In March 2003, NASD received a customer complaint letter accusing registered representative Morton Bruce Erenstein of misrepresenting investments, recommending unsuitable transactions and converting $10,000 of the customer's investment funds. Following receipt of Erenstein's written responses to the allegations, NASD conducted an on-the-record interview in October 2003 (the “OTR”).
The $10,000 Question
During the OTR, Erenstein explained that by mutual agreement, the $10,000 was compensation for helping the customer liquidate a large number of old U.S. savings bonds. Erenstein said that he orally disclosed this arrangement to his firm, but did not obtain written approval for this alleged outside business activity. When Erenstein stated that he could not provide documentation showing the time spent or work involved with the bond redemptions, NASD asked whether he had reported the $10,000 on his 1998, 1999 or 2000 income tax returns. Erenstein's attorney objected to the relevance of the question, and the client refused to answer questions about his returns on advice of counsel.
Many Unhappy Returns
After the OTR, NASD immediately sent Erenstein written demand for, among other things, complete State-and Federal-tax returns for 1998, 1999 and 2000, or any other tax returns on which the $10,000 was reported. Erenstein's counsel responded, “we're not producing any tax documents, period … you're not entitled to them — and you're not going to get them.” Then, on June 2, 2004, NASD notified Erenstein of its intent to issue a complaint based upon his failures to answer questions during the OTR and to produce tax returns.
A couple of weeks later, Erenstein changed his tune, producing, under protest, a copy of his 1998 federal income tax return, and an amendment to that return dated October 2003, that reflected $10,000 in additional income. The $10,000 was “initially overlooked … since there was, naturally, no 1099 from [Erenstein's customer],” he explained.
Hear Ye, Hear Ye
On August 6, 2004, NASD filed a Complaint alleging that Erenstein failed to respond to the tax question during his OTR, and failed to respond in a timely fashion to the staff's written request for copies of his returns. Erenstein filed an answer denying that he violated the NASD rules.
On December 8, 2005, the Hearing Panel issued its decision, and barred Erenstein. But on appeal, the National Adjudicatory Counsel reduced the bar to a one-year suspension.
Less Than Appealing
On appeal to the SEC, Erenstein essentially raised three arguments about the tax-return production:
The returns are private communications between the Internal Revenue Service and a taxpayer, and not subject to disclosure under Rule 8210.
NASD denied him his right to counsel by treating as a rule violation his reliance on his counsel's instruction not to answer questions about his returns.
His counsel's good-faith objection to the production demand, evidence of discussions and negotiations to resolve the disputed production, and the eventual production of the return should have negated a finding of “untimely” compliance.
The SEC sustained the one-year suspension. Pointedly, the SEC noted that although courts are not disposed to the indiscriminate disclosure of tax returns, where a party makes an issue of his income (as Erenstein did in disputing the alleged conversion), discovery of those returns may be permissible.
As for his right to counsel in NASD proceedings, the SEC starkly stated that although NASD procedural rules “permit the participation of counsel, ‘there is no constitutional or statutory right to counsel in NASD disciplinary proceedings.’” Moreover, “reliance on counsel is immaterial to an associated person's obligation to supply requested information to the NASD.”
There are two warnings here: One, those sacrosanct tax returns are not as private as you may think. Two, you have no right to counsel, and if you reasonably rely on your lawyer's advice, it may not be enough to protect you. Suffice it to say — you've been warned!
Writer's BIO: Bill Singer practices law at Stark &Stark, and is the publisher of RRBDLAW.com