Securities Regulation Daily SEC to explain FINRA lifetime bar under Kokesh
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Friday, October 13, 2017

SEC to explain FINRA lifetime bar under Kokesh

By Mark S. Nelson, J.D.

The D.C. Circuit upheld a Commission finding that remedial action should be taken against a broker-dealer who misappropriated his employer’s funds in violation of rules issued by the Financial Industry Regulatory Authority. John M.E. Saad had previously won a second chance when the court determined that the Commission failed to mull evidence that could help him. But now that that part of the case has closed, the Commission must still examine the lifetime bar imposed on Saad in light of the Supreme Court’s Kokesh decision (Saad v. SEC, October 13, 2017, Millett, P.).

Saad was terminated from his job as a broker-dealer in Atlanta for Penn Mutual Life Insurance Company’s affiliate Hornor, Townsend, & Kent, Inc. Saad was accused of misappropriating his employer’s funds by falsifying expense reports for a Memphis business trip he never took. Instead, Saad stayed at an Atlanta hotel for several days and racked up expenses that included a drinks bill, the receipt for which he later tried to throw away while being questioned by his employer’s administrator. Saad also used his employer’s funds to buy a cell phone for a female acquaintance. Saad blamed these departures from his previously clean record on high stress levels arising from both his job and a sick child.

Kokesh question still open. The Supreme Court in Kokesh held that the disgorgement often sought by the SEC in enforcement cases is a penalty for purposes of the statute of limitations contained in 28 U.S.C. §2462 (covering civil fines, penalties, or forfeitures). The case had resolved a circuit split in which some appeals courts upheld SEC disgorgement requests as nonpunitive, while others found the them to be penalties or forfeitures. Said the Court: "Sanctions imposed for the purpose of deterring infractions of public laws are inherently punitive because ‘deterrence [is] not [a] legitimate nonpunitive governmental objectiv[e]’" (citations omitted).

In its prior decision in Saad’s case, the D.C. Circuit declined to answer the question of whether a lifetime bar was "excessive or oppressive," the standard used by the Commission to set aside FINRA remedial orders. On prior remand, the Commission affirmed that the sanction against Saad was remedial, not punitive. The answer on further remand may depend on how the Commission interprets Kokesh, and whether the court agrees with the Commission.

Saad had been charged with violating FINRA’s Rule 2010, which requires members to observe "high standards of commercial honor and just and equitable principles of trade." FINRA imposed a lifetime bar on Saad for having violated its rules, and the Commission affirmed the bar. FINRA has issued guidance on sanctions for violations of its rules that include provisions imposing a lifetime bar for conversion (regardless of the amount involved), and permits a lifetime bar for improper use funds or securities. The D.C. Circuit had previously found FINRA’s guidance on conversion to be a "starting point" for evaluating sanctions for Saad’s analogous misappropriation.

Dubitante and concurring opinions. Judge Millett filed a dubitante opinion to highlight her doubts that further remand is needed because "Kokesh is of no help to Saad" (a composite definition of "dubitante" opinions suggests they are somewhat rare, but occur when a judge doubts a point is correct yet hesitates to reject it). For one, she explained that Kokesh involved a "public law" but that Saad’s case only involves rules issued by FINRA, a private self-regulatory organization that, according to the securities laws, must be able to discipline its members. Second, a lifetime bar under FINRA’s rules confers nothing on the government but a lifetime bar could address how Saad’s conduct had threatened his employer and the public; Kokesh involved disgorgement, which sometimes was ordered to be paid to the government, thus making it a penalty.

Moreover, Judge Millett said Saad could only advance his late Kokesh argument (she traced Saad’s effort to a lone citation in his reply brief that she said was bereft of context) if he now claims that "penalty" in 28 U.S.C. §2462 applies to the Commission’s "excessive or oppressive" standard and deprives the Commission of discretion to review FINRA disciplinary matters. Judge Millett also noted that other circuits, notably the Eighth and Tenth (opinion by Justice—then-Judge—Gorsuch), support the D.C. Circuit’s law on occupational debarment.

By contrast, Judge Kavanaugh’s concurrence explained that he understands Kokesh to mean that courts may not continue to call expulsions or suspensions remedial instead of punitive. He analogized the payment of disgorgement to the government to expulsions and suspensions because they too result in nothing being paid directly to victims (the Kokesh decision noted that one reason for its holding was that disgorgement did not always get paid to victims, one hallmark of a penalty).

Moreover, Judge Kavanaugh said Saad had raised the Kokesh issue by arguing to the court that the lifetime bar was punitive, not remedial, even if Kokesh had not yet been decided. Judge Kavanaugh also suggested that he would apply Kokesh beyond the "specific statute" in that case, as contrasted with Judge Millett’s reluctance to invoke Kokesh because the Supreme Court had not "overrule[d]" or "eviscerate[d]" D.C. Circuit precedent. Whether a Supreme Court opinion alters circuit law can spur vigorous debate, as happened recently in another securities law context in the Second Circuit, where a three-judge panel overturned part of another panel’s decision based on a Supreme Court opinion in a case from the Ninth Circuit that did not "expressly overrule" the prior Second Circuit case (See U.S. v. Martoma ).

Lack of mitigating evidence. The court upheld the Commission’s finding that Saad was not entitled to a different result based on mitigating evidence. Previously, the court had directed the Commission to reconsider whether any of the mitigating factors cited by Saad were applicable because the Commission had not given these factors adequate consideration.

The Commission sent Saad’s case back to FINRA’s National Adjudicatory Council (NAC), which found that while prior firm discipline may be mitigating for an individual, Saad’s termination before regulators investigated him would not be mitigating based on the facts of his case. The NAC also found that Saad’s stress levels were not mitigating. As a result, the NAC reiterated its prior conclusion that Saad deserved a lifetime bar.

When Saad appealed the NAC’s decision, the Commission again affirmed that Saad should be barred for life under FINRA’s rules, albeit by providing the detailed consideration the court had wanted. According to the court, the Commission properly concluded that Saad’s case demanded remedial action: (1) termination by an employer can be mitigating, but Saad used "dishonest" means to thwart his employer and investigators; (2) Saad’s stress levels were not mitigating because he acted with intent over a long period of time rather than impulsively; (3) the fact that Saad misappropriated his employer’s funds rather than funds of a customer was not mitigating because the source of the funds matters less than the threat misappropriation poses to the broker-dealer industry and customers; and (4) the broker-dealer industry reasonably expects its members to have clean records, so Saad’s previously clean record was not mitigating.

The case is No. 15-1430.

Attorneys: Sara Elizabeth Kropf (Law Office of Sara Kropf) for John M.E. Saad. Dina Bernick Mishra for the SEC.

Companies: Penn Mutual Life Insurance Company; Hornor, Townsend, & Kent, Inc.

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