Now You See It, Now You Don't -- FINRA Rule 2010 Applied by OHO But Rejected by NAC

June 3, 2021

FINRA Rule 2010 is applied in a disparate fashion against smaller member firms and the industry's associated persons in contrast to larger FINRA firms and powerful industry interests. For me, Rule 2010 is an overly elastic, rubbery bit of nonsense that gets stretched to fit the misconduct of the little guys but just never seems to get pulled around the big boys. As such, Rule 2010 is a lovely bit of aspirational regulation, but, in truth, it's a joke. As things tend to work out under Rule 2010's shadow, the small fry get expelled and barred for their transgressions of the industry's purported standards and principles; however, when the big boys screw up, FINRA tends to find mitigation and cooperation and explanations, and, well, you know, self-regulation looks quite different depending upon whether you're looking through the prism of the powerful versus the powerless. 


Veteran Wall Street lawyers, regulators, and compliance professionals will tell you that FINRA Rule 2010 is bedrock -- it is the foundation upon which FINRA's role as a regulator sits. More often than not, if an industry professional engages in misconduct, that individual will be charged with violating Rule 2010.  The odd thing about Rule 2010 is its brevity:

FINRA Rule 2010: Standards of Commercial Honor and Principles of Trade states that:

A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade. 

As far as the statutory language goes, it all sounds nice and should be comforting to those who actually think that self-regulation works. I don't. As such, I don't find Rule 2010 nice or comforting. Pointedly, I don't think that there are "high standards of commercial honor" extant on Wall Street, and I have a hard time locating Wall Street's "just and equitable principles of trade." 

2019 Potter OHO Decision

In 2019, William James Potter ran afoul of FINRA Rule 2010. FINRA Department of Enforcement, Complainant, v. William James Potter, Respondent (FINRA Office of Hearing Officers Extended Hearing Panel Decision, Disc. Proc. No. 2017052871401 / August 7, 2019),
As set forth in the "Syllabus" of the 38-page OHO Decision:

Respondent is barred from associating with any member firm in any capacity for conversion and unethical business conduct, including misuse of funds. He is ordered to pay $250,000 in restitution, and hearing costs.

As more fully explained in the "Introduction" to the OHO Decision [Ed: footnotes omitted]:

This case concerns the ethical obligations FINRA Rule 2010 imposes on a registered person entrusted with others' money even when his conduct is unrelated to the purchase or sale of securities. The Complaint's first cause of action alleges that Respondent William James Potter converted a portion of funds entrusted to him as a third party to a business agreement between two other parties. The second cause of action alleges that Potter acted unethically and misused another portion of the entrusted funds when one of the parties failed to perform as the agreement required. 

The critical events described in the Complaint occurred over a brief span of time in March 2013. However, the genesis of those events dates back to 1998 when a group of investors bought a valuable commercial property in Chicago, referred to as the Chicago Parcel, with an ambitious plan to develop it. 

Development of the Chicago Parcel was a complex, multifaceted project. In the aftermath of the 2007-2008 financial crisis, the developers had to refinance the Chicago Parcel under new, less favorable terms. They eventually fell behind on their obligations and in early 2013, their mortgage lender prepared to foreclose. The developers, by this time organized as Old Prairie Block Owner, LLC ("OPBO"), struggled to find a new source of financing to intervene and take over the mortgage under terms that would permit the development to proceed. Business contacts referred them to the representative of an investment company, American Capital Group LTD ("American Capital"), based in Germany. 

American Capital agreed to negotiate a settlement with the lender to forestall the foreclosure and save the project for OPBO. For its part, OPBO agreed to provide a $2 million retainer to American Capital. If American Capital failed to reach a settlement, it was to return the $2 million to OPBO. 

OPBO insisted that the retainer be deposited in a third party's account in the United States until American Capital fulfilled certain conditions. RD, a Swiss businessman acting as American Capital's agent, invited Potter, with whom he had a years-long business relationship, to facilitate the transaction as the third party who would hold the retainer. 

Unknown to OPBO, RD was substantially indebted to Potter. RD told Potter that he could keep $250,000 of the retainer for himself to defray the debt. Also unknown to OPBO, Potter and his business had been experiencing serious financial difficulties. On the day Potter received the $2 million retainer, he began spending it for personal and business purposes. Three days later, Potter wired most of the money to an entity affiliated with American Capital and to RD. Potter kept and used the rest of the funds. 

American Capital did not achieve the settlement OPBO hired it to reach. The foreclosure sale of the Chicago Parcel proceeded. OPBO lost the property and all of its equity in it. OPBO demanded return of the retainer, but American Capital refused to return it. After unsuccessful attempts to seek legal redress, OPBO's principals complained to the U.S. Postal Inspection Service. A Postal Inspection Service agent subsequently contacted FINRA.

A FINRA investigation ensued and led the Department of Enforcement to file the two-cause Complaint in this case. It charges Potter with conversion and unethical business conduct, including misuse of OPBO's deposit, in violation of FINRA Rule 2010. Potter denies the charges.

In justifying the imposition of Bars, the OHO Decision offers, in part, this rationale [Ed: footnotes omitted]:

Furthermore, aggravating factors present here underscore the appropriateness of imposing a bar for each cause of action. As noted above, Potter acted intentionally, converting thousands of dollars of OPBO's funds on the day they reached his account, and three days later transferring $50,000 to RD and $1.7 million to an affiliate of American Capital. Within a month of signing the Release Agreement, Potter had spent virtually all of the remaining funds. 

Potter denies responsibility for his wrongdoing, and shows no remorse for the harm he caused. To the contrary, he was fully aware that KS had loaned OPBO the $2 million and desperately needed repayment to avoid laying off employees. When confronted by his failure to offer to return any part of the funds he misused, Potter blithely shrugged off any concern or responsibility stating, "[t]hat was [RD's] problem or [BV's]."

At page 35 of the OHO Decision

Appeal to the NAC

Potter appealed the OHO Decision to FINRA's National Adjudicatory Council ("NAC"). FINRA Department of Enforcement, Complainant, v. William James Potter, Respondent (FINRA National Adjudicatory Council Decision, Complaint No. 2017052871401 / May 27, 2021),
As to the issues before it on appeal, the NAC offers this overarching observation [Ed: footnotes omitted]:

FINRA Rule 2010 requires associated persons, in the conduct of their business, to "observe high standards of commercial honor and just and equitable principles of trade." The rule is not limited to rules of legal conduct, but rather states a broad ethical principle. Dep't of Enf't v. Shvarts, Complaint No. CAF980029, 2000 NASD Discip. LEXIS 6, at *11 (NASD NAC June 2, 2000) (discussing FINRA Rule 2010's predecessor, NASD Rule 2110). The ethical standards imposed under FINRA Rule 2010 go beyond legal requirements, and depend on general rules of fair dealing, the reasonable expectations of the parties, marketplace practices, and the relationship between the parties. Id. at *12. We may find a violation of ethical obligations when no legally cognizable wrong has occurred. Id. at *11. To establish a Rule 2010 violation when there is no violation of any other FINRA rule or federal securities law, Enforcement must prove that the respondent acted unethically or in bad faith. Edward S. Brokaw, Exchange Act Release No. 70883, 2013 SEC LEXIS 3583, at *33 (discussing FINRA Rule 2010's predecessor, NASD Rule 2110). Conduct is unethical when it is "not in conformity with moral norms or standards of professional conduct," while bad faith means "dishonesty of belief or purpose." Id. at *33. In determining whether a Rule 2010 violation occurred, we employ "a flexible evaluation of the surrounding circumstances with attention to the ethical nature of the conduct." Shvarts, 2000 NASD Discip. LEXIS 6, at *15. 

at Page 16 of the NAC Decision

Duty to Speak

On appeal to the NAC, Potter argued that the OHO Panel had misunderstood applicable New York State law, which, as he characterized it, imposed no duty to speak simply because parties are involved in a transaction. The OHO found that Potter knew he would obtain a significant infusion of cash from Swiss Advisor, which imbued him with a financial interest in the transaction; and, as a consequence, Potter should have disclosed said interest given his role in facilitating the transaction. In rejecting OHO's finding, the NAC found in part that:

There is no evidence that Potter had a duty to speak arising from an explicit agreement between the Developer and Meredith Financial or Potter. The Agreement does not contain any term relating in any way to Meredith Financial's independence from the Financier or Meredith Financial's lack of interest in the transaction.18
= = = = =
Footnote 18: To the contrary, the Agreement strongly suggests that Meredith Financial acted as the Financier's agent. The Agreement provided that Meredith Financial would receive the retainer "on [BV's] behalf," and that the Swiss Advisor (the Financier's agent) had "instructed Meredith [Financial] to assist and facilitate in the execution of this Agreement."

at Page 18 of the NAC Decision

Further, the NAC found that in part that:

Enforcement did not establish that Potter had a duty to speak based on a prior representation of material fact." There is no evidence that, before the Developer entered into the Agreement, Potter made an affirmative statement that he had no interest in the transaction. Potter spoke one time each with PG and the Developer's attorney before the transaction was consummated. There is no evidence that during either conversation the participants discussed Potter's neutrality or whether he expected to benefit from the transaction. To the contrary, Potter testified that during his call with PG, she did not ask him about those subjects, even though she was aware of his past business dealings with the Swiss Advisor. PG's testimony did not contradict Potter's. Potter testified that his conversation with the Developer's attorney was limited to discussing the exchange of the retainer and security. The Developer's attorney did not testify at the hearing, but the email she drafted just after the conversation is consistent with Potter's testimony. 

at Page 18 of the NAC Decision

In nailing shut the coffin, the NAC found no evidence that the Developer had heavily relied upon Potter's judgment, and, to the contrary, note that the Developer "relied on its own attorney, banker, and broker-dealer, all of whom assured the Developer that the bond power and DTC codes were adequate to secure the $2 million retainer." Even if the Developer may have reposed some "trust" in Potter, that did not rise to the transforming him into a fiduciary.


As to OHO's finding that Potter had engaged in conversion, the NAC found that the record did not establish that Potter had engaged in the unauthorized use of funds held in Meredith Financial's checking account.  The NAC found that Potter did not have any fiduciary or confidential relationship with the Developer, and, as such, should not be viewed as an "agent."

Misuse of the Retainer

As to Enforcement's allegation that Potter had misused the Retainer, the NAC noted in part that:

The Hearing Panel disagreed with Enforcement's assertion that Meredith Financial was not authorized to release the retainer on March 15, but it nevertheless found Potter liable for misuse on a theory not alleged in the complaint. The Hearing Panel concluded that Meredith Financial was authorized to release the retainer once certain conditions were satisfied, and that those conditions were satisfied on March 14. As a result, Meredith Financial's release of the retainer on March 15, in and of itself, did not breach the terms of the Agreement. However, the Hearing Panel further found that, while Meredith Financial was authorized to release the retainer on March 15, it could release the money only to the Financier, not to the Financier's Affiliate, the Swiss Advisor, or Meredith Financial. The Hearing Panel found that Potter "should not have" released the retainer to anyone but the Financier "without first consulting with [the Developer]," because Potter "understood he was an intermediary, entrusted to effect the transfers of funds and documents pursuant to [the Agreement]."

at Pages 24 - 25 of the NAC Decision

Notwithstanding OHO's methodical analysis and conclusions, the NAC certainly honed in on the fact that during hearings, Enforcement advanced a "theory not alleged in the complaint." Taking its appellate role further, the NAC reversed OHO's finding of violation in part because:

The Agreement does not contain any term requiring Meredith Financial to release the retainer only to the Financier. The Agreement provides terms describing when Meredith Financial may release the retainer, but not to whom it may release the retainer. There is no dispute that the Financier was entitled to the retainer on March 15. The Agreement does not contain any term requiring Meredith Financial to pay the retainer to any specific person, entity, or account. Indeed, the Agreement does not contain any payment term at all. Had the Financier not provided further instructions to Meredith Financial, through the Swiss Advisor, Meredith Financial would not have known where to send the money.

at Page 25 of the NAC Decision


Finally, the NAC tackled OHO's finding that Potter had acted unethically by hindering the Developer's efforts to recover the Retainer from the Financier. Pointedly, the NAC declined to find that Potter had aided and abetted any fraud upon the Developer by the Financier and/or BV. Notwithstanding that the Financier seemed to have breached its agreement with the Developer by not returning the retainer, the NAC found insufficient evidence that Potter was aware of any scheme or involved in same. Similarly, as to Enforcement's allegation that Potter had unethically refused to tell the Developer that he had retained a portion of the retainer, the NAC found no evidence that the Developer had directly asked Potter whether he had retained a portion of the retainer. Finally, the NAC found that:

Enforcement failed to establish that Potter had an ethical duty to disclose to the Developer where he had wired the retainer. As discussed above, this was a commercial transaction between sophisticated entities. Meredith Financial did not owe a fiduciary duty to the Developer, nor did Meredith Financial have a relationship of trust and confidence with the Developer. Meredith Financial had no ethical duty to disclose information about the wire simply because the Developer wanted it.

at Page 31 of the NAC Decision


Having found that Enforcement failed to establish that Potter had violated FINRA Rule 2010, the NAC reversed the OHO Decision, vacated the sanctions, and dismissed the Complaint.

Bill Singer's Comment

Compliments to both the OHO and the NAC for their efforts to adjudicate the charges before them, and in doing so with obvious thoughtfulness and dedication. Notwithstanding the NAC's reversal of the OHO Decision, such an appellate result in no way diminishes the superb character of the hearing panel's written record. Frankly, this is what regulation should look like!

Also, compliments to Mark J. Astarita, Esq. of Sallah Astarita & Cox, LLC for a masterful defense of Respondent Potter!

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