Epstein v. Securities Exchange Commission , 416 F. App'x 142 ( 2010 )

NOT PRECEDENTIAL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)
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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
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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
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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
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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
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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).
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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
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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,
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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
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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-
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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
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order of the Commission.
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