Important Factors Considered in Eligibility Proceedings for Statutory Disqualification from a Felony Conviction

Article III, Section 3 of FINRA’s By-Laws provides that no person shall be associated with a member, continue to be associated with a member, or transfer association to another member if such person is or becomes subject to disqualification. Section 15A(g)(2) of the Securities Exchange Act of 1934 (“Exchange Act”) sets forth FINRA’s authority to deny the registration and/or membership of disqualified persons.  Section 3(a)(39) of the Exchange Act defines various ways an associated person or member can become disqualified. 

This article focuses of disqualification of an associated person due to the conviction of a felony.  Disqualification of this sort remains in force for ten years.  Thus, a Member who wishes to employ or contract a disqualified person must file a Membership Continuance Application (“MC-400”) with FINRA Registration and Disclosure (“RAD”).  FINRA Rules 9520-27 set forth procedures for a member to sponsor the proposed association of a person subject to disqualification.  These actions are referred to as “Eligibility Proceedings.”

When the conviction of a felony renders a registered person statutorily disqualified, the standard in determining whether the NAC should approve a MC-400 is “whether the particular felony at issue, examined in light of the circumstances related to the felony, and other relevant facts and circumstances, creates an unreasonable risk of harm to the market or investors.”  See Frank Kufrovich, 55 S.E.C. 616, 625-26 (2002)(emphasis added).  The sponsoring firm has the burden of demonstrating that the proposed association of the statutorily disqualified individual is in the public interest and does not create an unreasonable risk of harm to the market or investors.  In the Matter of the Application of Gershon Tannenbaum, 50 S.E.C. 1138, 1140 (1992).  

A review of numerous prior Statutory Disqualification decisions indicates that the following factors are typically considered:

-          the nature and gravity of the disqualifying event;
-          the length of time that has elapsed since the disqualifying event;
-          whether any intervening misconduct has occurred;
-          any other mitigating or aggravating circumstances that may exist;
-          the precise nature of the securities-related activities proposed in the application; and
-          the disciplinary history and industry experience of both the member firm and the person proposed by the firm to serve as the responsible supervisor of the disqualified person.

These proceedings should not be taken lightly.  It is especially important that the MC-400 application detail the terms and conditions of the proposed employment and contain a strong plan of supervision.  In many of the cases in which the MC-400 application was denied, the NAC cited one of the reasons for denial as being its concern for either the proposed plan of supervision, or the disciplinary history of the sponsoring firm and/or proposed supervisor.  See Continued Ass’n of X, SD09003 (2009)(denied application where plan of supervision lacked sufficient detail); Continued Ass’n of X, SD08007 (2008)(denied application where proposed supervisor directly profited from X’s production and where another employee was responsible for overseeing X’s daily trades); Continued Ass’n of X, SD06012 (2006)(denied application where proposed supervisor was subject to several customer complaints); Continued Ass’n of X, SD04012 (2004)(denied application where sponsoring firm had significant disciplinary and regulatory history and history of customer arbitrations and where plan was not specifically tailored to the type of business X planned to conduct); Continued Ass’n of X, SD02002 (2002)(denied application where proposed supervisor was in another state and hundreds of miles away from X where X operated out of his home with no employees on site).  Thus, the sponsoring firm’s ability to supervise the disqualified person is an extremely important factor in Eligibility Proceedings.    

The attorneys at Cosgrove Law Group, LLC have substantial experience in representing Members and associated persons in Eligibility Proceedings.  We have also thoroughly analyzed other Statutory Disqualification opinions where the associated person has been convicted of a felony.  Thus, we are familiar with the factors that the NAC weighs in making a determination as well as the necessary elements that should be contained in a plan of supervision.  

ANOTHER WAY FOR A BROKER TO UNWITTINGLY LOSE HER CAREER

By now most brokers and compliance departments should be aware that a broker becomes statutorily disqualified from associating with a FINRA member firm if convicted of a felony. They should also know by now that it doesn't matter if that conviction has nothing to do with moral turpitude or finances, such as a felony driving while intoxicated conviction. But what many may not realize is that, based upon “guidance” from the SEC, FINRA considers a mere plea of guilty—which is not a conviction under state or federal law—to be a conviction for purposes of statutory disqualifications. So, for example, even if you qualify for a prosecutorial diversion program in which you are never convicted if you satisfy certain probating terms, FINRA is still going to conclude you were convicted if you pled guilty in order to qualify for that program.


The genesis of what some might consider an absurdity lies in the fact that the 1934 Exchange Act does not define the term “convicted” in Section 3(a)(39) when setting forth those events which trigger a disqualification. Now, most attorneys understand that each and every word in a statute need not be defined, particularly if amenable to common understanding. Ironically, the FINRA By-laws also use, but fail to define, the term. So back in 1992, the SEC instructed the NASD to look to the definition of “convicted” in the 1940 Advisor's Act (“The Lederer Letter”).


And herein lies the problem for the unwitting broker or criminal defense attorney that thinks one is only “convicted” when one is sentenced and a judgment of conviction is entered: The 1940 Act includes “a plea of guilty” in the definition of “convicted.” There are, however, situations in which it is arguably unclear as to whether a conviction exists under even this expansive definition because the court might refrain from making a finding of guilt pending a probationary period. The SEC concluded that in such situations a person is convicted until the probationary period is completed. That's right folks—you can actually become “un-convicted!”


The SEC addressed this critical semantic issue again in 2000 in a letter to the NYSE (“The Germino Letter”). In that situation, the SEC looked to California law regarding a first-time drug offender program. In that instance, the SEC concluded that the defendant was not convicted because, although he pled guilty, the court did not “make a finding of guilt or accept the plea of guilty.” Confused yet?


For the most recent review of the nuances and history at issue here, take a look at the National Adjudicatory Council's Opinion in SD Decision No. 04017. In that case the Council looked at the CWOF (convicted without a finding) procedure under Massachusetts law and concluded that the MC-400 application subject in that matter had not in fact been convicted, so the broker should not have been disqualified in the first place! Belated good news for her for sure.


In Puello v. Bureau of Citizenship and Immigration Services, 511 F.3d 324 (2^nd. Cir. 2007), the United States Court of Appeals for the Second Circuit evaluated the meaning of the term “conviction” in the Immigration and Nationality Act (“INS”). In doing so, it noted that “well-established principles of (statutory) construction dictate that statutory analysis necessarily begins with the 'plain meaning' of a law's text and, absent ambiguity, will generally end there.” Id. At 327. In 1996, Congress amended the INS to include a definition of conviction that included, in addition to a formal judgment of guilt, “a plea of guilty...or [admission] of sufficient facts to warrant a finding of guilt.” Id. At 328. The court went on to explain that a conviction occurs when the court adjudicates guilt and imposes a sentence. Id. At 329. “The statutory definition of “conviction” speaks of a judgment 'entered by a court' the common understanding of which involves the entry on the docket of the documents envisioned in Rule 32(K)(1) and not a guilty plea alone. Id. The critical point here is that, unlike the INS, the Exchange Act does not involve any ambiguity as to “conviction” and it does not include a definition of conviction that includes anything less than a formal adjudication of guilt. Moreover, the SEC's suggestion that one looks to the 1940 Act to gain insight as to what a different Congress intended by the term “conviction” to mean when it passed the Exchange Act six years earlier is simply absurd. And the Second Circuit certainly agrees with this author's opinion on FINRA's current interpretation of “conviction” for a statutory disqualification: “ Construing a guilty plea alone as a 'formal judgment of guilt' makes little sense in the context of the definition of 'conviction' as a whole.” Id. “Construing a guilty plea alone to constitute a 'conviction' would be a significant departure from normal criminal procedure.” Id. At 330. And best of all: “ the statutory definition appears to lead to the bizarre result that a withdrawn guilty plea would still be a conviction.” Id. And there is no ambiguity in the Exchange Act that justifies a statutory interpretation by the SEC that directs FINRA to give a “bizarre” interpretation to what a “conviction” is for the purposes of statutory disqualifications. To borrow the words of Judge Katzmann: “a statute should be interpreted in a way that avoids absurd results.” Id. In sum, if Congress wanted a mere guilty plea to somehow be a “conviction” for purposes of the Exchange Act, it demonstrated its ability to do so when it so amended the INS.


The problem this author has confronted recently is that FINRA may send your Member firm a notice requiring them to file a MC-400 application or U-5 you without fully analyzing the state law at issue or exactly whether or not the court made the requisite finding of guilt (as opposed to the defendant merely admitting facts sufficient to allow the entry of a finding of guilt). Moreover, a defendant might plead guilty to the underlying offense without pleading guilty and the court finding sufficient facts as to a separate statute that enhances the misdemeanor to a disqualifying felony.


So what is the lesson here? Consult with a securities attorney and make sure you are both aware of and have a very clear record of the procedure before the court when pleading guilty as part of a diversion program lest your effort to avoid a conviction and save your career prove futile in the eyes of FINRA. Food for thought.