We have complained before in this blog about some of the obvious inequities associated with the FINRA Enforcement process that disfavor respondents. But I heard of a new one this week from a colleague, so I thought I would take the opportunity to revisit the issue.

While there are several things problematic about the Code of Procedure, perhaps the most notable is the limited amount of discovery accorded to respondents. Pursuant to the Code of Procedure, the only discovery to which respondents are entitled is the right to review FINRA’s investigative file. The thing is, FINRA is free to withhold from that file whatever documents it feels are the subject of some privilege or another. In addition, under Rule 9251(b), FINRA can also choose not to produce:

  • documents that constitute “an examination or inspection report, an internal memorandum, or other note or writing prepared by a FINRA employee that shall not be offered in evidence,”
  • documents that “would disclose an examination, investigatory or enforcement technique or guideline of FINRA, a federal, state, or foreign regulatory authority, or a self-regulatory organization,”
  • documents that would disclose “the identity of a source, including a federal, state, or foreign regulatory authority or a self-regulatory organization that furnished information or was furnished information on a confidential basis regarding an investigation, an examination, an enforcement proceeding, or any other type of civil or criminal enforcement action,” and
  • documents that would disclose “an examination, an investigation, an enforcement proceeding, or any other type of civil or criminal enforcement action under consideration by, or initiated by, FINRA, a federal, state, or foreign regulatory authority, or a self-regulatory organization.”

Not only are these categories broad, but, worse than that, there is really no way of knowing if FINRA is properly withholding documents from the investigative file. Here’s why: the Code provides that “The Hearing Officer may require the Department of Enforcement or the Department of Market Regulation to submit to the Hearing Officer a list of Documents withheld pursuant to paragraph (b) or to submit to the Hearing Officer any Document withheld.” Note the use of the word “may.” Anyway, the Code continues: “Upon review, the Hearing Officer may order the Department of Enforcement or the Department of Market Regulation to make the list or any Document withheld available to the other Parties for inspection and copying unless federal law prohibits disclosure of the Document or its existence.” More uncertainty. Finally, and most troubling, the Code says, “[a] motion to require the Department of Enforcement or the Department of Market Regulation to produce a list of Documents withheld pursuant to paragraph (b) shall be based upon some reason to believe that a Document is being withheld in violation of the Code.”

How can one ever determine if Enforcement is improperly withholding a document? I had a case in which Enforcement admitted it was withholding documents under Rule 9251. I asked them to identify the documents, or at least explain the basis for their decision to withhold. They declined, and simply represented that they had complied with Rule 9251 and asked the Hearing Officer (and me) to trust the accuracy of that representation. I, for one, was unwilling to do that. So, I filed a motion under 9251.

The Hearing Officer denied that motion, holding as follows:

            The motion does not state that Respondents have some reason to believe Enforcement is withholding any documents in violation of the FINRA Code of Procedure. This omission is fatal to their motion. Rule 9251(b)(1) permits a document to be withheld if it falls within certain enumerated categories, unless it contains exculpatory evidence. The Code does not require, however, that Enforcement explain the basis upon which it is withholding a document. Respondents do not contend otherwise. Instead, they seek to obtain this information through a Rule 9251(c) motion. But this Rule requires that such a motion “be based upon some reason to believe that a Document is being withheld in violation of the Code.” Respondents seek to bypass this requirement by claiming that without a withheld list and an accompanying explanation regarding “the respective basis for withholding,” they cannot determine if Enforcement is improperly withholding documents. This argument has previously been rejected, and the Rule’s requirement must be satisfied. Respondents have not done so.

I have a hard time following the circular, Catch-22-ish logic employed here. You can only – possibly – get a list of withheld documents if you have some reason to believe something has been improperly withheld. But, you can’t tell if something has been improperly withheld – even when you know some unidentified group of documents is being withheld – unless you see the list. Joseph Heller would undoubtedly be very proud of this decision by the Hearing Officer.

Enforcement, on the other hand, does not simply have to rely on representations made by a respondent, Enforcement is free to conduct continuing discovery. That is because Enforcement can, at will, issue post-complaint 8210 letters, to explore things like the basis for affirmative defenses asserted in an Answer, or the anticipated testimony of a potential witness. There are only two easy hoops through which Enforcement has to jump. First, they must “promptly inform the Hearing Officer and each other Party” when they issue 8210 letters, and, second, the 8210 request must be “issued under the same investigative file number under which the investigation leading to the institution of disciplinary proceedings was conducted.” It hardly seems fair that FINRA can conduct ongoing discovery while respondents are stuck with no equivalent tools.

Which brings me to the new thing I heard this week. When a new case is filed, the Chief Hearing Officer appoints a Hearing Officer to hear the case. Typically, that appointed Hearing Officer remains with the case through to its completion. The Code of Procedure, specifically, Rule 9231(e), outlines what happens if/when, however, the appointed Hearing Officer needs to be replaced: “In the event that a Hearing Officer withdraws, is incapacitated, or otherwise is unable to continue service after being appointed, the Chief Hearing Officer shall appoint a replacement Hearing Officer.” That doesn’t seem particularly controversial, does it? I suppose I understand what “incapacitated” means, and even “unable to continue service.” The issue surrounds the word “withdraws.” The Code doesn’t articulate why an appointed Hearing Officer might withdraw. But, as you will see below, perhaps it should.

In my friend’s case, not one but two appointed Hearing Officers withdrew. The second one gave no explanation. Hmm. But the first one, the one initially appointed, more interestingly, withdrew because she was not available on the dates when Enforcement insisted it wanted the case heard. Enforcement felt the hearing needed to held eight months from the date the complaint was filed; the Hearing Officer could not schedule the hearing, however, until ten months from the date the complaint was filed, i.e., two months after Enforcement’s desired timeframe. Enforcement refused to agree to that. Rather than simply move the hearing back, over Enforcement’s objection, instead, the Hearing Officer withdrew and a new Hearing Officer was appointed, one who apparently was able to schedule the hearing in accordance with Enforcement’s preference.

This is odd and troubling for a couple of reasons. First, the exam that led to the issuance of the complaint took years for FINRA to complete. Given that, how could a delay of only two months possibly prejudice Enforcement in the slightest, especially given respondent’s willingness to proceed? Delay in prosecuting a case is typically offered as a defense.[1] If the respondent did not mind another two-month delay, how could Enforcement? Thus, shouldn’t the Hearing Officer have simply rejected Enforcement’s proposed schedule and insisted that the hearing take place ten months after the complaint, rather than eight?

Second, how is that Enforcement got to force the issue? It is outrageous – to me – that the Office of Hearing Officers simply kowtowed to Enforcement here, replacing the Hearing Officer rather than disappointing Enforcement. If Enforcement is imbued with such power, it can literally dictate the identity of the Hearing Officers appointed to its cases simply by pushing to schedule hearings on dates that don’t suit the appointed Hearing Officer. I certainly do not have that ability as respondent’s counsel. No party to an Enforcement proceeding should have that kind of sway over decisions like this.

[1] See Jeffrey Ainley Hayden, Exchange Act Rel. No. 42772, 2000 SEC LEXIS 946 (May 11, 2000).