NAC Upholds Due Process

NASD Adjudicatory Council Strikes Case Because of Delays

Follows SEC Lead in Upholding Rights to Due Process and Fundamental Fairness after 7-year delay in commencing proceedings.

By Mark J. Astarita, Esq.


Delays by regulators in bringing enforcement actions is a recurring problem for brokers and firms, as well as their defense counsel. As those of us who defend brokers and firms are painfully aware, there is no statute of limitations for regulatory actions against brokers and firms by the regulatory agencies. See, William D. Hirsh, Exchange Act Rel. No. 43691, (Dec. 8, 2000), Stephen J. Gluckman, Securities Exchange Act Rel. No. 41628 (July 20, 1999).

Statutes of limitation exist for virtually every legal theory and serve to protect the prospective defendant, and ultimately society at large, from old claims, claims from years past, where memories have faded, documents have been lost, and so much time has passed that the matter is better left alone. Naturally, the statute of limitation for most causes of actions is quite long. For example, while the time varies in different states, and with different legal theories, in most states, the statute of limitations for fraud is six years. The statute of limitations for breach of contract is 4 to 6 years, depending on the state and the type of contract. The statute of limitations for most crimes is 5 years.

While the different statute of limitations for different states, and different legal theories, and the nuances of those theories, and determination of when the time starts to run, and when it stops, could take up a dozen columns, the point is, there is a limit. For every possible lawsuit and criminal prosecution in the country, there is a time limit, a point where society says, “Enough! If you haven’t sued for this by now, you never can.” Everywhere except in the world of securities regulation, that is.

For a variety of policy reasons, statutes of limitation do not exist in SRO actions. Simply stated, it has long been held that Congress’s general purpose in enacting the Exchange Act amendments related to SROs was to provide the broadest possible protection to the investing public and the securities markets by authorizing national self-regulation of broker-dealers under both legal and ethical standards, and that Congress provided the SROs with a wider array of tools with broader applications than those available to federal regulators.

These broad powers include the ability to bring actions without regard to the statute of limitations. While the goals are laudable, in practice, there are significant problems. As noted above, as time goes on, documents are lost, memories fade and witnesses become disinterested. Abuse of that power, in bringing claims that involve acts that occurred years earlier, causes a significant prejudice to the respondents. Further, in most cases involving older facts, the SRO conducted its investigation in a somewhat timely fashion, giving it access to witnesses and documents in a “normal” timeframe. The SRO then waits years to bring the enforcement action, forcing the respondent to conduct its investigation and to prepare its defense after documents have been lost and witnesses have long forgotten the events.

Recently there has been some movement to address this problem. In May 2000 the SEC dismissed a 14-year-old NYSE enforcement action because such a prosecution was inherently unfair. That case, JeffreyAinley Hayden, Exchange Act Rel. No. 42772, 2000 SEC LEXIS 946 (May 11, 2000), was discussed extensively in an earlier SECLaw.com article titled SEC Stands Up for Due Process for Registered Reps?

On July 29, 2002, the NASD’s National Adjudicatory Council (NAC) followed suit and upheld an NASD Hearing Panel’s decision to dismiss an NASD disciplinary case against Morgan Stanley Dean Witter because of the delays in bringing the action. The NAC was created in 1997. It decides appeals from disciplinary, membership, and exemption decisions; rules on statutory disqualification applications; and advises on other policy matters.

The case, filed by NASD’s enforcement division in November 2000, alleged that Morgan Stanley violated NASD conduct rules in 1992 and 1993.

The underlying acts involved the sale of securities known as “Term Trusts” by Dean Witter before the merger with Morgan Stanley. According to the NAC Decision, the NASD began receiving complaints regarding the conduct in early 1993. Between 1994 and 1995, Morgan Stanley itself filed numerous Form U-5s with NASD that reported customer complaints alleging problems with sales of the Term Trusts. During that same period, the New York Attorney General’s Office investigated the Term Trusts.

Additionally, in July 1994 investors filed a federal class action lawsuit against Morgan Stanley, alleging that Morgan Stanley had misrepresented the risks of the Term Trusts and used deceptive marketing practices in selling the products in Sheppard v. TCW/DW Term Trust 2000, 938 F. Supp. 171 (S.D.N.Y. 1996). That case was dismissed by the court, as were other state court actions regarding the instruments. The NY Attorney General did not take any action after its investigation.

The NASD began its investigation after the NYAG concluded its own investigation and according to the decision, conducted a “review of all transactions in the Term Trusts” that occurred at Morgan Stanley. That investigation took place from January 1996 to September 1998. During that time period, the NASD Enforcement Division issued 163 formal requests for documents, information and testimony to Morgan Stanley and more than 100 of its current and former employees. Enforcement deposed sixty individuals, and these depositions resulted in sixty-four transcripts totaling approximately 6,537 pages of recorded oral testimony. Enforcement also requested and received more than 1,600 documents and at least ten deposition transcripts from the NYAG that had been gathered during the course of its investigation of the Term Trusts.

The investigation was concluded in July 1998, but the NASD did not send out Wells Letters until June 1999. (A Wells Letter is a notification to a defendant that there is going to be a recommendation of an enforcement action, and giving the respondent the opportunity to make his own submission).

The NASD Hearing Panel dismissed the enforcement action, holding that the too much time had passed since the events. Enforcement appealed to the NAC.

In affirming the Hearing Panel’s dismissal of the action, the upheld the decision and issued a lengthy opinion on the issue of delay in the commencement of proceedings.

NAC acknowledged that there was no statute of limitations which protected respondents, but also acknowledged that the concepts of equity, due process, and fairness operated to prevent the prosecution of untimely complaints.

While the Hearing Panel apparently relied on standard “test” of reasonableness, the NAC rejected such a concept and noted that the concepts of fairness and due process required a case by case analysis. The Panel’s lengthy decision examines the fairness and due process considerations and sets forth the relevant considerations for making such a determination which is premised on traditional equitable concepts.

The factors examined by the Panel included:

  • The length of time from date of the alleged misconduct to the date that charges were filed (nearly 7 years in Hayden and 7 years in this case)
  • The length of time from when the SRO is informed of the conduct to the date it brought charges (5 years in Hayden and nearly 6 in this case)
  • The length of time from the date of initiation of the investigation to the filing of charges (3.5 years in Hayden and nearly 6 years in this case.
  • The concept hat a party with “unclean hands” may not benefit from equitable relief. In other words, the conduct of the respondents in delaying the proceeding may prevent the respondents from claiming that the delays were unfair or unreasonable.
  • Whether the respondent was harmed by the delay.

The NAC specifically rejected the NASD’s position that the complexity of the case should be a factor, and excuse the delays in bringing the action. The NAC specifically rejected this contention, stating “The complexity of a case, however, is not a traditional equitable consideration, even where timing issues are concerned, and we decline Enforcement’s invitation to adopt it as a factor here.”

The NAC summed up their decision as follows:

Delay in bringing an action at some point becomes unfair. When it does, the case must be dismissed. Of course, what constitutes unfair delay will vary from case to case. In the instant matter, we find that it is unfair for the respondents to be faced with the specter of litigating nearly decade-old claims. This is especially true because Enforcement was aware early on of the nature of the allegedly wrongful conduct. Furthermore, the justification for dismissal on fairness grounds is even more compelling when, as here, there is a showing of prejudice to the respondents as a result of that delay. Based on the totality of circumstances, including the length of delay and harm to the respondents, we dismiss this action as being inherently unfair.

Readers of my columns know that I am quick to point out when the regulators overstep their bounds. I am equally eager to commend them when the take action to prevent abuse. The Morgan Stanley case demonstrates both concepts. Investigating a case for years, and then waiting years to commence the underlying action is extremely prejudicial to the respondents. During the years, the Enforcement Division has the ability to compel testimony, force the production of documents, and to investigate virtually anything. During those same years, the respondent does not have the ability to depose anyone, or to compel the production of documents. In fact, in some cases, the Respondent is not even aware that an investigation is taking place.

Then, years later, Enforcement starts an enforcement proceeding, leaving the respondent to begin its investigation years after the fact. Using this case as an example, the conduct occurred in 1992 and 1993, the NASD investigation formally commenced in January 1996, and it sent out Wells letters in June 1999.

While it is apparent from the decision that Morgan Stanley was aware of the investigation, and was defending (successfully I might add) investor lawsuits, there are cases with the same timeline where the respondent is not aware of the investigation. Further, since the NASD and NYSE do not have a policy of notifying firms of the conclusion of an investigation, there are a significant number of cases where the regulators seek information from the firm or broker, and then have no contact with the firm or broker for years.

In such cases with a similar timeline, the Respondent learns that he is the subject of an enforcement action 7 years after the fact. The respondent then finds himself attempting to obtain documents that were required to be retained for only three or six years. He must attempt to locate witnesses to events that occurred 7 years earlier, and assuming he can find those witnesses he needs to hope that they remember events which occurred that long ago, which may or may not have been significant to the witness at the time.

Clearly, commencement of actions after the passage of a significant amount of time is a clear prejudice to the respondent and a prejudice that the statutes of limitation were designed to address. We are heartened to see the SEC and the NAC holding the enforcement staffs to some type of limitation, even if they refuse to adopt a bright line rule.

An interesting side note. The NASD’s press release on the decision presented an interesting spin on the decision. While fairly reporting the decision, the release focused on the factors that were not present in the actual case, focusing on the point that a respondent’s delay would bar the defense. The NASD’s release also failed to mention the rejection of its “complexity” argument, which was a significant blow to the NASD in the case. We are reminded of a recent SEC press release which spun another series of facts, to make the SEC look better, and which “overlooked” the SEC’s conduct. Are regulators now hiring press agents? Don’t they have an obligation to fairly report events to the investing public?

Nothing herein is intended as legal or financial advice. The law is different in different jurisdictions, and the facts of a particular matter can change the application of the law. Please consult an attorney or your financial advisor before acting upon the information contained in this article.


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