NASD REGULATION, INC.

NATIONAL ADJUDICATORY COUNCIL DECISION [In the Matter of Morgan Stanley DW Inc.,at al., July 26, 2002

SOURCE CITE

In Re Hayden(NYSE), SEC
Rel. No. 34-42772, Admin. Proc. File No. 3-9649,(May 11, 2000)

In Re Hirsh(NYSE) SEC
Rel. No. 34-43691, Admin. Proc. File No. 3-10129 (December 8, 2000)

NASD delay in filing of Complaint too long after notice of underlying acts; violates fundamental notions of fair-play/due process; prosecutorial inefficiency no excuse.  SEC's standard as enunciated in Hayden is that some prosecutorial delays --- in and of themselves --- are so long as to constitute an affront to fairness; regardless of whether there is any showing of harm to respondent.  Hirshdecision complicated issues but can be distinguished based upon its focus on shorter delay between SRO's notice of misconduct and filing of Complaint.  NAC ruling suggests that even a delay as long as that in Haydencould still be subjected to test as to contributory dilatory conduct by respondent and degree of harm suffered by respondent.  NAC's interpretation seems contrary to SEC'sfindings.  NASD Hearing Panel seems to have gotten the basis for denying action correct; thankfully NAC affirmed (even with fuzzy logic).

The NASD brought a disciplinary hearing against Morgan Stanley Dean Witter [name redacted in the Hearing Panel decision but inexplicably divulged in the NAC press release], and John Doe1 and John Doe2 alleging that BD used a firm-wide, internal marketing campaign that misrepresented the nature of certain Term Trusts, resulting in fraudulent and unsuitable sales between October 1992 and November 1993 in violation of NASD Conduct Rules 2110 (just and equitable principles of trade), 2120 (antifraud), 2310 (unsuitability), and 3010 (supervision).  The NASD described this matter as the largest and most complex case it ever brought.  

The Respondents moved for summary disposition arguing that the proceeding is time-barred under two theories 

1. In re Hayden, Exchange Act Release No. 42,772 (May 11, 2000), compels the conclusion that the delay in bringing this proceeding renders it inherently unfair; and 

2. that the five-year statute of limitations contained in 28 U.S.C. § 2462 has run. 

By way of background, in 1994 both a federal class action and a Congressional investigation with hearings were initiated concerning the transactions at issue. In 1995, Barron's published a story about the matter (which article NASD Staff cited to in a contemporaneous memo). From 1996 through September 1998, NASD investigated the activities in question. In 1996 the class action was dismissed. In 1999 NASD issued a Wells letter, Respondent's replied, and the parties met to discuss the pending charges. On November 20, 2000, the NASD finally filed the subject Complaint. 

In Hayden, the SEC cited just three circumstances: 

1. the elapsed time between the last alleged occurrence of misconduct and the date the Complaint was filed (6 years, 7 months); 

2. the elapsed time between the date the SRO received notice of the alleged misconduct and the date the Complaint was filed (approximately 5 years); and 

3. the elapsed time between the date the investigation commenced and the date the Complaint was filed (3 years, 6 months). 

In Hayden, the SEC emphasized that "a fundamental principle governing all SRO disciplinary proceedings is fairness," and that an SRO has "a statutory obligation to ensure the fairness and integrity of its disciplinary proceedings." Applying such principles, and without significant comment, the SEC held that "the delay in the underlying proceedings was inherently unfair." The SEC based its decision on the time that had elapsed in the case, not the underlying facts. The SEC did not consider the nature of the charges or the reasonableness of the course of the SRO's investigation, nor did it balance the relative equities of the parties. In particular, the SEC did not rely on a finding that the delay prejudiced the respondent. The SEC stated, "[w]ithout further inquiry, we cannot find, as a factual matter, that Hayden's ability to mount an adequate defense was impaired by the [New York Stock] Exchange's delay."  Essentially, Haydensays that  prejudice to the respondent may not even be a consideration when delays are deemed fundamentally unfair.  Unfortunately, the important question that the decision sidesteps, and none to adroitly, is how long is too long? 

The only other reported decision addressing the impact of delay on the fundamental fairness of an SRO's disciplinary process is In re William D. Hirsh, Exchange Act Release No. 43,691, 2000 SEC LEXIS 2703 (Dec. 8, 2000). On appeal, Hirsh did not challenge any of the NYSE's findings; rather, he asserted that a portion of the matter was time barred by "any number of statutes of limitations."  The SEC pointedly distinguished Hirsh from Hayden by noting:

We have consistently held that no statute of limitations applies to the disciplinary actions of the Exchange or other self-regulatory organizations ("SROs").¹¹ We have, however, held that under certain circumstances inordinate time delays can render a proceeding inherently unfair and be cause for dismissal.¹² In Hayden the misconduct occurred between 1982 and 1990. The charges were brought against respondent fourteen years after the first act of misconduct and over six years after the last incident. In 1991 (five years before the charges were brought) the Exchange was informed about significant misconduct by the respondent through a voluminous sales practice report. We do not believe that the factors discussed in Hayden necessarily require the dismissal of the charges as to Mishel. Once the Exchange was notified of Mishel's arbitration award only 20 months elapsed before the charges were filed.

What the SEC not so deftly danced around was the fact that nearly 8 years had elapsed between the last act of misconduct relating to the challenged conduct in Hirsh and the filing of the complaint - - -approximately 16 months longer than in Hayden! Hirsh suggests that the more critical focal point is not how long it has been since the date of misconduct but how much time has elapsed since the date an SRO is on notice of the misconduct and the filing of a Complaint.  Consider the following chart:

In attempting to distinguish Hayden,  NASD argued that it was fair to take longer with this case because it is more complex. NASD emphasized that the investigation in this case was plagued by staff turnover, a factor not mentioned in Hayden. It was further argued that the unprecedented size of this case overwhelmed NASDR's available resources. If one were to buy these excuses, then any SRO could simply argue that it was entitled to take whatever time it arbitrarily decided it needed under the particular facts and circumstances of each case. The Panel seemed particularly annoyed at this position.  

In 3M Co. v. Browner, 17 F.3d 1453 (D.C. Cir. 1994), a case involving the application of the federal statute of limitations to administrative proceedings, the Court rejected a nearly identical argument by the Environmental Protection Agency that government agencies should have virtually unrestricted time to discover violations and investigate them. The Court disagreed:

 An agency may experience problems in detecting statutory violations because its enforcement effort is not sufficiently funded; or because the agency has not devoted an adequate number of trained personnel to the task; or because the agency's enforcement program is ill-designed or inefficient; or because the nature of the statute makes it difficult to uncover violations; or because of some combination of these factors and others. . . . 
An agency's failure to detect violations, for whatever reasons, does not avoid the problems of faded memories, lost witnesses and discarded documents in penalty actions brought decades after alleged violations are finally discovered. 
3M Co., 17 F.3d at 1461. 

Based upon the compelling nature of Hayden,the NASD Hearing Panel dismissed the proceeding, but because of the uncertainty of the SEC standard in Hayden and the importance of the issue, the Panel recommended that the National Adjudicatory Council ("NAC") call this case for an expedited review. 

NASDR's Dept. of Enforcement appealed the December 14, 2001 decision of a Hearing Panel as to respondent Morgan Stanley DW Inc. ("Morgan Stanley"), but the NAC called the case for review as to all respondents—Morgan Stanley, John B. Kemp ("Kemp") and Lawrence J. Solari, Jr. ("Solari"). The sole issue considered by the NAC was whether the Hearing Panel erred by dismissing this case as untimely based on its interpretation of the Hayden.  The NAC upheld the Panel's decision to dismiss the disciplinary case against Morgan Stanley Dean Witter, while disagreeing with the Hearing Panel's rationale.  

The NAC acknowledged that 

The SEC's Hayden and Hirsh decisions recognize that after a certain period of time it is unfair to require respondents to attempt to piece together defenses to old claims. With the passage of time, memories fade, witnesses become unavailable and documents are lost or destroyed. Indeed, even without a showing of actual harm, it can be inherently unfair to require respondents to face the prospect of potential claims for prolonged and indeterminate periods of time.

Furthermore, the NAC conceded a public policy basis for "requiring actions to be brought in a reasonable amount of time serves the purposes of encouraging SROs to investigate promptly wrongdoing and prevents adjudicators from being overburdened with stale claims."

In its decision the NAC acknowledged Hayden but emphasized that  length of delay alone is not necessarily a controlling factor. The NAC held that fairness is an equitable principle requiring consideration of the facts and circumstances of each particular case, and that adjudicators may also look to traditional equitable concepts for guidance on whether the proceeding is fair under the circumstances.

The NAC believes it appropriate to consider whether 

1. the respondent had unreasonably caused a portion of the delay

2. whether the proponent was harmed by the alleged delay

As such, the  NAC concluded that Morgan Stanley's conduct in the investigation did not excuse any delay in NASD's investigation and that the delay in bringing the action was prejudicial to Morgan Stanley. The NAC affirmed the Hearing Panel's dismissal. Notwithstanding the ultimate result, the NAC appears to have misinterpreted Hayden,which admittedly lacks a clear-cut standard. However, it seems worth reminding the NAC that  the SEC voiced concern in Hayden about  the lapse between an SRO's notice of misconduct and its filing of a complaint; perhaps stressing a need for regulators to act on a timely basis.  Those hallowed words:  justice delayed is justice denied seem apt.  

Further, the NAC's newly enunciated two-part test urges a first prong that is unnecessary and a second prong that imposes a condition contrary to the SEC's controlling decision in  Hayden. First, it is absurd for any SRO to justify any investigative delay because of a given target's failure to timely cooperate.  All SROs routinely charge members and registered persons for failing to cooperate in investigations.  See, NASD Procedural  Rule 8210.Consequently, if any SRO perceives a target is improperly delaying an inquiry, it has a simple remedy.   Second, Hayden makes it crystal clear that the SEC was not considering whether the Respondent was even harmed by the delay.  Pointedly, Haydendoesn't care whether there was harm to Respondent; the issue was the inherent unfairness --- the unseemliness, if you will --- of the NYSE's delay:

Without further inquiry, we cannot find, as a factual matter, that Hayden's ability to mount an adequate defense was impaired by the Exchange's delay. However, the Exchange does have a statutory obligation to ensure the fairness and integrity of its disciplinary proceedings. We believe that the delay in the underlying proceedings was inherently unfair.

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