I’ve previously posted about my frustration with the way the discovery guide is written, with particular attention focused on List 1 Item 10.  See my prior post here.  Item 14 causes me similar angst. Why? Because Item 14 is so poorly worded that, if read literally, almost no audit report will ever be responsive to it. Under Item 14, a Broker-Dealer involved in a customer arbitration must produce:

Those portions of internal audit reports for the branch in which the customer parties maintained accounts that: (a) concern associated persons or the accounts or transactions at issue; and (b) were generated not earlier than one year before or not later than one year after the transactions at issue, and discussed alleged improper behavior in the branch against other individuals similar to the improper conduct alleged in the Statement of Claim.

At first blush, Item 14 seems aimed at requiring production of documents that satisfy either part (a) OR part (b). In other words, the drafters probably intended that broker-dealers would produce audit reports that directly mention the associated person/accounts/transaction at issue, or audit reports that discuss other instances of misconduct similar to that alleged during in the Statement of Claim (within the one-year time frame).

But, there are two problems with this. First, the request uses the word “and” directly before part (b).  So the way the request actually reads, a broker-dealer would never need to produce an audit report that mentions the transactions at issue in the Statement of Claim unless the audit report also mentions similar transactions or behavior that occurred with other customers.

The second problem with Item 14, and one that is more troubling than the grammar issues, is that by requiring production of documents responsive to part (b), FINRA seems to endorse the idea that a person is guilty with regard to one customer if he is merely suspected of misconduct with regards to other customers.  Production of audit reports highlighting “similar conduct” “against other individuals” sets the case up to be one based on a pattern or practice, rather than evidence about what happened with regards to this particular customer. Claimant will simply argue that Respondent must have wronged him because there are allegations that Respondent also wronged all these other folks.

At a hearing, these types of arguments inevitably require the Respondent to explain – and defend – any of the suspicions raised in the audit reports related to other customers, rather than focusing on facts pertaining to this particular Claimant. The end result is a series of mini-trials within a trial in order to defend the allegations about other investors. This runs counter to the foundational maxim that arbitration is supposed to be an expedited proceeding, not to mention such other minor things like the presumption of innocence, relevance, and burdens of proof.

In conclusion, if Respondent produces any documents in response to Item 14, this opens the door for a prolonged final hearing due to the distracting nature of audit reports that discuss “similar conduct” “against other individuals.” Thankfully, the way Item 14 is currently drafted with the word “and,” there are actually very few audit reports that are responsive to this request.