SEC Not Only Reverses FINRA Disciplinary Action, But Provides Blueprint For Respondents To Use In Their Defense Of Similar Claims

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My friend and former colleague, Brian Rubin, publishes annually his analysis of FINRA Enforcement cases, spotting trends in terms of the number and types of matters it brings, the sanctions meted out, etc. It is an excellent tool, and eagerly anticipated by lots of us who practice in this industry. One of the hard parts of his analysis is his effort to figure out how respondents who elected to take their case to hearing, as opposed to settling, fared. That is, did they end up getting harsher or more lenient sanctions as a result of rejecting FINRA’s offer and going to hearing. (It’s a labor intensive analysis, inasmuch as FINRA’s (rejected) settlement offer is not public information, so Brian has to call lawyers and cajole them to share that information on an anonymous basis.)

Something that Brian’s study typically reveals is a fact well known to lawyers who defend Enforcement cases, but which is surprising to everyone else: respondents often – certainly not all the time, or even most of the time – actually do better – in terms of sanctions[1] – by going to hearing. The so-called “hearing discount.” Which is a bit counter-intuitive since in most settings, settlements result in more benign sanctions (because by settling, the respondent is saving the other side from having to prepare the complaint and then prepare for and attend the hearing, all of which takes a lot of time and effort).

With that introduction behind me, let me get to the point: last week, Brian himself got a result in a case that demonstrated, once again, the phenomenon of the hearing discount – in this case, the ultimate discount: a finding of no liability and, therefore, no sanctions whatsoever. Granted, it was not a short or easy road to get to that result, as the case took a long time – seven years – and a tortured route, as follows:

If you wanted, you could stop reading here and feel good about having learned a lesson from poor Mr. Tysk’s travails, namely, if you have the gumption and the money to fight, fight, fight, you just may, someday, prevail. Or you can simply relish the notion of FINRA taking it on the chin from the SEC, hardly an everyday occurrence. But, if you take the time to read through these decisions, particularly the last one, there are a few more points very worthy of discussion.

Before I do that, I have to give (or try to give, anyway) a brief synopsis of this procedurally complicated case.

  • At Mr. Tysk’s recommendation, his biggest customer made a $2 million annuity investment.
  • That customer later lodged a complaint against him with his BD, Ameriprise, alleging that the recommendation was unsuitable
  • Ameriprise embarked on an internal review to assess the merits of the customer’s complaint.
  • Based on a review of Mr. Tysk’s paper files, Ameriprise concluded the complaint was meritless.
  • In addition to his paper files, Mr. Tysk also maintained an electronic file – ACT! – that he used “to document client interactions, including a chronological record of client meetings, notes, and to-dos.”
  • After Ameriprise’s review, Mr. Tysk concluded that his electronic notes relating to the complaining customer “were not as complete as he would have liked them to be. As his biggest client, Tysk was in contact with him much more frequently than his other clients and did not make notes of each interaction at the time the interaction occurred. Consequently, Tysk’s ACT! notes for his biggest client were much sparser than for nearly all of his other clients.”
  • So, relying on his memory and his papers, Mr. Tysk added approximately 70 supplements to his notes for this customer, most of which were new entries.
  • The added notes were accurate.
  • The supplements accurately reflect the fact that they were added at a later date, and Mr. Tysk never represented that the notes were made contemporaneously with the events they described.
  • Neither Ameriprise nor Mr. Tysk relied on the notes to establish the suitability of his annuity recommendation.
  • A few months later, the customer filed an arbitration against Mr. Tysk and Ameriprise alleging that the annuity was unsuitable
  • During discovery, a hard copy of Mr. Tysk’s ACT! notes was produced to claimant, which reflected that they had been supplemented at a later date.
  • The ACT! notes played no pertinent role at the arbitration hearing.
  • The Panel issued an Award in favor of Mr. Tysk’s client on the issue .
  • More important, the Panel faulted Mr. Tysk for altering his ACT! notes, and made a disciplinary referral.
  • FINRA then brought an Enforcement action against Mr. Tysk, alleging two things:
    • First, that Mr. Tysk violated FINRA Rule 2010 and NASD Rule 2110 by “alter[ing] his customer contact notes after receiving” the complaint letter “to bolster his defense of the customer’s claim . . . in violation of his firm’s policies”
    • Second, that Mr. Tysk violated IM-12000 of the FINRA Code of Arbitration and FINRA Rule 2010 by not notifying his client or Ameriprise of the edits to his ACT! notes when he “responded to discovery requests for his notes and when he responded to subsequent requests for edits to his notes.”

You already know how the story eventually played out. But, how did the SEC come to the conclusion that FINRA erred – twice – in finding Mr. Tysk liable?

It started with an analysis of FINRA Rule 2010. You know this one, it’s the general rule that FINRA cites when there’s no specific rule governing the conduct at issue, and requires that members and associated persons “observe high standards of commercial honor and just and equitable principles of trade.” The SEC correctly noted that “[a]ssociated persons violate these rules (where the alleged violation is not premised on the violation of another FINRA rule) if they act unethically or in bad faith.” The SEC defined “unethical conduct” as that which is “not in conformity with moral norms or standards of professional conduct,” and “bad faith” as “dishonesty of belief or purpose.”

Applying those definitions, the SEC concluded that FINRA failed to prove its case. While FINRA had found that Mr. Tysk acted unethically by “deliberately creat[ing] misleading evidence,” i.e., that he created “the false impression that he wrote contemporaneous notes of his conversations” with his biggest client when in fact those notes were written many months later,” the SEC disagreed, finding that “the record does not show that Tysk attempted to create a false impression as to the date he created the [supplements to the] notes, either affirmatively or by implication.” Moreover, the SEC observed that FINRA hadn’t even bothered to attempt to prove that Mr. Tysk added his supplements in some effort to “bolster his defense.”

Which brings us to the SEC’s next point, the one with, perhaps, the biggest ramifications for respondents everywhere. Remember, FINRA alleged that Mr. Tysk violated 2010 because his actions violated Ameriprise’s policies by supplementing his ACT! notes during the firm’s pending exam.[2] Specific to that allegation, the SEC stated that it did not need to decide whether or not Mr. Tysk violated Ameriprise policies “because even if he did so FINRA failed to establish he thereby violated FINRA Rule 2010 and NASD Rule 2110. A violation of a firm policy does not necessarily mean that a registered representative has also violated these rules.”

This is HUGE. There are maybe, what, a million Enforcement cases that FINRA has brought where the allegation was simply that the respondent violated some firm policy, and, therefore, Rule 2010? Based on the SEC’s reasoning here, it is evident that going forward, FINRA is actually going to have to do some work in such cases. It is actually going to have to prove that the respondent somehow acted unethically or in bad faith, not merely that a firm policy was violated. And this, I venture to say, will not always be possible for FINRA to pull off.

Back to the SEC decision. In reversing FINRA’s ruling on the second charge, the SEC made two important observations. First, Mr. Tysk was asked in discovery in the arbitration to produce the pre-supplemented versions of his ACT! notes, but he could not do so, despite the fact that the fancy-schmancy forensic computer expert FINRA engaged was somehow able to do that. The SEC was unimpressed by that showing: “Tysk’s discovery obligations – under both FINRA Rule 12506(b) and IM-12000 – extended only to documents in his possession or control. He was under no obligation to create new documents.” This is as true in arbitrations as it is in FINRA exams: Rule 8210 allows FINRA to request the production of documents, but it does not give FINRA the power to compel you to create one. So bear that in mind the next time you receive a request asking you to create a spreadsheet.

Second, the SEC wrote that “FINRA’s decision suggests that if Tysk could not produce documents showing edits to his ACT! notes he was nevertheless required to provide additional explanation of those edits during discovery. But FINRA has not shown that Tysk was required by the arbitration rules or by Rule 2010 to include an explanation of the ACT! notes that he produced, particularly here where the document disclosed on its face that it had been edited in May 2008, and Tysk took no other action to state or imply that the notes were created contemporaneously.” As the case that the SEC cites for this proposition provides, it is not bad faith not to “spontaneously volunteer information” that was not requested. I suggest you bear this mind not only when responding to discovery in arbitration, but also when responding to questions from FINRA during exams.

A final thing worth noting is what FINRA did NOT charge Mr. Tysk with: a violation of the books-and-records rule. There are likely a couple of reasons for this. First, broker notes are not included in the long list of documents in SEC Rules 17a-3 and -4 that a BD has to make and preserve. These are optional, and what you do with them is largely up to you. Second, Mr. Tysk did not make the mistake of altering documents after they were requested by FINRA during an exam. Do that and FINRA will write you up no matter what the document at issue happens to be. All you have to do is look, for instance, at this AWC, which FINRA issued three days before the SEC’s Tysk decision.[3]

I apologize for the length of this post, but there was a lot to work with, and a lot of lessons to glean. Not everyone has the luxury of being able to pay counsel to wage a seven-year fight with FINRA, I get that. But, at least this one time, it was worth it for Mr. Tysk.

[1] The reason I highlight this point is because taking a case to hearing vs. settling can be a hugely expensive decision in terms of attorneys’fees. Thus, even if a respondent does end up with lesser sanctions after going to hearing, it could cost hundreds of thousands of dollars in legal expenses. That is why it is usually a difficult decision to reject a settlement offer, even in a case with good facts, because, as I tell my clients, all you are buying, ultimately, is the right to read the Panel’s decision, not the right to dictate how it reads.

[2] Oddly, although Ameriprise issued a lukewarm reprimand to Mr. Tysk, according to the SEC decision, the firm determined that Mr. Tysk’s “addition to his ACT! notes did not violate any section of [Ameriprise]’s policies and procedures” or any “specific provision of the Code of Conduct.” Moreover, Ameriprise did not find that Mr. Tysk had “engaged in any wrongdoing.” Just one more example of FINRA knowing more than its members.

[3] I hate to dredge up old memories, but FINRA knows this lesson very well, after being sanctioned by the SEC back in 2011 for supplying the SEC with altered or misleading documents three times in an eight-year period. Here is that Order, in case you wanted to relive this one.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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