SEC Denies Stay of FINRA Expulsion Over Annual Audit Report

January 28, 2020

For many FINRA member firms and associated persons, the self-regulatory-organization's response to infractions of its rules may be the imposition of a suspension, expulsion, or bar. In some cases, aggrieved respondents file an appeal with the SEC. What happens to the FINRA sanctions during the pendency of the appeal to the federal regulator? As it often the case, the best answer is that it "depends;" and there are numerous rules, requirements, and tests by which one either overcomes or is frustrated by such dependency. As demonstrated in a recent appeal by an expelled FINRA member firm, the quality of the SEC's mercy is not only strained but it is also sliced, diced, chopped, and pureed. 

2019 Annual Audit Report

KJM Securities, Inc. had been a FINRA member firm since November 1987, and its sole owner, Kosta J. Moustakas, served as the firm's President, Chief Executive Officer, Chief Compliance Officer, Chief Operating Officer, Chief Financial Officer, and Anti-Money Laundering Compliance Officer. For  KJM's fiscal year ending March 31, 2019, its annual audit report was due on May 30, 2019; however, the firm requested an extension to June 17, 2019, as a result of its auditor's need to file an extension. On May 27, 2019, FINRA Staff informed KJM that the extension request was deficient, and the firm thereafter supplemented its request on May 29, 2019, with an auditor's letter in which the reasons for the delay were set forth. On May 30, 2019, FINRA granted the extension with the admonition that a failure to file the Annual Audit Report by June 17, 2019 would prompt a $100-per-day late fee for up to ten days plus possible regulatory/disciplinary action. Department of Enforcement, Complainant, v. KJM Securities, Inc., Respondent (FINRA Office of Hearing Officers Expedited Hearing Panel Decision; Exp. Proc. No. FPI190006; STAR No. 2019063489 / November 1, 2019)

August 2, 2019, Rule 9552 Suspension

In response to KJM's failure to meet the June 17th deadline, on July 9, 2019, FINRA issued a FINRA Rule 9552 Notice by which the firm was informed, in part, of the imposition of a $1,000 late fee and the firm's proposed suspension on August 2, 2019, if the Annual Audit Report was not submitted. Without availing itself of its right to request a Rule 9552 hearing, on August 1, 2019, KJM filed what FINRA deemed incomplete statements and reports lacking audited financials. Accordingly, the Staff informed KJM that the filing was rejected and the firm was suspended on August 2, 2019. 

September 2019 Telephonic Hearing

A few hours after receiving the Staff's August 2nd notice of suspension, KJM filed a written request with FINRA's Office of Hearing Officers seeking a hearing at which to explain its prior conduct and to offer an update on its ongoing audit process, which the firm alleged had been delayed by the "untimely death of our previous auditor." At a September 13, 2019, telephonic hearing (at which time no Annual Audit Report had still been filed), Moustakas appeared as his firm's only witness and did not dispute the allegations that the report had not yet been filed but [Ed: footnotes omitted]:

implored FINRA not to suspend the Firm, claiming that in 30 years, the Firm had never failed to file an annual audit. Although Moustakas did not specify a date by when the Firm would file its Annual Audit Report, he asked for "a couple more days" to do so because the auditor had been paid and was "in the homestretch," i.e. it was "in the tail end of finishing up."

Suspension To Evolve Into Expulsion

The OHO Hearing Panel deemed Moustakas's testimony as lacking in credibility and largely uncorroborated.  Pointedly, the OHO Decision characterized Moustakas's testimony as "vague, confusing, and contradictory;" and, further, the Panel found Moustakas to be "evasive and appeared deliberately obtuse." Finally, and perhaps most damning, the Panel noted that the subject Annual Audit Report was still not filed as of the September hearing, in violation of '34 Act Section 17(e) and Rule 17a-5 thereunder, and FINRA Rule 2010. 

The OHO Panel imposed a $1,000 late fee fee, $2,699.77 in costs,  and suspended the KJM from FINRA membership, with said suspension converting to an expulsion two months after the issuance of the Order in the event that the firm failed to file the Annual Audit Report by that date. 

SEC Appeal

KJM appealed FINRA's OHO Decision to the SEC and filed a Motion to Stay its expulsion from FINRA membership pending its appeal, which FINRA opposed. In the Matter of the Application of KJM Securities, Inc. for Review of Disciplinary Action Taken by FINRA (SEC Order Denying Stay, '34 Act Rel. No. 88053; Admin. Proc. File No. 3-19631)

SIDE BAR: SEC Rule of Practice 401: Issuance of Stays

(a) Procedure. A request for a stay shall be made by written motion, filed pursuant to Rule 154, and served on all parties pursuant to Rule 150. The motion shall state the reasons for the relief requested and the facts relied upon, and, if the facts are subject to dispute, the motion shall be supported by affidavits or other sworn statements or copies thereof. Portions of the record relevant to the relief sought, if available to the movant, shall be filed with the motion. The Commission may issue a stay based on such motion or on its own motion.

(b) Scope of Relief. The Commission may grant a stay in whole or in part, and may condition relief under this rule upon such terms, or upon the implementation of such procedures, as it deems appropriate.

(c) Stay of a Commission Order. A motion for a stay of a Commission order may be made by any person aggrieved thereby who would be entitled to review in a federal court of appeals. A motion seeking to stay the effectiveness of a Commission order pending judicial review may be made to the Commission at any time during which the Commission retains jurisdiction over the proceeding.

(d) Stay of an Action by a Self-Regulatory Organization.

(1) Availability. A motion for a stay of an action by a self-regulatory organization for which the Commission is the appropriate regulatory agency, for which action review may be sought pursuant to Rule 420, may be made by any person aggrieved thereby.

(2) Summary Entry. A stay may be entered summarily, without notice and opportunity for hearing.

(3) Expedited Consideration. Where the action complained of has already taken effect and the motion for stay is filed within 10 days of the effectiveness of the action, or where the action complained of, will, by its terms, take effect within five days of the filing of the motion for stay, the consideration of and decision on the motion for a stay shall be expedited in every way, consistent with the Commission's other responsibilities. Where consideration will be expedited, persons opposing the motion for a stay may file a statement in opposition within two days of service of the motion unless the Commission, by written order, shall specify a different period.

Comment: The Commission has stated that it "generally considers four factors" when evaluating the appropriateness of a stay of its own orders:

(1) whether there is a strong likelihood that a party will succeed on the merits in a proceeding challenging the particular Commission action (or, if the other factors strongly favor a stay, that there is a substantial case on the merits); (2) whether, without a stay, a party will suffer irreparable injury; (3) whether there will be substantial harm to any person if the stay were granted; and (4) whether the issuance of a stay would likely serve the public interest.

Order Preliminarily Considering Whether to Issue Stay Sua Sponte and Establishing Guidelines for Seeking Stay Applications, Exchange Act Release No. 33870 (Apr. 7, 1994), 56 SEC Docket 1189, 1190-91 (Apr. 26, 1994). The evaluation of the factors enumerated by the Commission, according to the release, will vary with the "equities and circumstances" of the case before the Commission. Id. See also In re Hibbard, Brown & Co. et al., Admin. Proc. File No. 3-8418, SEC Press Release No. 94-72 (Aug. 2, 1994) at 4.

The General Counsel has been delegated the authority to decide whether a stay should be granted. 17 CFR 200.30-14(g)(5), (6). Such decisions by the General Counsel are subject to review pursuant to Rule 430.

The Commission may condition the grant of a stay on such terms or upon the implementation of such procedures as it deems appropriate. For example, where a respondent seeks a stay of a disgorgement order, the Commission may require safeguards, such as establishment of an escrow, that would assure that funds will be available for payment at a later date if the disgorgement order is upheld.

Comment (c): Rule 401(c) requires that a motion for a stay of a Commission order pending review by a court be made to the Commission while the Commission retains jurisdiction over the proceeding. Other than a temporary cease-and-desist order, which is subject to judicial review in the first instance in a United States District Court, Commission orders are reviewable by a court of appeals. See, e.g., Exchange Act § 25, 15 U.S.C. § 78y (governing judicial review of final orders of the Commission generally), Exchange Act § 21C(d)(2), 15 U.S.C. § 78u-3(d)(2) (governing judicial review of temporary cease-and-desist orders). The Commission loses jurisdiction to grant a stay of an order subject to review in a court of appeals only after the record is filed in a court of appeals. See, e.g., Exchange Act §§ 25(a)(3), (c)(2), 15 U.S.C. §§ 78y(a)(3), (c)(2), and Fed. R. App. P. 18.

Comment (d): This paragraph is based on Section 19(d) of the Exchange Act, 15 U.S.C. § 78s(d), and former Exchange Act Rule 19d-2, 17 C.F.R. 240.19d-2 (1994).

The provision for expedited consideration in paragraph (d)(3) is based on the requirement of Section 19(d)(2) that the Commission establish an expedited procedure for consideration and determination of the question of a stay for "appropriate cases." The Commission has established a guideline for the timely determination of such requests. See 17 CFR 201.900 (Informal Procedures and Supplementary Information Concerning Adjudicatory Proceedings). A self-regulatory organization controls the effective date of the sanctions it imposes. If it desires additional time to address the issue of whether a stay should issue, it may consider delaying the effective date of its order. If the determination complained of has not taken effect, the time limits for the filing of opposing and reply briefs would be those set forth in Rule 154.

Extraordinary Remedy

In denying KJM's Motion to Stay, the SEC offered, in part, rationale [Ed: Footnotes omitted]:

Under Rule of Practice 401(d)(1), an aggrieved person may move to stay an SRO action reviewable under Exchange Act Section 19(d). A stay is an "extraordinary remedy," and the moving party bears the burden of establishing that relief is warranted. In deciding whether to grant a stay, the Commission traditionally considers the following four factors: (i) the likelihood that the moving party will eventually succeed on the merits of the appeal; (ii) the likelihood that the moving party will suffer irreparable harm without a stay; (iii) the likelihood that another party will suffer irreparable harm as a result of a stay; and (iv) a stay's impact on the public interest. While a movant need not necessarily establish that success on the merits is more likely than not, it must show at least "a fair prospect" of success, or demonstrate "that it has raised a serious legal question on the merits." And, where a movant shows less than a strong likelihood of success, it must show "that the other factors weigh heavily in its favor."

KJM has failed to satisfy its burden. Rather than addressing any of the stay factors outlined above, KJM's motion merely asserts that it has engaged and paid auditors and awaits the results of the audit. Its reply brief repeats the same representation. But far from demonstrating a likelihood of success on the merits, or even a serious legal question, KJM's briefing confirms that its annual audit report remains delinquent nearly eight months after its initial due date. 

For the first time in its reply brief, KJM asserts that it will suffer irreparable harm from FINRA's expulsion because it cannot function as a broker-dealer and because the expulsion will harm its reputation. "G]enerally, any argument raised for the first time in a reply brief shall be deemed to have been waived." In any case, KJM's assertion does not establish that a stay is warranted.

As discussed above, even under the view that a stay may be granted absent a showing of a strong likelihood of success on the merits, courts agree that the movant must show not only that the other factors weigh heavily in its favor but also that it has at least "raised a 'serious legal question' on the merits." In other words, "even if a movant demonstrates irreparable harm that decidedly outweighs any potential harm to the [stay opponent] if a stay is granted, [it] is still required to show, at a minimum, 'serious questions going to the merits.' " We need not determine, therefore, whether KJM has shown that it will be irreparably harmed absent a stay because it has not shown that its appeal presents a serious legal question.  

In denying KJM's Motion to Stay, the SEC further noted that the Audited Annual Report at issue safeguards the investing public and permitting the firm to continue to participate in the securities industry in the absence of such a filing "poses substantial risks to investors and the public." 

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