Did a Federal Court Mistakenly Deem FINRA a Federal Prosecutor?

January 24, 2020

After a seven-week trial in the United States District Court for the Northern District of California ("NDCA"), Defendant Melvin Shields was found guilty on 32 counts including conspiracy, wire fraud, bank fraud, securities fraud, and making false statements to a bank; and said conviction was affirmed by the United States Court of Appeals for the Ninth Circuit. United States of America, Plaintiff, v. Melvin Russell "Rusty" Shields, Defendant (Order Denying Defendant's Motion, 12-CR-00410, 17-CV-03978 / January 21, 2020) 
http://brokeandbroker.com/PDF/ShieldsOrderNDCA200121.pdf. After his conviction, Shields sought an evidentiary hearing and the ability to supplement the record, and, in response, NDCA denied the former and granted the latter. 

For the purposes of today's blog, the facts and history of Shields' prosecution is not important -- you are invited to peruse the NDCA Order for the details. What is of interest today is the following reference in the Order [Ed: emphasis added]:

[T]he Government called thirty-eight witnesses, including victims who testified about their dealings with S3 Partners and their losses; Kathryn Comer, the bookkeeper for S3 Partners, who testified about money flow; Stafford, who pled guilty to conspiracy with Shields and Sims and testified about the S3 Partners' dealings; and Thomas Carocci, an attorney with the Financial Industry Regulatory Association ("FINRA"), a private organization funded by the securities industry that investigates and regulates white collar crime.

Page 4 of the NDCA Order 

I applaud the federal court for its spot-on characterization of FINRA as "a private organization funded by the securities industry." All public-customer advocates and those who defend the industry's associated persons should frequently cite in boldface, upper-case, 16-point type, the Court's somewhat pejorative characterization. Indeed, FINRA is not a governmental organization, but, as the Court so aptly notes, "a private organization." Moreover, FINRA is a private organization that is "funded by the securities industry," which certainly places the self-regulatory-organization in the proper light. 

Some might call FINRA the lap-dog of its large, member firms. 

Some might call FINRA a glorified trade group. 

I've heard FINRA called worse -- in fact, if memory serves me, I've actually grumbled some nasty slams of my own. Be that as it may, NDCA captured FINRA's true essence as a private organization funded by vested, industry interests. Unfortunately, the Court bungled its characterization of FINRA when is said that the organization "investigates and regulates white collar crime." White collar crime? Crime? FINRA not a criminal investigator, which would require it to be either a state or federal prosecutor/regulator. Similarly, FINRA is only permitted to impose regulatory sanctions and is pointedly not allowed to impose criminal penalties. That distinction is not esoteric. It is critical. Among the reasons that the private-government/regulatory-criminal distinction is important is because the burden of proof for criminal convictions is "beyond a reasonable doubt," whereas FINRA's burden is only "by a preponderance of the evidence." Further, as a private actor, FINRA does not afford respondents constitutional Due Process, does not recognize the assertion of the Fifth Amendment, does not recognize statutes of limitation, and is not bound by State or Federal rules of procedure.

If nothing else, NDCA may have inadvertently given Shields yet another basis for appeal; namely, that the Court entertained the testimony of witness Thomas Carocci, Esq. as if he were empowered to investigate and regulate white collar crime. I would argue that Carocci is not. He is not a federal prosecutor. He is not a state prosecutor. He is not a county prosecutor. He is not a district attorney. Mr. Carocci is merely an employee of a "private organization funded by the securities industry" -- one would no more ascribe the role of an attorney for the Better Business Bureau with that of investigating and prosecuting white collar crime. 

To drive the point home, consider  In the Matter of Department of Enforcement, Complainant, v. Robert R. Tweed, Respondent (FINRA National Adjudicatory Council Decision, Complaint No. 2015046631101 / December 11, 2019)
%20Robert%20R.%20Tweed%20CRD%202339324%20%20NAC%20Decision%20va.pdf, in which FINRA's NAC clearly states on Page 11 of its Decision that:

Tweed argues that the Hearing Panel erred in finding that the statute of limitations does not apply because, according to Tweed, "FINRA disciplinary decisions are appealable to the Securities and Exchange Commission and the United States Courts of Appeal[s], which make them governmental or, at the very least, quasi-governmental actions subject to "the statute of limitations. The SEC previously has considered and rejected this argument, finding that FINRA is not a governmental entity and therefore not bound by any statutory limitations period. See, e.g., William J Murphy, Exchange Act Release No. 69923, 2013 SEC LEXIS 1933, at *92-93 (July 2, 2013) ("But [Section] 2462 does not apply to FINRA disciplinary proceedings because FINRA is not a government entity. Indeed, we have repeatedly held that 'the disciplinary authority of private self-regulatory organizations (`SROs') such as [FINRA] is not subject to any statute of limitation."), aff'd sub nom. Birkelbach v. SEC, 751 F.3d 472 (7th Cir. 2014). 

The conflation of FINRA's private-industry-funded role with that of a government investigator/regulator/prosecutor is becoming increasingly problematic. As set forth in the Syllabus in Shawn Kristi Dicken, Petitioner, v. Shawn Brewer, Respondent  (Opinion and Order, United States District Court for the Eastern District of Michigan, 19-CV-11676  December 9, 2019)

Shawn Kristi Dicken, ("Petitioner"), confined at the Huron Valley Women's Correctional Facility in Ypsilanti, Michigan, filed a petition for a writ of habeas corpus pursuant to 28 U.S.C. § 2254 through her attorney F. Randall Karfonta. Petitioner challenges her conviction for conducting a criminal enterprise, Mich. Comp. Laws § 750.159i(1); embezzlement from a vulnerable adult, $50,000 or more but less than $100,000, Mich. Comp. Laws § 750.174a(6)(a); and seven counts of obtaining money by false pretenses, $1,000 or more but less than $20,000, Mich. Comp. Laws § 750.218(4)(a). Petitioner was sentenced to concurrent prison terms of 140 months to 20 years for the criminal enterprise conviction, 23 months to 5 years for each false pretenses conviction, and 71 months to 15 years for the embezzlement conviction. For the reasons that follow, the petition for writ of habeas corpus is DENIED WITH PREJUDICE.

As set forth in part in the EDMI Opinion/Order [Ed; emphasis added]:

Petitioner seeks a writ of habeas corpus on the following grounds: 

I. In a fraud case where the issue was Defendant's disclosure to clients and unlawful and illegal intent, Defendant was denied fundamentally fair discovery of the investigation of the business entities in the case including a clearly intentionally and important Brady v Maryland violation. 

II. Improper expert opinion as to evidence that "is not a defense" and opinion as to the meaning of federal statu[t]es and regulations is plain error[.] 

III. Recordings of Shawn Dicken's testimony before the FINRA state investigative agency are required evidence showing her lack of intent to defraud. 

IV. Where the charge is embezzlement from a vulnerable adult, prosecutorial arguments and evidence that the power of attorney in the case was the equivalent of legal incapacity denied Defendant a fair trial and due process of law. 

The FINRA state investigative agency! 

The FINRA state investigative agency? 

Frankly, I'm not quite sure what to even make of that characterization, which is repeated in the EDMI Opinion as follows [Ed: emphasis added]:

Petitioner next contends that the trial judge violated her right to present a defense when he refused to allow defense counsel to play petitioner's entire seventy five minute tape recorded interview with state investigators with the Financial Industry Regulatory Authority [FINRA]. Petitioner claims that this tape recording would show that she cooperated with state investigators, so as to negate any criminal intent on her part. Petitioner also claims that the statements that she made during the interview showed that she did not have the intent to defraud her victims.

Within a span of about a month, we have a federal court deeming FINRA to be investigating and regulating white collar crime, and we have a state court deeming FINRA to be a state investigative agency. Without question, it's time for the courts to be clear that FINRA is NOT a governmental actor -- or at least it's not supposed to be. If FINRA is contributing to the false impression that it is somehow a federal or state regulator/prosecutor, that must stop. 

I have long called for the decertification of FINRA as a so-called self-regulatory-organization under the 1938 Maloney Act. In a frequently cited speech by Francis A. Bonner to the 1938 Annual Convention of the Investment Bankers Association of America  https://www.sec.gov/news/speech/1938/102838bonner.pdf, he offered this observation about the newly-launched scheme of Wall Street self-regulation:

Some have criticized, perhaps some still do, the kind of regulation envisioned here, in view of the Commission's supervisory powers, Yet they could hardly have expected repeal of the Securities Exchange Act as it relates to our business, and that is what an unsupervised form would have represented. Let us be realistic. We have an opportunity here to set up our rules of business conduct under a system of business penalties -- far preferable, is it not, to Commission regulations covering the same field, enforceable through criminal penalties, The process, I think you will find, is parallel to the governmental supervision now existing over the stock exchanges. Governmental controls, moreover, must provide the essential safeguards to prevent discriminatory, monopolistic, or other unfair tendencies.

Eighty-one years ago, the 1938 Maloney Act launched the self-regulation of Wall Street -- first by the National Association of Securities Dealers ("NASD") and now, in part,  by the Financial Industry Regulatory Authority ("FINRA"). From its inception, the Act was criticized as an opportunity for Wall Street "to set up our rules of business conduct." After all, in those days, many blamed Wall Street for the deprivations of the Great Depression. A devil's bargain seemed to have been struck in which the securities industry did, indeed, set up its own regulatory rules that envisioned so-called "business" rather than "criminal" penalties. It was a fascinating experiment in a private-sector-public-sector partnership. My appraisal is that it failed, and did so miserably, and continues to fail in its core mission of both protecting public investors and ensuring that purported industry rules of conduct are fairly enforced and reasonably sanctioned. 

As a libertarian, I favor any public role in regulation; and as such, I have often called for the demolition of self-regulation of the industry by the industry in favor of private-sector-regulation of the industry by a broad constituency that would rightfully include public customers, issuers, associated persons, member firms, and regulators. My animosity to FINRA's brand of self regulation is only heightened when I see state and federal courts ascribing governmental roles replete with purported criminal powers to a trade group that is beholden only to its member firms. Not my words. That's what a court said. The Financial Industry Regulatory Association ("FINRA"), a private organization funded by the securities industry.


All of those in the FINRA community must accept the symbiotic need to police the industry, to root out the bad actors, to empower regulatory staff with the prerogatives and tools to fairly investigate and prosecute misconduct, and, in the end, to persuade the public for whom the industry exists that, yes, the private sector is a more nimble and effective regulator than big government. If you re-read the Special Notice, you will not find a single reference to the appropriate influence of associated persons, public customers, issuers, and other market participants. Who stands for those stakeholders? Who speaks out on their behalf? When do those market participants get to raise concerns about the inappropriate influence of FINRA's larger firms and of FINRA itself?

I urge FINRA to reinvent itself as a "private sector regulatory organization" ("PSRO") and to expand and enhance its mission from one for the broker-dealer industry towards one for the larger private sector served by the financial services community. In furtherance of that change, the PSRO would serve in a holding-company role that oversees each of three regulatory divisions dedicated to Small member firms (smallest 25% of broker-dealers), Mid-sized member firms (50% of broker-dealers measured from midpoint), and Large member firms (largest 25% of broker-dealers). Pursuant to that restructuring, each division would draft a rulebook responsive to the unique needs of its constituency. The PSRO would fully enfranchise associated persons, and provide for the proportionate representation for such stakeholders as public customers, issuers, and regulators. Without question, a PSRO Board seat should be set aside for an investors' advocacy group such as PIABA.

As part of reimagining the SRO into a more expansive PSRO, all industry registration and continuing education should be undertaken directly by an applicant through the PSRO holding company and not through the member firms. FINRA should establish an Anti-Fraud Fund whereby all defrauded public customers would obtain restitution in the event that member firms or associated persons fail to timely honor any awards for compensatory damages, costs, and fees. Finally, I would abolish mandatory arbitration for customers and associated persons.