August 24, 2010
-Brian N. Smiley—SEC Comment Letter—Discovery Guide
(Release No. 34-62584 File No. SR-FINRA—2010-035)
I am pleased to have the opportunity to comment on the proposed revisions to the FINRA Discovery Guide. I offer my comments from the perspective of an attorney who has been involved in securities arbitration since the mid-1980s. I am the immediate past President of the Public Investors Arbitration Bar Association (PIABA). In addition, I served as a public member of FINRAs National Arbitration and Mediation Committee (NAMC) from 2002-2007 and chaired its rules committee.
I support the idea of a Discovery Guide listing documents that are deemed presumptively discoverable. I do not doubt that a number of commenters on both sides will challenge the concept of ready-made lists, which may not include relevant documents in some cases, while requiring excessive production in others. That is a valid criticism however, the approach of simply leaving the scope of production to the arbitrators in each case has been tried by customers and found wanting. Prior to the current Guide, brokerage firms routinely refused to produce even the most transparently relevant documents. This resulted in the need for motions to compel being filed against brokerages in virtually all of my cases, with highly inconsistent results. The 1999 Discovery Guide met a very real and on-going need.
In general, I believe that the proposed revisions to the Guide represent a net benefit to investors. That said, I realize that gaining a consensus to support a Discovery Guide required compromises at FINRA some of which should be reconsidered by the SEC to satisfy the public interest of investors. If forced to choose between the revisions and no changes at all, I would recommend adopting the proposed rules. On the other hand, I think there are opportunities to improve the current proposal that the Commission should consider.
Discovery Guide Introduction
The language in the Introduction counseling against unwarranted claims of confidentiality is welcome, but does not go far enough. Brokerages systematically require claimants counsel to enter confidentiality orders before any documents are produced. Expediency requires counsel to acquiesce. Defense counsel then stamp virtually everything produced confidential. Arbitrators are reluctant to upset confidentiality agreements, with the result that firms use bogus assertions of confidentiality to hide documents that reveal serious violations of securities laws.
Much of the language in the Introduction concerning confidentiality is quoted from the NAMCs April 2004 Neutral Corner article and The Arbitrators Manual. While helpful, these authorities have not inhibited brokerage firms from successfully cloaking all kinds of documents with improper confidentiality restrictions. This is an abuse which prevents counsel from sharing the documents with counsel for other victims of the same misconduct and even limits their ability to provide information to the SEC and other regulators.
It is disturbing to note that the original Neutral Corner article specifically advised arbitrators to consider two factors that are not mentioned in the Introduction to the new Discovery Guide. Bullet points six (6) and eight (8) of the original article stated that before treating documents as confidential, arbitrators should consider:
"Would an excessively broad confidentiality order be against the public interest in disclosure? Keep in mind that securities arbitration is highly regulated by the Securities and Exchange Commission. The former SEC Director of Enforcement, William R. McLucas, has stated: Private securities actions will continue to be essential to the maintenance of proper investor protection.": and
"Would an unduly extensive confidentiality order impair the ability of counsel to represent other clients?"
The ability to share information developed in discovery is vital to effective public and private enforcement of the securities law, and should be explicitly referenced in the Introduction as guidance to arbitrators. Omitting them can only help brokerage firms cover up serious violations of law.
Comments on List 1—Firm/Associated Person Documents
In general, List 1 is a major improvement over the current Discovery Guide. The changes appear to recognize the need to fill in gaps in the earlier Guide which tended to focus too much on the conduct of the individual Associated Person (AP) handling the claimants account and too little on institutional conduct. Similarly, it is helpful that much of the language in the new Guide tracks the language of SEC rules concerning required records. This will make it more difficult for firms to pretend that terms are ambiguous. Positive developments in the new guide include: requiring more disclosure of information the firm has about the client and what it recommended to him or her providing more specific information about investment products and, better disclosure concerning supervision and manuals.
My concerns about the new proposed List 1 are as follows:
Item 9:
Rather than limiting the new rules to documents reflecting communications between the client, the AP, and the firm's compliance department, the list should cover communications involving any agent or employee of the firm.
Item 13, 14, 17:
Each of these sections contains a one (1) year look-back or look-forward provision. This time limit should be expanded to at least two (2) years. It is manifestly unfair to impose three (3) year time limits on clients and only one (1) year on firms.
Items 16, 17:
Both of these sections focus on the AP's conduct. Many of the cases being brought by investors deal with firm-wide misconduct (e.g., auction rate securities, misleading sales practices for complex products, etc.). The lists should cover conduct by the AP and/or the firm similar to that at issue.
Comments on List 2—Public Investor Documents
Item 1:
Tax returns should not have to be routinely produced, as tax information is highly personal and intrusive. Firms are required to make suitability determinations based upon what they knew about the client at the time of the transaction, not what they can contrive later. Moreover, the requirement of providing tax returns three (3) years before the transaction through the date of the filing of the Statement of Claim is excessive on its face. If required at all, tax returns should only have to be produced for a relevant time period. Returns filed years before or after the transaction in question do not meet that standard. In general, however, tax returns should only have to be produced if specifically relevant to the controversy. Why, for example, should tax returns have to be produced in an unauthorized trading case?
Item 2:
It is appropriate to clarify that clients need not create financial statements. This is an all but impossible task that detracts from the proper focus of what information the firm had about the client at the time of a recommendation. Otherwise, my comments as to Item 1 above (tax returns) apply equally here.
Item 4:
Again, the time period for production of account records from other firms is excessive for both before and after the transactions in question. Moreover, brokerages routinely subpoena these records and experience shows us that firms are quick to cooperate in helping out other FINRA members.
Items 13, 15:
I do not object to a client providing documents concerning his or her decision to make a disputed trade. However, the SEC should clarify that the language in Items 13 and 15 should not be construed to cover production of materials obtained by an investor in anticipation of litigation/arbitration and/or from counsel.
Summary
In conclusion, I believe the proposed Discovery Guide has much to commend it. However, the burdens placed on investors, who already must pay steep filing fees and arbitration-related expenses, should be reduced by eliminating the "discovery overkill" that is already a part of the current Discovery Guide. Experience has shown that these burdens on individual customers detract from the process of fair and efficient dispute resolution.
Respectfully submitted,
Brian N. Smiley
SMILEY BISHOP PORTER, LLP
1050 Crown Pointe Parkway, Suite 1250
Atlanta, GA 30338
(770) 829-3850