==========================================START OF PAGE 1====== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 38390 / March 12, 1997 Admin. Proc. File No. 3-9005 --------------------------------------------------- : In the Matter of the Application of : : STRATTON OAKMONT, INC. : 1979 Marcus Avenue : Lake Success, New York 11042 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : : __________________________________________________: OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS Violations of Rules of Fair Practice Attempts to Impede NASD Investigation Where member firm of registered securities association settled customer claims with agreements that prevented the customers from cooperating with association's investigation of their claims, and member failed to release customer from the settlement agreement when directed to do so by the association, held, association's findings of violation sustained, and the sanctions it imposed modified to provide that, in view of firm's bankruptcy, any association efforts to collect the fine and costs shall be pursued as a claim in firm's liquidation proceeding under the Securities Investor Protection Act of 1970. APPEARANCES: Martin P. Unger and Andrew M. Zeitlin, of Tenzer Greenblatt, L.L.P., for Stratton Oakmont, Inc. Deborah F. McIlroy and Alden S. Adkins, for NASD Regulation, Inc. Appeal filed: May 15, 1996 Briefing completed: September 26, 1996 ==========================================START OF PAGE 2====== I. Stratton Oakmont, Inc. ("Stratton" or the "Firm"), formerly a member firm of the National Association of Securities Dealers, Inc. ("NASD" or "Association"), appeals from NASD disciplinary action. 1/ The NASD found that the Firm, in settlement agreements executed with various customers who had filed complaints against it, included confidentiality provisions that impermissibly restricted the customers' ability to discuss the substance of their complaints with the NASD, in violation of Article III, Section 1 of the NASD Rules of Fair Practice ("Rules"). The NASD also found that Stratton violated Article III, Section 1 and Article IV, Section 5 of the Rules when, despite repeated requests by the NASD to do so, the Firm failed to release one customer from the confidentiality provision in his settlement agreement so that the NASD properly could investigate the customer's complaint. 2/ The NASD censured Stratton, fined the Firm $20,000, and assessed costs. 3/ Our findings are based on an independent review of the record. 1/ In connection with an unrelated disciplinary matter, the NASD expelled Stratton from membership in December 1996. In late January 1997, in response to Stratton's petition for Chapter 11 protection filed in federal bankruptcy court, the Securities Investor Protection Corporation successfully petitioned in federal court for Stratton's liquidation under the Securities Investor Protection Act of 1970. Stratton's liquidation now is proceeding. 2/ The NASD recently revised and renumbered its Rules, but no substantive changes were made to the particular rules at issue here. Article III, Section 1 of the Rules (new Conduct Rule 2110) requires that members, in the conduct of their business, observe high standards of commercial honor and just and equitable principles of trade. Article IV, Section 5 (new Procedural Rule 8210) requires member firms to make themselves available to the NASD and to permit NASD investigation of the firm's books, records and accounts. 3/ In addition, the NASD ordered that Stratton, within 30 days of any request to do so made by the Association in connection with its investigative duties, release identified customers from a settlement agreement that imposes any form of condition on the customers' ability to provide information to the NASD. The NASD's order also specified that Stratton's failure to comply with this requirement would result in Stratton's suspension from NASD membership until the Firm complied. These ancillary orders are no longer relevant, given Stratton's subsequent expulsion from membership and ongoing liquidation. ==========================================START OF PAGE 3====== II. In November 1993, the NASD staff sought the cooperation of Harold Copeland, a former Stratton customer, in the NASD's investigation of a complaint Copeland had made against the Firm. The NASD subsequently learned that Copeland had settled the matter with Stratton in October 1993, and that the confidentiality provision in the settlement agreement executed by the parties prevented Copeland from disclosing to the NASD information relating to the matter. This confidentiality provision stated: I hereby also agree that I will keep confidential the terms of this settlement and will not disclose information relating to the settlement or the subject matter of my claims or allegations against your firm or any officers, directors or employees acting in those capacities and subject only to a court order of competent jurisdiction or a lawful subpoena issued by a governmental agency and upon reasonable notice to you so that you can have an opportunity to object and/or take lawful steps to prevent the disclosure. 4/ Thereafter, the NASD staff informed Stratton's Compliance Director by letter that the Firm's confidentiality provision violated the Rules. The NASD staff also requested that Stratton both amend the confidentiality provision of its form settlement agreement to comply with the Rules and release Copeland from this provision to permit Copeland to cooperate with the NASD if he desired. 5/ During the next five months, the NASD staff and Norman Arnoff, counsel for Stratton, exchanged at least a dozen letters regarding the confidentiality provision and the NASD staff's continuing requests that Stratton amend the confidentiality provision and release Copeland from the provision in Copeland's settlement agreement. 6/ These contacts resulted in neither amended confidentiality language acceptable to the NASD staff nor 4/ The record indicates that Stratton used this confidentiality provision in the Firm's form settlement agreement through at least Spring 1994. 5/ The NASD staff enclosed with its letter the Notice to Members 86-36, dated May 14, 1986, which states that settlement agreements that preclude customers from testifying in NASD proceedings may violate applicable Rules. 6/ Representatives of Stratton and the NASD also met personally about these matters. ==========================================START OF PAGE 4====== Copeland's release from his settlement agreement. Toward the end of this period, Arnoff offered to modify Copeland's settlement agreement to permit Copeland to cooperate, subject to certain conditions. These conditions were that the NASD staff interview Copeland in the presence of counsel for Stratton, afford Stratton's counsel the opportunity to question Copeland under oath, and permit counsel for the Stratton registered representative whose alleged conduct gave rise to Copeland's complaint to be present during the NASD interview. The NASD staff, however, advised Arnoff that this proposal imposed unacceptable conditions on Copeland's ability to cooperate. In late May 1994, the NASD staff informed Stratton that the Examination Subcommittee of the District Business Conduct Committee ("Examination Subcommittee") had instructed the staff to direct Stratton to modify (1) Copeland's settlement agreement to permit his cooperation with the NASD; and (2) the confidentiality provision in Stratton's form settlement agreement to remove any impediment to a customer's ability to cooperate with the NASD. The NASD staff also advised Stratton that the Examination Subcommittee had authorized the staff to file a disciplinary complaint on behalf of the District Business Conduct Committee ("District Committee") against the Firm if Stratton failed to comply with these directives. Arnoff then proposed the substitution of the following revised form confidentiality provision in Stratton's settlement agreements: [Customer] further represents and warrants that should he determine to voluntarily and without compulsion of law cooperate, give testimony, and/or a written or oral statement to any securities self-regulatory organization, including, without limitation, the National Association of Securities Dealers, Inc., concerning Stratton, any of the account executives, or the subject matter of this settled claim, he will do so only upon ten (10) business days prior notice to [counsel for Stratton and its account executives] and, in addition, prior to any such cooperation, testimony, and/or written or oral statement [customer] shall make himself available to Stratton and/or its attorneys and the attorneys for the account executives for the taking of testimony and/or a written or oral statement at Stratton or, alternatively, at another mutually acceptable place and at a mutually acceptable time. Around this time Stratton began using this proposed language in all of the Firm's settlement agreements and continued to do so at least through January 1995. ==========================================START OF PAGE 5====== Arnoff also advised the NASD staff that the Firm would release Copeland from the confidentiality provision in his settlement agreement if Copeland first executed a statement describing the events relating to his complaint. In fact, Arnoff interviewed Copeland and prepared and sent Copeland a written summary of the matters discussed. However, for reasons not apparent from the record, Copeland never executed the statement. Ultimately, in July 1994, after the NASD staff and Arnoff could not agree on confidentiality language acceptable to the staff, the District Committee filed its complaint against Stratton. The complaint was based on the original and revised confidentiality provisions utilized by Stratton in settlements since October 1993 and the Firm's failure to release Copeland from his settlement agreement. III. Our analysis here is guided by the fundamental principle that a member firm is obligated to cooperate fully with the investigative efforts of the self-regulatory organization to which it belongs. The NASD's ability to police its members' compliance with the federal securities laws, generally, and the organization's rules, in particular, is a core component of the NASD's regulatory functions. 7/ Accordingly, the NASD must have the full and prompt cooperation of persons subject to its jurisdiction in order for the Association to be able to carry out its responsibilities. 8/ We agree with the NASD that attempts to impede NASD investigations violate Article III, Section 1 of the Rules since such conduct undermines the Association's regulatory functions. 9/ We further agree that the confidentiality 7/ See Securities Exchange Act of 1934  15A(b)(2) (herein, "Exchange Act"); William Edward Daniel, 50 S.E.C. 332, 335- 36 (1990) ("[a]n integral aspect of the statutory scheme for regulating broker-dealers and protecting investors is the responsibility of self-regulatory organizations such as the NASD to investigate allegations that members and their associated persons have engaged in misconduct and to impose sanctions when appropriate."). 8/ See, e.g., Mark Allen Elliott, 51 S.E.C. 1148, 1150-51 (1994); Michael David Borth, 51 S.E.C. 178, 180 (1992). 9/ Cf. William Edward Daniel, 50 S.E.C. at 335-36 (registered representative's offer to settle claim contingent upon customer withdrawing complaint filed with NASD violated just and equitable principles of trade since offer undermined the NASD's regulatory functions). ==========================================START OF PAGE 6====== provision to which Copeland was subject embodied just such an attempt to impede as it precluded Copeland from speaking voluntarily with the NASD. Indeed, the Firm conceded during its appeal before the NASD's National Business Conduct Committee ("National Committee") that the Copeland provision violated NASD Rules. 10/ We, therefore, sustain the NASD's finding that Stratton violated Article III, Section 1 by using the Copeland provision in its form settlement agreements. Turning to the revised confidentiality provision that Stratton began using in mid-1994, we find that, while this provision permitted a customer to speak with the NASD, it did so by conditioning the customer's ability to cooperate on the customer's willingness first to supply the Firm (and any counsel for the particular account representative whose conduct was at issue) with testimony or a statement. We conclude, as did the NASD, that this revised provision also erected obstacles that impeded the customer's ability to cooperate fully and promptly with the NASD and that, by using the provision, Stratton violated Article III, Section 1 of the Rules. We further conclude, in accord with the NASD, that Stratton's failure to release Copeland from the confidentiality provision of his settlement agreement when directed to do so also violated Article III, Section 1. Stratton disregarded the Association's requests, thus frustrating the NASD's efforts to communicate with Copeland. Stratton's responsive conduct -- insisting at various times, as a prerequisite to Copeland's release, that the Firm have the opportunity to attend and question Copeland during his NASD interview; that Copeland provide Stratton a statement regarding his complaint; and that Copeland return the funds Stratton paid him in connection with the settlement and agree to arbitrate his claim -- impeded the NASD in carrying out its essential self-regulatory functions by effectively dissuading Copeland from cooperating with the NASD. 11/ 10/ Stratton's counsel advised the National Committee that the Firm did not contest the District Committee's finding as to the Copeland confidentiality provision because the Firm realized that the provision was "too restrictive" and, therefore, modified it. 11/ We do not conclude that Stratton's failure to release Copeland from the settlement agreement also violated Article IV, Section 5 of the Rules. That provision requires members to make themselves available to the NASD and to grant the NASD access to a member's books, records and accounts. Here, the NASD staff sought information from a customer (Copeland), not a member (Stratton). This does not mean, (continued...) ==========================================START OF PAGE 7====== Stratton asserts that it could not be found to have violated the Rules since, prior to the District Committee hearing, Copeland indicated that he did not desire to talk to anyone, much less the NASD, about the facts surrounding his complaint. Copeland's unwillingness to cooperate with the NASD months after the Association requested that he do so is not probative here. The record indicates that at one time Copeland desired to cooperate with the NASD, but Copeland subsequently was warned that such cooperation would violate the settlement agreement. IV. Analogizing this matter to that presented in General Bond & Share Co. v. SEC, 39 F.3d 1451 (10th Cir. 1994), Stratton urges that the NASD's interpretation of Article III, Section 1 as precluding the Firm's conduct here constitutes an invalid rule change. We reject the Firm's argument. The NASD's application of Article III, Section 1 to Stratton's actions did not establish a new standard of conduct to which the Association's members must adhere. The provision requiring members to observe just and equitable principles of trade has long obligated NASD members to cooperate with the Association in its effort to perform its regulatory functions. 12/ This requirement to cooperate is reasonably and fairly implied not only from Article III, Section 1 and other NASD Rules, but, more essentially, from the very structure of the Exchange Act and from the specific Exchange Act provision that requires a registered securities association to discipline its members and associated persons for violations of the federal securities laws and the association's rules. 13/ We believe that these regulatory provisions afforded Stratton ample 11/(...continued) however, that Article IV, Section 5 is irrelevant to our analysis. Article IV, Section 5 exemplifies the fundamental requirement that members cooperate with the NASD so that the Association may perform its regulatory functions. 12/ See, e.g., William Edward Daniel, 50 S.E.C. at 335-36. Stratton claims that it presented compelling testimony by two experienced securities professionals (one in person and the other by proffer) that Stratton's use of the revised confidentiality provision was consistent with Article III, Section 1. The testimony presented, however, ignores the revised provision's adverse impact on the NASD's self- regulatory obligation to investigate possible violations by its members. 13/ See Exchange Act  15A(b)(7). ==========================================START OF PAGE 8====== notice 14/ that its conduct was wrongful. 15/ V. Stratton also raises various constitutional and procedural objections to the NASD proceedings that we find meritless. Stratton alleges that the NASD disciplinary procedures contain inherent flaws that effectively denied the Firm due process of law. We find that Stratton was afforded due process because, consistent with the relevant Exchange Act provisions governing Association discipline, 16/ Stratton received adequate notice of the specific charges against the Firm; was given the opportunity to defend itself against these charges; and had the opportunity to confront and cross-examine adverse witnesses. 17/ Nor can we agree that the record supports the Firm's contention that the District Committee's prosecutorial and adjudicatory functions were commingled so as to deny the Firm due process. 18/ Similarly, we are not persuaded that the 14/ Here, the NASD staff also supplied Stratton a Notice to Members that explained that the Firm's conduct could be found to violate various NASD Rules. See, supra, n.5. 15/ For these reasons, as well as those we previously have articulated, we reject Stratton's contention that, as applied here, Article III, Section 1 is unconstitutionally vague. See, e.g., Conrad C. Lysiak, 51 S.E.C. 841, 847 n.24 (1993) (Article III, Section 1 is "sufficiently specific and provides an adequate standard of compliance") (quoting Benjamin Werner, 44 S.E.C. 622, 625 and n.11 (1971), aff'd without opinion (D.C. Cir. Jan. 24, 1972)), aff'd, 47 F.3d 1175 (9th Cir. 1995) (unpublished opinion). 16/ See, e.g., Exchange Act  15A(h). 17/ See Richard W. Perkins, 47 S.E.C. 847, 849 (1982); see also, Mathews v. Eldridge, 424 U.S. 319, 333 (1976) ("The fundamental requirement of due process is the opportunity to be heard at `a meaningful time and in a meaningful manner.'") (quoting Armstrong v. Manzo, 380 U.S. 545, 552 (1965)). Also, because we conclude that Stratton was afforded due process, we need not address whether the NASD is a "state actor" and, as such, subject to the due process requirements of the United States Constitution. 18/ See Daniel C. Adams, 47 S.E.C. 919, 922 (1983). Moreover, despite Stratton's contrary suggestion, the NASD is not subject to the strictures of the Administrative Procedure Act. See Richard W. Perkins, 47 S.E.C. at 849-50. ==========================================START OF PAGE 9====== appointment of an attorney-advisor to assist the District Committee hearing panel prejudiced Stratton. 19/ Stratton theorizes that this individual -- a regional counsel from another NASD district with responsibility for prosecuting matters in that district -- was apt to favor the NASD's prosecutorial staff's arguments over the Firm's and to communicate that bias to the panel. Stratton, however, has presented no evidentiary basis for a finding that the District Committee's rulings during the hearing or its ultimate decision did not reflect the independent views of that body. Finally, we find no unfairness -- let alone "irrationality," as Stratton describes it -- in the hearing panel's decision not to compel nine NASD staff members to testify regarding alleged, but wholly unsubstantiated, contacts between the NASD staff and members of the District Committee. 20/ VI. 19/ We do agree with Stratton that the NASD staff, on the Firm's request, should have disclosed the identities of the members of the Examination Subcommittee that authorized filing the disciplinary complaint. The Examination Subcommittee, however, did not preside over the hearing or make findings in this matter. 20/ Stratton sought the staff members' testimony as it related to the Firm's affirmative defenses that there was insufficient separation of the adjudicatory and prosecutorial functions of the NASD staff and District Committee and that the District Committee and NASD staff were biased and had a conflict of interest concerning Stratton. Cf. Meritquest Group, Inc., 51 S.E.C. 223, 227 (1992) (hearing panel properly prevented firm from probing the personnel records of NASD examiners and calling the NASD employees to testify to probe their motivation and conduct during the investigation). Furthermore, the District Committee's ruling here is nothing like the arbitrary rulings at issue in the precedent upon which Stratton relies. In Crandell v. United States, 703 F.2d 74 (4th Cir. 1983), for example, the appellate court reversed a trial court determination and remanded the matter to a new judge in part because the trial court prevented effective cross-examination of defendant's most important witness. In Harvey Aluminum v. United Steelworkers of Amer., 263 F. Supp. 488 (C.D. Cal. 1967), the district court vacated an arbitration award because the arbitrator had refused to permit a material witness to complete his testimony and to consider the witness' testimony in rendering the award. ==========================================START OF PAGE 10====== As we have noted, a member firm's failure to cooperate with an NASD investigation seriously undermines the Association's ability to fulfill its self-policing functions. Here, Stratton's actions clearly prevented the NASD from carrying out its investigation into the conduct of Stratton personnel. Despite numerous requests for the Firm's cooperation, Stratton refused to release Copeland unconditionally from the confidentiality provision, thus stymieing the NASD's investigation into Copeland's complaint. Stratton also insisted on using confidentiality provisions in its settlement agreements despite the NASD's repeated warnings that the language violated NASD Rules. Under these circumstances we are unable to conclude that the censure and fine are excessive or oppressive. We hereby specify, however, that, in view of Stratton's pending liquidation, any efforts to collect the fine and costs shall be pursued as a claim in Stratton's liquidation proceeding under the Securities Investor Protection Act of 1970. ==========================================START OF PAGE 11====== An appropriate order will issue. 21/ By the Commission (Chairman LEVITT and Commissioners WALLMAN, JOHNSON, and HUNT). Jonathan G. Katz Secretary 21/ All of the arguments advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed in this opinion. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. Admin. Proc. File No. 3-9005 : In the Matter of the Application of : : STRATTON OAKMONT, INC. : 1979 Marcus Avenue : Lake Success, New York 11042 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : : ORDER MODIFYING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the findings of violation made by the National Association of Securities Dealers, Inc. against Stratton Oakmont, Inc. be, and they hereby are, sustained, and the sanctions imposed be, and they hereby are, modified to provide that any efforts to collect the fine imposed and costs assessed shall be pursued as a claim in Stratton Oakmont, Inc.'s liquidation proceeding under the Securities Investor Protection Act of 1970. By the Commission. Jonathan G. Katz Secretary