SEC Sustains in Part and Remands FINRA Case Against Southeast Investments and President Black

December 8, 2023

2019 FINRA NAC Decision

Way back in 2019, the FINRA National Adjudicatory Council (NAC) issued a well-drafted Decision, which methodically and comprehensively addressed the various issues presented on appeal. In the Matter of FINRA Department of Enforcement, Complainant, v. Southeast Investments, N.C., Inc. and Frank Harmon Black, Respondents (FINRA National Adjudicatory Council Decision; Complaint #2014039285401 / May 23, 2019) As set forth in the introductory "Decision" portion of the FINRA NAC Decision:

In the proceedings below, an Extended Hearing Panel ("Hearing Panel") found that Southeast Investments, N.C., Inc. ("SEI") and Frank Harmon Black ("Black"), the firm's president: produced fabricated documents to FINRA staff and testified falsely during an on-the-record interview concerning Black's purported inspections of five SEI offices; failed to ensure that SEI retained business-related electronic communications from March 2010 to May 2015, and that SEI's failure in this regard was in willful violation of Section 17(a) of the Securities Exchange Act of 1934 ("Exchange Act") and Exchange Act Rule 17a-4; and failed to exercise reasonable supervision to prevent the failure to inspect offices and retain firm emails. 

The Hearing Panel imposed on SEI fines totaling $243,000, broken down as follows: a $73,000 fine for providing fabricated documents and false testimony to FINRA; a $50,000 fine for failing to retain firm emails; and a $120,000 fine for supervision failures relating to office inspections and email retention. The Hearing Panel barred Black from associating with any FINRA member in any capacity for providing fabricated documents and false testimony. The Hearing Panel also indicated that Black's failure to retain emails warranted a one-year suspension and a $50,000 fine (joint and several with SEI), and that his supervisory failures relating to office inspections and email retention warranted a bar from associating with any member firm in a principal capacity and a $120,000 fine (joint and several with SEI). The Hearing Panel, however, did not impose the fines, one-year suspension, or principal bar on Black, in light of the bar that it imposed on him. Respondents appealed the Hearing Panel's decision. 

Having reviewed the record, we take the following actions, as fully explained in this decision: 

    • We affirm the Hearing Panel's findings that respondents provided to FINRA fabricated documents and false testimony concerning Black's purported inspections of SEI offices.

    • We reverse the findings that respondents failed to establish and maintain a system to ensure that SEI offices were inspected. Although we find that Black did not inspect four SEI offices as he claimed to have done, FINRA's Department of Enforcement ("Enforcement") failed to clearly allege or prove what kinds of offices the SEI offices were and, consequently, failed to demonstrate how frequently SEI was required to inspect each of those offices.
    • We affirm the findings that respondents failed to establish and maintain a reasonable supervisory system and failed to establish, maintain, and enforce reasonably designed written supervisory procedures to ensure the retention and review of business-related emails. SEI's so-called "honor system" for retaining business-related electronic correspondence-in which SEI permitted its representatives to use third-party email accounts instead of a central server and required representatives to copy or forward all business-related emails to SEI's home office-was not reasonably designed to comply with the electronic correspondence retention requirements. 

    • We affirm the findings that SEI and Black failed to retain 16 business-related emails of SEI representative Richard Sebastian ("Sebastian"), but reverse the finding that SEI "willfully" violated federal securities laws and regulations in failing to retain those 16 emails. Although the preponderance of the evidence demonstrates that SEI and Black failed to retain 16 emails of Sebastian, Enforcement did not prove that this failure was not inadvertent. 
    • We reverse the Hearing Panel's findings that SEI and Black failed to retain other business-related electronic correspondence. Although Enforcement alleged that SEI and Black failed to retain several other categories of emails (in addition to the 16 emails of Sebastian), Enforcement did not prove those specific allegations by a preponderance of the evidence. 

    • We affirm the bar imposed on Black and the $73,000 fine imposed on SEI for their providing to FINRA fabricated documents and false testimony. For failing to retain firm emails, we reduce the sanctions to a $500 fine (joint and several). For respondents' supervision failures, we reduce the sanctions to a $73,000 fine (joint and several). We do not impose any of the fines on Black, however, in light of the bar imposed on him. 

2023 SEC Opinion

On May 29, 2019, Southeast Investments and Black filed an appeal of FINRA's findings and sanctions to the SEC. The federal regulator ultimately sustained the findings of violations and sanctions imposed for the supervisory violation and the failure to preserve the 16 emails, but remanded the proceeding to FINRA with respect to the alleged provision of false testimony and fabricated documents. In the Matter of the Application of Southeast Investments, N.C., Inc. and Frank Harmon Black for Review of Disciplinary Action Taken by FINRA  (SEC Opinion, '34 Act Rel.. No. 99118; Admin. Proc. File No. 3-19185 / December 7, 2023)

On appeal, the SEC reviewed FINRA's disciplinary action against the two Respondents in order to determine [Ed: footnote omitted]:

(1) whether Applicants engaged in the conduct FINRA found; (2) whether that conduct violated the provisions specified in FINRA’s determination; and (3) whether those provisions are, and were applied in a manner, consistent with the purposes of the Exchange Act.6F. . . .

at Page 8 of the SEC Opinion

A Matter of Conduct

As to the first prong of the SEC's punch-list for review, it concurred with FINRA's finding that Southeast and Black had "violated NASD Rule 3010 and FINRA Rules 3110 and 2010 by failing to establish and maintain a reasonable supervisory system, and by failing to establish, maintain, and enforce WSPs to comply with Southeast’s email retention requirements under the Exchange Act." at Page 9 of the SEC Opinion. In offering its rationale, the SEC cites in part that:

Southeast representative Sebastian’s use of private email to conduct Southeast business and his inadvertent failure to forward or copy Southeast’s home office on 16 of his business-related emails illustrates the unreasonable design of this system. This failure resulted from an oversight, not any intentional circumvention of the Southeast email retention system. Yet Southeast did not conduct any monitoring for compliance with its requirement that registered representatives forward or copy emails sent or received through private accounts to the home office, even though the policy could fail due to inadvertence or inattention on the part of its registered representatives. That Southeast did not have in place a system to prevent or detect such inadvertent failures establishes that the firm’s policy was not reasonable designed to ensure compliance with the Exchange Act.

at Page 10 of the SEC Opinion

More Harmful Than Harmless Error

Although the Opinion is largely supportive of the FINRA NAC's findings, the SEC does take issue with the self-regulatory-organization's failure to produce emails and memorandum:

Applicants argue that FINRA Enforcement’s failure to produce Arnold’s notes of the initial calls between FINRA and the Four Representatives before the September 2016 hearing denied Applicants the opportunity to show at the hearing that the Four Representatives were not credible. They ask us to vacate the findings against them due to spoliation of evidence. They argue further that the failure to timely produce the emails from Arnold to Palacios and Palacios’s memorandum summarizing the calls also prevented them from challenging the Four Representatives’ credibility. Applicants assert that the emails and memorandum show that the Four Representatives testified inconsistently on various matters and contained statements helpful to the Applicants. Yet Applicants did not have the benefit of the emails and memorandum at the time of the hearing and therefore could not use them as part of their cross-examination. Accordingly, they assert, the failures to produce these documents constituted prejudicial error. 

at Page 14 of the SEC Opinion


Among the allegations made by Southeast and Black concerning purported misconduct by FINRA's Enforcement staff was that [Ed:footnotes omitted] :

[FINRA] acted with “malfeasance” in “either knowingly destroy[ing]/los[ing] the [notes] or negligently los[ing]/destroy[ing] them,” Applicants provide no evidence to support this allegation. In a brief to the Hearing Panel on remand, FINRA Enforcement explained that it had Arnold’s notes in its possession early in this proceeding; that the relevant FINRA office recently eliminated its on-site file room and moved its files off-site; and that the relocation process may have caused the inadvertent loss of the notes. FINRA’s conduct, although perhaps negligent, does not establish culpability under Fourth Circuit law.

at Page 15 of the SEC Opinion

In what largely amounts to a punt, the SEC offered this response:

Although we find dismissal not warranted, the alleged spoliation may justify an adverse inference against FINRA Enforcement.  Should Applicants pursue such a remedy upon the remand to FINRA as discussed below, the Hearing Panel or the NAC may consider the propriety of this sanction. We express no view as to whether the record would support this outcome. 

at Page 16 of the SEC Opinion

Untimely Production

As to the allegations about FINRA's apparent gamesmanship in discharging its obligation to timely produce notes and memorandum to the Respondent, the SEC offers a harsh rebuke of the self-regulator's conduct [Ed: footnotes omitted]:

FINRA Rule 9253 allows a respondent to move for inspection and copying of certain written statements made by FINRA staff “during a routine examination or inspection about the substance of oral statements.” If the staff does not provide “a statement required to be made available,” rehearing or an amended decision is required if, and only if, the respondent demonstrates that the failure was not harmless error. FINRA concluded that the post-hearing production of the emails and memorandum was harmless error. But FINRA based its findings of violation in significant part on the credibility determinations of the Hearing Panel. And the Applicants were not afforded the opportunity during the hearing to use what they claim are inconsistencies in the emails and memorandum to question witnesses and attempt to impeach their credibility. Accordingly, based on the facts and circumstances of this case, we cannot conclude that the untimely production of the emails and memorandum was harmless error.

We remand this case to FINRA for further proceedings consistent with this opinion. Such proceedings might include, should Applicants request it, further record development through cross-examination of the Four Representatives with the benefit of Arnold’s emails and Palacios’s memorandum. Again, we express no view of the outcome of these proceedings. 

at Page 16 of the SEC Opinion

Fine with the Fines

Notwithstanding the SEC's concerns about FINRA's conduct, the federal regulator let stay the imposition of the fines that were contested on appeal. In part, the SEC determined that [Ed: footnotes omitted]:

We sustain the fine at the top of the Guidelines’ recommended range. As the NAC found, several factors aggravate Applicants’ supervisory failures. Applicants failed to establish and maintain a reasonable supervisory system for ensuring email retention over the course of several years. We agree with the NAC that it is “especially troubling” that although both our staff and FINRA informed Southeast in 2012 and 2014 that its email retention system was inadequate, Applicants ignored those warnings and instead continued to use what the NAC characterized as an “honor system.”

We also sustain the determination to impose the fine jointly and severally. Despite the Guidelines, the Hearing Panel found that, because “Black is the owner and President of Southeast,” it was “appropriately remedial to fine [Applicants] jointly and severally for their supervision violations.” Although the NAC did not expressly address this issue, it did not disagree with the Hearing Panel’s basis for imposing the joint and several fine. Nor do we, because Southeast’s wrongdoing occurred through Black while Black owned Southeast.

at Page 18 of the SEC Opinion

Bill Singer's Comment

For starters, I reiterate my observations from 2019 that:

The NAC Decision redounds to FINRA's credit as an articulate expression of the best of self-regulation. Rare words of praise from me, indeed! A well-drafted and methodical effort that comprehensively addresses the various issues and offers a lucid presentation of the panelists' rationale

from Securities Industry Commentator / May 28, 2019

Too often, the Decisions that emanate from FINRA's Office of Hearing Officers ("OHO") or NAC are conclusory and bereft of sufficient discussion and rationale as to justify the effort. In the case of the 2019 NAC Decision at issue here, that body discharged its role in superb fashion -- which in part may account for the SEC's ability to dissect and analyze FINRA's analysis and rationale underpinning its two decisions. What is too often lost when dealing with FINRA regulatory cases is that there is supposed to be a distinction between the role and conduct of the Enforcement staff prosecuting a case and the role and conduct of the OHO and NAC panelists adjudicating the case. In Southeastern, there is no question that the line of demarcation is wide between the prosecutors and adjudicators. Notwithstanding that the SEC has to some extent rebuked FINRA's Enforcement staff, that determination was to a large degree facilitated by the extensive record published by the NAC. 

Finally, compliments to Alan M. Wolper and Blaine F. Doyle of Ulmer & Berne LLP for their impressive representation of their clients Southeast Investments, N.C., Inc. and Frank Harmon Black.