SEC Declines To Stay FINRA Bars Pending Appeal

March 11, 2015

Today's 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.


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:
  1. 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
  2. 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).


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]:

The 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.
Page 3 of the SEC Order

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:
  1. 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.

  2. 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.


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)