January 2013 – Almost two years ago, I wrote an article discussing FINRA’s seemingly tireless efforts to expand the scope of Rule 8210 beyond the clear bounds as established by the language of the rule itself.1 In particular, the problem on which I focused was FINRA’s increasing use of Rule 8210 to request documents seemingly outside its jurisdiction because the documents at issue were created and possessed by non-member entities, albeit entities which typically had some affiliation, e.g., common ownership, with a member firm. (Remember, Rule 8210 applies only to member firms and individuals associated with such firms, but not to anyone else.) Recognizing its problem, FINRA began to employ the tactic of directing the 8210 requests not to the non-member entities themselves, but, rather, to associated persons of member firms who also happened to own or manage the non-member, insisting that the non-member’s documents were, therefore, somehow within the “possession, custody or control” of the associated person.
Unfortunately, both for FINRA and for member firms and their associated persons, FINRA’s ability to do this was unclear, as Rule 8210 did not contain the “possession, custody or control” definition. This caused recipients of 8210 requests which essentially sought the documents of non-member entities rightfully to balk. Given the gravity of the sanctions recommended for 8210 violations, however – bars for individuals and expulsions for firms – FINRA usually ended up getting what it wanted.
In an attempt to address this problem, back in September 2009, FINRA filed a request with the SEC to amend Rule 8210, to expressly incorporate the “possession, custody or control” definition into the rule. It took the SEC over three years, and two amendments by FINRA to the initial rule proposal, but it finally got around to adopting the amended rule, with some changes that were triggered by the strongly worded comments of member firms and industry pundits to the initial rule proposal. In December 2012, the amendments to Rule 8210 were approved on an expedited basis, and become effective on February 25, 2013.2
This would seem to have resolved the problem, but, sadly, it does not. The Supplementary Material to the amended rule is rife with waffle words and undefined terms and phrases, making it still nearly impossible to predict with any degree of certainty whether documents of non-member entities may be obtained via an 8210 request directed to an individual who is simultaneously associated with both a non-member entity and a FINRA member firm, or to affiliated entity of the non-member that is subject to 8210’s jurisdiction.
The Supplementary Material raises more questions than it answers.
The particular language that creates this issue starts with the fairly non-controversial statement in the Supplementary Material that FINRA is entitled to see the “books, records and accounts” of a “member or [associated] person,” and that the phrase “books, records and accounts” “refers to books, records and accounts that the broker-dealer or its associated persons make or keep relating to its operation as a broker-dealer or relating to the person’s association with the member.” So far, so good. No member firm could reasonably object to an 8210 request seeking documents that, in fact, relate to the operation of the broker-dealer.
Then, the Supplementary Material continues, albeit perilously: “This includes but is not limited to records relating to a FINRA investigation of outside business activities, private securities transactions or possible violations of just and equitable principles of trade, as well as other FINRA rules, MSRB rules, and the federal securities laws.” This is, frankly, no limitation at all. Because nearly any conduct imaginable by a broker-dealer is subject to being investigated, including certain conduct that occurs “away” from the broker-dealer, FINRA is saying that it can, in essence, use Rule 8210 with impunity. But, that’s not even the bad part of the amended rule.
The real problem arises in the next sentence in the Supplementary Material: “It does not ordinarily include books and records that are in the possession, custody or control of a member or associated person, but whose bona fide ownership is held by an independent third party and the records are unrelated to the business of the member.” These few words and phrases – none of which is defined – are brimming over with ambiguity, vagueness and confusion.
To begin with the most obvious, what does “ordinarily” mean? To state that “ordinarily” FINRA will not seek documents from non-member firms necessarily means that there will be some “extraordinary” investigations in which it will do so. Again, because FINRA makes no attempt to define just what such an extraordinary investigation may be, the rule, in fact, provides no comfort at all.
Next, what does “bona fide ownership” mean? Who owns an entity’s documents? Consider the extremely common corporate ownership scenario that involves a member firm and its non-member affiliates, all wholly owned by a mutual non-member parent holding company. Clearly, the non-member affiliate “owns” its own documents. But, does the parent holding company also own them? The question is hardly academic if the parent holding company happens to be disclosed on Schedule A of the member’s Form BD as a direct owner, thus subjecting the parent to Rule 8210 requests.3 In that event, does this mean that FINRA can send the 8210 request to the parent company, seeking documents of the wholly-owned non-member subsidiary? The amended rule hardly provides any clarity here.
A similar problem stems from FINRA’s use of the phrase “independent third party.” Is an affiliated entity, i.e., one sharing common ownership with a member firm, an “independent third party?” In the eyes of the law, any entity properly organized and operated in accordance with the laws of some state, is recognized to be independent. Absent some “alter-ego” theory, or piercing the corporate veil, a parent company is not responsible for the liabilities of its subsidiaries; an affiliate is not responsible for the liabilities of its other affiliates. But, here, it is not clear just what FINRA intended. Accordingly, member firms can anticipate, at a minimum, the need to seek clarification from FINRA, and, at worst, to challenge an 8210 request, based on the ambiguity created by the amendments to the rule.
Finally, it is also strangely uncertain what FINRA means by “records [that] are unrelated to the business of the member.” FINRA has already announced in the second sentence of the Supplementary Material, discussed above, that its right to seek documents is incredibly broad, and includes not just investigations of outside business activities and private securities transactions – two violations that necessarily implicate the need to review conduct that takes place away from the broker-dealer – but any FINRA rule, including Conduct Rule 2010, which FINRA uses when it lacks a specific rule to cite, and constitutes the general prohibition against bad behavior. In light of the breadth of FINRA’s ability to explore possible rule violations, it is hard to imagine FINRA ever conceding that any portion of an investigation being conducted could somehow not relate to the business of the member firm.
If there was any doubt that amended Rule 8210 was designed not to provide a better definition of FINRA’s investigatory powers, but, rather, to broaden those powers, it is dispelled in the final sentence of the Supplementary Materials. Immediately after reciting that “ordinarily” FINRA will not use Rule 8210 to request documents owned by an independent third party, FINRA goes on to state that “[t]he rule requires, however, that a FINRA member firm, associated person, or person subject to FINRA’s jurisdiction must make available its book, records or accounts when these books, records or accounts are in the possession of another person or entity, such as a professional service provider, but the FINRA member, associated person or person subject to FINRA’s jurisdiction controls or has a right to demand them.” Any possible protection from FINRA’s efforts to obtain the documents of a non-member entity that are accorded by the preceding sentence, however slight it may be, is completely destroyed by the final sentence.
In the scenario I addressed at the outset, i.e., FINRA wants documents from a non-member, so, to get them, it directs the 8210 request to an individual simultaneously registered with a member firm and in a management/ownership position with the non-member, that registered individual will always “control” those documents because he/she, as manager or owner, has the right to “demand” them. Thus, regardless of anything else contained in the Supplementary Material, when someone has the right to “demand” documents, irrespective of whether those documents may be “owned” by an “independent” non-member firm, FINRA can get them.
There may be a small ray of hope here, however. In its initial Rule Filing back in September 2009, FINRA told the SEC that “[i]n using the word ‘control,’ in addition to possession and custody, FINRA intends to require members or persons covered by the rule to provide, for example, records that they have the legal right, authority, or ability to obtain upon demand,” citing Camden Iron & Metal v. Marubeni Am. Corp., 138 F.R.D. 438, 441 (D.N.J. 1991).4 When it finally approved the rule proposal, the SEC quoted this very language: “When filing the proposed rule change with the Commission, FINRA indicated that in using the word ‘control,’ in addition to possession and custody, it intended to require members or persons covered by the rule to provide, for example, records that they have the legal right, authority, or ability to obtain upon demand.”5 Oddly, however, in the final version of the rule, FINRA omitted from its definition of “control” the ability actually to “obtain” the documents, not just to demand them.
That can be a significant difference. As noted above, any manager or owner has the right to demand documents from his own company, but not every such manager or owner has the right to obtain them. Indeed, in response to the wave of overly broad 8210 requests that FINRA has been issuing, some non-member entities with affiliated FINRA member firms have created perfectly legal corporate governance mechanisms designed to prevent a manager or owner who also happens to be simultaneously associated with the member firm from singlehandedly obtaining the non-member’s documents. For instance, the non-member’s By-Laws may be amended to require that requests for documents that originate from third parties, such as FINRA, be approved by the entire Board of Directors before any documents are provided. As a result of this, the individual effectively loses his or her “control” over the documents of the non- member, notwithstanding the fact he or she is an owner or manager and, therefore, has the right to demand the documents.
There is still no realistic way to challenge an overly broad 8210 request.
Apart from these issues, the biggest problem that members still face is that FINRA ignored those commentators who advocated for the creation of some procedural mechanism to challenge 8210 requests that appear to be beyond FINRA’s jurisdiction. As things stand, the only permissible way to fight an 8210 request is simply not to answer it, and then wait for FINRA to bring a formal disciplinary action. The downsides to this are plentiful, and serious: (1) it is a disclosable event on Form U-4 and Form BD, and most firms and associated persons do what they can to avoid such things; (2) it can be insanely expensive to defend a FINRA Enforcement action, which have morphed from the quaint “businessman’s forum” of the past into hotly contested legal battles, occupying days of hearings and battalions of lawyers; and (3) most important, the price for losing such a battle is not the obligation to turn over the documents in question, but, rather, to give up one’s ability to operate in the securities industry: The standard sanctions in 8210 cases are a permanent bar for an individual and an expulsion for a firm. Given the possibility of such a dire outcome, legitimate6 challenges to 8210 requests are practically nonexistent.
The SEC had a real opportunity here to rein in FINRA, but it has elected not to do so. As a result, there is little question that these new amendments will embolden FINRA to push the limits of Rule 8210 even further than has already been witnessed by member after member over the last few years. Nevertheless, because the rule itself is hardly a model of clarity, even with the supposed guidance offered by the Supplementary Material, there remains ample room for recipients of 8210 requests aimed at non-members’ documents to raise vigorous and well-reasoned defenses…at least up to the point where FINRA threatens to file an Enforcement action; then, because of the harsh sanctions that will be meted out in the event FINRA prevails, even the most litigious among us will likely just capitulate. That is not how it should be.
2 See Regulatory Notice 13-06
3 Section (rr) of Article I of FINRA’s By-Laws, the “Definitions” section, defines “person associated with a member” or “associated person of a member” to mean, among other things, “for the purposes of Rule 8210, any other person listed in Schedule A of Form BD of a member.”
4 Exchange Act Rel. No. 60836 (Oct. 16, 2009) at n. 3.
5 Exchange Act Rel. No. 68386 (Dec. 7, 2012) at n. 9.
6 While there are a number of reported 8210 Enforcement cases, the vast majority involve circumstances where there was no apparent basis for the failure to produce the requested documents, and the respondents’ arguments do not include any real analysis of the wording of the rule itself. In such cases, the imposition of a permanent bar is routinely upheld on appeal, with fairly little discussion.