One of the things you’re not supposed to do if you’re in the securities business – or any business, really – is buy and sell securities on the basis of material, nonpublic information in breach of a duty not to do so. The SEC doesn’t like it. Federal prosecutors don’t like it. Even state prosecutors don’t like it, and are starting not to like it in imaginative ways. You know who else doesn’t like it? FINRA. FINRA doesn’t bring insider trading cases itself all that much, but it does sometimes. And on July 2 it settled a weird one with Kenneth Ronald Allen, a registered representative at First New York Securities.
According to FINRA’s Letter of Acceptance, Waiver and Consent, its investigation found that in September 2010, Allen placed orders using a firm proprietary trading account to short sell shares of Tokyo Electric Power Company Inc. (TEPCO), which is listed on the Tokyo Stock Exchange. Allen created a short position in TEPCO shares while he was in possession of material, non-public information that TEPCO was close to announcing a secondary public offering of its securities. Allen obtained this information from a consultant whose source was a Tokyo-based employee of Nomura Securities Co. Ltd., a large Japanese broker-dealer, which underwrote the TEPCO offering.
As FINRA says, after receiving this information, Allen traded in TEPCO shares between September 15 and September 28, 2010. TEPCO publicly announced the secondary offering on September 29, and the market price for its shares declined. Allen covered the short position after the announcement, realizing a profit of approximately $206,000.
Perhaps as a result of this conduct, First New York terminated Allen’s registration on May 29, 2012, and filed an amended Form U5, the Uniform Termination Notice for Securities Industry Registration, on July 3, 2012.
As part of the AWC, Allen consented to a bar from association with any FINRA member firm. As we’ll discuss below, he didn’t pay a fine or any other monetary sanctions.
This case is a little odd for several reasons. First, Allen settled this case on June 25, 2014, but FINRA’s jurisdiction over Allen was going to expire in nine days. This doesn’t mean FINRA just had to initiate a disciplinary proceeding against him by July 3; it had to impose sanctions by then. If on June 25, Allen had said, no, he didn’t really feel like signing the AWC, FINRA would have been jammed up. It’s not clear to me what it could have done besides pound sand, because it could not have gotten a hearing panel to impose sanctions in that time. In which case, no sanctions at all.
Second, where was the SEC on this? Shouldn’t it have filed a case against Allen? Well, probably not. Under Morrison v. National Australia Bank Ltd., 561 U.S. 247 (2010), the Supreme Court held that Section 10(b) and Rule 10b-5 apply “only in connection with a purchase or sale of a security listed on an American stock exchange, and the purchase or sale of any other security in the United States.” Under Allen’s facts, the only securities were those of a Japanese issuer trading on a Japanese exchange. So the SEC was probably out of the game from the start. This means FINRA might have been the only game in town to bring a case against Allen, under its trusty and expansive Rule 2010. FINRA Rule 2010 is the mother of all squish tests, and says, “A member, in the conduct of its business, shall observe high standards of commercial honor and just and equitable principles of trade.” Almost any sort of conduct can fit under it.
Third, the SEC’s absence means that FINRA would have had to do this investigation entirely on its own, and without piggybacking on the Commission’s work. This is a long way to go when a bar is the only sanction Allen was ever going to get. As noted above, Allen consented to that bar, but did not consent to paying a dime of the $206,000, or any penalty or interest, to anyone. That is because since Fiero v. FINRA, 660 F.3d 569 (2d Cir. 2011), FINRA hasn’t been able to enforce collection of its fines in the courts. It can bar Allen, but then its ability to collect money from him effectively vanishes. If he doesn’t want to be associated with a FINRA member, what does he care what FINRA says about a fine?