Court Opinion

ID: 179760
Source: CourtListenerOpinion
Date Created: 2010-11-23 17:46:50+00
Date Added: 2024-06-11T17:25:49.583082
License: Public Domain

NOT PRECEDENTIAL

                       UNITED STATES COURT OF APPEALS
                            FOR THE THIRD CIRCUIT
                                 _____________
                                  No. 09-1550
                                 _____________
                                SCOTT EPSTEIN,
                                           Petitioner

                                            v.

                      SECURITIES EXCHANGE COMMISSION,
                                       Respondent

                                    ______________

          APPEAL FROM THE SECURITIES EXCHANGE COMMISSION
                      (Admin. Proc. File No. 3-12933)
                       Secretary Elizabeth M. Murphy
                              ______________

                       Submitted Under Third Circuit LAR 34.1(a)
                                   October 20, 2010
                                   ______________

      Before: HARDIMAN, GREENAWAY, JR., and NYGAARD, Circuit Judges

                          (Opinion Filed: November 23, 2010)

                                    ______________

                                        OPINION

GREENAWAY, JR., Circuit Judge

       Scott Epstein (―Epstein‖) appeals the Securities Exchange Commission‘s (the

―Commission‖) affirmation of the Department of Enforcement‘s (―DOE‖) permanent bar

of Epstein from the securities industry for violating the Financial Industry Regulatory
                                             1
Authority (―FINRA‖)1 Conduct Suitability Rules. Epstein contends that the Commission

abused its discretion because his sanction is grossly disproportionate to his violation and

FINRA‘s hearing lacked procedural fairness. We disagree. For the following reasons,

we will affirm the Commission‘s decision to uphold Epstein‘s permanent bar from the

securities industry.

                                   I. BACKGROUND

       Epstein, a registered general securities representative, worked at Merrill Lynch‘s

Financial Advisory Center (―FAC‖) after graduating college, from 2000 to 2002 as an

Investment Services Advisor (―ISA‖). He was twenty-three years old at the time he left

Merrill Lynch. The FAC is an office within Merrill Lynch, which handled accounts with

assets of $100,000 or less. The FAC contained approximately 300 ISAs, who were

permitted to make mutual fund recommendations, but did not make individual stock or

bond recommendations. ISAs worked with customers, either through cold calling, or

random routing when the customer called Merrill Lynch. Epstein received a base salary

of $35,000 and ―variable compensation‖ based, in part, on production credits earned

when his customers made mutual fund switches. From October 1, 2001 until March 2,

2002, the period at issue in FINRA‘s complaint against Epstein, he received $26,443 in

variable compensation.

1
  The National Association of Securities Dealers (―NASD‖) changed its name to FINRA in
2007. The two names are used interchangeably in this opinion.

                                             2
       A mutual fund switch occurs when the shares of one mutual fund are liquidated

and those proceeds are used to purchase shares in another mutual fund. Various families

of mutual funds exist and each family of a mutual fund may have different classes. The

costs to the customer vary depending on which class the customer purchases and whether

the customer switches from one class to another or from one family to another.

Switching from one family to another typically results in a higher cost to the customer

than switching from one class to another. Generally, Epstein earned production credits

when customers switched from one family to another family.

       Merrill Lynch‘s Compliance Outline for Private Client Financial Consultants,

which Epstein signed, explained that representatives must discuss investment objectives,

strategies, and risks with the customer. Additionally, a ―Mutual Fund Share Class Script‖

advised ISAs to explain to customers the benefits of each class option, taking into

account the length of time shares are held and the amount of money invested. Merrill

Lynch warned ISAs of risks specific to elderly customers. The culture at FAC placed a

great deal of pressure on ISAs to recommend mutual fund switches to their customers.

       Epstein‘s violations are based on unsuitable recommendations to twelve

customers. Rose Roberts (―Roberts‖), an unsophisticated investor, made a call to Merrill

Lynch to withdraw $300 and with no intention to buy or sell from her accounts. During a

twenty minute conversation, Epstein recommended, and ultimately made, the following

switches: he liquidated her Eaton Vance Virginia Municipal Fund and switched to a fund

in a different fund family (which triggered higher expenses), and moved money from her
                                             3
IRA account into government bonds. Roberts stated during the call that she was

confused about the recommendations, but Epstein neglected to inform her of the names of

the new funds or of the fees and expenses associated with the switches. Meanwhile,

Epstein gained over $1,240 in production credits from these transactions.

       In addition to Roberts, Epstein engaged in a similar pattern with eleven other

customers. Epstein recommended costly switches to the customers without properly

advising them of the risks and expenses, and he gained production credits for each of the

switches. The majority of Epstein‘s customers ranged in age from 71 to 93 years old and

were widowed, retired, and earned low annual incomes.

       FINRA‘s investigation of Epstein began when Roberts wrote a letter to the NASD

on August 30, 2002. On December 3, 2002, Merrill Lynch‘s General Counsel, Joseph

Reynolds, responded to a letter from Roberts, stating that, ―[w]hile we regret any

dissatisfaction you may have with your Merrill Lynch accounts . . . [w]e believe Mr.

Epstein properly serviced your accounts and you made properly informed investment

decisions.‖ (App. 661.)

       On May 7, 2004, the DOE served Epstein with a ―Wells Notice,‖ putting him on

notice that the DOE was investigating him for potential violations and charges for

violating the FINRA suitability rules and the anti-fraud provisions of the Securities

Exchange Act of 1934. FINRA had also begun a separate investigation of Merrill

Lynch‘s securities violations regarding the FAC. Epstein wrote a letter to the NASD on

August 20, 2004 complaining about the pervasive environment at Merrill Lynch
                                             4
pressuring ISAs to recommend mutual fund switches. Ultimately, Merrill Lynch settled

with the NASD for $5 million.

       On November 11, 2004, FINRA filed a Disciplinary Complaint against Epstein for

the above-mentioned potential violations. Epstein wrote a letter to the Hearing Office in

January 2005 to inform the office that he had not received documentation, such as—

exculpatory documents relating to his Section 10b and Rule 10b-5 violations, documents

implicating senior management at Merrill Lynch and the FAC, Wells Notices against

senior executives with respect to the FAC violations, and documents relating to Epstein‘s

customer accounts. According to Epstein, he never received this documentation. A

hearing was held on July 11 and 12, 2005. FINRA‘s staff offered into evidence

testimony of the FINRA compliance specialist who investigated the mutual fund switch

recommendations and tape recordings and transcripts of Epstein‘s conversations with

customers. Epstein failed to appear at the hearing and did not testify. Epstein‘s counsel

left the hearing before it had ended, without introducing any evidence on Epstein‘s

behalf. The hearing continued without Epstein or his attorney.

       On October 31, 2005, FINRA issued a decision concluding that Epstein had

violated FINRA Conduct Rules 2310, 2110, and IM 2310-2 and Section 10b and Rule

10b-5 of the Securities Exchange Act. More important, FINRA permanently barred

Epstein from the securities industry. The FINRA Conduct Rules that Epstein violated

generally require brokers to determine the suitability of an investment for a particular

customer prior to making recommendations. For unsuitable recommendations, the
                                             5
FINRA sanction guidelines recommend a monetary sanction between $2,500 and $75,000

and a suspension of ten business days to one year. In egregious cases, the suspension

may be one to two years or a bar from the industry. Epstein appealed this decision to the

National Adjudicatory Council (―NAC‖), which dismissed the Section 10b and Rule 10b-

5 charges, but affirmed Epstein‘s FINRA conduct violations and his permanent bar from

the securities industry.

       On January 30, 2009, the Commission sustained FINRA‘s findings of Epstein‘s

violation and sanctions. The Commission found that FINRA‘s proceedings were not

procedurally deficient and that FINRA did not act with any misconduct. FINRA

provided Epstein with all documents relevant to his investigation. Documents related to

FINRA‘s other investigations were irrelevant to his proceedings and the Commission

found that FINRA did not act with misconduct in not providing them. Moreover, the

Commission noted Epstein‘s failure to testify or conduct any due diligence by

interviewing his customers, other ISAs or Merrill Lynch employees. Epstein did not

submit his required exhibit and witness list.

       With respect to the sanction permanently barring Epstein from the securities

industry, the Commission concluded that Epstein‘s case was egregious because he

violated the suitability rule with numerous elderly, unsophisticated, and retired

customers, and because his involvement was ―more than a mere mistake in judgment.‖

(App. 34.) The Commission rejected Epstein‘s youth, inexperience, and lack of

supervisory control in the FAC as mitigating factors because shifting responsibility for
                                                6
compliance was impermissible. Rather, the Commission found that Epstein‘s

―insouciance and indifference towards his responsibilities under NASD rules poses a

serious risk to the investing public . . . [and] taking advantage of investors for ‗pecuniary

benefit‘ . . . ‗necessitate[s] exclusion from the securities business for protection of public

investors.‘‖ (App. 35.) Epstein petitions for review of the order of the Commission.

                 II. JURISDICTION AND STANDARD OF REVIEW

       The Commission had jurisdiction to review disciplinary action taken by FINRA

against Epstein under Section 19(d)(2) of the Securities Exchange Act of 1934, 15 U.S.C.

§ 78s(d)(2). We have jurisdiction to review a final order of the Commission under

Section 25(a) of the Securities Exchange Act, 15 U.S.C. § 78y(a)(1).

       We review the agency‘s decision to uphold sanctions for abuse of discretion and

overturn the sanction only if ―unwarranted in law or . . . without justification in fact . . . .‖

Butz v. Glover Livestock Comm‘n Co., Inc., 411 U.S. 182, 185–86 (1973) (citation

omitted) (internal quotation marks omitted); see 5 U.S.C. §§ 702, 706(2)(A) (―The

reviewing court shall . . . hold unlawful and set aside agency action, findings, and

conclusions found to be . . . arbitrary, capricious, an abuse of discretion, or otherwise not

in accordance with law . . . .‖). Moreover, the court has authority to review SEC penalty

determinations and limit such sanctions when appropriate. McCarthy v. SEC, 406 F.3d

179, 188 (2d Cir. 2005). We must affirm the Commission‘s findings of fact that are

supported by substantial evidence. D‘Alessio v. SEC, 380 F.3d 112, 120 (2d Cir. 2004).

                                                7
                                     III. ANALYSIS

A.     Sanctions

       An abuse of discretion occurs where (1) a sanction is ―palpably disproportionate to

the violation,‖ or (2) the Commission ―fail[s] to support the sanction chosen with a

meaningful statement of findings and conclusions, and the reasons or basis therefor, on

all the material issues of fact, law, or discretion presented on the record.‖ McCarthy, 406

F.3d at 188 (citation omitted) (internal quotation marks omitted).

       For permanent disbarment, the ―most potent weapon in the Commission‘s ‗arsenal

of flexible enforcement powers,‘‖ the Commission has a greater burden of justification.

Steadman v. SEC, 603 F.2d 1126, 1139 (5th Cir. 1979), aff‘d, 450 U.S. 91 (1981)

(quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 195 (1976)). Specifically, the

Commission ―has an obligation to explain why a less drastic remedy would not suffice.‖

Id. Permanent debarment may be justified where the Commission articulates a

reasonable likelihood that ―a particular violator cannot ever operate in compliance with

the law, or might be so egregious that even if further violations of the law are unlikely,

the nature of the conduct mandates permanent debarment as a deterrent to others in the

industry.‖ Id. at 1140 (citations omitted).

       Still, the Commission is not required to apply a ―mechanical formula‖ in justifying

sanctions. Paz Sec., Inc. v. SEC, 566 F.3d 1172, 1775 (D.C. Cir. 2009) (citation

omitted). The Commission, not the court, is responsible for ―[t]he fashioning of an

appropriate and reasonable remedy.‖ Butz, 411 U.S. at 188-89; see also id. (―We will not
                                              8
lightly disturb the findings of an agency in its area of expertise. . . . [T]he Commission is

better equipped to judge [the significance of certain violations] than this Court.‖ (citation

omitted) (internal quotation marks omitted)).

       Epstein argues that the Commission abused its discretion in affirming sanctions

because it did not consider mitigating factors. The Commission found Epstein‘s

violations particularly egregious because of the multiple unsuitable recommendations he

made to elderly, unsophisticated customers that amounted to ―more than a mere mistake

in judgment.‖ (App. at 34.) With respect to mitigating factors, the Commission

disagreed with Epstein that his age, inexperience, working environment, and a lack of

supervision should lower his sanction. Rather, Epstein‘s continuous attempt to shift

blame to Merrill Lynch‘s working environment was deemed a failure to accept

responsibility. Epstein‘s significant risk to the securities market motivated the

Commission to permanently bar him from the industry. In particular, the Commission

found that Epstein‘s ―insouciance and indifference towards his responsibilities under

NASD rules poses a serious risk to the investing public . . . [and] taking advantage of

investors for ‗pecuniary benefit‘. . . ‗necessitate[s] exclusion from the securities business

for protection of public investors.‘‖ (Id. at 35.)

       The Commission was not required to apply a mechanical formula in its discussion

of Epstein‘s mitigating factors and the Commission adequately supported its affirmance

of sanctions by discussing the egregiousness of Epstein‘s violations and the future harm

he would pose to the public. Thus, the Commission did not abuse its discretion. See Paz,
                                               9
566 F.3d at 1175-76 (holding that the Commission made the necessary findings by

explaining the harm to the public and a clear risk of future misconduct).

       Epstein contends that the gross disparity between his sanctions and those of the

other ISAs merits reducing his sanction. While ―gross disparities in sanctions for similar

behavior would at least suggest underlying bias,‖ D‘Alessio, 380 F.3d at 125, Epstein

provides no evidence to demonstrate a disparity. He contends that Merrill Lynch was

―meaninglessly sanctioned‖ and ―only a few ISAs were disciplined for approximately 3-6

months and the other hundreds of ISAs similarly situated to Epstein were not charged or

disciplined.‖ (Appellant‘s Br. 41.) Yet, his assertion regarding the ISAs is based on his

―information and belief‖ (Appellant‘s Reply Br. 8); thus, we have no evidence in the

record to determine to what extent disparities exist between the ISAs. And, even so,

―dissimilar facts result[ing] in dissimilar sanctions does not . . . show that the sanction

imposed was impermissibly disproportionate.‖ D‘Alessio, 380 F.3d at 125.

       Furthermore, his reliance on Lipper v. SEC, 547 F.2d 171 (2d Cir. 1976), and

Blinder, Robinson & Co. v. SEC, 837 F.2d 1099 (D.C. Cir. 1988), to argue that his

allegedly disproportionate sanctions should be reduced is unfounded. In Lipper, a

permanent bar from the industry was reduced to a twelve month bar, in part, because of

the disparity of the sanctions between Lipper and two other brokers. But, the decision to

reduce sanctions in Lipper focused heavily on the uncertainty of whether customer-

directed give-ups, the violation at issue, were even illegal. Moreover, customer-directed

                                              10
give-ups were later abolished, thus the Commission could not have found it necessary to

protect petitioners from posing a future threat.

       The court in Blinder, Robinson vacated and remanded a sanction of a permanent

bar. The decision was not based on ―mere disparities, but rather an asserted systematic

pattern of disparate treatment‖ of smaller firms. 837 F.2d at 1112 (citation omitted).

Epstein does not assert that an unclear regulatory environment of the FINRA suitability

rules or a systematic pattern of disparate treatment exists. Thus, Lipper and Blinder,

Robinson do not support his position.

B.     Procedural Deficiencies

       Epstein next claims he was denied due process because of procedural deficiencies

in his FINRA hearing. He complains generally that: (1) he was denied documentation,

evidence, and the right to fully present his claim, (2) he was the target of selective

prosecution because of the letters he wrote to the NASD about the conditions at Merrill

Lynch, and (3) that his hearing officer was biased.

       Epstein cannot bring a constitutional due process claim against the NASD,

because ―[t]he NASD is a private actor, not a state actor.‖ Desiderio v. NASD, 191 F.3d

198, 206 (2d Cir. 1999). Still, the Exchange Act requires self-regulating organizations

(―SRO‖), such as the NASD, to provide fair procedures in disciplinary actions, including

an impartial decision-maker. 15 U.S.C. § 78f(b)(7); see D‘Alessio, 380 F.3d at 121

(―[W]e think that provision of ‗a fair procedure‘ in SRO disciplinary proceedings gives

rise to a due-process-like requirement that the decision-maker be impartial.‖).
                                             11
       We agree with the Commission that the procedural deficiencies that Epstein

claims are largely a result of his own inaction. First, the Commission found that FINRA

provided Epstein with all the documents relevant to his investigation. As for Epstein‘s

assertion that he was denied evidence from other FINRA investigations, the Commission

noted that NASD Rule 9251 only requires that FINRA provide relevant documentation to

Epstein. Second, Epstein took no steps to develop the record himself. He had the ability

to call his own witnesses and testify himself to his knowledge of Merrill Lynch‘s working

environment, and he failed to do so. Nor did he request evidence from customers, ISAs,

or Merrill Lynch. And, while Epstein complains about the Hearing Officer‘s denial of his

evidence, Epstein neglected to file a witness and exhibit list, as required by the

Prehearing Order. Essentially, Epstein took no steps to develop the record and cannot

now claim procedural unfairness. See Rutherford v. SEC, 842 F.2d 214, 216 (9th Cir.

1987) (rejecting the claim of procedural unfairness because Rutherford made no timely

discovery requests and the Commission did not abuse its discretion in later denying an

overbroad and vague request).

       Epstein‘s assertion that FINRA prosecuted him as a result of letters he wrote to the

NASD is also meritless. To succeed on a selective prosecution claim, Epstein must show

that that the prosecution was motivated by a discriminatory purpose — race, religion, or

another constitutionally protected classification. See United States v. Armstrong, 517

U.S. 456, 464 (1996). Epstein does not contend that he was prosecuted on any

constitutionally protected ground. Additionally, Epstein‘s argument that he was singled-
                                             12
out because of his letters to the NASD about the FAC is without support. Epstein did not

write to the NASD about the FAC until August 2004. Yet, Roberts had already written a

letter to the NASD in August 2002 about Epstein‘s recommendations and FINRA had

already issued Epstein‘s Wells Notice in May 2004. Likewise, we reject Epstein‘s

contentions that the alleged disparity in his sanctions demonstrate bias or selective

prosecution. See D‘Alessio, 380 F.3d at 112 (noting ―that those dissimilar facts resulted

in dissimilar sanctions, does not, of course, tend to establish bias or selective

prosecution‖).

       Finally, Epstein argues that his hearing was procedurally unfair because the

Hearing Officer was biased against Epstein. In particular, he points to the Hearing

Officer‘s decision to refuse to rule in his favor for discovery requests or grant Epstein a

one year extension for the hearing. These allegations do not rise to a bias of the Hearing

Officer. See id. at 122 (finding no bias because ―[t]hey have adduced no evidence

tending to show that the interests of the hearing officer himself were directly adverse to

the petitioners or amounted to a personal stake in the outcome of the civil suit‖). As the

Commission noted, the Hearing Officer ―gave Epstein‘s counsel wide latitude to plead

his case.‖ (App. 30.) See NLRB v. Lewisburg Chair & Furniture Co., 230 F.2d 155, 156

(3d Cir. 1956) (―The feeling that the trier of the fact, . . . [the] hearing officer, is biased is

not uncommon for one against whom decision has gone.).

                                     IV. CONCLUSION

       For the reasons discussed above, we deny Epstein‘s petition for review of the
                                                13
order of the Commission.

                           14