Monday, February 8, 2010

Advisers Sue State Securities Regulator

Years ago I wrote a column for Research Magazine titled Fight Back, an analysis of a litigation strategy for advisers when faced with frivolous customer complaints. The article created something of a stir among securities lawyers, which was a good thing. Sometimes regulated professionals are too timid to stand up for their rights.

Two former financial advisers have taken this a step further, and have sued the Utah Securities Commission for conducting what the advisers claim was an over-zealous campaign against them.

According to press reports, the two advisers, who were who were barred from the securities industry, have sued Utah for $357.6 million, accusing state regulators of targeting them without proof of wrongdoing.

The advisers allege that the Securities Division heaped dozens of allegations on each of them without giving them a chance to appear before a judge in a timely manner. They claim that they were put out of business and forced to declare bankruptcy as a result of the agency's actions. The press reports contain some serious allegations, including alleging that the Division bribed clients, downloaded the entire contents of one adviser's office computers without permission or a warrant and issued a press release announcing the action that contained false information.

I reviewed the complaint as filed in Court, which is available here. While the complaint itself is not the model of clarity, it does make some very serious allegations against the Division.  The complaint is a bit rambling, and some of its allegations may be the result of misunderstanding of securities regulation, but the allegations are disturbing.

This case may have legs. In 2008 the Utah state Senate conducted an audit of the Division as a result of a number of adviser complaints against the Division. The Audit report states that the examination was conducted because " [t]he credibility of the Division of Securities (division) within the Department of Commerce has been challenged by those investigated by the division. Their primary concerns are with procedural errors, an alleged overzealous pursuit of securities violations, and the perception that those investigated do not receive fair treatment." The report is available here.

The 47 page report is an eye-opener, and a look inside a securities regulatory agency with serious problems. For example, the report critized the Division's practice of having the Director of the Divison taking an active role in the investigation and case management of his office, and then serving as the hearing officer for the resulting hearing. (No one knew this was a problem?). In one case, he did not recuse himself as the hearing officer, even though he had been the person who drafted the complaint.

The report also details significant issues with the enforcement process, which the former director admitted existed, but claimed that the problems were caused by one overzealous employee. The audit committee found that the procedural problems were more widespread. According to the report, "[o]ur review of case files resulted in a number of questionable actions including: inappropriate publicity, emphasis on punishment rather than compliance, the use of intimidation tactics, violating terms of settlement agreements, failure to notify those being investigated, and inconsistent case management."

The division has publicized administrative actions without giving the individuals being investigated an opportunity to defend themselves. The former director began issuing multiple press releases for developing cases and publishing a quarterly newsletter shortly after he was hired.

During the audit, and before the release of the report, the head of the Utah Securities Division resigned. Press reports at the time reported that he was resigning following allegations of mismanagement and misuse of authority. The original investigation into the Division arose from allegations made by employees of another brokerage firm.

The Division was also sued by the Securities Industry Association in a claim that the Division overstepped its authority. The SIA obtained a preliminary injunction, on consent, preventing the Division from enforcing the new regulation.

I have dealt with overly aggressive regulators before, but that means regulators who want to permanently bar individuals for innocent mistakes or oversights. An aggressive regulator can be a problem; an over-zealous one can be a nightmare

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