November 19, 2001

Of quasi-horses, quasi-donkeys, quasi-governmental
entities, andself-regulatory organizations

By Bill Singer 

In Part I of this series, I set forth the proposition that the courts have promulgated a heads-I-win-tails-you-lose standard for the self-regulatory organizations (SROs). When registered persons sue the SROs, the courts effectively shield the regulators with quasi-governmental absolute immunity.  However, when those same registered persons assert their Fifth Amendment right against self-incrimination before those same SROs, the courts sustain the regulators’ refusals to recognize that right by finding that the regulators are private entities not capable of government action. Forgetting for the moment the issue of whether an SRO can “incriminate” anyone, the simple fact remains that at any given point in time, the courts are capable of deeming SROs both private entities and governmental (or quasi-governmental) entities.  

The proposition is simple: can an entity at any given point in time be both governmental and private?  I believe that the commonsense answer is “no.”  You’re either an official organ of the government or you are a private enterprise. The United States Senate is not a private sector equivalent of Macy’s.  Microsoft is not the governmental equivalent of the United States Department of Justice. We intuit the differences even in the absence of an ability to succinctly explain them.  However, in the world of finance, at the fringes of local government and its constituents, we often find hybrids of governmental/private sector cloning.  Bonds are issued by government-sanctioned organizations, which, in turn, function competitively in the private sector.  Municipalities and counties license private businesses to operate on government property. These almost private, almost public manifestations are frequently referred to as “quasi-governmental” --- they’re almost like a government entity but not quite. Nonetheless, the fact is clear: such entities are not private, are not governmental,  but, rather, a third, quite different mutation. 

Quasi-Private --- a term not used

Interestingly, we never seem to use the term “quasi-private.”  The reason for the disparity is obvious.  There are few legal concerns when a hybrid entity takes on the characteristics of the private sector, provided that such a business does not use its government ties to engage in anticompetitive practices.  However, when a hybrid entity has some government-like powers, when it operates within the prerogatives of a sovereign, we must be careful.  Thus, quasi governmental isn’t merely a description it is a warning.  

Quasi-governmental rights

Given that the courts have recognized the existence of quasi-governmental entities, one should ask why there have not been similar judicial efforts to recognize that individuals subject to regulation by those hybrid actors must have quasi-governmental rights. If I am called as a witness before a government agency conducting a civil investigation, I am entitled to constitutional and statutory civil due process protections.  If I am a target/subject in a criminal investigation, I am entitled to similar criminal due process protections. But when the arena is one of a mixed metaphor, there is a danger.  

SRO investigations and subsequent disciplinary proceedings all too often occur within some distant shadows, outside the pale of federal, state, or administrative practice. The SROs arrogate to themselves the right to do what they want, when they want --- even to the extent that they proclaim that as private entities they are not subject to constitutional due process obligations.  In diluting the impact of such extraordinary powers, the defenders of the SRO system routinely assure its critics that the SROs are subject to governmental oversight by the SEC, which must approve their rules and regulations. I’ve never found that explanation comforting. If the SROs are “subject” to governmental oversight, then why aren’t they obligated to afford witnesses and respondents federally guaranteed due process rights?  

A criminal justice process by any other name

When a lawyer represents an individual before an SRO, that individual is technically involved in a “civil” proceeding. There is not supposed to be a government agency on the other side of the table. Your adversary is not supposed to be a state or federal prosecutor. Your client does stand accused of a “crime.” But, in reality, everything about the process smacks of a government investigation, a criminal prosecution, and a verdict that may deprive the respondent of his career and imposes a substantial fine.  

Consider the following. Your client is ordered to appear before an SRO to give on-the-record (OTR) testimony; at the same time, he or she is the subject of a state or federal grand jury investigation. As to the ongoing, parallel criminal investigation, you are concerned that the self-incriminating testimony that cannot be forced from your client by prosecutors will be compelled by the SROs under threat of fine and suspension --- and any material so obtained will likely be provided to the prosecutors by the SROs. That which prosecutors cannot legally obtain directly, they can obtain indirectly from the SROs --- and, as demonstrated in the previous article, the path between those two actors is well worn and well tended.  No one needs a road map or directions. 

This problem also surfaces in the absence of ongoing parallel criminal investigations or proceedings. Among the more common examples of this issue would be the client who received some cash compensation over the years but didn’t declare the payments for tax purposes.  The mere admission of receiving such payment could result in an Internal Revenue Service inquiry, with an attendant criminal prosecution.  The false denial of such payments could expose the witness to a subsequent criminal prosecution for perjury.  Under the circumstances, an experienced practitioner might counsel the client to assert the Fifth Amendment right against self-incrimination.  

Fifth Amendment RIGHT against self-incrimination

It is important to remember that the assertion of the Fifth Amendment is a constitutional right deemed so basic to the fabric of our society that the framers of the Constitution included it within the Bill of Rights.  Historically, we have viewed efforts to coerce criminal convictions as repugnant to our national sense of fairplay and decency.  Those who defend the present system of Fifth Amendment non-recognition by SROs frequently argue that such regulators are not government entities capable of pursuing criminal justice agendas and they do not have the power to convict anyone of a crime. But that of course begs the question: Since the courts deem SROs to be quasi-governmental, are they actually quasi-criminal justice organizations conducting quasi-criminal investigations and adjudicating quasi-criminal indictments? 

A legitimate argument against recognizing the Fifth Amendment in SRO proceedings would be to note that in any typical civil proceeding the assertion of the right against self-incrimination still permits the judge or jury to draw a negative inference. Note, however, that the proper application is that the trier of fact “may” draw a negative inference. The negative inference is not mandatory. Further, it is not the act of refusing to answer that is deemed criminal or tortious, but, rather, one may infer from the invocation that the underlying misconduct occurred. A legal nicety, yes --- but an important one within our system of justice. Similarly, the assertion of the Fifth within the context of a criminal trial is sacrosanct and deemed a constitutional right not properly permitting a negative inference nor probative of guilt. Simply put, in the United States you cannot be convicted of a crime if the only evidence against you is your refusal to incriminate yourself. 

Is the assertion of a constitutional right “unethical”?

What comes as a surprise to lawyers unfamiliar with practice before the SROs is that those organizations do not recognize the Fifth Amendment assertion and routinely initiate disciplinary proceedings solely based upon the mere refusal to testify.  Again, let me underscore that point.  You can be charged with a violation of an SRO rule merely for declining to incriminate yourself. And the result of such a violation will likely be the loss of your right to pursue a career in the securities industry, with many additional ramifications arising from the loss of your industry registrations.  The SROs not only deem the refusal to incriminate oneself as a proper basis for imposing a fine and suspension, but also deem the invocation of your constitutional right to be an unethical practice.

In Department of Enforcement v. Mario J. Coniglione[i], registered representative Coniglione asserted his Fifth Amendment right against self-incrimination during an NASD Regulation (NASDR) on-the-record interview (OTR).  Prior to that invocation, his counsel asserted his belief that the NASD is a governmental agency and that his client was entitled to assert the Fifth Amendment. The NASDR staff informed him that: 

[Y]our testimony has been requested in this matter pursuant to Procedural Rule 8210.  Rule 8210 requires any person associated with an NASD member to provide all information requested by the staff. Therefore please be advised that failure to answer any of our questions, ... [or] to provide any information requested by the staff during this meeting ... could be inconsistent with Rule 8210 and could be the basis for the initiation of sanctions, including a bar, censure, suspension and/or fine. 

The NASDR staff then asked Coniglione questions relating to his prior employment with a member firm. He refused to answer each and every question asked of him, replying only, "I respectfully rely on my Fifth Amendment right and decline to answer this question." Counsel for NASDR informed him that: 

NASD and NASD Regulation is not a government entity, so ... you have an obligation to answer all of the Staff's questions .... I remind you if you continue to refuse to answer the questions for whatever reason, whatever grounds, we will seek disciplinary action for your failure to answer. 

Based on Respondent's continued refusal to respond to any of the NASDR staff's questions, the NASDR staff concluded the interview. As a result he was charged with violations of NASD Procedural Rule 8210 and NASD Conduct Rule 2110. Conduct Rule 2110 imposes ethical standards upon the members and their associated persons to observe “high standards of commercial honor and just and equitable principles of trade.” Consequently, Coniglione was charged with engaging in unethical behavior by invoking his constitutional right against self-incrimination..  His unwillingness to incriminate himself constituted the sole basis for the disciplinary proceeding and subsequent disbarment. 

In analyzing the bases for granting NASDR’s motion for summary disposition, the Hearing Officer concluded that a violation of Rule 8210 is also a violation of Rule 2110. He further commented that the Securities and Exchange Commission ("SEC") has stated that 

[w]e have repeatedly stressed the importance of cooperation in NASD investigations.  We have also emphasized that the failure to provide information undermines the NASD's ability to carry out its self-regulatory functions.... Failures to comply are serious violations because they subvert the NASD's ability to carry out its regulatory responsibilities."  In re Joseph Patrick Hannan, Exchange Act Rel. No. 40438 (September 14, 1998) (omitting citations noted therein). 

Hearing Officer Carleton reiterated that the Fifth Amendment prohibits only governmental action, and that the NASD is a private entity   He then cited the NASD Sanction Guidelines ("Guidelines"), which provide that in the case of a failure to respond, "a bar should be standard." Consequently, Coniglione was barred for asserting his Fifth Amendment rights and refusing to answer the Staff’s questions. 

If, in fact, the NASD is a quasi-governmental entity, how is it that Coniglione was barred for invoking his Fifth Amendment right?  If he invoked that right in a criminal proceeding in any court in the United States, no negative inference could be drawn and any finding of guilt would be predicated upon the evidence introduced against him. If he invoked that right in a civil proceeding in any court in the United States, a negative inference could be drawn, but any finding of liability would still be predicated upon the evidence introduced against him.  Should the fact that the NASD is a quasi-governmental entity serve to deprive Coniglione of those rights he would have had before a government entity?  Furthermore, assuming that the NASD now argues it is a private entity, why does that fact render the assertion of one’s constitutional rights as being “unethical?”

Brady in a non-criminal environment . . . does it make sense?

In a recent NASDR enforcement proceeding, OHO Order 01-13,[ii] Hearing Officer Andrew H. Perkins ruled on the Department of Enforcement’s (DOE’s) obligations to produce various documents, which Respondents claimed contained exculpatory evidence and were discoverable under NASD Code of Procedure Rule 9251, and specifically under the doctrine enunciated by the Supreme Court in Brady v. Maryland, 373 U.S. 83 (1963), as incorporated under Rule 9251(b)(2).  NASD Code of Procedure Rule 9251. Inspection and Copying of Documents in Possession of Staff, sets forth requirements as to documents that must be made available for inspection and copying by the Departments of Enforcement and Market Regulation, and similarly sets forth those standards under which such production may be withheld.  As Hearing Officer Perkins notes:

The Department’s right to withhold documents under Rule 9251(b)(1) is itself limited by Rule 9251(b)(2), which states: “Nothing in subparagraph (b)(1) authorizes the Department of Enforcement . . . to withhold a document, or a part thereof, that contains material exculpatory evidence.” “This provision is intended to be consistent with the doctrine enunciated in Brady.” Notice of Filing of Proposed Rule Change, Exchange Act Release No. 38,455, 1997 SEC LEXIS 959, at *14 n. 99 (Apr. 24, 1997) However, the NASD has not provided guidance on how Brady, a criminal law doctrine, is to [be] applied in NASD disciplinary proceedings. Hence, to set a standard for its application, it is necessary to review the origins of Brady and the manner in which it has been applied in other proceedings. 

In explaining the origin of the Brady Doctrine, Hearing Officer Perkins observes that 

Ultimately, Brady and its progeny are concerned with the “special role played by the American prosecutor in the search for truth in criminal trials.”  Strickler v. Greene, 527 U.S. 263, 281 (1999).  As the Supreme Court explained in Strickler, 

The United States Attorney is “the representative not of an ordinary party to controversy, but of a sovereignty whose obligation to govern impartially is as compelling as its obligation to govern at all; and whose interest, therefore, in criminal prosecution is not that it shall win a case, but that justice shall be done.” 

(Id.) quoting Berger v. United States, 295 U.S. 78l, 88 (1935). 

However, Brady arises out of consideration of the special role that American prosecutors play within the criminal justice system.  The Supreme Court further acknowledged that such prosecutors are not mere parties in litigation but representatives of a sovereign.  Which of course brings us back to a series of interesting questions.  Is the NASD a quasi-prosecutor? Are NASD enforcement proceedings enmeshed in a quasi-criminal justice system?  Is the NASD a quasi-sovereign, i.e., a government-like power? 

Even Hearing Officer Perkins seems somewhat uneasy in applying Brady to the NASD’s proceedings. He candidly notes: 

Given the Supreme Court’s concern with the special role prosecutors play in the American criminal justice system, it is not surprising to find that Brady has not been applied to administrative proceedings.  Because administrative proceedings are civil in nature, the same constitutional concerns are not present. Indeed as the SEC has recognized, there is no constitutional requirement that administrative agencies apply Brady . . . Nevertheless, some agencies have incorporated the principles set forth in Brady into their procedural rules, See, e.g., SEC Rule 230(b)(2). ..

Where does all this leave us? The Brady Ruleis  invoked in criminal proceedings to constrain government prosecutors --- but we find this rule referenced within the procedural rules of an SRO, a quasi-governmental or private entity.  Even within the context of the example Hearing Officer Perkins cites of an agency that incorporates Brady into its procedural rules, the referenced agency (the SEC) is an arm of a sovereign, i.e., a commission of the United States Government.  

I submit that the incorporation of Brady into the NASD’s procedural rules underscores the reality of the SROs’ true nature. SROs are more governmental than private. Their disciplinary proceedings are more criminal prosecutions than civil suits.  The results of SRO hearings are not the rendering of a civil award imposing civil damages to be paid to the prevailing civil litigant. To the contrary, SROs impose “sanctions,” which are generally suspensions from association and fines; and such sums of money that are routinely collected do not go to benefit the alleged victims of securities fraud (other than disgorgement) but normally wind up in the coffers of the SRO itself --- again, more in keeping with criminal fines than civil damages.   

The protections afforded to the respondents trapped within this quasi system are inadequate and unfair. Individuals enmeshed in a quasi-governmental prosecution by the SROs are routinely barred from their livelihoods because they assert a constitutional right.  That they may ultimately be guilty of underlying misconduct is besides the point --- due process is not intended to be viewed as an inconvenience but as a protection. Concededly, the SROs are not criminal prosecutors acting pursuant to indictments, putting citizens in jail.  The NASD is not a sovereign government.  The NYSE is not empowered to issue grand jury indictments.  But that distinction may well be lost upon any citizen who happens to be employed in the securities industry when ordered to appear at an SRO, subjected to interrogation, forced to answer every question or be fined and/or barred for failing to do so.  

In closing, I offer the following definition from Encyclopedia.com:

mule
hybrid offspring of a male donkey (see ass) and a female horse, bred as a work animal. The name is also sometimes applied to the hinny, the offspring of a male horse and female donkey; hinnies are considered inferior to mules. . . They lack the speed of horses, but are more surefooted and have great powers of endurance. Like donkeys, they are of a cautious and temperamental disposition and require expert handling to perform well. Both sexes are sterile. . . 

Engaging in a tremendous amount of professional restraint, I will avoid the quick and easy jokes as to the parents of the SROs (and I will particularly avoid any reference to any parenthetical references). But isn’t it interesting that the world of science doesn’t resort to the inartful classification of these animals by calling them quasi-horses or quasi-donkeys? Mules are neither donkeys nor horses, they are mules. Now if only we could so classify SROs and instill within them the better virtues of their parents. 

 Bill Singeris the regulatory partner of the securities industry law firm of Singer Frumento LLP in New York.  This article represents the personal views of Mr. Singer.  He may be reached at bsinger@singerfru.com. © 2001 Bill Singer.