Scottsdale and John Hurry Push Back – FINRA Assault on Small Broker Dealers

On December 17, 2018, John Hurry broker dealer, Scottsdale Capital Advisers Corporation sued the Financial Industry Regulatory Authority (“FINRA”), for breach of contract in the U.S. District Court for the District of Columbia.  Scottsdale and its sister company, Alpine Securities, Inc., are broker-dealers controlled by John J. Hurry and his wife Justine.  Both companies are FINRA members.  Both John and Justine Hurry are registered brokers regulated by FINRA.

The complaint alleges that FINRA has breached its agreement with and obligations to member firms by its “increasing and current failure to provide fair and meaningful representation” to them, and by taking “affirmative acts that have the effect if not the purpose of burdening competition, harming not only member firms but also issuers and customers.”  Broadly, Scottsdale is saying that rather than help small securities firms, it’s unfairly attacking and damaging them:

Through… improper enforcement efforts, FINRA has… engaged in “unfair discrimination” against certain of its members in violation of its governing statute and By-Laws.  It has aggressively targeted and sought to punish or even eliminate specific segments of the securities market.  Through its coercive actions against smaller member firms who are engaged in the microcap and low-priced securities business, FINRA has gotten to the point that it is gutting the ability of firms, issuers and investors to participate in that market.

FINRA’s breach is the direct cause of damage being inflicted on Plaintiff and other microcap market participants.  As a result of its leadership and through its actions, FINRA has increasingly taken irrational and unfounded positions that are “choking” the microcap markets and preventing smaller and startup issuers from being able to finance the operation and growth of their businesses.  At this point, only a handful of firms are still willing and able to process and clear sales of microcap securities, and those firms are under intense pressure to cease their participation in the market.

Everyone who follows penny stocks knows that in recent years, the Securities and Exchange Commission (“SEC”) and FINRA have made it increasingly difficult for companies like Scottsdale and Alpine to clear stock and to sell it for their own clients.  As the regulators see it—and is in fact the case—those clients are often offshore entities located in countries where securities regulations are lax.  Some of those clients are brokerages that open their own accounts with U.S. firms and use those accounts to sell their clients’ stock in the States.  The names of the actual owners of the stock are often unknown, because the stock is almost always held in nominee accounts.  That allows the actual owners to remain anonymous, and also to conceal the fact that they are affiliates; that is, they own more than ten percent of the issuer’s shares outstanding.  The owners are often what could be described as “financiers,” but are usually described as “toxic funders,” lending money to issuers in exchange for promissory notes that can, after an appropriate holding period, be converted to free trading stock and sold into the U.S. market, which in most cases is the only market for these securities.

Because of the anonymity of the owners, and the question of affiliation, the regulators take the view that these transactions may constitute illegal money laundering.  In the past five or six years, they’ve brought an increasing number of legal actions designed on the one hand to expose and punish the owners, and on the other to force clearing firms and brokers to file Suspicious Activity Reports (“SARs”) before engaging in any transactions involving potentially illegal activities.  Not only must SARs be filed; they must also contain specific information explaining why the brokerage in question believed the transaction in question might be fraudulent.  Guidelines for the preparation for SARs are offered by the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”), and they clearly state that “[e]xplaining why the transaction is suspicious is critical.”  In June 2017, the SEC charged Alpine with failing to comply with anti-money laundering (“AML”) laws because it sometimes neglected to file SARs at all, and, when it did file them, “omitted material red flags and other material information that were in Alpine’s possession and that were required to be reported.”  In these cases, Alpine acted as the clearing firm, with Scottsdale as the introducing broker.  During the relevant period—May 17, 2011 through December 31, 2015–1,950 SARs were found to be deficient in various ways and for various reasons.

The Backstory

Before the SEC went after Alpine, FINRA took an interest in Scottsdale.  On May 15, 2015, the regulator initiated an enforcement action against the brokerage, John Hurry, Timothy DiBlasi, and Michael Cruz.  DiBlasi and Cruz are registered representatives who work for Scottsdale.  The complaint alleged that between December 1, 2013 and June 30, 2014, Scottsdale liquidated more than 74 million shares of the stock of three microcap companies:  Neuro-Hitech Inc. (NHPI; now WDBG, Woodbrook Group Holdings, Inc.), Voip Pal.com (VPLM), and Orofino Gold Corp. (ORFG; now BKEN, Bakken Energy Corp).  The stock was deposited by Scottsdale’s customer Cayman Securities Clearing and Trading SECZ, Ltd. (“CSCT”) into its account with Scottsdale.  The shares were unregistered, and did not qualify for any exemption from registration.  The sales were, FINRA concluded, illegal.  CSCT generated more than $1.7 million in proceeds for its own customers, the owners of the stock.

John Hurry was the founder and owner of CSCT.  FINRA alleges that CSCT “became a customer of Scottsdale, established accounts and subaccounts for its customers on whose behalf CSCT deposited over 650 million shares of microcap stocks, and liquidated nearly 145 million shares, generating profits of approximately $5.5 million.”  CSCT became an “attractive intermediary” for shady individuals who wanted to liquidate large positions in microcap stocks.  CSCT was not regulated by the Cayman Islands—in 2013, Hurry claimed and received exemption from regulation by the country’s Monetary Authority—and benefited from the Caymans’ secrecy laws.  Those laws protected customers’ identities from disclosure.  Hurry put the firm’s liquidation business in the hands of an individual who had no prior securities industry experience.  According to FINRA, that person, called “GR” in the complaint, “lacked basic computer skills.”  Hurry himself found the firm’s customers, and traveled to Central America to meet with three of them.  During the period in question, CSTC generated more than $170,000 in revenue for Scottsdale.

CSCT had four customers, identified by FINRA only as MS, UIS, TIS, and DC.  All four were located in Belize or Panama, which are, as FINRA points out, “countries of primary money laundering concern.”  The customers opened a total of 27 subaccounts, in addition to their primary accounts.  That provided additional protection for the actual owners (and real sellers) of the stock:  CSCT itself did not necessarily know who the customers of the four customers were.

One of the primary customers, MS, was a Panamanian broker-dealer.  MS’s own customers were nominees; it’s apparently uncertain whether CSCT even knew who really owned MS.  UIS was a broker-dealer located in Belize, as were TIS and DC.  All three, like MS, did their best to conceal the identities and even the nationalities of their control persons, and of their clients as well, creating risks that were passed on to Scottsdale and Alpine when the liquidations they ordered were executed.  At Scottsdale, Timothy DiBlasi failed to create a supervisory system that included written supervisory procedures (“WSPs”) and Michael Cruz failed to investigate the many red flags raised by the CSTC transactions.

The Issuers

In early 2014, Neuro-Hitech, once an unsuccessful pharmaceutical company, abruptly switched business sectors, getting into the oil and gas production and exploration business, though it didn’t entirely abandon its earlier interests.  It had minimal revenues and considerable expenses, and so decided to run a promotion.  Between mid-February and mid-March 2014, NHPI was hyped extravagantly in at least 17 press releases and newsletters.  The story is familiar:  the stock rose from $0.0125 on February 10 to a high of $0.0550 on March 12.  Five days later, it had sunk to $0.0160.  That happened for the usual reasons.  Between February 7 and May 7, CSTC deposited 60 million shares of NHPI stock in certificate form in its account at Scottsdale.  It liquidated the shares shortly after deposit, taking advantage of the promo campaign, and wired the proceeds out of its Scottsdale account quickly.

The paperwork sent by CSCT to Scottsdale—a promissory note, a note conversion agreement, three more promissory notes, and three related note satisfaction agreements—indicated that a Texas resident called Thomas Collins had loaned $10,000 to NHPI and converted 90 percent of the debt to 90 million shares of NHPI stock, which he received on November 15, 2013.  According to FINRA, it isn’t certain that a real “Thomas Collins” ever existed, but the relevant documents were signed with that name.  Since NHPI was said to have about 980 million shares issued and outstanding, FINRA says “the conversion should have raised a “red flag” because, by converting only 90 percent of the debt to 90 million shares of NHPI stock, Collins avoided becoming a ten percent owner of NHPI and thereby a presumptive affiliate of NHPI.”

More problematic still, on September 1, 2013, Collins pledged 60 million of the shares he didn’t yet own to three Belizean entities as collateral for funds those entities loaned to him.  The entities—Sky Walker, Inc., Swiss National Securities, and Ireland Offshore Securities—were clients of UIS. The loans were supposedly paid in full, as each of the three entities signed a note satisfaction agreement on September 16, 2013, when they purportedly received the stock pledged to them.  Despite what FINRA considers invalid title to the shares in question, between February 7, 2014 and March 12, 2014, CSCT deposited 60 million shares of NHPI at Scottsdale for the benefit of UIS, which was acting for its customers, the three Belizean entities.

For those and other reasons detailed in the complaint, FINRA found that “[t]he due diligence documents for the NHPI deposits obtained by Scottsdale are contradictory, incomplete, and inaccurate.”  Yet between late February and early May 2014, CSCT liquidated all 60 million shares through Scottsdale and wired the proceeds of about $263,000 out of its account.  FINRA argues that because of the obvious problems with the due diligence packet sent to Scottsdale, the stock sold was unregistered and Rule 144 safe harbor was unavailable.

The story was similar with VPLM and ORFG:  inadequate due diligence packets were presented to Scottsdale by CSCT, and were relied upon by Scottsdale to deposit and liquidate large amounts of stock.  As with NHPI, the stock was unregistered, and Rule 144 was unavailable.

FINRA charged Scottsdale and Hurry with sales of unregistered securities, a violation Section 5 of the Securities Act of 1933 (the “Securities Act”), Scottsdale and DiBlasi with deficient supervisory procedures, and Scottsdale and Cruz with a failure to supervise.

The Decision

An Amended Extended Hearing Panel Decision in the case was handed down on June 20, 2017.  (It was, FINRA explains, amended only to correct a single factual error; the regulator has evidently removed the original from its website.)  The Respondents’ Answer was filed on June 26, 2015, but is not included among the filings provided by FINRA.

In its Findings, the panel discusses the arguments presented by Scottsdale and the individual respondents, and by so doing reveals the identities of some of the players left unnamed in the complaint.  In that document, CSCT’s four clients are called only “MS, UIS, TIS, and DC.”  We learn from the complaint that MS, located in Panama, was Montage Securities.  Montage appears still to exist, though its website is currently dead.  UIS and TIS, located in Belize, were Titan International Securities and Unicorn International Securities.  Titan, Unicorn, and their owners were indicted by the Department of Justice on September 9, 2014 for the roles they played in an elaborate securities fraud and money laundering scheme run by Robert Bandfield and Arthur Godfrey.  The identity of “DC” remains a mystery; it is nowhere mentioned outside the FINRA complaint.

“GR” the CSCT employee with questionable computer skills who worked at CSTC during the relevant period, is revealed as one Gregory V. Ruzicka.  Ruzicka was in fact an attorney who was not practicing at the time.  According to FINRA, he had suffered serious financial difficulties and was unemployed.  He asked John Hurry, whom he’d known for years, for a job at a bicycle shop Hurry owned.  Though Hurry admitted he was “kind of taken back a little bit,” he instead offered to put Ruzicka in charge of CSTC.  Hurry would later point out that Ruzica had two master’s degrees, one of them in U.S. tax law, and claimed he had spent months studying Rule 144 before starting at CSTC.

In the Findings, the panel points out that before Hurry created CSTC, Scottsdale had done business directly with Titan and Unicorn.  Scottsdale (and Alpine) had also worked with Gibraltar Global Securities, a Bahamian broker dealer.  In 2013, the SEC sued Gibraltar and its owner Warren Davis, alleging that the firm had sold millions of dollars’ worth of stock in Magnum d’Or (MDOR), a penny mining company, through omnibus accounts held in five U.S. brokerages.  The five included Scottsdale and Alpine.  Gibraltar closed its doors as a result of the SEC litigation, and a number of its clients migrated to Titan.

FINRA also made note of two other SEC enforcement actions involving offshore brokerages with which Scottsdale had had dealings, saying the actions should have caused the firm to take precautions to make sure it didn’t participate in sham transactions, with special attention given to the involvement of nominees.  One of those cases involved Biozoom, Inc. (BIZM).  The stock was pumped, and then suddenly a number of Argentine citizens dumped millions of shares of unregistered BIZM stock.  It was obvious to anyone following the story that they were nominees, not the real owners of the stock.  The SEC suspended trading, and obtained an asset freeze of the Argentines’ accounts in July 2013.  In May 2018, the agency brought civil charges against penny promoter and manipulator Francisco Abellan Villlena and three associates.  Testifying before FINRA in the Scottsdale case, Henry Diekmann, the firm’s president, testified lamely that nominees were tricky, because it was “just impossible to know that there was somebody else behind this.”  Michael Cruz said, “[I]t’s almost impossible to detect these nominees, that they’re going to be… misrepresenting the—you know, the true identity of these persons.”  FINRA was not persuaded by the respondents’ argument that Scottsdale’s role in these earlier penny scams was insignificant, and irrelevant to the current FINRA action.

In his own testimony at the FINRA hearing, Hurry attempted to minimize his role in CSCT’s management and operations, seeking to convince the panel that Ruzicka and an assistant did the heavy lifting, seeking out and bringing in clients like Titan, Unicorn, and Caledonian Securities.  (Caledonian Securities and a sister entity, Caledonian Bank, were sued by the SEC for their role in distributions of unregistered stock in four penny companies.  Scottsdale is mentioned in the complaint, but was not a named defendant.) Ruzicka had consented to an on the record interview (“OTR”) with FINRA earlier, but did not appear at the hearing because, the panel says, “after being contacted by counsel for Respondents, Ruzicka declined to testify.”  The attorney first tried to call Ruzicka, and then sent a text saying:

You may want to know how FINRA has been characterizing you during the first week of the hearing.  For example, you were “hapless,” “malleable,” and “bereft of other options.”  You may want to know the other side of what FINRA is telling you.  I would welcome the opportunity to discuss. 

Ruzicka, apparently offended by this portrayal, texted FINRA Enforcement, saying he was “done” cooperating.

In its findings, the FINRA panel explains the lengths to which Hurry went to conceal the extent of his involvement with CSCT, from using Apple FaceTime to discuss business with Ruzicka and with clients, to insisting on an email address in which his name appeared only as “x.”  In response, Hurry said he liked FaceTime because it was free.  The panel did not find any of his responses convincing.  It also disputed the reason Hurry gave for setting up CSCT in the first place:  that by doing so, he would relieve Alpine of IRS withholding obligations.  The panel offers an alternative explanation:

Rather, we conclude from Cruz’s and Diekmann’s testimony regarding heightened regulatory scrutiny in the period leading up to the establishment of CSCT, and the filing of the four prior SEC complaints against Scottsdale customers and employees, that Hurry sought to insulate his business from regulatory oversight by moving Scottsdale’s FFI [foreign financial institution] business offshore.

It added:

We observe that Hurry appeared to be a canny, sophisticated, controlling, and hard-driving businessman.  Hurry’s attempt to portray himself as a distant figure, far removed from CSCT’s business was not credible.  Although he claimed that he likes to empower his people to run their businesses on their own, that is demonstrably untrue.

The panel came to equally harsh conclusions about DiBlasi and Cruz.

As to the fundamental charge in FINRA’s enforcement action—the sale of unregistered securities—the panel notes that “a firm must examine the information it receives with a skeptical eye because the interested parties have an incentive to mislead and deceive a firm in order to facilitate their sale of securities,” and quotes the SEC on that subject:

A dealer who offers to sell, or is asked to sell a substantial amount of securities must take whatever steps are necessary to be sure that this is a transaction not involving an issuer, person in a control relationship with an issuer[,] or an underwriter.  For this purpose, it is not sufficient for him merely to accept “self-serving statements of his sellers and their counsel without reasonably exploring the possibility of contrary facts.”

In sum, the panel concluded that “Respondents were confronted by abundant evidence that they were likely participating in unlawful distributions of securities.  They cannot clam that they were unaware of facts signifying that possibility or the need to conduct further inquiry.”

The hearing panel fined Scottsdale $1.5 million, “in light of the egregious nature of the Firm’s violation, the Firm’s institutionalization of the misconduct as its standard way of doing business, and the other aggravating factors set forth” in the Findings.  Hurry, who the panel believes “is a threat to the investing public,” was barred from associating with any FINRA member in any capacity.  While the panel believes a fine of $100,000 would be “appropriately remedial,” it waived that in light of the bar.  DiBlasi was suspended from associating with any FINRA member in any capacity for two years, and was fined $50,000.  Cruz received the same penalties.  The respondents were also ordered to pay costs in the amount of $22,124.29.

Scottsdale, Hurry, DiBlasi, and Cruz appealed the Hearing Panel’s decision to FINRA’s National Adjudicatory Council (“NAC”).  The Council delivered its own decision on July 20, 2018.  The relevant document covers ground that had already been covered in great detail.  In the end, the Council arrived at conclusions almost identical to those reached by the hearing panel.  As before, Scottsdale was fined $1.5 million:  $250,000 for each violative deposit of unregistered stock, and an additional $250,000 as an aggregate sanction for its supervisory violation.  The firm was also ordered to engage an independent consultant to monitor its “acceptance and liquidation of microcap securities deposits and review the firm’s supervisory procedures related to its microcap securities liquidation business.”  Hurry was barred in all capacities, and DiBlasi and Cruz were again suspended for two years and fined $50,000 each.

The SEC Review

On July 23, 2018, three days after FINRA’s NAC delivered its decision, Scottsdale, Hurry, DiBlasi, and Cruz filed an application for review with the SEC.  On the same day, and as part of the same SEC filing, Hurry filed a motion to stay the sanctions levied against him.  His bar was to have become effective immediately upon the NAC’s decision.

To allay any doubt the Commission might feel about the FINRA Hearing Panel’s contention that Hurry was a “threat to the investing public,” Hurry offered to “remain uninvolved in evaluating whether potential sales of unregistered stock are eligible for an exemption from registration” if the bar were stayed while the case was under SEC review.

Hurry’s memorandum in support of the motion for a stay starts off with a bang:  Hurry alleges that “[i]t is no secret that FINRA dislikes the microcap market.”  He appears to believe that means by extension, FINRA dislikes John Hurry.  In support of that contention, he attaches a copy of the second amended complaint in his own civil lawsuit against FINRA.  The original complaint was filed in federal district court in Arizona on November 10, 2014.  The plaintiffs are Hurry, his wife Justine, their family trust, and a host of companies controlled by them.  Though the case has not yet been decided, there’s been no activity on the docket since April 10, 2017.

In the memorandum attached to the motion to stay, Hurry presents himself as an heroic figure:

John Hurry’s role in the securities industry extends beyond any ownership interest he has in the Member Firms.  In his capacity as an experienced industry leader and as one of a growing chorus of critics with regard to overreach and abuse by FINRA, John Hurry has sought to improve the industry through the creation of a new self-regulated organization, the “Association of Securities Dealers LLC” or “ASD,” a potential competitor to FINRA.  ASD’s purpose includes the laudatory goals of removing barriers to and preserving a free and open market and a national market system, while adhering to securities laws.

Hurry believes he’s been targeted by FINRA because he’s a successful entrepreneur working in a sector the regulator disfavors.  He alleges FINRA has “pursued an unlawful course of conduct designed to prevent the Hurrys from expanding in the over-the-counter sector, shrink their sphere of influence in the securities industry, and, ultimately, drive them out of business altogether.”  He also floats the idea that FINRA’s tactics are similar to those employed by the federal government in its Operation Choke Point, a Justice Department initiative undertaken in 2013 and discontinued in 2017.  Choke Point’s stated goal was to choke off the oxygen supply, in the form of banking services and more, to businesses that were exploiting consumers.  While that seems a laudable objective, it was controversial, and may have been carried too far.  The FDIC issued guidance urging banks to consider their own “reputational risk” in their dealings with clients.  The industries that could, the FDIC suggested, trigger these risks included firearms, ammunition sales, pornography, and “payday” lending.  Those who objected to Choke Point did so because although there may be some exploitative participants in those industries, the industries themselves are legal, and honest practitioners should not face discrimination.

All of that is, Hurry believes, relevant to his motion for a stay of his industry bar because “FINRA has engaged in extra-regulatory activity targeted at the Hurrys and their businesses using the Operation Choke Point model.”  FINRA is not, of course, a federal agency, but as a regulator of securities dealers, it can inflict reputational harm and more damage by the imposition of permanent industry bans.

FINRA had accused Hurry of selling unregistered stock, and thereby violating Section 5 of the Securities Act of 1933.  That was, in fact, its only charge against him.  Hurry contends, as he had before the FINRA Hearing Panel and the NAC, that he played hardly any role in the operations of Scottsdale or CSCT.  He contends that:

There is not a shred of evidence—neither testimony nor exhibits—indicating that Mr. Hurry had any role in the stock deposits for the three issuers.  All witnesses who testified about CSCT’s and SCA’s stock deposit review practices… confirmed that Mr. Ruzicka, not Mr. Hurry, ran the daily operations of CSCT.  And those same witnesses all confirmed that Mr. Hurry neither asked them about any particular stock deposit requests—let alone the three stock deposits at issue—nor urged them to reconsider any rejections…

A review of Section 5 case law demonstrates that individual liability uniformly turns on proof that the defendant has either sold the unregistered securities himself or has taken concrete steps necessary to effectuate those sales…  Given the non-existence of such evidence with respect to Mr. Hurry, the Hearing Panel’s decision was legally unsustainable.

In closing, Hurry contends that he can’t be barred from the securities industry “simply because FINRA does not like what he does.”  Violations of the securities laws must be real and substantial, especially if the contemplated punishment is a lifetime bar.

On July 25, 2018, FINRA filed an opposition to the motion to stay, arguing that Hurry had not demonstrated a strong likelihood that his appeal of the NAC decision would prevail, and had not shown that denial of the stay would cause him irreparable harm.  The regulator added that if the stay were not imposed immediately, Hurry’s continued association with Scottsdale would create the potential for the firm to “continue to flood the US markets with millions of shares of unregistered microcap securities.”  Hurry then filed a reply to FINRA’s opposition, and the following day, FINRA’s attorneys wrote a letter to the Commission asking that Hurry’s reply be struck, because the Commission’s rules did not contemplate replies to opposition filings in matters like this one.  Hurry’s lawyer objected to that by writing a letter of his own.  The SEC granted Hurry’s motion for a stay on August 6, 2018 because, among other reasons, “Hurry has at least raised serious legal questions about the NAC’s findings, and that the balance of hardships tips decidedly in favor of a stay.”

The Commission then set a briefing schedule.  At that point, the case becomes difficult to follow, because for some reason none of FINRA’s briefs can be seen at the SEC site.  We do know that at the end of October FINRA asked permission to increase the 14,000 word limitation for its brief in opposition to 30,000 words, and that permission was granted, so perhaps the unavailability of that document and others is a mercy.  The most recent items on the docket are separate reply briefs from Hurry, DiBlasi (and Scottsdale), and Cruz (and Scottsdale) from December 3.  The docket was last updated on December 17, the day before Hurry filed his lawsuit against FINRA in federal district court.

Hurry’s Federal Lawsuit

Apparently without waiting for a decision in the Commission’s review, on December 18, 2018, Hurry filed a civil complaint in the name of Scottsdale Capital Advisors against FINRA in federal court in the District of Columbia.  He does not appear individually as a plaintiff.

Perhaps Hurry anticipates losing his appeal to the SEC, and has decided to challenge FINRA in a different way.  The complaint does not address specific issues raised by the respondents in the NAC or SEC reviews, but instead attempts to deal with what Scottsdale and Hurry see as attitudes assumed by FINRA that have led the agency to treat some of its members unfairly simply because those members deal chiefly with penny stock issuers.  FINRA then, Scottsdale asserts, uses its own “guidelines” not as suggestions, but as regulations which are then employed to discipline member firms, their owners, and their employees.

We saw above that early in the complaint, Scottsdale objected to “irrational and unfounded positions” taken by FINRA that are “choking the microcap markets,” evoking the references made in the briefs filed by Hurry in the SEC review to Operation Choke Point.  Though Scottsdale doesn’t cite it, more than four years ago, Advance America, a payday loan chain that operates in 28 states, and two similar companies filed suit against the Federal Deposit Insurance Company (“FDIC”) and the Office of the Comptroller of the Currency (“OCC”) in D.C. District Court.  According to Advance America, starting around 2010 or 2011, FDIC regulators sought to portray payday lending as “high-risk” and a “dirty business.”  More sinister still, “by cutting off the industry’s access to the banking systems, they could ‘choke out’ payday lending, without ever regulating it directly, merely by leveraging their existing supervisory authority over the banks.”  While payday lending is seen by many as a distasteful business, it is a legal one, and lenders feel they shouldn’t be harassed by regulators.

Clearly John Hurry feels he and his businesses have been treated similarly, threatened and persecuted by FINRA for years.  The Advance America case is, however, not a slam dunk for the plaintiff.  As noted, it’s been underway since 2014.  On October 12, 2018, Advance America filed a motion for summary judgment; on November 9, the FDIC filed a motion for summary judgment on count 1 of the third amended complaint.  In its filing, Advance America noted:

The record demonstrates that Defendants doggedly and repeatedly coerced banks across the Nation into terminating any relationships with payday lenders or their third-party payment processors.  The evidence shows that this was a national campaign imposed by headquarters on all seven regional directors and targeting the entire payday lending industry, including plaintiffs.

The FDIC disagrees, pointing out, among other things, that “[t]o the limited extent [the plaintiffs] have suffered any harm from losing their deposit accounts, they cannot show that the FDIC caused that harm by inducting banks to terminate the accounts, as no banks have attributed those terminations to the FDIC.”

While it’s easy to see why Hurry feels he has much in common with payday loan companies that say their business is legal and they’ve done nothing wrong, there are who feel the Operation Choke Point story isn’t as straightforward as it may seem at first glance, at least as to payday lenders.  American Banker has recently suggested that in several cases, banks that terminated payday lenders’ accounts were themselves being looked at for possible violations of anti-money laundering laws.  Scottsdale has been penalized for its inattention to potential AML problems, and for other compliance issues.

Scottsdale also argues that its treatment at FINRA’s hands damages not only the firm, but also issuers and investors.  But FINRA has no jurisdiction of issuers or investors, which makes it difficult to see how that objection might be considered relevant.

Scottsdale had been fined by the SEC for selling unregistered stock.  The sale of unregistered stock was also the only infraction imputed to Hurry himself.  Sales of unregistered stock are violations of Section 5 of the Securities Act of 1933. In its complaint, Scottsdale seeks to show that FINRA is not authorized to deal with Section 5 violations at all:

Section 15A of the 34 Act [the Securities Exchange Act of 1934] also limits FINRA’s reach to matters related to the 34 Act.  Specifically, it provides that an SRO’s rules must “not [be] designed… to regulate by virtue of any authority conferred by this chapter [2B of Title 15 of the United States Code] matters not related to the purposes of this chapter.”  [Emphasis original.]

 The reference in Section 15A(b)(6) to “this chapter” is plainly a reference to Chapter 2B of Title 15 of the United States Code, which chapter contains only the 34 Act and does not include the 33 Act.  [Emphasis original.]

Scottsdale concludes that “the SROs [including FINRA] have never been authorized to interpret or enforce the 33 Act.”  It adds that “[a]s stated in its by-laws, FINRA is obligated to adopt only rules that ‘carry out the purposes of… the [34] Act.” To sum up a much longer argument, Scottsdale believes FINRA is not the SEC, does not have the powers of the SEC, and should not attempt to discipline members as if it did.

That argument builds to the conclusion that “FINRA has engaged in ultra vires actions under the guise of FINRA Rule 2010.”  “Ultra vires”—literally “beyond the powers”—means beyond one’s legal power or authority.  In this case, Scottsdale contends that in the enforcement action brought by FINRA against it, Hurry, DiBlasi, and Cruz in May 2015, FINRA alleged that Scottsdale violated FINRA Rule 2010 because it sold unregistered securities.  But it did not allege any violations of the Exchange Act.  This was a new interpretation of Rule 2010, and FINRA failed to submit that interpretation to the SEC for approval.  Therefore, Scottsdale believes, “FINRA has breached its agreement with its member firms.”

Complicating the bigger picture is the pendency of the SEC’s suit against Alpine Securities, filed in June 2017.  On December 11, Judge Denise Cote granted in part the SEC’s motion for summary judgment.  The National Law Review points out that the suit is of particular interest because Alpine has asked whether, in the absence of explicit authority the SEC can bring suit to enforce alleged violations of the Bank Secrecy Act (“BSA”).  The regulator has argued that it may indeed do that, through Exchange Act Section 17(a), which allows it to require broker-dealers to keep books and records. It then “promulgated Exchange Act Rule 17a-8, which incorporates the regulations promulgated by the Treasury Department under the BSA and requires broker-dealers to comply with them.”

Ingenious reasoning or more administrative creep?  The judge agreed with the SEC, and also ruled against Alpine’s defense of what she characterized as the compilation and filing of inadequate Suspicious Activity Reports.  But no one would rule out an appeal.  In this anti-regulatory climate, it might have a shot.  Hurry evidently feels he’s fighting for his professional life, and fighting on several fronts.  He seems unlikely to give up quietly.

This securities law blog post is provided as a general informational service to clients and friends of Hamilton & Associates Law Group and should not be construed as, and does not constitute, legal and compliance advice on any specific matter, nor does this message create an attorney-client relationship. Please note that the prior results discussed herein do not guarantee similar outcomes.

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