The FINRA Regulatory Mule Kicks Defrauded Customers In the Head

February 2, 2023

In today's Blog we got a FINRA regulatory decision, a state court judgment, a bankruptcy, and a federal court action. As the legal matters now stand, some defrauded customers are left scratching their heads. All of which prompts us to consider the outdated, unworkable construct of FINRA. The experiment of allowing Wall Street to regulate itself has been abused for so many decades as to undercut virtually any argument favoring the continuation of FINRA. If you need proof, just consider one federal court's awkward attempt to explain what FINRA is or isn't. It's sort of a horse. It's sort of a donkey. It's sort of a mule but it isn't except it is . . . sort of.


A Long And Winding Road (And A Tortured One)

This one's going to be a bit of a mess just to set up; and, as such, let's go slow.

During Allan Anderson's lifetime, he invested in four joint ventures operated by Regal Energy LLC, whose Chief Executive Officer was Brian Keith Hardwick.

Allan Anderson was married to Maria Anderson, who were the parents of siblings Brian Anderson and Lori Anderson.

After the parents' deaths, Brian and Lori Anderson became Co-Trustees of the Allan G. Anderson Revocable Trust (the "Trust").


2017 FINRA OHO Decision

So . . . why are we all here? Well, consider this FINRA News Release:

FINRA Hearing Panel Expels Red River Securities, LLC and Bars CEO Brian Keith Hardwick for Fraud; Ordered to Pay $24.6 Million in Restitution to Investors (February 14, 2017)
In pertinent part the 2017 FINRA News Release asserts that:

The Financial Industry Regulatory Authority (FINRA) announced today that a FINRA hearing panel has expelled Plano, TX-based broker-dealer Red River Securities, LLC, barred its CEO Brian Keith Hardwick, and ordered the firm and Hardwick to jointly and severally pay $24.6 million in restitution to customers for fraudulent sales in five oil and gas joint ventures. The hearing panel found that the respondents engaged in a pattern of misrepresentations and omissions that spanned nearly four years and involved sales in the risky joint ventures. The hearing panel dismissed FINRA Department of Enforcement’s allegations that the firm sold interests in two of the joint venture offerings in violation of the general solicitation prohibition for the private placement of securities under Regulation D, one alleged misrepresentation charge, several alleged suitability violations by the firm, and additional suitability allegations against Hardwick. The decision resolves charges brought by FINRA's Department of Enforcement in July 2015.

The panel found that Red River Securities and Hardwick intentionally and fraudulently misrepresented and omitted material facts in connection with the sales of interests in oil and gas joint ventures issued by Regal Energy, LLC, a close affiliate of Red River Securities. The oil and gas offerings, which the panel noted were already high-risk ventures, misrepresented the amount of income distributed to investors in other Regal Entity joint ventures, failed to disclose material conflicts of interest, and failed to disclose that one of the wells was a “wildcat,” which carried risk in addition to the usual risks of oil and gas joint ventures. In addition, Red River Securities and Hardwick omitted material information about the sizable management fees that would be paid to the affiliated entity and failed to disclose Hardwick’s participation in drafting an independent geologist’s report.

In addition, the hearing panel held that the joint venture purchase was not suitable for two customers. One customer was a 74-year-old, self-employed farmer and dog breeder with a net worth of $2 million, liquidity of $20,000, and $150,000 in annual income. Given her level of liquidity and her self-employed/seasonal employment situation, the hearing panel found that her investment of $94,754, representing well over half of her annual income, in three risky oil and gas ventures in a period of a year, was not suitable.

The panel decision also characterized Red River Securities and Hardwick’s misconduct as “egregious” and noted several aggravating factors, including the respondents’ “failure to develop and enforce a robust supervisory system” and “the extent of the respondents’ monetary gain,” including $3.6 million in due diligence fees and commissions from the five offerings, money earned as owners of Regal Entities, and management fees. Investors received total distributions of less than $500,000 from the more than $25 million they invested in the five offerings.

For the full FINRA OHO Decision, READ: FINRA Department of Enforcement, Complainant, v. Red River Securities, LLC, and Brian Keith Hardwick, Respondents (FINRA Office of Hearing Officer Extended Hearing Panel Decision / February 9, 2017)


2019 State Court Settlement and Judgment

Movin' along here . . . Allan Anderson and Plaintiff, Lori Anderson, as the Executrix of Mrs. Anderson's estate, sued Defendant Brian Keith Hardwick in Texas State Court citing violations of securities law or for fraud in connection with the sale or purchase of securities. In August 2019, Defendant Hardwick settled the State lawsuit; and a judgment was entered against him in the state court case on October 4, 2019, whereby Plaintiffs were awarded actual damages of $3,252,399.68 plus interest.


2020 Chapter 7 Bankruptcy

No . . . we're not done yet and, obviously, things are going to go awry -- otherwise, why would I be writing about this?

In December 2020, Defendant Hardwick and his wife filed a voluntary Chapter 7 Petition for Bankruptcy, which scheduled out the $3.2 million debt owed to the Estate. In March 2021, the Andersons filed a Complaint in Texas federal court seeking summary judgment that the damages awarded to them against Defendant Hardwick survived the bankruptcy discharge. 
In re: Brian Keith Hardwick Sara Ann Hardwick, Chapter 7, Debtors.
Andrew H. Anderson And Lori Anderson, As Co-Trustees Of The Allan G. Anderson Revocable Living Trust, Plaintiffs, v. Brian Keith Hardwick, Defendant. (Decision, United States Bankruptcy Court, Eastern District of Texas,("Bankr. E.D. Tex") Case No. 20-42475, Adversary No. 21-04065 / January 27, 2023),33


Is There An "Exception" To Discharge?

Interesting issue, no? The whole point of a bankruptcy discharge is to give a debtor a fresh start, and, as such, courts strictly construe any requested "exceptions" to discharge against a creditor and in favor of a debtor. Among the exceptions provided under the Bankruptcy Code [Ed: footnotes omitted]:

A debt may be found nondischargeable if it meets the requirements of 11 U.S.C. § 523(a)(19).This provision was added to 11 U.S.C. § 523 "in order `to make judgments and settlements based upon securities law violations nondischargeable, protecting victims' ability to recover their losses.'" Wright v. Minardi, 536 B.R. 171, 191 (Bankr. E.D. Tex. 2015), quoting In re Chan, 355 B.R. 494, 503 (Bankr. E.D. Pa. 2006). This addition was "intended to preclude the necessity of securities regulators and investors to spend precious enforcement resources to `reprove' securities law" Id.

Two conditions must be met for § 523(a)(19) to make a debt dischargeable. "First, the debt must be for a violation of state or federal securities law, or for common law fraud, deceit, or manipulation in connection with a sale of any security." Nationwide Judgement Recovery Inc. v. Sorrells, 644 B.R. 158, 164 (Bankr. E.D. Tex. 2022). "Second, the debt must result from a judgement or court order." Id. To satisfy this second element, the debt may also result from "any settlement agreement entered into by the debtor" or from "any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor." 11 U.S.C. §§ 523(a)(19)(B)(ii) and (iii); see Minardi, 536 BR. at 192; see also McGraw v. Collier, 497 B.R. 877, 902 (Bankr. E.D. Ark. 2013); Faris v. Jafari, 401 B.R. 494, 496 (Bankr. D. Colo. 2009). It should be up to "a tribunal other than the bankruptcy court determine the liability aspect — e.g., whether a federal or state securities violation or some type of related fraud has occurred." Minardi, 536 BR. at 192. After such a determination is made however, "and proof of the entry of that order or the existence of a settlement of such charges is tendered to the bankruptcy court, the debt is rendered nondischargeable under § 523(a)(19) without proof of any additional element." Id.; see also Jenkins v. Jones, 600 B.R. 561, 568 (Bankr. W.D. Tex. 2019) (following the two-prong test discussed in Minardi); Kokas v. Osborne, 2017 Bankr. LEXIS 931, at *10, 2017 WL 1232407, at *4 (Bankr. E.D. Tex. 2017) (also following Minardi).


The State Court Judgment

Making short shrift of any protests to the contrary, the federal court cuts to the chase [Ed: footnotes omitted]:

The Court finds there is no genuine issue that the agreed state court judgment in this case is a determination of a securities violation or related fraud by a non-bankruptcy tribunal. There is also no genuine issue that the agreed state court judgment was entered. Thus, following the two-step Minardi analysis under this Court's precedent, the agreed state court judgment in this case meets the requirements under § 523(a)(19) to be nondischargeable.


The FINRA OHO Decision: $24 Million in Restitution

The Federal Court rejected any discharge of the State Court's judgment of about $3.2 million in damages, which, y'know, seems fair and right. On the other hand, what about that juicy FINRA Order requiring the payment of about $24 million in restitution plus interest? Assuming that the Andersons would receive a portion of that restitution, will they get short-changed by the bankruptcy discharge as to their share? As the Federal Court noted:

Plaintiffs argue that the FINRA order renders its indebtedness nondischargeable under § 523(a)(19) because FINRA determined that Defendant's company, Regal, committed security law violations and ordered an award paid in Plaintiffs' favor.[42] The problem for Plaintiffs is that the debt created by the FINRA order does not constitute a "judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding." 11 U.S.C. § 523(a)(19)(B)(i).

The Financial Industry Regulatory Authority ("FINRA") is a government authorized organization that regulates broker dealers engaging in the buying or selling of securities. See Wiley v. SEC, 663 F. App'x 353, 356 n.1 (5th Cir. 2016). In Wiley, the Fifth Circuit described FINRA as follows:

"FINRA is a self-regulatory organization ("SRO") registered with the SEC under 15 U.S.C. § 78s. Although FINRA is not a government entity, it is responsible for the self-regulation of member brokerage firms, exchange markets, and individuals associated with those firms and markets. FINRA is empowered to discipline members for violations of their rules by suspension, expulsion, or by barring an individual from associating with a FINRA member. 15 U.S.C. § 78o-3(b)(7); see also Fiero v. FINRA, 660 F.3d 569, 574 (2d Cir. 2011). The SEC is charged with the oversight and supervision of SROs, including FINRA, and must approve all rules of an SRO before their implementation. Relevant to Wiley's case, appeals from decisions by FINRA are taken by the National Adjudicatory Counsel, which can then be appealed to the SEC. 15 U.S.C. § 78s(d)(2). The SEC performs an independent review of the record and applies a preponderance of the evidence standard when reviewing SRO disciplinary actions. In re Levine, SEC Release No. 48760, 2003 WL 22570694, at *2, *9 n.42 (Nov. 7, 2003)."

Id. Despite Plaintiffs' contentions, case law makes it clear that FINRA is not a federal administrative body but is instead a self-regulatory organization distinct from a normal administrative agency. See D.L. Cromwell Investments, Inc. v. NASD Regulation, Inc., 279 F.3d 155, 162 (2nd Cir. 2002) (holding that the precursor to FINRA, the NASD, is not a government agency but a private actor); North v. Smarsh, Inc., 160 F.Supp. 3d 63, 78 (Dist. Col. 2015) ("More importantly, the APA does not apply to SROs such as FINRA because FINRA is not an `agency' within the meaning of the statute."); In re Hartmann, 2011 WL 2118870 at * 4 (Bankr. D. Col. 2011) ("Therefore, absent confirmation of the Arbitration Award by a court of competent jurisdiction, the award alone cannot provide a basis for the dischargeability of debt under § 523(a)(19)."); In re Jones, 600 B.R. 561, 569 (Bankr. W.D. Tex. 2019) (finding a FINRA award nondischargeable where FINRA had determined defendant violated securities laws and the FINRA award had been memorialized in a judicial order in a county court). Because there is no evidence that Plaintiffs' FINRA order has been memorialized in a separate judicial or administrative order, it cannot be the basis for a summary judgment finding of nondischargeablility under § 523(a)(19).[43]

Consequently, the FINRA order standing alone cannot support a summary judgment finding of nondischargeability under § 523(a)(19).

Oh my!!! That's not encouraging for Plaintiffs. The Court granted partial summary judgment to them only as to the State Court judgment against Hardwick not being dischargeable; however, FINRA's Order of Restitution seems left to flap in the wind. Why? For starters, because in my opinion (as I have often voiced it in this blog), FINRA is an outdated, unworkable construct. What may have been an understandable regulatory response in the late 1930s to the deprivations of the Great Depression, no longer has validity in the 2020s. The experiment of allowing Wall Street to regulate itself has been abused for so many decades as to undercut virtually any argument favoring the continuation of FINRA. As to just what FINRA is or isn't in this day and age, consider the Court's tortured language:

The Financial Industry Regulatory Authority ("FINRA") is a government authorized organization that regulates broker dealers engaging in the buying or selling of securities. . . . [FINRA]  is not a federal administrative body but is instead a self-regulatory organization distinct from a normal administrative agency."

Yeah . . . sure . . . FINRA is NOT a government agency but a "government authorized organization," which is not a "federal administrative body" but some odd half-horse-half-donkey mule masquerading as a "self-regulatory organization distinct from a normal administrative agency." Indeed, there is nothing "normal" about FINRA and there is no justification for the ongoing existence of this dubious hybrid. 

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