasn't a
clear-cut fact. The SEC short-circuited those arguments by noting that the
cited disclosure was a material issue because the conduct arose
"in
connection with" the purchase/sale of securities. Further, the SEC raised an
institutional eyebrow in disbelief as to the suggestion that appellants had no
conflict of interest inherent in the cited transaction when they failed to
disclose the agreement with the issuer to the buyers (and the SEC further
suggested that a reasonable buyer would have
wanted to know about the terms of the agreement).
Assuming that the
appellants wanted to assert that their misconduct was accidental or negligent
but not intentional, the SEC cited to the key finding by FINRA that the
misconduct occurred with "scienter." Working through the other arguments for a Stay, the SEC
then made quick work of appellants' fall-back position that FINRA's
Bars were excessive or oppressive because the SEC saw no
likelihood that such could be proven and seemed satisfied that the SRO had
imposed reasonable sanctions under the
circumstances.
Although appellants asserted
that the un-stayed Bars would cause financial
detriment and/or reputational harm, the SEC rejected that argument and held
that mere harm did not rise to the standard of irreparable
injury. Finally,
in denying the Stay, the SEC found that the public interest was served by
maintaining the sanctions in place during the
appeal.
Bill Singer's
Comment
Respondents certainly seem to
have gotten their money's worth from their legal counsel. The FINRA
Complaint was filed in January 2012, which likely means that
the investigation began in 2010 or 2011, and that the underlying matters likely
went back to 2009 or earlier. In terms of the strategy and tactics of defense,
respondents "gained" about three years by opting to contest (rather
than settle) FINRA's January 2012 Complaint through the
SEC's March 2015 denial of the request for a stay. Keep in mind, however, that
appellants may yet prevail on their appeal and win from the SEC a remand or
reversal -- what is lost at this juncture is the ability for Scholander and
Harris to remain in the industry pending the SEC's decision on their
appeal.
Is there a point or advantage to
fighting what you may deem a losing cause? Cynically, the answer is
"yes." By demanding a hearing and exhausting your administrative remedies,
you put into play two different
strategies:
- You may prompt a better settlement offer. By clearly and unequivocally sending the message to a regulator that you intend to climb into the ring and duke it out until the final round, what was conveyed to you as a take-it-or-leave-it last offer of, say a Bar and $50,000 fine, may amazingly be reduced to 18 months and $25,000 -- and if that alchemy does not occur months or weeks before the first hearing session, it may amazingly be offered to you in the hallway outside the first day's hearing or sometime after opening statements.
- You delay the inevitable. This option troubles public advocates, and for good reason. It's gaming the system. It's the cold math that many bad actors use when realizing that they've been caught and don't have much (if any) excuse but, hey, if I could only buy some more time . . . say another year or so. Wow, could I go out with a bang!
I'm not here to sugar coat
anything. Readers of the BrokeAndBroker Blog tend to
appreciate my cynicism and honesty, both of which come after over three decades
on the Street representing the industry, the investing public, and
whistleblowers. Like it or not, defendants/respondents are entitled to exhaust
their administrative remedies. The challenge for regulators is to
discern those cases where it's better to sweep the perceived garbage off the
Street quickly, even if it's only for a year or so rather than a Bar.
In some case -- in many cases -- regulators may themselves feel boxed
in with no choice but to also get into the ring and fight till the last clang
of the bell, even if it means that some bad guys get to run up the numbers of
victims in the interim.
Savvy and intelligent regulators
recognize that you can't try every case and that a triage of sorts is necessary
to maintain adequate resources and assets. Similarly, defense lawyers also know
that there are some cases that are simply unwinnable, no matter how clever you
are or how much an hour your client will pay. The dynamic and tension within
the separate considerations and mandates of regulators and defense lawyers is
what keeps the system moving or grinds it to a standstill.
READ:
FINRA
Department of Enforcement, Complainant, v. William
Scholander and Talman Harris,
Respondents (OHO
Decision, Disciplinary Proceeding 2009019108901, August 16,
2013)
FINRA Department of
Enforcement, Complainant, v. William Scholander and Talman Harris,
Respondents
(NAC Decision, Disciplinary Proceeding 2009019108901,
December 29, 2014)
In the Matter of the
Application of William Scholander and Talman Harris for Review of Action Taken
by FINRA (Order
Denying Stay, '34 Act Release, 74437 Admin. Proc. File 3-16360 / March
4, 2015)