FINRA’s “Massive” Discovery Failure Results In…Absolutely Nothing

From Ulmer’s Broker-Dealer Law Corner Blog
By Alan M. Wolper

You are not going to believe this one. Here are the unadulterated facts, taken directly from the Order entered by the FINRA Hearing Officer (an Order, by the way, which FINRA elected not to publish on its website):

  • Five days into an Enforcement hearing against Respondent Steven Larson, “Enforcement disclosed that it just realized it had failed to produce certain documents in discovery.”
  • Enforcement admitted that it was unable “to represent that it knew the full extent of the non-production.”
  • The Hearing Officer adjourned the hearing to give Enforcement time to figure out the scope of its discovery failure.
  • After a week, Enforcement “announced at a status conference the extent of the non-production.”
  • “It was massive,” according to the Hearing Officer.
  • “Enforcement admitted to not producing at least 30,000 emails (plus attachments).”
  • “[T]he volume of improperly non-produced documents [was] more than double the total documents [Enforcement] had produced.”
  • “Stated differently, well into the final phase of the hearing, Enforcement had only provided [respondent] with approximately half the documents he was entitled to receive.”
  • In addition, Enforcement also admitted that it had “inadvertently omitted” from its previous discovery production “an additional 160 documents and 17 emails (plus attachments).”

In response to this astonishing development, Mr. Larson filed a motion to dismiss, essentially seeking dismissal as a sanction for Enforcement’s “massive” discovery failure. Enforcement responded to the motion, and, according to the Order, “[w]hile conceding it should have produced the documents as part of its FINRA Rule 9251-mandated discovery, Enforcement argues that sanctions should not be imposed because its document production failure was inadvertent; it has now produced the omitted documents; [respondent] has not been prejudiced; and it did not make any representations.”

In other words, according to FINRA, hey, we messed up but it wasn’t intentional, and anyway, no harm no foul, so let’s just let bygones be bygones.

The Hearing Officer considered FINRA’s argument. He labeled FINRA’s discovery failure to be “disconcerting in a number of respects.” First, FINRA not only failed to timely comply with its discovery obligations under Rule 9251, but it “also violated the Case Management and Scheduling Order.” Second, “the period of non-compliance was lengthy.” Eight months late and, indeed, five days into the actual hearing. Third, “the volume of documents that Enforcement failed to produced is staggering.” Fourth, “the non-production did not result from a single cause, but from a combination of miscommunication, misunderstandings, and other errors.” Fifth, “the discovery failure resulted in a four-month delay in the completion of the hearing.” Finally, “while it is unclear whether any of the additional documents contain material exculpatory evidence, some of these documents may at least be relevant to [respondent’s] defense.”

All of these facts seemed to dictate that dismissal was appropriate. Against those facts, however, the Hearing Officer weighed the following: First, the record did not show that Enforcement “engaged in willful misconduct, bad faith, or that it otherwise acted contemptuously.” Second, “Enforcement admitted it made a mistake.” Third, “Enforcement has made substantial remediation efforts.” Fourth, “any prejudice resulting from Enforcement’s failure to timely produce the documents has been eliminated, or at least substantially mitigated, because” the Hearing Officer continued the hearing for four months. Finally, and most alarming (at least to me), “dismissing this proceeding” at what the Order calls “this late stage” “would undermine the public policy favoring the disposition of cases on their merits.”

Can you guess what the Hearing Officer decided to do? Not only did he deny the motion to dismiss, he concluded that “the imposition of lesser sanctions [was] unwarranted.” In other words, he did nothing.

All because, basically, he determined that FINRA didn’t intentionally screw up.

Eventually, months later, the hearing continued and – shockingly!! – FINRA prevailed. In the final Decision, all the hubbub about FINRA’s “massive” discovery failure was reduced to a single mention. In one measly footnote. Nothing to see here, move along, apparently.

Just imagine what FINRA would have done to a respondent who failed to produce 30,000 emails in response to an 8210 request. Even a respondent who admitted his failure, and whose failure was inadvertent, would, in my experience, be staring at nothing less than a permanent bar as a sanction. The double-standard that the Hearing Officer employed here is staggeringly obvious and, frankly, outrageous. It was not enough that he gave respondent a four-month break in the middle of the hearing to deal with the giant, late production by Enforcement. To suggest that doing so “eliminated, or at least substantially mitigated” any prejudice to the respondent is sheer fantasy, a dream that, I suppose, helps FINRA management sleep at night.

I have complained before about the fact that FINRA does not hold itself to the same standards as the individuals and firms that it regulates. So, this sort of thing isn’t new. But, this case may take that concept to a new height (or depth), unrivaled for the patently inequitable way respondent was treated. I harbored some hope that under its (relatively) new stewardship, FINRA Enforcement might start to demonstrate a greater degree of fairness, but such hope was dashed by this case.

You want more proof, more reason to remain a cynic? How about this: it was not enough, apparently, that the respondent’s rights under the Code of Procedure were so thoroughly trampled.  On top of all that, Enforcement has now filed an appeal. Yes, that’s right, even though Enforcement prevailed on some of the charges it brought, other charges, including, notably, the fraud charge, were dismissed (in a 2 – 1 decision, prompting a dissent from the Hearing Officer). So, despite the fact respondent was suspended for 18 months “for submitting materially misleading Continuing Membership Applications to FINRA,” fined $37,000 and suspended for two years “for failing to provide complete and timely responses to FINRA document and information requests,” and suspended for 18 months “for falsifying firm records by backdating supervisory documents and then submitting some of them to FINRA,” I guess that’s not enough sanctions for Enforcement. Because the two industry members of the hearing panel concluded that “Enforcement failed to prove by a preponderance of the evidence that Respondent made fraudulent misrepresentations and omissions to customers about their church bond holdings and in connection with church bond cross trades he arranged” and dismissed the charges relating to these allegations, respondent was not barred. And, like the evil clown Pennywise from Stephen King’s It, with his insatiable appetite for the children who inhabit the town of Derry, Maine, FINRA will not be cheated of its own pound of flesh from respondents like Mr. Larson here, who had the temerity somehow to avoid a bar.