FINRA Moves to Dismiss Spoliation Claims

May 5, 2015

As reported in "FINRA Named As Defendant In Case Alleging Altered Electronic Files" ( Blog, April 24, 2015), iThaddeus J. North and Mark P. Pompeo, Platintiffs, v. Smarsh, Inc. and Financial Industry Regulatory Authority/Department of Enforcement, Defendants (Complaint, DDC, 15-CV-00494, April 6, 2015), Plaintiffs North and Pompeo sought at least $3,000,000 in damages and relief against Defendants Smarsh and FINRA for spoliation, tampering and destruction of evidence and to prevent use of such spoliated and tampered evidence.

NOTE: Defendants in a civil lawsuit are presumed innocent unless and until proven guilty by a preponderance of the evidence in a court of law.

FINRA Motion To Dismiss

On April 29, 2015, Defendant FINRA filed a Motion to Dismiss the Complaint. As set forth in FINRA's Memorandum of Points and Authorities In Support of the Motion to DismissAs set forth in the self-regulatory organization's Memorandum in Footnote 2:

This is not the first time Mr. North and his counsel have prematurely and improperly sought to enjoin these FINRA disciplinary proceedings. On December 10, 2014, in an action styled "In re Thaddeus J. North", United States Court of Appeals for the D.C. Circuit, Case No. 14-1274, Mr. North filed an "Emergency Petition for Mandamus, Temporary and Permanent Injunctive Relief, and Stay of Proceedings Before the Financial Industry Regulatory Authority." The Petition challenged the determinations of two separate FINRA Hearing Officers in the FINRA cases regarding the same allegedly spoliated records at issue in the current Complaint, and sought to permanently enjoin the FINRA cases. The next day, on December 11, 2014, the Appeals Court Ordered that the Petition be denied finding that mandamus relief was not warranted. See December 11, 2014 Order, attached as Exhibit 1.

Further, FINRA argues that dismissal is compelled for the following reasons:
  1. This Court lacks subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1) and 12(h)(3) because the Exchange Act provides the exclusive judicial remedy for complaints arising from FINRA disciplinary proceedings and requires Plaintiffs to exhaust their administrative remedies. 15 U.S.C. § 78s, 78y; See Marchiano v. NASD, Inc., 134 F.Supp.2d 90 (D. D.C. 2001); see also McGinn, Smith & Co.. Inc. v. FINRA, 786 F.Supp. 2d 139, 146 (D. D.C. 2011).
  2.  FINRA "is absolutely immune from suit for the improper performance of regulatory, adjudicatory, or prosecutorial duties delegated by the SEC." In re Series 7 Broker Qualification Exam Scoring Litigation, 548 F.3d 110, 114 (D.C. Cir. 2008). No court has ever allowed tort claims to proceed against FINRA related to its enforcement duties under the Exchange Act.
  3. Neither the Exchange Act, nor any provision of the federal securities laws expressly provides for a cause of action against an SRO like FINRA for acts or omissions in connection with its regulatory duties. See, e.g., In re Series 7 Broker Qualification Exam Scoring Litigation, supra, 548 F.3d at 115 ("The elaboration of duties, allowance of delegation and oversight by the SEC, and multi-layered system of review show Congress's desire to protect SROs from liability for common law suits").
  4. Even if such a claim were viable, Plaintiffs fail to state a claim of "negligent spoliation" claim against FINRA. See Cook v. Children's National Medical Center, 810 F.Supp. 2d 151, 155 (D. D.C. 2011); see also Holmes v. Amerex Rent-A-Car, 180 F.3d 294, 297 (D.C. Cir. 1999).
Non-Existant Tort

In substantively addressing the spoliation claims, FINRA's Memo asserts that:

[T]he crux of the negligent spoliation claim against FINRA is that it somehow "contributed to" the spoliation of emails maintained by Smarsh solely because FINRA requested those emails "in a "special format", e.g. ".pst." Complaint, ¶34. Specifically, the Complaint alleges "Enforcement also had a duty to avoid spoliation to ESI, however, by and through its agents and employees, FINRA negligently contributed to the spoliation during the examination and investigations of Southridge and Ocean Cross by requiring that electronic communications be converted and delivered in .pst format, non-native to Bloomberg communications and certain other email programs." Complaint, ¶92. Not only does this paragraph seem to plead the nonexistent tort of "contribution to spoliation", but on its face fails as FINRA had no duty to request emails in native format. FINRA did not own, maintain, or control these emails. As a regulator, FINRA made a routine request to the firms' email vendor to obtain emails in .pst file format.

Requesting emails in ".pst" format is far from "special" as Plaintiffs contend - rather, it is usual and customary: "Email is not typically produced in native file format because the extraction of individual emails from a large database containing other emails requires conversion of the file format into a near-native format." 1-37A Moore's Federal Practice - Civil § 37A.43(1) (3d ed. 2015). "Collections of entire sets of emails, often stored in networked servers, can be extracted in a PST or NSF format, i.e., file extensions.pst or .nsf." Id. at § 37A.43(2). Like FINRA, the SEC also often requests emails in .pst file format. See Division of Enforcement, Enforcement Manual, § ("Format for Electronic Production of Documents to the SEC") specifically provides that SEC staff may accept emails in .pst file format.10 FINRA owed no duty to Plaintiffs to request data from their firms' email vendor in a native file format. Even if the allegations of the Complaint could be considered, Plaintiffs' negligent spoliation claim against FINRA is so untenable that it fails as a matter of law.

Pages 24 - 25 of FINRA Memorandum

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