WealthManagement Magazine

The NASD's All-New Taste

On Aug. 7, the SEC gave NASD Regulation the green light to put its new "Code of Procedure" into effect as part of the NASD's broad settlement with the SEC last year.The new code, which governs enforcement actions and disciplinary proceedings, is a complex document, but what the NASDR has done (at the insistence of the SEC) is to create a new structure that clearly separates the people who initiate

On Aug. 7, the SEC gave NASD Regulation the green light to put its new "Code of Procedure" into effect as part of the NASD's broad settlement with the SEC last year.

The new code, which governs enforcement actions and disciplinary proceedings, is a complex document, but what the NASDR has done (at the insistence of the SEC) is to create a new structure that clearly separates the people who initiate the investigations, draft the charges and prosecute the cases from the people who conduct the hearings and render a decision as to whether a person or a firm is guilty as charged. (The new code has nothing to do with customer arbitrations, or with arbitrations on employment matters.)

Under the old code, enforcement cases were authorized by the district business conduct committees (DBCCs) in the NASD's 11 regional districts, and by what is now known as the Market Regulation Committee (previously the Market Surveillance Committee) at the national level. And, the panelists who heard the charges came from the same DBCCs and market regulation.

That was so inherently "incestuous" that it "was not unreasonable to conclude that one was being subjected to a kangaroo court," says Martin Kaplan, a partner in the New York City law firm of Gusrae Kaplan & Bruno who regularly defends cases in front of NASD arbitration panels. There was also "a fear that certain protected interests [the major securities firms] were treated one way, while others [the smaller firms] were treated in a different way," he adds.

The SEC did not find that the NASD's old code was unfair, but it nonetheless insisted that the NASD bend over backward to eliminate any conflicts of interest, whether real or perceived. And, the new structure "should, and hopefully will, allow respondents greater due process," Kaplan says.

***

The new code does "totally revamp the disciplinary process at the NASD," said Barry Goldsmith, the NASDR's executive vice president for enforcement, in opening a conference sponsored by Glasser LegalWorks of Little Falls, N.J., in late September in New York City. That was the first time that all of the NASDR's key officials appeared publicly to discuss the new code and take questions from compliance practitioners.

As the give-and-take showed, the NASDR hasn't yet worked out all the details, but the new structure is already fully operational. As of September, 45 disciplinary and enforcement cases had been filed under the new code.

The biggest change is in the case authorization process, which has been shifted pretty much in its entirety to Goldsmith's enforcement department. Enforcement became a completely independent department under the new code, with a dedicated staff that will number 130 by year-end. Previously, enforcement was "subsumed" within the member regulation department, Goldsmith noted.

"The only other place in the organization where disciplinary actions are brought is in the Market Regulation Department, and they still have enforcement responsibilities for what we term 'quality of market' type cases" such as late-trade reporting and backing away complaints, Goldsmith explained at the meeting. But while the staff of market regulation still will develop those cases, action also must be authorized by the enforcement division.

The one exception is that a newly created department, called the "Office of Disciplinary Policy," or ODP, can also authorize cases that involve "important regulatory or significant policy issues," on behalf of the president of NASDR, Goldsmith said.

This department is just now being staffed up, but its main function will be to review "all of the cases generated out of the Washington enforcement group" and in addition, some of the cases that are brought at the district level also will be reviewed, if they "meet this somewhat flexible standard of complex issues raising important policy or regulatory issues," Goldsmith said.

ODP also will be reviewing quality of market cases coming from the NASD's division of market regulation. "That's an area, obviously, that's on everyone's radar screen," Goldsmith said.

***

Retail reps are most likely to end up charged by an NASD district office and the NASD's new operating procedures involve a significant change in the composition of the three-person panels that will hold the disciplinary hearings. Two of the three panelists still will be selected from among the ranks of the NASD, but NASDR hearing officers are now in charge.

"The District business conduct committees and the Market Regulation Committee will still be providing panelists," said Linda Fienberg, the NASDR's executive vice president of dispute resolution and chief hearing officer. But the third panelist will now be a "professional, independent hearing officer," she added. The NASDR has established an Office of Hearing Officers, which now includes seven staff hearing officers who are attorneys with at least 10 years of experience each, she said, along with Joseph Furey, her deputy chief hearing officer.

In this regard, the NASD is following the example of the NYSE, which has long included an independent hearing officer as part of its three-person panels.

The NASDR's hearing officers will be in control of the panels, right from the start. The hearing officer will "administer the case from the day a complaint is filed with us until a decision is rendered," Fienberg said.

"We are asked frequently who is going to select the industry panelists, and that is solely a function of the Office of Hearing Officers," Fienberg said. "The staff, either of the districts, or of enforcement or market regulation, will have absolutely no role in that."

The hearing officers also will convene and run the prehearing conferences. At that point, both the defendant and the enforcement department will have an opportunity to have "a dialogue, on the record," with a court reporter present, "to discuss with the hearing officer who they think, in terms of expertise, ought to sit on the panel," Fienberg said. That input will be taken "into consideration when the hearing officer recommends to Joe [Furey] and myself" who the industry panelists should be, Fienberg said.

Even though the NASDR had held only three prehearing conferences as of late September, Furey noted that his office already had encountered a case in which several potential panelists were "more or less precluded" from serving based on information developed at the prehearing conference.

Furey explained that the point of the prehearing conferences is "to bring more focused case management to the disciplinary proceedings from the very beginning, and continue all the way through the hearing."

Hearing officers also will decide most of the prehearing motions and draft the decision for the full panel. If there's a disagreement between the hearing officer and the two industry panelists, the hearing officer can draft a separate minority decision, but the Office of Hearing Officers still will draft the majority decision. (If one of the industry panelists dissents, then he or she also can issue a minority decision.)

No more will district conduct committees draft a preliminary decision that is vetted by the full district committee. The decisions that are rendered by the new hearing panels "will be the definitive decision," Fienberg said.

This system gives the hearing officers "a tremendous amount of influence," says Louis Lowenfels, a partner in the New York City law firm of Tolins & Lowenfels and a veteran securities lawyer who has practiced in front of NASD panels. "The fairness of this process will depend on the fairness of these people," he says.

The fact that one of the seven hearing officers always will be one of the hearing panelists will, of course, bring greater consistency to the process. "Under the old code, we felt that we got people from the industry catch-as-catch-can, to a degree," Lowenfels says.

But that doesn't mean there can't be different results in similar cases, Fienberg cautioned. The hearing officers will all be based in the NASDR's headquarters in Washington, D.C., so they can talk to one another on an ongoing basis, and that's meant "to encourage uniformity and consistency in our decisions," Fienberg said.

But, "because the hearing officer is only one of a three-person panel, we cannot assure uniformity and consistency," she said, comparing the NASDR's panels to the federal court system, where judges might issue different rulings in different districts.

Therefore, the organization has hired Rory Flynn to fill the newly created position of chief litigation counsel. Flynn will be "monitoring" the NASDR's litigation processes and "we're going to try to give some greater consistency to the positions we're taking and the issues that we're litigating," Goldsmith said at the conference.

A defendant can appeal an adverse decision to the National Business Conduct Committee (which next year will be renamed the National Adjudicatory Council), and if someone loses at that level, the decision still can be appealed to the SEC or to a federal court.

But appealing a case now creates more risk for the accused. Under the new code, the NASDR's enforcement staff will be able to appeal adverse decisions as well. That means that even if you win, you might still be subject to an appeal. And, if you lose and you appeal, you might be subject to a cross-appeal from the enforcement division, Goldsmith cautioned. In fact, Goldsmith believes that it's "likely" his department will file more cross-appeals than appeals since in those cases it's going to have to deal with an appeal anyway.

It all means a broker or firm challenging an enforcement action could end up with an even larger penalty, meted out by an enforcement staff with far more power over district hearings.

Call it the new NASD.

The NASDR has formed a committee consisting of representatives from districts and staff people that is putting together an overhaul of the NASDR's sanctions guidelines. The revisions are expected to be significant.

"I would predict, at least in some areas, some ratcheting up on the sanctions," said Barry Goldsmith, the NASDR's executive vice president for enforcement at a recent conference sponsored by Glasser LegalWorks.

Alden Adkins, the NASDR's vice president and general counsel, said he expects that the committee's recommendations will be presented to the NASDR's board in November and be effective "by the end of the year." Those changes do not need to be approved by the SEC, he added.

In a separate move, the NASDR has decided to make some of its complaints and initial disciplinary decisions public, "when they present significant investor protection issues," Goldsmith said. This was a decision that was made earlier and approved by the SEC last April, and the NASDR started publishing summaries of the complaints that relate to "fraud, manipulation, violation of the penny stock rules, suitability, unauthorized trades, churning, markups" and other types of complaints beginning in October.

"Initial decisions with sanctions of $10,000 or more, or penalties involving expulsions, suspensions or bars will be publicized," Goldsmith said, adding that "the president of NASDR can also designate decisions or complaints that can be made public, if it's in the public's interest."

By way of contrast, the NYSE has never made its complaints or charges public, noted Regina Mysliwiec, an NYSE vice president, who spoke at the same conference. "Although we will never stand too far behind the rest of the industry in that matter, I know of no move at the NYSE to release charges at this time," she said.

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