April 1, 2009
Elizabeth M. Murphy
Securities Exchange Commission
100 F. Street NE
Washington, DC 20549
RE: FINRA Proposed Changes to the Discovery Guide
Dear Ms. Murphy:
I appreciate the opportunity to comment on FINRAs proposed changes to the discovery guide. I am attorney who concentrates his practice on representing investors in securities arbitration and litigation.
The proposed revisions to the Discovery Guide have both positive and negative changes. It seems that the proposed discovery guide wants to turn customer cases into an investigation of the investors life rather than whether misconduct occurred or did not occur. Considering that the purpose of FINRA and the SEC is to protect the investing public, many of the proposed changes to the discovery guide fly in the face of that purpose.
The first major concern that I have involves extending the applicable discovery timeframe for many of the proposed requests in List 2. The proposed discovery guide seeks documents from 5 years prior to the transactions at issue to the date the Statement of Claim was filed (currently, it is only 3 years prior to the transactions at issue).
Investors financial objectives, risk tolerances, and individual circumstances change over time, especially for those who are near retirement or recently retired. The investors circumstances from 5 years ago often have no relevance to their current circumstances (in fact, this is precisely the reason why broker-dealers often ask clients for annual or bi-annual updates as to their income, net worth, work status, investment objectives, etc.). It is unreasonable and too burdensome to make these documents presumptively discoverable in EVERY case.
There are also several specific requests addressed below:
The Current List 1, Item 7 requires brokerage firms to produce audio recordings and notes of phone conversations between the customer and the firm. The new rule proposes to eliminate mandatory production of these items in every case because such is labor intensive, expensive, and unnecessary. Frequently, that is not true. In the hundreds of arbitration cases that I have been involved in, there are very few cases in which any audio recordings are produced (and in the rare circumstance that audio recordings are produced, there is usually only one or two recordings). Conversations between customers and brokers are often central as to what representations were made to customers and are highly relevant. These documents should be produced in every case, especially considering that there are generally few audio recordings made. This is reinforced by the fact that FINRAs proposed discovery guide mandates customers to produce all audio recordings in proposed List 2, Item 8.
The Current List 1, Item 8 requires brokerage firms to produce Forms U-4 and U-5. I applaud FINRAs proposal to clarify that Disclosure Reporting Pages should be produced. However, FINRA should change this rule and allow for the production of all customer complaints, regardless of their nature. This gives firms an excuse to withhold these customer complaints. Prior customer complaints are relevant to issues of supervision – if a broker has one or multiple complaints on his record, it should prompt a firm to have some kind of heightened supervision.
The proposed List 1, Item 11 requires production of documents received by the firm via subpoena request. This proposal seems logical and should be included in the discovery guide. The same would hold true for the proposed List 2, Item 17.
The proposed List 2, Item 11 presents some problems. The proposed rule asks customers to identify confidential settlement agreements and allows panels to order production of such agreements. The identification and/or production of such an agreement may be precluded by the agreement itself. This can create a dilemma where a customer is supposed to keep a prior settlement agreement confidential, but then may be ordered to produce the agreement by the panel. This part of the proposed rule should be eliminated.
The proposed List 2, Item 12 should be eliminated entirely. This proposed rule asks customers to produce loan documents or to identify such loans. The supposed purpose for the rule is to get information about the customers assets and liabilities. If that is true, the discovery guide should simply ask the customer to identify his or her assets and liabilities. These documents have no relevance in most cases, especially in cases not involving suitability.
The inclusion of currents Lists 8, 10, and 14 into the proposed List 2 has some issues. For example, this would include production of documents relied upon by the customer in making the investment decisions at issue, which is not applicable in all cases. Generally, reliance is not an element in breach of fiduciary duty or negligence cases. In addition, if the broker is making an investment recommendation to a client, the onus should be on the broker to produce this document. It is the brokers duty to make suitable investment recommendations and to study an investment sufficiently before recommending it to a client. The broker or firm, not the customer, should have the burden to produce these documents, especially where the recommendation is solicited.
Current List 5/Proposed List 4
The current List 5, Item 1 requires brokerage firms to produce commission runs related to the customers account. The proposed rule does not go far enough. The firm should be required to produce the brokers complete commission runs (including those of other customers, with personal information redacted) in all cases. These documents are crucial for suitability cases and unauthorized trading cases.
In unauthorized trading cases, often the broker will say that he/she did get authorization, or that such recommendation was the clients idea. If the brokers other clients are also investing in the same security around the same time, it tends to show that this recommendation is the brokers idea, not the clients. In the same regards, the production of full commission runs in unauthorized trading cases (proposed List 9, Item 4) is a welcome addition, but the timeframe should be expanded from 10 days to 30 days.
The same holds true for suitability cases. If the broker contends that a security was suitable for that client, but all of his or her clients invested in the same security around the same time, it tends to show that the broker uses a one-size-fits-all approach to his investment recommendations, regardless of the clients investment objectives, risk tolerances, etc.
The addition of proposed List 4, Item 5 is welcome. If a regulator investigates a broker for misconduct, this should put the firm on notice that they may have a problem broker. Heightened supervision for that broker may be necessary at that point, and the failure to do so could be evidence of a failure to supervise. However, this should not be limited to conduct similar to that alleged in the Statement of Claim.
The additions of proposed List 4, Items 7 and 8 are also welcome, as documents, correspondence, and notes regarding the supervisors conduct in monitoring a broker is obviously relevant to any supervision case.
Current List 11/Proposed List 9
Proposed List 9, Item 4 requires firms to produce the brokers full commission runs for 10 days before and after the transactions at issue. This should be expanded to 30 days before and after the transaction at issue, as the 10 days may not be broad enough to illuminate the brokers conduct fully.
Current List 13/Proposed List 11
Proposed List 11, Item 1 expands some of the documents produced in suitability cases. I support the inclusion of sales literature and performance or risk data into the proposed request. In all practicality, the broker often relies heavily on sales literature when discussing investments with clients. These are highly relevant documents in sales practice cases.
Proposed List 11, Item 3 includes the production of asset allocation models, which I support. Many firms use asset allocation or diversification models and send these to their brokers to use when putting together a clients portfolio. If the broker is making asset allocation recommendations which clearly deviate from what the firm is suggesting, then this could be evidence of unsuitable investments. Moreover, if the asset allocation of a particular clients portfolio is vastly different than the suggested model, then this also is relevant to whether the firm is adequately supervising the broker or the customers account.
Proposed List 12
In general, there needs to be much more clarification on what constitutes particular products or securities. This could virtually be anything, from options, to variable annuities, penny or pink sheet stocks, mutual funds, auction rate securities, structured financial products, etc.
Proposed List 12, Item 1 limits a request to up to five securities/products listed below. Why is there a limitation here? In many instances, firms can easily search a brokers commission runs for every product that has been sold. It should not be difficult to expand this search to as many products or securities that are relevant to the issues of the case. Otherwise, I do support the inclusion of this request, and of Item 2 of Proposed List 12.
Proposed List 12, Items 3 and 4 are puzzling. These requests are related to a customers death benefits in insurance products. It does not specify if the customer or the firm is supposed to provide this information.
Nevertheless, this should not be part of the discovery guide, as disputes involving the insurance business activities of a member that is also an insurance company are not eligible for arbitration under the FINRA Code. See FINRA Rule 12200. If the parties are not allowed to arbitrate insurance issues, then why should insurance be part of discovery? Insurance is not necessarily relevant to a customers investment portfolio, mainly because the customer will not receive insurance benefits until after death. Life insurance death benefits provide a different benefit than many securities products.
Proposed List 12, Item 5 is also a welcome addition. Information about the brokers compensation can be relevant, especially in suitability cases where allegations are made that the broker was incentivized to push certain investments over others.
Again, I appreciate the opportunity to comment on these proposed rules.