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A Stockbroker’s Guide to Regulatory Investigations (2nd Edition, 2012) Understanding regulatory examinations and enforcement actions. Joel R. Beck, Esq. The Beck Law Firm, LLC

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A Stockbroker’s Guide to Regulatory Investigations (2nd Edition, 2012) Copyright ©2010-2012 Joel R. Beck This work is licensed under the Creative Commons Attribution-No Derivative Works 3.0 United States License. To view a copy of this license, visit http://creativecommons.org/licenses/by-nd/3.0/us/ or send a letter to Creative Commons, 171 Second Street, Suite 300, San Francisco, California, 94105, USA.

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Table of Contents About the Author 5 Foreward Regulatory Exams = Serious Matters 8 Part One – FINRA Examinations and Actions Chapter 1 Overview of Examinations 12 Chapter 2 The FINRA Exam Process 18 Chapter 3 Rule 8210 and Jurisdiction Issues 25 Chapter 4 Informal Disciplinary Actions 31 Chapter 5 The Formal Action Process – An Overview 35 Chapter 6 Pre-Complaint Settlement / AWC 42 Chapter 7 No Settlement = Litigation An Overview of the FINRA Hearing Process 48

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Chapter 8 Settlements after the Complaint The “Offer of Settlement” 57 Chapter 9 Appeals and Calls for Review 61 Chapter 10 Other Considerations 65 Part Two – SEC Matters Chapter 11 SEC Matters 69 Part Three - State Securities Commission Matters Chapter 12 State Examinations and Enforcement Activities 72 Conclusion 76

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About the Author

Joel R. Beck is a

lawyer and founder of The

Beck Law Firm, LLC in

metro Atlanta, Georgia.

Joel’s practice primarily

focuses on financial markets

law, representing firms and

brokers across the country in

regulatory matters, arbitration cases, and providing general

legal advice relating to compliance issues for broker-

dealers and registered investment advisors. Joel also works

as a consultant to other attorneys representing clients in

securities regulatory matters and has testified as an expert

witness in securities-related cases, and worked as an

independent consultant for a broker-dealer to satisfy

undertakings imposed by the SEC. Prior to opening The

Beck Law Firm, LLC, Joel worked at NASD (now known

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as FINRA) for ten years, including six years as an attorney

in the Enforcement Department. There, Joel litigated cases

involving penny stock fraud, misrepresentations and

omissions of material facts, unsuitable recommendations,

unauthorized trading, forgery, supervision, selling away,

conversion of funds and other violations. In addition to

working as an attorney in the Enforcement Department,

Joel also worked as an examiner in the Member Regulation

Department, and as a paralegal in Enforcement at NASD.

Now, in addition to securities regulation and

compliance matters, Joel’s practice also includes criminal

defense (including white collar type matters relating to the

financial markets), basic estate planning for individuals,

and small business law, including business formations and

operations, contracts, agreements, and the day to day legal

needs of a small business owner.

Joel earned his BBA at Georgia Southern

University and his JD at John Marshall Law School,

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Atlanta, where he graduated with honors and was a

recipient of the West Publishing Company Award for

Academic Excellence. In November 2005, Joel was

designated a Certified Regulatory and Compliance

Professional (CRCP) by the NASD Institute and the

Wharton School of Business at the University of

Pennsylvania. He no longer maintains that designation as

active, focusing his continuing education efforts in a

variety of other areas. In March 2010, and again in March

2011, Law & Politics and the publishers of Atlanta

Magazine named Joel as a Georgia Rising Star lawyer in

securities litigation. Joel is a member of the State Bar of

Georgia.

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Foreword

Regulatory Examinations =

Serious Matters. If I were to try to come up with a catchy title or

subtitle to this short book, it might be “Oh S*&#!” because

that’s the reaction I think many brokers have when they

receive a notice from a regulator asking for information or

informing them that they are under investigation. Perhaps

you received a letter from a FINRA examiner, or maybe

your compliance officer or branch manager has asked you

for information in response to a regulatory inquiry. Or,

maybe a client has filed a complaint against you and you

are expecting to hear from the regulators. Whatever the

reason you’re interested in learning more about these

matters, you should understand that regulatory

examinations, whether conducted by FINRA, the SEC, or a

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state securities regulator, are serious matters because

disciplinary actions resulting from these examinations can

have a significant impact on your career. Sanctions for

violations of industry rules and regulations, or federal or

state securities laws may result in: a censure, fines being

assessed against you, orders to pay restitution to customers,

a suspension from working in the industry for a number of

days to years, or an outright bar from being associated with

a broker-dealer. Further, the regulatory actions taken

against you may become reportable on your Form U4 and

made available to the public through press releases and

announcements by regulators. These actions can result in

your broker-dealer terminating your employment or your

independent contractor agreement, can make it more

difficult to join another broker-dealer in the future, can

make it more difficult to be registered with the states, and

can make your practice and advice less appealing to

existing or potential clients. Further, it is possible that a

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disciplinary action can have collateral consequences in

other areas, including licensing for insurance, investment

advisor, mortgage and other areas. As a result, brokers

must treat regulatory examinations as serious matters.

In this short book, I’ll share with you the basics of

regulatory examinations, focusing primarily on exams and

regulatory actions initiated by the Financial Industry

Regulatory Authority (FINRA®), as I believe that more

representatives are likely to face FINRA matters than

matters involving other regulators. But, I’ll also share

some information on SEC and state exams and actions as

well.

Why did I write this book? It’s simple. I believe

there is a lot of information that a broker under

investigation needs to know. They should understand the

process they are in, what some of the steps involved are,

and what the possible outcomes might be. As the old

saying goes, forewarned is forearmed. The more solid

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information you have, the better your decision-making

process can be. While I believe that this book contains

very useful information, please understand that this book

is not a substitute for competent, experienced legal

advice. This book simply seeks to educate you about these

types of investigations and highlight issues and outcomes

that might apply in your situation. Put simply, if you need

legal advice, you need to consult a lawyer. And if you need

legal advice relating to regulatory investigations, you owe

it to yourself, and your career, to consult with a lawyer

experienced in these areas.

All information in this ebook is believed to be

accurate at the time it was written, but there are no

guarantees of such accuracy and the author and publisher

assume no responsibility to update and maintain this

ebook.

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Part One - FINRA Examinations and Actions Chapter 1 Overview of Examinations

From both my time as a securities regulator and

now in the private practice of law, I’ve been involved in

hundreds (if not thousands) of regulatory examinations. In

private practice, I often represent individual brokers and

firms that are involved in an investigation or examination

(these words are used interchangeably) by FINRA or other

regulators. Many times, I find that brokers don't

understand the role that FINRA plays, what their own

responsibilities and obligations are, and what can come

about as a result of a FINRA examination. We’ll cover

these items in this section, beginning with some

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background on FINRA, and the types of examinations that

they may initiate.

FINRA is not a part of the government and FINRA

examiners won't throw you in jail for some type of

violation of industry rules and regulations. FINRA is a

self-regulatory organization and all broker-dealers doing

business with the public are members. Pursuant to their

membership in the organization, brokerage firms, and the

brokers working for them, agree to abide by industry rules

and regulations, including FINRA rules, and agree to be

subjected to FINRA's jurisdiction in disciplinary actions.

These disciplinary actions are civil in nature, and are not

criminal matters (FINRA matters are civil; there are federal

and state law enforcement agencies that investigate

securities violations and, if appropriate, criminally

prosecute violators). The distinction of FINRA as a non-

government regulator is important because under the

current state of the law you don't have certain rights with

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FINRA that may exist with the SEC or a state regulator

(think of the 5th amendment right against self-

incrimination –for more information see the chapter on

Rule 8210).

FINRA conducts routine exams of broker-dealers to

check for compliance with industry rules and regulations.

These routine examinations generally follow a cycle that

results in a firm being inspected once every year, two years,

or three years, depending on the type of business the firm

does, its size, and its perceived risk to the markets and the

investing public. The scope of these examinations are very

broad with examiners making sure that the firm is operating

with sufficient capital, is adequately supervising its

employees and business operations, and has proper internal

systems and controls in place. Examiners also focus on

more mundane elements, like making sure a firm displays a

“SIPC” sign on its premises in the manner prescribed by

industry regulations.

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In addition to these routine exams, FINRA also

conducts “cause” (think “for cause”) examinations based

on information that it receives that indicate that there might

be a rule violation. For example, an examination may be

started based on information from a Form U4 or U5

disclosure, a Rule 4530 report, a customer complaint, an

arbitration claim, a referral from an arbitration panel, or

information received from another regulator or law

enforcement agency. Sometimes exams are initiated based

upon information received from a competing broker or

broker-dealer employee in the form of a regulatory tip.

These cause exams typically focus on sales practice matters

involving allegations of unauthorized trading, unsuitable

recommendations, misrepresentations or omissions, selling

away (private securities transactions), participating in

undisclosed outside business activities, forgery, theft or

conversion of funds, and other unethical behavior.

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Information that FINRA obtains in its exams is

generally not publicly available, but brokers and firms

should be aware that FINRA might share certain

information with other regulators, as well as with law

enforcement agencies. Further, the exam file may be

subject to a subpoena in civil litigation, including

customer-initiated arbitration claims. For these reasons, it

is wise to consult with legal counsel when facing a

regulatory exam, particularly in cases where the broker

may have participated (intentionally or not) in criminal

misconduct, or where there may be a serious risk of civil

litigation by investors or others who may have been

damaged as a result of the broker’s conduct. As discussed

later with regards to Rule 8210, while failing to cooperate

with FINRA will typically ultimately result in an individual

being barred from working in the industry, such option may

be the chosen strategy when faced with other criminal or

civil actions or claims.

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Various departments within FINRA conduct

examinations, including Member Regulation, Enforcement,

and Market Regulation. Member Regulation typically is

responsible for the routine examinations of firms, but it, as

well as Enforcement, also conducts cause exams focusing

on sales practice violations of firms and brokers.

Enforcement will typically be involved in larger-scale

investigations covering a wide range of issues or other

cause exams, and Market Regulation is the primary

department for conducting exams relating to the operation

of the markets, and trade reporting compliance, etc. While

many exams conducted by FINRA do not lead to no

disciplinary action being taken, or only an informal (and

non-public) type of action, firms and brokers cannot tell at

the outset of an examination what the end result will be.

As such, it is best for a broker to treat all examinations as

serious matters.

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Chapter 2

The FINRA Exam Process

Most of the regulatory exams that result in

disciplinary actions against individual brokers result from

cause exams and relate to sale practice issues, disclosure

(Form U4) issues, or the broker’s other activities (such as

outside business activities). Whatever the type of violation

being investigated, the process the examiners use remains

basically the same.

At the outset of the exam, the regulators generally

know little about the activities or conduct being

investigated. The examiner’s first step is usually to send a

written request for information to the broker-dealer and

another one to the broker, seeking basic information on the

complaint or other disclosure. These initial requests letters

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often simply ask for the broker to provide a written

response to the allegation. The request letter to the firm

usually seeks a written narrative of the complaint or other

disclosure and the firm’s findings, and may also seek

copies of relevant documents, including correspondence

with the customers involved, account records such as

statements and new account forms, and other relevant

items. After obtaining this initial information, examiners

review the documents and information received to

determine whether the issue is one over which FINRA has

jurisdiction, may indicate a potential rule violation, and

meets other thresholds for FINRA to continue reviewing

the matter. Historically, FINRA does not conduct

examinations into conduct that it considers too old (perhaps

older than two years) unless that conduct is egregious.

Examiners use a variety of investigative methods to

conduct their examination, but the vast majority of

information gathered comes about as a result of written

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letters. Letters seeking information and documents, and

responses to specific questions are frequently sent to firms,

brokers, and other involved persons associated with broker-

dealers. Oftentimes a letter to a broker seeking

information will ask the broker to respond with a signed,

written statement, responding to specific questions. It is

commonplace for a broker to receive two, three, four or

more such letters.

In addition to writing letters, examiners may

conduct telephone interviews with brokers, managers,

compliance department employees, customers, and others

to obtain additional information. These interviews are

considered to be informal interviews, but brokers must be

cautious nonetheless, as what they say can certainly be used

against them. In most cases that lead to a disciplinary

action, the examiners and/or attorneys for FINRA will

request that the broker or other associated persons of the

firm meet with the regulators for an on-the-record interview

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(“OTR”). These OTRs are very similar to a deposition in a

civil court case as the witness is sworn in to tell the truth,

the interview is recorded by a court reporter, and a

transcript of the interview is prepared. Usually, when

FINRA staff seek to take testimony with an OTR, they

believe that it is likely that the case will result in some type

of disciplinary or enforcement action, though that will not

be communicated to the broker. Since brokers are allowed

to have legal counsel appear at the OTR with them, a wise

broker will obtain legal counsel to help prepare for the

OTR, for the OTR itself, and for any forthcoming

enforcement action. Sometimes there may be two OTRs of

a broker during the course of an examination; FINRA is not

limited to just one interview with an individual.

Once the examiners believe that they have gathered

all of the relevant information, documents, and other

evidence, a report of examination will be prepared by the

examiner(s) and submitted to a supervisor. That supervisor

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will review the report and the evidence obtained, and then

make a recommendation to close the file without action, to

pursue some type of informal disciplinary action, or to

pursue a formal disciplinary action, or to resolve the matter

with a combination of these items. A more senior manager

generally reviews the supervisor’s recommendation and

then the exam is closed, or informal or formal disciplinary

action is pursued (or a combination of those).

While this is a short chapter and the process of the

examination seems simple enough, it does not mean that a

regulatory examination will be completed quickly. To the

contrary, the examination will likely take many months,

and it is not unusual for an examination to take over a year

to be completed. Of course, those cases that are deemed

more serious may be completed more quickly than many

routine types of examinations. The good news, however, is

that, until a “Wells” letter or phone call is issued to the

broker officially putting he or she on notice that the staff

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intends to pursue a disciplinary action against him or her,

no disclosure of the regulatory examination is required to

be made on the broker’s U4.

One final point relating to the exam process:

FINRA does not have jurisdiction over people that are not

affiliated with the securities industry. Since FINRA cannot

require or compel the cooperation of these folks, such as

customers, some examinations go nowhere due to a lack of

customer cooperation, if such cooperation is necessary to

establish the existence of a violation. Brokers should not

attempt to persuade a customer not to cooperate with the

regulators, because such persuasion can be found to be a

violation of FINRA rules, for which the broker or firm can

be sanctioned. This holds true for settlement agreements

with customers to resolve customer complaints or

arbitrations. FINRA expressly prohibits any settlement

agreements from restricting the customer’s ability to

communicate with and cooperate with any regulator.

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Likewise, brokers must also be wary of settling a complaint

with a customer without approval of their firm, as FINRA

can sanction brokers for settling away from the firm.

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Chapter 3

Rule 8210 and Jurisdiction Issues

A question I am frequently asked relates to FINRA

Rule 8210, with brokers wanting to understand whether

they have to comply with requests for information from the

regulator. The short answer to that question is no, but there

may be significant consequences for not doing so. The

standard sanction for failing to respond to information

requests or requests for testimony is a bar from the

industry, meaning that the person is no longer eligible to be

registered or even associated with a broker-dealer. So,

while a broker does not have to respond to FINRA, he or

she will almost certainly be kicked out of the industry for

such failure. And importantly, that type of disciplinary

action may have an impact on the broker’s future

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employment prospects, as well as on licenses for other

activities, such as an insurance license, investment advisor

registration, mortgage license, etc.

Put simply, Rule 8210 is essentially FINRA’s

version of a subpoena. FINRA is not a part of the

government and it therefore does not have subpoena

authority, but Rule 8210 comes close. The rule requires

that a broker-dealer firm, and registered and associated

persons, and persons subject to FINRA’s jurisdiction,

cooperate in a regulatory examination and provide

information in writing, electronically, or orally, including

testimony, when requested by FINRA staff. Should a

broker choose not to comply with the request, he may be

suspended through an expedited proceeding, and, as a result

of a disciplinary proceeding, he may be barred from

association with any broker-dealer in any capacity for the

failure to respond, in addition to other sanctions.

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As I’ll discuss in a later chapter, FINRA is different

than other regulators. Because the other regulators (the

SEC and the states) are the government, a broker can

usually, where appropriate, assert his or her right against

self-incrimination and elect not to answer certain questions

from those government regulators where the misconduct

may have criminal ramifications. But, because FINRA is

not the government, such 5th amendment protections do not

apply, and a broker who refuses to answer questions or

provide information to FINRA on these grounds can be

sanctioned and barred from the industry. Nevertheless, in

certain cases it may be preferable for a broker to not

cooperate with FINRA if he is facing criminal charges, as

the statements and information he provides FINRA can be

subpoenaed or requested by law enforcement agencies, or

FINRA may make a criminal referral to such agency and

provide them with information it obtains. The decision on

whether to cooperate with securities regulators while facing

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possible criminal exposure is a complicated one that should

always be made with the advice of legal counsel

experienced in these matters, only after reviewing the facts

and circumstances of the broker’s particular situation.

One more point on 8210: It is a violation of Rule

8210 to provide misleading, untruthful or outright false

information to the regulators, and may brokers have been

sanctioned for lying to the regulators. Sometimes, the

sanctions for lying to the regulators is worse than the

sanction for other violations identified during the

investigation, leading to more significant, and needless,

sanctions against the broker. And, if the untruthful

information is provided to FINRA in the context of a sworn

statement, it is possible that the broker could face criminal

charges for perjury.

Another question I often get about regulatory

examinations is that of jurisdiction, and how that relates to

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a former broker who is now out of the securities industry.

Article V, Section IV of FINRA’s Bylaws provides for

FINRA’s jurisdiction over formerly registered and

associated persons. Pursuant to the Bylaws, a person is

subject to FINRA’s jurisdiction for purposes of Rule 8210

requests and disciplinary proceedings for two years

following the effective date of termination of the broker’s

registrations (or termination of the association with a

broker-dealer in the case of associated persons). Note that

the effective date of termination may be after the date that

the broker ceases working for a firm, because the firm has

to have a reasonable amount of time to file a Form U5

disclosing the broker’s departure. There’s another wrinkle

with respect to the two-year period of retained jurisdiction

as it relates to a formerly registered person. If the broker’s

U5 is amended during that two-year period in a manner that

discloses new, actionable conduct, the two-year period

starts over. So, under this bylaws provision, it is

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technically possible for FINRA to maintain jurisdiction

over a formerly registered broker for almost four years, if

an amended U5 is filed just shy of two years of the broker’s

departure from the firm. Because many persons, including

regulator staff, misunderstand these technical jurisdiction

provisions, if a broker has been out of the industry for

about two years and is dealing with an examination or

disciplinary action, he or she should consult with

experienced legal counsel about the jurisdiction issue.

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Chapter 4

Informal Disciplinary

Actions

In the old days at NASD, once the examination was

completed and a recommendation had been made to pursue

informal disciplinary action, the broker could expect one of

two possibilities: a Letter of Caution or a Compliance

Conference. Both of these mechanisms were methods to

take disciplinary action against the broker in an informal

fashion. It is informal in the sense that it is not reported on

a broker’s U4, is not made publicly available at that time,

and does not impose any sanctions against the broker. It is

essentially a private admonishment or censure by the

regulators, wherein the broker is informed of the alleged

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improper conduct, and is required to affirm that he

understands, and will endeavor not to engage is such

improper conduct again. Now, with FINRA (post-

consolidation of NASD and NYSE Enforcement), it seems

that the terms “letter of caution” and “compliance

conference” have been replaced with one term for an

informal action: the “Cautionary Action.”

Typically, with the Cautionary Action, the FINRA

staff sends the broker a letter explaining that they have

completed the examination, and has concerns about the

broker’s compliance with industry rules. The letter will

specify the rule believed to have been violated, and perhaps

specify the reasons for such violation. Sometimes the letter

requests that the broker submit a letter in reply

acknowledging that he has received the letter, understands

the regulator’s concerns, and will work to ensure that no

additional violations of the rules occur in the future.

Sometimes no such reply is requested. The matter is

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generally closed once the Cautionary Action letter has been

sent, and, if applicable, once the broker has submitted the

reply, unless the staff is also pursuing some additional

items through formal action as well.

In more serious cases, the staff may require the

broker to come to a FINRA office for a meeting, where

they will orally explain the findings of their examination to

the broker, relay their concerns about the broker’s

compliance with industry rules and regulations, and

admonish the broker to follow the straight and narrow path

of full compliance with the rules. At the conclusion of

these meetings, the broker may be requested to send in a

letter acknowledging the concerns that were addressed and

articulating any steps that the broker may take to ensure a

repeat of the violation does not happen.

From a broker’s perspective, if an examination is

not going to be closed without action, then it is preferable

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for the disciplinary action to be informal, and resolved

through a Cautionary Action. But not all types of

violations will be considered appropriate for informal

action, and certainly the more serious violations will never

be handled in this fashion.

One final note on informal action: the regulator

keeps up with its informal actions. So, when a broker

engages in the same improper or unlawful conduct in the

future, you can expect the informal disciplinary action to be

brought up at a disciplinary hearing, showing that the

broker was placed on notice to cease the misconduct.

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Chapter 5

The Formal Action Process – An Overview

Once the examination has been completed, and a

recommendation that formal disciplinary action be pursued,

the examination is then often turned over to lawyers

working for FINRA, generally in either the Enforcement or

Market Regulation Departments (if these departments did

not actually conduct the examination). The lawyer will

typically review the file and the recommendation to ensure

that the examiners have obtained all of the necessary

evidence and information, and if not, may request that the

examiner staff continue in its evidence gathering. Once the

file is determined to be essentially complete, the lawyer

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will likely contact the broker with a phone call or letter, or

both.

Oftentimes, the FINRA lawyer will contact the

broker (or his lawyer) advising him or her that FINRA

intends to take a disciplinary action against the broker for a

violation of FINRA rules or certain other industry rules,

regulations or laws. A general description of the rules or

laws alleged to have been violated will be provided, and the

broker will be invited to make a submission to FINRA

providing it with any additional information or documents

not previously provided, and to present an argument as to

why the FINRA staff should not proceed with a

disciplinary action. This process is called the “Wells”

process, named after Senator John Wells who chaired a

Congressional committee in the early 1970s charged with

reviewing the enforcement activities of the SEC. Senator

Wells’ committee recommended that the SEC provide

notice to prospective respondents of charges being

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considered by the SEC staff. The SEC adopted such

practice, as did many SROs such as FINRA.

The “Wells” notification is significant. Once the

broker receives the “Wells” notification advising he or she

that FINRA intends to proceed with disciplinary action

against the broker, the broker has an obligation to amend

the Form U4 to disclose that the broker is under

investigation. Additional disciplinary charges can be made

against the broker for not updating the U4, or not timely

updating the U4.

The “Wells” notification will generally give the

broker a few weeks to respond by submitting a “Wells”

submission to FINRA, or to speak with the FINRA lawyer

about settling the case before a disciplinary complaint is

filed against the broker. A “Wells” submission is typically

a written argument as to why it is not appropriate, not

necessary, or both, for FINRA to pursue the proposed

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action against the broker. The submission may provide

FINRA with additional information and evidence it did not

obtain during the course of the examination that might tend

to show that the broker did not commit the violation, or that

the violation is not as serious or significant as the regulators

believe, among other things. Any “Wells” submission sent

in by the broker (or his lawyer) will be reviewed by the

FINRA lawyer and his or her supervisor, and, if they still

intend to move forward and issue a disciplinary complaint,

the submission will also be reviewed by staff in the

independent Office of Disciplinary Affairs (ODA). ODA

must approve the issuance of all disciplinary complaints (as

well as settlements) by either the Enforcement or Market

Regulation departments.

The question of whether to submit a “Wells”

response in any particular case cannot be answered in the

context of this short book. The answer depends on the

case, what has been provided during the course of the

39

examination and the posture of the parties at that point in

time, among other things. My experience and observation

over the years is that “Wells” submissions are generally not

successful at persuading the regulators not to pursue a

disciplinary action. They may be successful in altering the

action by changing a rule or law alleged to have been

violated, or in reducing the number of charges being

pursued. And they may also be successful in providing

rationale and support for more reasonable settlement terms

if the parties have discussed settling but are still far apart

on terms. Ultimately, whether to submit a response to a

“Wells” letter will be determined by the facts and

circumstances of the particular case. And in making that

decision, it is important to understand that such submission

is not a confidential settlement agreement and that it might

be used against the broker by the regulator, or by civil

claimants if the submission is produced pursuant to a

subpoena.

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If, after receiving a “Wells” response, the regulators

determine not to pursue formal disciplinary action, they

may either close the examination without action, or proceed

with informal disciplinary action as discussed in a previous

chapter. If they are proceeding with formal action, the

broker can either settle the matter or stand up and fight. The

broker can answer a disciplinary complaint and request a

hearing, and have a hearing before a hearing panel. The

panel will hear the evidence and make a determination as to

whether the broker committed the alleged violations, and if

so, determine the appropriate sanctions. The hearing panel

decision is not necessarily the end of the case, as there are

avenues to appeal the decision.

One final note on formal disciplinary actions: if the

broker chooses not to participate in the process, the process

will continue, and a default decision can be issued against

the broker, subjecting the broker to sanctions. Simply

closing your eyes and ears and pretending that the action

41

does not exist doesn’t stop it from moving forward.

Because it is incredibly difficult (if not impossible) to

reverse a default decision entered against you, the time to

deal with the matter is when it is ongoing.

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Chapter 6

Pre-Complaint Settlement / AWC

Oftentimes brokers will settle a proposed

disciplinary action with FINRA before a formal

disciplinary complaint has been issued. These settlements

are done through a Letter of Acceptance, Waiver and

Consent (AWC) in which the broker neither admits nor

denies the allegations, but agrees to the imposition of

findings of facts and of violations, and to the imposition of

negotiated (to some extent) sanctions. Once finalized, the

AWC completely resolves the matter, and pursuant to the

terms of the AWC, FINRA will not come back later and

bring another action alleging violations based on the same

conduct as described in the AWC.

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Many brokers who settle through AWCs do so to

avoid the uncertainties of going through the hearing

process, thereby accepting a known resolution of the matter

through the AWC. Others settle because they believe they

have no choice, as they are not able to retain counsel to

represent them, and don’t want to fight the matter

themselves. Others simply settle because they simply don’t

care anymore as they are no longer working in the

securities industry and don’t plan on returning to the field.

Whatever the reason, there are pros and cons to settling any

case.

Before agreeing to settle a proposed action through

an AWC, a broker should understand the nature of the

charges being settled, the type and quality of the evidence

against the broker that the regulator might have, and the

actual repercussions of entering into a settlement. For

example, a regulatory body may seek to settle charges

against a broker that make findings that the broker

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committed fraud, or committed violations in a willful

manner, among other things. Because these types of

findings can have significant impact on the broker, it is

important to understand exactly what conduct, and how

charged.

It is also important to understand what evidence the

regulator has that might tend to show the broker committed

the violation, and understand the quality of that evidence.

It may be that a regulator seeks to settle a case that it

believes in, but does not believe that it can win at hearing,

if the case went to hearing. As such, brokers and their

lawyers must consider the unique facts and circumstances

of their case, as well as what the regulators have to prove,

and how, before agreeing to settle.

Finally, a broker should understand the actual

repercussions of entering into a settlement. While a broker

may not care about working in the securities industry again,

45

the broker should understand that a disciplinary action

might have an impact on an ability to work in other fields,

especially fields that require licenses such as insurance,

mortgages, and others. And, the broker must understand

that the nature of the findings made in the settlement can

greatly impact the situation. Take for example a broker

that is charged with willfully failing to amend his Form U4

to disclose a reportable item. While the sanctions in a

settlement may include a small fine and a very short

suspension, the fact that the violation was alleged to have

been done in a willful manner results in the broker being

statutorily disqualified from working with a broker-dealer.

So, in effect, the short suspension is essentially a bar,

unless the broker is able to obtain special authorization

from FINRA and the SEC to be associated with a broker-

dealer. Because there can be collateral consequences

beyond the simple appearance of the settlement, brokers

46

should engage hiring experienced counsel to guide them

through this process.

Procedurally, once the broker and FINRA staff

agrees on a settlement, the FINRA lawyer drafts the AWC.

Once the broker signs it and returns it to FINRA, it must be

approved by the prosecuting department (Enforcement or

Market Regulation), and then reviewed and approved by

the Office of Disciplinary Affairs pursuant to delegated

authority from the National Adjudicatory Council. If ODA

approves the settlement, then the matter is settled and it is

resolved according to the terms of the AWC. Sometimes,

however, a settlement will not be approved by ODA. In

those cases, the FINRA lawyer will likely advise the broker

as to the changes required for the AWC to be acceptable to

ODA, and the broker can agree to those terms, or can

refuse and instead opt to litigate the matter.

47

A final note on AWCs: Some folks are under the

misguided impression that by settling early, they get a

discount on sanctions, meaning that they might expect to

receive more significant sanctions if they fight the matter

and go to a hearing. Certainly sometimes the sanctions at

hearing are harsher than what a broker might have settled

for, but not always. And, many times a broker can obtain

more favorable results in terms of sanctions (if found to

have violated the rules as alleged by the regulator.) So,

brokers who can stomach going through the hearing

process may fare much better than by settling out early.1

1 I’ve tried hard not to resort to using footnotes in this book. But I just have to do it here on the concept that sometimes pays to fight the regulators. I’ve had success for clients obtaining lower sanctions by litigating and going through a hearing, as opposed to taking the settlement terms offered by FINRA Enforcement. Other lawyers have had this same success as well from time to time. You can also find some articles written along the lines that it sometimes pays to fight the regulators. Note, however, that while I agree that it sometimes pays to fight the regulators, that does not mean it always pays to fight the regulators. As the gambler teaches us, you got to know when to fold ‘em as well.

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Chapter 7

No Settlement = Litigation An Overview of the FINRA Hearing Process

Not all brokers settle proposed charges against them

through an AWC for a variety of reasons such as a desire to

clear their names, the inability or unwillingness to agree to

sanctions demanded by the regulators for a settlement, or to

simply avail themselves of the litigation process to be able

to continue to work for a period of time. Generally, should

there not be a settlement reached immediately following the

“Wells” letter, then FINRA will seek to file a formal

disciplinary complaint against the broker before FINRA’s

Office of Hearing Officers. (Note: In some cases, the

Complaint may allege more serious misconduct or charges

49

than what was proposed to settle the matter; the staff is not

limited to charging the broker only with the charges it was

willing to settle.)

Procedurally, the FINRA lawyer will go through a

similar process to get approval to file a Complaint as he or

she does to get an AWC approved. The prosecuting

department (Enforcement or Market Regulation) will

review the matter and determine that it believes that it has

sufficient evidence to support a rule violation, and ODA

must approve the issuance of the Complaint.

Once the Complaint is filed with FINRA’s Office of

Hearing Officers, a notice that the complaint has been filed,

along with a copy of the complaint, is mailed to the broker

at his or her CRD address, and any other address for which

FINRA believes is a valid address. The notice provides a

due date for the broker to file an answer, sets forth

information relating to the possible location of the hearing,

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discovery of certain information, and other technical

information. The broker can then file an answer to the

complaint, admitting or denying the allegations, and can

also request a hearing.

If an answer is filed and a hearing is requested, the

Hearing Officer assigned to the case will conduct a pre-

hearing conference with the parties and schedule the case.

Scheduling includes deadlines for discovery issues, filing

of pre-hearing briefs and motions for various things, and

scheduling the hearing itself. The schedule issued by the

Hearing Officer will govern the proceeding, and the parties

must seek the Hearing Officer’s permission to deviate from

it.

The Hearing Officer, an employee of FINRA,

serves as the chairperson of the Hearing Panel that will

judge the case at hearing. Two other hearing panelists

serve on the panel as well. These other panelists generally

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come from a Regional Committee that consists of folks

from the industry (typically principals of firms) elected by

the member firms.

A respondent in a disciplinary proceeding is entitled

to discovery in the case, and is generally allowed to inspect

and copy the documents and information in the

investigative file that led to the issuance of the complaint.

A respondent is not entitled to all of FINRA’s documents in

the case as some things may be excluded under the Rules.

Unlike a civil court case, however, discovery is only one

way, and Enforcement or Market Regulation do not have

the right to obtain discovery from the respondent (though

there may be investigative letters issued under Rule 8210

seeking information or facts relating to certain affirmative

defenses or facts that a respondent might raise in his or her

answer).

52

In the course of moving forward to a hearing,

various motions might be filed by either side of the case.

Common motions include motions to allow witnesses to

testify at hearing via telephone instead of in person, as well

as motions in limine that seek to have the Hearing Officer

rule on evidentiary issues before the hearing. Other

motions might seek to disqualify a Hearing Officer or

hearing panelist, seek to obtain additional discovery or

more information on the Complaint, or motions by the

FINRA staff seeking summary disposition (seeking to

resolve the mater without hearing, or to at least resolve the

issue of liability for the violations). Shortly before the

hearing occurs, the parties will exchange witness lists,

exhibit lists and proposed exhibits, as well as file pre-

hearing briefs outlining their arguments about the evidence

of the case, the applicable law and what findings the

hearing panel should make after hearing all of evidence and

testimony.

53

The hearing itself is less formal than a trial in a

courtroom, does not follow court rules and procedures, but

generally operates in the same fashion. The FINRA

attorney will make an opening statement, followed by an

opening statement from the respondent’s lawyer. FINRA

will then call its witnesses, typically including the FINRA

examiner who investigated the case, customers and others,

to testify about the facts supporting the allegations in the

Complaint and to introduce and testify about exhibits that

FINRA seeks to introduce against the respondent. The

respondent or his or her counsel has the opportunity to

cross-examine these witnesses. Following the completion

of the FINRA staff’s case, the respondent is also given the

opportunity to call witnesses to testify, for the respondent

to testify himself, and for the respondent to offer exhibits as

evidence in the matter. Likewise, the FINRA attorney will

also have the opportunity to cross-examine any witnesses

who are called to testify on behalf of the respondent, and

54

the respondent himself, if he testifies. Unlike most court

cases, the hearing panelists might also ask questions of the

witnesses at any time, and sometimes have many questions

for the witnesses, especially the broker.

Following the testimony of the witnesses and the

presentation of evidence, the lawyers will make their

closing arguments and ask the panel to make findings in

favor of their respective client, to find the that FINRA

proved or failed to prove the allegations against the broker,

to impose a certain level of sanctions, or to otherwise rule

as they argue. From there, the hearing panel will meet to

determine how they wish to rule. In many cases they may

make their decision right away, but that decision is not

immediately communicated to the parties. Instead, the

Hearing Officer will draft a written decision outlining the

charges, the respondent’s answer, the evidence and

testimony presented, and the legal basis for the panel’s

55

ruling. It is common for the decision to be issued many

months after the hearing is concluded.

Once the hearing panel decision is issued the matter

is closed, and the sanctions (if any) imposed by the panel

will become effective, unless either side appeals the case,

or the case is called for review by the National

Adjudicatory Council (see subsequent chapter for

discussion of appeals/calls for review). The final result is

reported on the broker’s U4 and is made publicly available.

One final note on timing: The process is lengthy.

After the complaint has been issued, the hearing might not

be held for six months to a year or more, depending on

several factors including the complexity of the case, the

number of respondents, the availability of witnesses and the

schedules of the hearing officer and the parties. Then, after

the hearing is held, it may take several more months before

the hearing panel releases a written decision. So, including

56

the hearing process with the examination itself, the whole

regulatory matter might reasonably take one and a half to

two years or more to conclude.

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Chapter 8

Settlements after the Complaint

“The Offer of Settlement” While brokers often settle the regulatory charges

before a Complaint is filed, not all do. Of those who don’t,

many will settle the matter after the Complaint has been

filed, but before the matter goes to a hearing. These post-

complaint settlements are resolved in similar fashion to the

pre-Complaint settlements (AWC). The post-Complaint

settlements are made through the broker submitting an

Offer of Settlement.

Like an AWC, these offers are made without the

broker admitting or denying anything, but agreeing to the

entry of an order showing that the broker committed the

58

violations as alleged in the Complaint and imposing

sanctions. The broker agrees to waive the right to go to a

hearing and to settle the matter allowing FINRA to make

findings of fact and of violations consistent with those in

the Complaint. Typically, the offer is negotiated with the

prosecuting FINRA department (Enforcement or Market

Regulation) and the parties have a good idea that the

sanctions will be approved by FINRA once it is submitted

and worked its way through the approval process.

One advantage to settling through an offer of

settlement is that the broker gets to take advantage of the

discovery process and can see and understand the evidence

gathered against him or her in the regulatory examination.

The broker and his attorney can perhaps then better weigh

and consider the evidence, the possible outcomes at

hearing, and make a more informed choice as to whether it

is better to settle or go to hearing. The disadvantages of

this strategy include additional costs in legal fees, as well

59

the risk that the regulator might have issued a complaint

against the broker containing additional charges that might

not have been made if the matter was settled through an

AWC.

Procedurally, if the offer has been negotiated with

the prosecuting FINRA department, the approval process

for the offer is the same as that of the AWC. Only if the

offer is approved will an order accepting the offer be

issued, thereby closing the disciplinary action.

The broker also has the ability to submit a contested

offer of settlement. Under this rule, the broker submits the

offer, agreeing to the entry of findings of fact and of

violations, and the imposition of sanctions. However,

Enforcement or Market Regulation opposes the offer,

typically due to sanctions that the department believes are

insufficient. Under Rule 9270, the contested offer, along

with its opposition, is then submitted directly to the hearing

60

panel. If the hearing panel accepts the offer, it goes to the

National Adjudicatory Council for approval, and must

receive such approval before it can be fully accepted by

FINRA. This mechanism, while allowed under the rules, is

rarely used and not readily embraced by hearing panels,

which may be more inclined to hold a full hearing to

determine the appropriateness of resolving the case on

those terms.

One final note on settlements: Part of the their

appeal is the broker maintains the ability to have a final

order issued that specifically says that in settling the matter,

the broker neither admitted nor denied the allegations

against him. If you go to hearing, you lose that

opportunity. For some, this fact is an important

consideration.

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Chapter 9

Appeals and Calls for Review

Suppose you take your case to hearing, and you get

a victory – either getting the charges against you dismissed,

or having what you consider to be reasonable and

appropriate sanctions imposed against you as opposed to

what you perceive as more harsh sanctions sought by the

FINRA staff. You decide not to appeal, and Enforcement

(or Market Regulation) doesn’t appeal either. Seems like

the matter is over, and everyone can go on with their

business. Not necessarily.

In the civil court world, if neither party appeals a

court decision, the case is over. An appeals court will not

decide that it wants to review the matter and force the

parties through an appeal that neither wants. That system

makes sense. But that’s not how the FINRA system works.

62

FINRA’s National Adjudicatory Council (the NAC) is the

regulator’s appellate-level body. The NAC can decide that

it wants to review the case and force the parties through an

appeal. Cases can be called for review to consider the

hearing panel’s findings as to violations, as well as its

imposition of sanctions. During the course of this review

the NAC can modify, reverse or affirm the hearing panel’s

decision, turning the broker’s victory into a defeat.

Like the civil court system the broker can appeal a

hearing panel decision, as can the prosecuting FINRA staff.

These appeals are heard by the NAC. And, as with the call

for review system, the NAC can modify, reverse or affirm

the hearing panel’s decision.

The process before the NAC, whether it is the result

of a call for review or an appeal by a party, is also lengthy,

and a basic appeal or call for review may take many

months or a year or more to be completed. Generally

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speaking, any sanctions imposed by the hearing panel do

not go into effect while the appeal/call for review is

proceeding before the NAC, so an appeal or call for review

will still allow a broker to continue working (provided he

or she has a firm with which he or she is registered).

There is not another hearing where evidence and

testimony is presented. Instead, the parties will submit

written briefs on the issues that are the basis for the call for

review or appeal, and then may also make an oral argument

on those issues before a subcommittee of the NAC. That

subcommittee will make a recommendation as to a decision

to the full NAC, which in turn will issue FINRA’s final

decision in the matter.

If the broker believes that he received a bad

outcome, he can again appeal, this time to the SEC. In

most cases, absent special instructions by the SEC, the

sanctions imposed by FINRA will not be delayed pending

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the appeal to the SEC. Should the FINRA staff lose at the

NAC level, it cannot appeal, but is stuck with the NAC

decision.

65

Chapter 10

Other Considerations

Beyond the regulatory issues and potential criminal

concerns that must be considered in formulating a response

to a FINRA examination and disciplinary action, brokers

must also consider other ramifications including an impact

on their job, civil lawsuits and securities arbitration cases

and state registration issues.

While it has been briefly addressed earlier in this

book, particular attention should be paid to potential

criminal charges that might be brought against a broker that

may be related to matters under review by FINRA. If a

broker has committed an industry rule violation that is also

a criminal violation, providing information and testimony

to FINRA might be detrimental to the broker in terms of

66

the criminal case, as that information can likely be obtained

by criminal prosecutors and used against the broker.

Typically, when I know that a broker has significant

criminal exposure, I often recommend that the broker

refuse to cooperate with FINRA, so that the broker may

focus on the more important criminal defense issues, even

though it means that the broker would likely lose his or her

ability to work for a broker-dealer again. Most of the time

mitigating the potential criminal case is much more

important.

Additionally, in cases where customers have

suffered financial losses, those customers may seek

compensation for their damages from the broker or his or

her broker-dealer, most typically in an arbitration case.

Admissions and testimony made in FINRA disciplinary

cases might possibly be obtained by the customers and their

lawyers and may be used against the broker to further the

customers’ claims. Brokers must be aware that it is

67

possible that everything they provide to FINRA, including

testimony, might someday be in the hands of a customer’s

lawyer as the result of a subpoena. In cases where there is

civil exposure to customer claims, brokers should review

these issues carefully with counsel.

Brokers at some firms must also understand the

effect that a disciplinary action (resolved either through a

settlement or a hearing) might have on their job. Some

firms have a zero-tolerance policy and will not employ any

broker with a regulatory disclosure on their record. If this

is the case, while responding to the regulatory exam, the

broker may need to consider making preparations for

alternative employment if the need arises. Beyond that, all

brokers must be aware that a disciplinary action against

them puts a mark on their record, which may make it more

difficult to find employment at other firms in the future,

may make it more challenging to obtain or retain clients,

among other things. As such, all of these factors should be

68

considered in determining how to deal with and resolve a

regulatory investigation.

Similarly, brokers must understand that there may

be licensing issues with some states during the course of,

and following, the FINRA matter. This may impact the

broker’s ability to get licensed timely with a state, and may

require that the broker and firm agree to the imposition of a

heightened supervision requirement to obtain the state

license, if such license will issue at all.

Because there are collateral issues flowing from the

regulatory exam, brokers should work with experienced

counsel to navigate their way through the regulatory exam

and action.

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Part Two – SEC Matters Chapter 11 SEC Matters

The SEC also investigates brokers for violations of

federal securities laws and SEC rules and regulations, and

brings civil charges against the brokers when considered

appropriate. SEC actions can result in a broker being

barred from working in a number of registered capacities,

being fined, and having an injunction imposed prohibiting

future violations, among other things.

Unlike FINRA, the SEC is part of the federal

government. As a result, it works much more closely with

federal law enforcement agencies including the Department

of Justice. When the SEC believes that criminal activity

has been uncovered, it may investigate the case with a view

70

towards pursuing civil charges as well as developing a

criminal case that it can refer to the FBI, a U.S. Attorney,

or other agencies. Therefore, as the case with other types

of investigations, it is very important to consider the

possibility of criminal charges against the broker when

determining how best to respond to an SEC investigation.

If the SEC has granted a formal order of

investigation, its lawyers and examiners are empowered

under the law to issue subpoenas to obtain documents and

records, and testimony to aid in its investigation. There

may be significant penalties for failing to respond to these

subpoenas, but, unlike FINRA exams, a broker may validly

refuse to answer certain questions posed by the SEC by

asserting his right against self-incrimination under the fifth

amendment to our Constitution. But asserting such a right

allows the SEC to make inferences that may be used

against the broker in civil cases arising from the

investigation. It’s important to carefully consider the legal

71

posture, civil and criminal exposure to the broker, and other

factors when deciding on a strategy to respond to SEC

investigations. These decisions must be made on a case-

by-case basis, and simply can’t be fully discussed in the

context of this short book.

A final note on SEC matters: they are serious, and

brokers must treat them as such.

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Part Three - State Securities Commission Matters Chapter 12 State Examinations and Enforcement Activities

Each of our fifty states has a securities

commissioner or someone with a similar title who is

responsible for the regulation of securities business in the

state including licensing issues and enforcement of the

state’s securities laws. While many of the laws from state

to state are similar, each state’s system is somewhat unique,

as is their investigations and enforcement activities.

Some states conduct very few examinations or

investigations of brokers’ conduct in the securities field,

while others maintain large staff, conduct many

investigations and vigorously prosecute violators. The

scope of a state’s securities regulatory activities may be

73

based upon staffing and budgetary concerns dictated

through the state’s legislature as well as the priorities of the

state securities commissioner.

The states belong to the North American Securities

Administrator’s Association (www.nasaa.org) that as an

organization fosters the states’ ability to work together and

conduct its regulatory oversight by proposing uniform rules

and laws, as well as joint investigations into more serious

securities laws matters that may go beyond activity in one

state.

When it comes to state licensing or registration,

each state sets forth its own registration requirements and

their own process for being registered. Disclosures on a

Form U4 that might concern one state may not be of

concern to another. And one state might review and

approve a U4 application quickly, while another may take

months or more depending on the disclosures on the U4

74

and any additional investigation that the state believes

needs to be done to determine whether to approve or deny

the application, and whether approval of the application

must be conditioned upon a heightened supervision or other

restricted licensing agreement. And, like the SEC, the staff

of the state securities commissioner may also work closely

with law enforcement agencies in that state, and may refer

matters for criminal prosecutions where appropriate.

When dealing with state licensing applications, it is

usually considered important to ensure that an application

is not denied, and many states will provide the broker an

opportunity to withdraw his or her application before it is

formally denied. A denial from one state may trigger

reviews of the broker’s licenses in another state that might

result in other states taking an action with respect to the

broker’s registration or pending application.

75

One final note on state matters: each state is

different, and what works for one might not work for the

other. Patience and knowledge of the state’s securities laws

and rules are critical when dealing with the state

commissioner’s office.

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Conclusion

I can’t say it enough: regulatory examinations and

actions from FINRA, the SEC or a state are serious matters.

Brokers who wish to continue working in their field must

treat them that way, and, I believe, should make sure they

are working with experienced counsel to help them resolve

all regulatory issues.

If you’re still looking for more information, you can

find a wealth of it online, starting with my blog that covers,

among other things, legal and compliance issues for

brokers and firms at www.bdlawblog.com. The FINRA

and SEC websites also contain a lot of information, as do

many of the state commissioner’s sites.

I hope that you have found this book useful and

informative. The more information you have, the better

77

your decision-making process will be, in my view. Again,

this book is designed for general educational purposes and

cannot and does not take the place of a lawyer providing

legal advice specific to your unique situation. If you have

questions, or need to discuss your regulatory concerns, I

invite you to contact me.

Joel Beck The Beck Law Firm, LLC

Snellville (Metro Atlanta), Georgia www.thebeckfirm.com

(678) 344-5342