Source: http://www.brokeandbroker.com/2994/finra-smarsh-spoliation/
Timestamp: 2019-04-24 20:32:06+00:00

Document:
This is an update of "FINRA Named As Defendant In Case Alleging Altered Electronic Files" (BrokeAndBroker.com Blog, April 24, 2015) and "FINRA Moves To Dismiss Spoliation Claims" (BrokeAndBroker.com Blog, May 5, 2015).
The April 24, 2015, BrokeAndBroker.com Blog discussed a civil Complaint filed in the United States District Court for the District of Columbia ("DDC") involving the somewhat esoteric legal issue of "spoliation," the alleged destruction or alteration of evidence. Although that doesn't necessarily sound like a riveting story, consider the fact that the federal lawsuit under consideration names as one of the Defendants Wall Street's self-regulatory organization, the Financial Industry Regulatory Authority ("FINRA").
34. In the course of FINRA examination(s) and various 8210 letter requests for information that began in 2010, the Southridge and Ocean Cross firms arranged for Smarsh to deliver the firms' electronic communications records directly to FINRA, because the 8210 letters demanded delivery of electronic communications in "a special format", e.g. .pst. CEO Schloth stated under oath before Enforcement attorneys and investigators, " . . . when you guys request something, we just don't want to screw it up in terms of download. So we just ask SMARSH [sic] to do it. That's generally what - - the best way to do it." Excerpts from Schloth On the Record Interview ("OTR") (In the Matter of Southridge) dated February 9, 2012 p. 89, ll. 2-9,marked Exhibit 1. As a result, Smarsh delivered Southridge and Ocean Cross ESI directly to Enforcement according to FINRA Rule 8210 requests throughout the Relevant Period.
This XLM data appears to be in the same format, with the same XML tags as all the other Bloomberg messages. I see nothing to indicate they are in any way "instant messages." All of the messages I have observed from these two DVDs are consistent in format . . . I do note that in this case, as with all the other instances of Bloomberg XML data being converted to PST format, that a substantial amount of information has been added that gives a false and misleading impression of the nature and form of these messages. In Smarsh's processing, produced on the PSTs, they have added to the beginning of each (approximately 190,000) message body the text "BB Message". This text does not appear in the originals. Id. ¶¶ 20-21.
This is not the first time Mr. North and his counsel have prematurely and improperly sought to enjoin these FINRA disciplinary proceedings. On December 10, 2014, in an action styled "In re Thaddeus J. North", United States Court of Appeals for the D.C. Circuit, Case No. 14-1274, Mr. North filed an "Emergency Petition for Mandamus, Temporary and Permanent Injunctive Relief, and Stay of Proceedings Before the Financial Industry Regulatory Authority." The Petition challenged the determinations of two separate FINRA Hearing Officers in the FINRA cases regarding the same allegedly spoliated records at issue in the current Complaint, and sought to permanently enjoin the FINRA cases. The next day, on December 11, 2014, the Appeals Court Ordered that the Petition be denied finding that mandamus relief was not warranted. See December 11, 2014 Order, attached as Exhibit 1.
This Court lacks subject matter jurisdiction under Fed. R. Civ. P. 12(b)(1) and 12(h)(3) because the Exchange Act provides the exclusive judicial remedy for complaints arising from FINRA disciplinary proceedings and requires Plaintiffs to exhaust their administrative remedies. 15 U.S.C. § 78s, 78y; See Marchiano v. NASD, Inc., 134 F.Supp.2d 90 (D. D.C. 2001); see also McGinn, Smith & Co.. Inc. v. FINRA, 786 F.Supp. 2d 139, 146 (D. D.C. 2011).
FINRA "is absolutely immune from suit for the improper performance of regulatory, adjudicatory, or prosecutorial duties delegated by the SEC." In re Series 7 Broker Qualification Exam Scoring Litigation, 548 F.3d 110, 114 (D.C. Cir. 2008). No court has ever allowed tort claims to proceed against FINRA related to its enforcement duties under the Exchange Act.
Neither the Exchange Act, nor any provision of the federal securities laws expressly provides for a cause of action against an SRO like FINRA for acts or omissions in connection with its regulatory duties. See, e.g., In re Series 7 Broker Qualification Exam Scoring Litigation, supra, 548 F.3d at 115 ("The elaboration of duties, allowance of delegation and oversight by the SEC, and multi-layered system of review show Congress's desire to protect SROs from liability for common law suits").
Even if such a claim were viable, Plaintiffs fail to state a claim of "negligent spoliation" claim against FINRA. See Cook v. Children's National Medical Center, 810 F.Supp. 2d 151, 155 (D. D.C. 2011); see also Holmes v. Amerex Rent-A-Car, 180 F.3d 294, 297 (D.C. Cir. 1999).
[T]he crux of the negligent spoliation claim against FINRA is that it somehow "contributed to" the spoliation of emails maintained by Smarsh solely because FINRA requested those emails "in a "special format", e.g. ".pst." Complaint, ¶34. Specifically, the Complaint alleges "Enforcement also had a duty to avoid spoliation to ESI, however, by and through its agents and employees, FINRA negligently contributed to the spoliation during the examination and investigations of Southridge and Ocean Cross by requiring that electronic communications be converted and delivered in .pst format, non-native to Bloomberg communications and certain other email programs." Complaint, ¶92. Not only does this paragraph seem to plead the nonexistent tort of "contribution to spoliation", but on its face fails as FINRA had no duty to request emails in native format. FINRA did not own, maintain, or control these emails. As a regulator, FINRA made a routine request to the firms' email vendor to obtain emails in .pst file format.
Requesting emails in ".pst" format is far from "special" as Plaintiffs contend - rather, it is usual and customary: "Email is not typically produced in native file format because the extraction of individual emails from a large database containing other emails requires conversion of the file format into a near-native format." 1-37A Moore's Federal Practice - Civil § 37A.43(1) (3d ed. 2015). "Collections of entire sets of emails, often stored in networked servers, can be extracted in a PST or NSF format, i.e., file extensions.pst or .nsf." Id. at § 37A.43(2). Like FINRA, the SEC also often requests emails in .pst file format. See Division of Enforcement, Enforcement Manual, §3.2.6.2.3 ("Format for Electronic Production of Documents to the SEC") specifically provides that SEC staff may accept emails in .pst file format.10 FINRA owed no duty to Plaintiffs to request data from their firms' email vendor in a native file format. Even if the allegations of the Complaint could be considered, Plaintiffs' negligent spoliation claim against FINRA is so untenable that it fails as a matter of law.
For the foregoing reasons, the Court will grant both FINRA's Motion to Dismiss, Dkt. 6, and Smarsh's Motion to Dismiss, Dkt. 9, and deny Plaintiffs' Motion for Orders to Produce Digital Records for Examination, Dkt. 28. In sum, the Court finds that it has no general or specific jurisdiction over Smarsh. Accordingly, the Court will dismiss the Complaint against Smarsh without prejudice for lack of in personam jurisdiction. With respect to Plaintiffs' negligent spoliation claims against FINRA, the Court finds that TRAC divests the Court of jurisdiction to entertain Plaintiffs' prayer for injunctive relief. Moreover, since Plaintiffs are unlikely to succeed on the merits of their claim and it is unclear that they will suffer irreparable harm as a result of the continuation of the FINRA proceedings, the Court finds that transfer to the D.C. Circuit is not in the interest of justice. The Court will dismiss Plaintiffs' claim for injunctive relief against FINRA without prejudice for lack of subject matter jurisdiction. The Court also holds that FINRA is absolutely immune for its regulatory and prosecutorial acts and, thus, will dismiss Plaintiffs' claim for monetary relief against FINRA with prejudice. A memorializing Order accompanies this Memorandum Opinion.
The DDC Opinion tackles the issue of whether Plaintiffs successfully advanced the required demonstration of "irreparable harm" in order to provide the foundation upon which a transfer of the case to a federal Court of Appeals or the imposition of an injunction could be predicated.
The Exchange Act establishes a mandatory process for resolving FINRA disciplinary actions. Marchiano, 134 F. Supp. 2d at 92. That process does not contemplate the involvement of federal district courts. Id. at 92, 94-95. The D.C. Circuit has clearly held that "where a statute commits review of agency action to the Court of Appeals, any suit seeking relief that might affect the Circuit Court's future jurisdiction is subject to the exclusive review of the Court of Appeals." Telecommunications Research and Action Center v. F.C.C., 750 F.2d 70, 75 (D.C.Cir.1984) (TRAC)). Pursuant to TRAC, a district court does not have jurisdiction to review or enjoin FINRA's disciplinary actions if: (1) the relevant statute "commits review to the Court of Appeals"; and (2) "the action seeks 'relief that might affect the Circuit Court's future jurisdiction.'" Marchiano, 134 F. Supp. 2d at 93 (quoting TRAC, 750 F.2d at 75). Both factors are satisfied in the instant case.
With respect to the issue of irreparable harm, Plaintiffs do not allege that there is a risk of further spoliation. Mr. Pompeo already settled the allegations against him by entering into an AWC with FINRA and the merits hearings in the Southridge and Ocean Cross Proceedings against Mr. North have already concluded. Also, Mr. Pompeo does not explain how he would be irreparably harmed if the Court does not enjoin the pending proceedings against Mr. North. In terms of concrete damages, Plaintiffs complain that they have incurred significant litigation expenses in responding to FINRA's disciplinary proceedings. Nonetheless, "courts have uniformly recognized that '[m]ere litigation expense, even substantial and unrecoupable cost, does not constitute irreparable injury.'" McGinn, Smith, 786 F. Supp. 2d at 147 (quoting Renegotiation Bd. v. Bannercraft Clothing Co., 415 U.S. 1, 24 (1974)). They also allege without specificity that FINRA's alleged negligent spoliation has resulted in retribution, as well as loss of gainful employment and professional reputation. See Compl. ¶¶ 62, 64-65. The Court recognizes that these damages could rise to the level of irreparable injury. However, FINRA has not issued a final disciplinary action against Mr. North and some of the charges in the Southridge and Ocean Cross Proceedings -- i.e., whether Mr. North reviewed sufficient electronic correspondence as required by securities laws and regulations -- have nothing to do with the content of the spoliated ESI. Therefore, it is unclear how enjoining FINRA from using spoliated ESI against Mr. North would avoid the alleged harms.
exclude expert testimony and reject the spoliation allegations as irrelevant were nothing more than evidentiary decisions, subject to appeal.11 Accordingly, FINRA was acting within the scope of its delegated adjudicatory authority. See FINRA's MTD, Ex. 2 (FINRA Rule 9263) at 3. Finally, the Complaint does allege that FINRA was misled by Smarsh and negligently relied on spoliated ESI to pursue the underlying enforcement actions against Plaintiffs. Compl. ¶¶ 90-103. Nonetheless, at the very most, these allegations only show that FINRA failed to properly perform its delegated functions. Since FINRA is "absolutely immune from suit for the improper performance of . . . [its] duties," Plaintiffs cannot defeat immunity in the instant case. In re Series 7, 548 F.3d at 115 (affirming the dismissal of a tort action against FINRA for admitted mistakes committed while administering a securities licensing exam). Plaintiffs' claim for monetary relief will be dismissed with prejudice.

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