JUDGE RAKOFF DISMISSES CASE AGAINST FINRA OVER MERGER OF NASD AND NYSE

March 3, 2010 By Jay Eng

On March 1, 2010, District Judge Rakoff issued an opinion in two federal cases concerning alleged misrepresentations in the solicitation of NASD shareholder votes necessary for the consolidation of the NASD and NYSE and formation of FINRA. In both cases, the defendants filed motions to dismiss arguing, among other things, that they were entitled to absolute immunity. In his opinion, Judge Rakoff agreed with the defendants stating:

Pursuant to the Securities Exchange Act of 1934 , 15 U. S .C. §§ 78a-7800 , the United States Securities and Exchange Commission is authorized to delegate certain regulatory functions to SROs, which are therefore considered ‘quasi-governmental’ bodies…. As a result , SROs and their offi cers are absolutely immune from private damages suits challenging official conduct performed within the scope of their regulatory functions.

Judge Rakoff concluded that “[i]t is patent that the consolidation that transferred NASD’s and NYSE’s regulatory powers to the resulting FINRA is, on its face, an exercise of the SROs’ delegated regulatory functions and thus entitled to absolute immunity.”

Standard Investment Chartered v. NASD, No. 07 Civ. 2014 (JSR) and Benchmark Financial Services, No. 08 Civ. 11193 (JSR) (S.D.N.Y. Mar. 1, 2010).

WHAT CONSTITUTES “SUBSTANTIAL EVIDENCE” TO SUPPORT AN SEC FINDING OF A FALSE STATEMENT IN A FORM U-4

August 31, 2009 By Jay Eng

In a recent decision, Toth v. S.E.C., No. 03-12739 (3d Cir. Apr. 6, 2009), the United States Third Circuit Court of Appeals considered what constitutes substantial evidence to support a finding by the Securities and Exchange Commission.

In this matter, FINRA (formerly, NASD) brought a disciplinary proceeding against a registered representative for incorrectly stating on his Form U-4 that he had not been “named in any pending investment-related civil matter.” (A Form U-4 is the Uniform Application for Securities Industry Registration or Transfer. Representatives of broker-dealers, investment advisers, or issuers of securities must use this form to become registered in the appropriate jurisdictions and/or SROs.) In fact, the registered representative had been named as a defendant in a civil securities fraud action brought by the New Jersey Bureau of Securities.

At a hearing this matter, the firm’s majority owner testified that the registered representative never told him about the New Jersey action. The registered representative and his witness testified that they had told him so.

On August 9, 2006, a NASD Hearing Panel issued a written decision sustaining the charge and suspending the representative’s license for one year. The Panel found that: (1) the representative knew that he was required to disclose the New Jersey action on the Form U-4; (2) the representative discussed with firm’s majority owner what to include on the Form U-4 but failed to disclose the New Jersey action; and (3) the representative failed to review and sign the Form U-4 either before or after firm’s majority owner filed it despite firm’s majority owner’s efforts to get him to do so. The National Adjudicatory Council and the Securities and Exchange Commission affirmed the findings of the Hearing Panel.

On a petition to the Third Circuit, the registered representative argued that the factual finding by the Hearing Panel that he had not told the firm’s majority owner about the New Jersey action was in error and unsupported by substantial evidence.

In rejecting this argument, the Third Circuit noted that “the evidence on which the SEC relied need not be ‘compelling’ to survive review. Instead, it need only be substantial—i.e., evidence that ‘a reasonable mind might accept as adequate to support a conclusion.’” (citation omitted).

Here, the firm’s majority owner’s testimony was supported by the parties’ correspondence. The court also rejected the contention that an isolated mistaken recollection about where the meeting had taken place by the firm’s majority owner was “the kind of minor discrepancy that does not require the rejection of a witness’s testimony.” Moreover, the testimony of the registered representative and his witness was suspect because the witness failed to disclose his own involvement in the New Jersey action in a Form U-4, neither could recall the details regarding their alleged discussion of the New Jersey action, and that the only documents sent by the registered representative regarding his employment disclosed certain arbitrations but not the New Jersey action.

The Court concluded, “Our review of the record confirms that [the firm’s majority owner] testimony, together with documentary evidence such as the correspondence between [the registered representative] and [the firm’s majority owner], was more than adequate to support the SEC’s ruling.”

FINRA’s NATIONAL ADJUDICATORY COUNCIL (NAC) INCREASES SUSPENSION OVER APPROVAL OF FALSIFIED DOCUMENTS

August 29, 2009 By Jay Eng

On August 25, 2009, the National Adjudicatory Council (“NAC”), the national committee that reviews initial decisions rendered in FINRA disciplinary matters, reviewed a matter in which a Hearing Panel found that the respondent approved the falsification of IRA adoption agreements , in violation of NASD Rule 2110. Rule 2110 requires that member firms observe high standards of commercial honor and just and equitable principles of trade.

In determining his sanction, the Hearing Panel had concluded that misconduct was serious, not egregious. In reaching this conclusion, the Hearing Panel emphasized that the concealment of the falsification was attributable to several firm officers, that the respondents misconduct was negligent, not reckless or intentional, and that the nature of the documents supported lower sanctions.

On appeal, the NAC reversed this finding.

First, the NAC found that the FINRA Sanction Guidelines (“Guidelines”) for the forgery and falsification of documents were applicable to the alleged misconduct and that the Guidelines for the forgery and falsification of records recommend a fine of $5,000 to $l00,000. The Guidelines also recommend that the adjudicator consider a suspension in any and all capacities for up to two years, when mitigating factors exist. In egregious cases, the Guidelines recommend considering a bar. The specific principal considerations to determine sanctions for this violation are “the nature of the documents forged or falsified, and whether the respondent had a good-faith, but mistaken, belief of express or implied authority.”

Second, with these principals in mind, the NAC stated:

Based on [his] entire course of conduct, we conclude that his violation was egregious. Although [his] stand alone approval of the falsification may not have risen to the level of egregious misconduct, his attempted concealment of the misconduct, coupled with his outright disregard of the compliance officer’s advice, push his actions into what is egregious under the circumstances presented. Accordingly, we increase the duration of [his] suspension as a principal from six months to one year.

In the Matter of Dep’t. of Enforcement v. Vines, Complaint No. 2006005565401 (NAC Aug. 25, 2009).

NATIONAL ADJUDICATORY COUNCIL EXPELS FIRM FOR ARTIFICIALLY INFLATING STOCK PRICE

May 19, 2009 By Jay Eng

On May 18, 2009, FINRA announced that in Dept. of Enforcement v. Kirlin, Complaint No. EAFO400300001 (NAC Feb. 25, 2009), the National Adjudicatory Council (“NAC”), a national committee which reviews initial decisions rendered in FINRA disciplinary proceedings, expelled Kirlin Securities (a wholly owned subsidiary of Kirlin Holding Corporation, n/k/a Zen Holdings Corp.) and barred two Kirlin officials from the securities industry for engaging in a manipulative trading scheme to artificially inflate the price of Kirlin Holding stock formerly trading on the NASDAQ under the symbol “KILN” (now trading on the Pink Sheets as “ZNHL.PK”).

The NAC found, among other things, that the purpose of the scheme was to increase the price of KILN to $1.00 a share or higher for 10 consecutive trading days to avoid being delisted from the NASDAQ. According to the NAC, the respondents learned in February 2002 that KILN would be delisted from the NASDAQ unless, within 90 day, its stock price increased to and remained above $1.00 per share for 10 consecutive trading days. In response, respondents began a scheme to increase the stock price of KILN by entering large and frequent purchase orders through an account of one respondent’s sister at prices in excess of the inside bid. After placing orders, a respondent often cancelled those that had been only partially filled and replaced them with successively higher priced purchase orders in an effort to bid up the price of the security. During the manipulative period, more than 90 percent of the total volume of KILN trades was executed at Kirlin or by other firms in connection with orders for respondent’s relatives or other Kirlin customers. Kirlin was therefore found to have dominated and controlled the thinly traded market for KILN during the period of manipulation.

According to the NAC, the scheme succeeded in raising the price of Kirlin Holding’s common stock from 64 cents per share on March 18, 2002, to more than $1.00 per share on April 2, 2002, despite an absence of any news or other apparent reason for the company’s stock price to increase. After April 2, 2002, respondents successfully maintained KILN’s price at or over $1.00 per share for at least 10 trading days, using the same manipulative methods. On April 18, 2002, NASDAQ informed Kirlin Holding that it had satisfied the market’s listing requirements by having its stock price exceed $1.00 for 10 consecutive trading days and therefore the stock would not be delisted.

In January 2005, Kirlin Holding ceased having its stock listed on NASDAQ and ceased filing periodic reports under the federal securities laws. In August 2008, Kirlin Holding changed its name to Zen Holdings Corp. and changed its stock symbol to ZNHL.

Respondents have appealed to the NAC decision to the Securities and Exchange Commission which may review and modify the NAC’s findings and sanctions.

FINRA PROPOSES ADDITIONAL DISCLOSURE IN BROKERCHECK

May 16, 2009 By Jay Eng

On April 27, 2009, FINRA announced that  it was proposing the expansion of its BrokerCheck service to make records of final regulatory actions against brokers permanently available to the public.  Under current rules, a broker’s record generally becomes unavailable to the public two years after he or she leaves the securities industry and is therefore no longer under FINRA’s jurisdiction.  BrokerCheck is derived from which is the securities industry online registration and licensing database, referred to as the Central Registration Depository or “CRD.”

Defamation Award In Favor of Former Employee

May 15, 2009 By Jay Eng

On April 23, 2009, in Schiavi v. Merrill Lynch, Pierce Fenner & Smith, Inc., Case No. 08-02116 (FINRA Dispute Resolution), a claimant was successful in asserting a claim against his former employer based on certain reasons placed on his Form U-5 for his termination.  At the close of his hearing, the arbitration panel found in favor of the claimant for defamation and awarded $200,000 in compensatory damages.  The panel also recommended the the expungement of the following language from Question 3 of claimant’s Form U-5 maintained by the Central Registration Depository (“CRD”) based on the defamatory nature of the information:  ”[claimant] was terminated on April 21, 2008 after the Firm concluded that he violated the Firm’s policies by signing a client’s name to letters of authorization and for maintaining a file of blank signed documents, including IRA Distribution Forms and Letters of Authorization.”  Instead, the panel recommended that the following language be inserted: “[Claimant] was terminated for violation of firm policy concerning internal client forms, which conduct was not to his financial benefit.”