It may be better to fight than to make a deal when the Financial Industry Regulatory Authority’s (FINRA) enforcement division comes calling, according to an annual study of disciplinary proceedings by the Washington D.C. office of the law firm Sutherland Asbill & Brennan.
You may lose in arbitration, but the punishment may be less than you would have received in a settlement, the law firm says.
Sutherland Asbill analyzed cases that went to a hearing and a hearing panel decision, rather than settling, as most cases do. The law firm found that 70 percent of the time, defendant broker/dealers and reps were able to convince the panel to reduce proposed fines from an average of $30,000 sought, to $19,000 ordered. Defendant b/ds and reps were also able to convince panels to reduce suspensions 56 percent of the time.
“Too often, firms and individuals think it is easier to just settle, and be done with it,” says Brian Rubin, the Sutherland Asbill partner who conducted the analysis. “Our study continues to show that it often pays for member firms and registered representatives to litigate rather than to settle.”
Because most cases settle, these conclusions are based on a relatively tiny universe: Sutherland Asbill reviewed 55 panel decisions from January 2006 through June 2007, involving 67 defendants, facing 119 charges by FINRA. The overall win/loss rate was bleak: Panels ruled in favor of FINRA on the charges alleged 90 percent of the time.
“What we are looking at is more than just wins versus losses, we are looking at the sanctions,” says Rubin, a former enforcement counsel at the NASD, FINRA’s predecessor. “A lot of the time, respondents are more or less outraged at the sanctions being sought, and sometime they say we are not going to be held up with this extortion and we are going to litigate.”
These examples are still the exception: FINRA resolved 1,147 formal actions in 2006 and 1,344 formal actions in 2005, according to statistics on its Website. “The vast, vast, vast majority of cases settle,” says FINRA spokesman Herb Perone. “It doesn’t surprise us that a lawyer who makes his living by litigating cases with FINRA would produce a study that suggests it’s beneficial to litigate with FINRA.”
The study references one “highly publicized” case in which FINRA enforcement staff sought a fine of either $28 million or $98 million under alternative theories. That case charged American Funds Distributors with violating “directed-brokerage” rules, which were first adopted in 1973, and which prohibit firms from providing preferential treatment to mutual funds in exchange for brokerage business. NASD enforcement brought its first case for violation of these rules in December 2004, an example of what Rubin calls “Rip Van Winkle” enforcement.
In August 2006, the hearing panel in the American Funds case “disagreed” with enforcements claims that the company had engaged in a “pattern of misconduct” for years, which was either intentional or reckless. It found the violations were only “negligent,” and fined American Funds $5 million. Rubin estimates that amount is below the $8.4 million or $29 million that it would have cost American Funds to settle the claims, assuming that NASD applied the 30 percent of directed brokerage payment that it appears to have applied in 27 case settled with other firms. American Funds is appealing the decision to the National Adjudicatory Council, and, if the Sutherland Asbill study is any guide, its prospects are not good: About 84 percent of defendants who appealed sanctions to the NAC got decisions that affirmed those sanctions or reduced them by a “de minimis” amount.
Other lawyers who defend broker/dealers and reps in enforcement proceedings were encouraged by the study’s findings. Eugene I. Goldman of McDermott Will & Emery’s Washington D.C. office has done his own studies, in 1998 and 2000, showing that enforcers at the SEC often lose cases heard by their own administrative law judges. “One of the most important things to a broker and the employer is whether they have to ‘take a vacation,’ as we call it,” says Goldman.
And the FINRA cases show hearing panels reduced suspension periods by about 73 percent, from an average of 9.2 months sought to 3.4 months ordered. When the enforcers sought a bar, defendants were able to convince panels to reduce it 48 percent of the time to a suspension, averaging 14.5 months. “It does appear that this is an area where it may be worth fighting. But the key missing ingredient is what the settlement posture was before it went to a hearing,” says Goldman.
