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

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.”