The SEC upheld a FINRA determination to suspend, and subsequently bar, a broker for failing to appear to testify in connection with a FINRA investigation. The Commission upheld the FINRA order on procedural grounds, because the broker, Behnam Halali, failed to exhaust his administrative remedies. Despite the procedural nature of the disposition, the case does highlight an important point about the scope of FINRA’s investigative authority and the choice that brokers may face between asserting their constitutional rights and maintaining their livelihood.
Halali's employer, Allstate Financial Services, fired him in December 2014 after learning that he faced criminal wire fraud and money laundering charges based on a scheme to defraud an insurance company. Allstate filed a Form U5 in January 2015 disclosing Halali’s termination, and filed an amended Form U5 in October 2015 to report that a former customer had filed a complaint against Halali. FINRA’s Enforcement Department informed Halali that he would be called to testify. Halali responded through his lawyer that he was asserting his Fifth Amendment rights and would not appear to testify. FINRA barred Halali from associating with any FINRA member in any capacity because he failed to provide information to FINRA in accordance with Rule 8210.
The SEC’s decision to dispose of the matter on procedural grounds was not a difficult one, as Halali clearly failed to exhaust all available administrative remedies. He did not respond to the suspension notice or request a hearing, and also did not file a written request with FINRA for termination of the suspension.
What is important to note, however, is that FINRA did not bar Halali for the alleged wire fraud while working for the insurance company, however egregious that might have been, or for the misconduct alleged by the Allstate customer. FINRA expelled Halali from the brokerage industry for failing to testify in reliance on his Fifth Amendment rights.
FINRA has expansive authority under Rule 8210 to compel testimony “with respect to any matter involved in the investigation, complaint, examination, or proceeding,” and to demand production of books, records and other documents. As Halali discovered, the failure to cooperate, even under color of a claim of Fifth Amendment privilege, can involve dire consequences, including a permanent bar from the brokerage industry.
The SEC and the courts have long recognized that self-regulatory organizations are not government agencies, and that their enforcement activities are not state actions that trigger the privilege against self-incrimination. The Second Circuit observed in a 1975 decision, U.S. v. Solomon, that “[m]ost of the provisions of the Fifth Amendment, in which the self-incrimination clause is embedded, are incapable of violation by anyone except government in the narrowest sense.” The court concluded that the New York Stock Exchange's functions in administering parts of the Exchange Act were not enough to establish that the exchange was an agent of the government. Several subsequent decisions held that NASD, the predecessor to FINRA, was not a state actor.
In a case decided by a FINRA hearing officer in 2015, FINRA Department of Market Regulation v. Lubetsky, former broker Alex Lubetsky claimed that FINRA and the SEC were engaging in joint action in connection with their respective investigations of Lek Securities Corp., Lubetsky's employer. The hearing officer recognized that SROs can be subject to the Fifth Amendment if they engage in state action "by becoming significantly involved with a government investigation." According to the FINRA hearing opinion, respondents bear a “heavy burden” to meet this threshold. State action by an SRO “occurs only when the nexus between the government and the challenged action by a private party is so close that the seemingly private behavior may be fairly treated as that of the State itself.”
The hearing officer concluded that cooperation and information sharing between FINRA and the SEC was insufficient proof of state action by FINRA. The proximity in time of the FINRA and SEC investigations was also insufficient to prove that the SEC was guiding FINRA's investigation or was otherwise closely entwined with the FINRA proceeding. The hearing officer concluded that “at best, the record shows investigative overlap by two regulators, nothing more.” The hearing officer denied Lubetsky’s Fifth Amendment defense and suspended him from the industry.
The takeaway for brokers and their counsel is that FINRA has an impressive array of enforcement tools at its disposal. Under Rule 8210, FINRA has wide-ranging authority to request documents and testimony, and holds the power to suspend or bar brokers from doing business to make good on those requests. Brokers should be prepared to cooperate fully, because in all but the rarest of cases, the Fifth Amendment will provide no obstacle to FINRA sanctions.
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