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SEC Dismisses Attempt to Do Something About a FINRA AWC
August 14, 2023
Over five years ago in "FINRA Sanctions Charitable Remainder Trust Pitch" (BrokeAndBroker.com Blog / January 22, 2018), our publisher Bill Singer, Esq., applauded a well-written FINRA AWC settlement concerning the respondent registered representative's promotion of a charitable remainder trust. Further, Bill found that the self-regulatory-organization imposed a fine and suspension that seem balanced and fair. Despite all of that, the Respondent had a belated bit of buyer's remorse about the AWC.
Case In Point
For the purpose of proposing a settlement of rule violations alleged by the Financial Industry Regulatory Authority ("FINRA"), without admitting or denying the findings, prior to a regulatory hearing, and without an adjudication of any issue, Sandeep Varma submitted a Letter of Acceptance, Waiver and Consent ("AWC"), which FINRA accepted. In the Matter of Sandeep Varma, Respondent (AWC 2014040164801, January 19, 2018)
https://www.finra.org/sites/default/files/fda_documents/2014040164801%20Sandeep%20Varma%20CRD%201926613%20AWC%20sl%20%282019-1563342564174%29.pdf
https://www.finra.org/sites/default/files/fda_documents/2014040164801%20Sandeep%20Varma%20CRD%201926613%20AWC%20sl%20%282019-1563342564174%29.pdf
The AWC asserts that Varma was first registered in 1990 and from 1995 through October 2015, he was registered with FINRA member firm LPL Financial LLC. The AWC asserts that he has “no relevant disciplinary history.”
CRT Tax Strategy
As set forth in part in the AWC, starting in the early 1990s, Varma purportedly employed a tax-strategy using a charitable remainder trust (“CRT”) with certain customers as follows:
[C]ustomers would typically sell appreciated real estate through a CRT, without immediately paying capital gains tax on the sale, and the proceeds from the sale could then be invested in various investment instruments held within the CRT. Typically, Varma recommended that the proceeds from the sale be invested in variable annuities held within the CRT. At the time the CRT was created, Varma's customers would also typically purchase some form of life insurance policy through an irrevocable children's trust to replace the value of the appreciated asset for the customers' heirs. Varma's customers would then take periodic, required income from the CRT and use the income from the CRT to pay, in whole or in part, premiums associated with the life insurance policy Varma recommended to replace the value of the sold appreciated asset.
Seminar Presentation
As set forth in part in the AWC, from September 2013 through February 2014, Varma allegedly conducted four seminars promoting the use of CRTs. The AWC alleges that about 70 prospective customers attended these seminars, during which. Varma delivered a written presentation in the form of a slide deck that he had created.
Oversimplified and Misleading
The AWC deemed Varma’s presentation as oversimplified and misleading in violation of FINRA Rule 2210(d)(1)(A) and (B), and cited the following in support of that allegation:
Varma's presentation repeatedly referenced the elimination of capital gains tax on the sale of appreciated assets by using the CRT strategy. The presentation failed to disclose, however, that the strategy only avoided capital gains tax at the time of the sale of the appreciated asset. Specifically, if the investments held in the CRT purchased with the proceeds of the sale performed poorly, then the principal of the proceeds would be invaded to pay the CRT's required, periodic income and, in that case, the customer may have to pay some portion of the capital gains taxes from the sale of the appreciated asset. . .
Unfair and Unbalanced
Also, the AWC deemed Varma’s presentation as having failed to provide a fair and balanced discussion of the risks associated with the strategy in violation of FINRA Rule 2210(d)(1)(A). and cited the following in support of that allegation:
By illustration, Varma's presentation depicted the purchase of a significant life insurance policy to replace for the prospective customers' heirs the value of the appreciated asset sold to fund the CRT. The presentation, however, failed to disclose that the customers' ability to pay the life insurance premiums using income from the CRT was dependent on the performance of the investments held by the CRT. The seminar presentation further failed to disclose the potential risk that the life insurance policy could lapse should customers be unable to afford to pay premiums associated with maintaining it or that the life insurance policy payout was dependent on the claims-paying ability of the insurance provider. . .
Unsound Basis for Evaluation
Finally, the AWC deemed Varma’s presentation as having failed to provide a sound basis for evaluating the CRT investment strategy and violated FINRA Rule 2210(d)(1)(A) and (B), and cited the following in support of that allegation:
The presentation depicted increased income and improved cash flow from employing the CRT strategy, as well as the increased amounts left to the customers' heirs due to securing the substantial life insurance policy. In doing so, the presentation projected performance of assets held in the CRT in an exaggerated and promissory manner by projecting only positive performance and not clearly disclosing how negative investment performance could affect the strategy. . .
FINRA Sanctions
In accordance with the terms of the AWC, FINRA imposed upon Varma a $15,000 fine and a 10-business-suspension from associating with any FINRA member firm in any capacity.
The Corrective Action Statement
The Varma AWC includes a provision under "III. OTHER MATTERS" that states:
D. I may attach a Corrective Action Statement to this AWC that is a statement of demonstrable corrective steps taken to prevent future misconduct. I understand that I may not deny the charges or make any statement that is inconsistent with the AWC in this Statement. This Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
As more fully explained in a 1998 NASD (FINRA's predecessor) document: "Regulatory Short Takes: NASD Clarifies Policy On Corrective Action And Mitigation Statements": http://finra.complinet.com/en/display/viewall_plain.html?rbid=1189&element_id=1159005107 :
Respondents in a settled disciplinary action may submit a Corrective Action Statement and/or a Mitigation Statement to NASD Regulation. This article clarifies the NASD policies regarding such Statements.A Letter of Acceptance, Waiver and Consent (AWC) permits a respondent in an NASD Regulation disciplinary action to settle the matter prior to the filing of a formal complaint. A Corrective Action Statement may be attached to the AWC, which is filed with the SEC and available to the public, provided such statement is: (1) limited to demonstrable steps taken to correct a problem associated with the disciplinary action; (2) generally no longer than 2-3 pages; and (3) contains the following legend:
This Corrective Action Statement is submitted by the Respondent. It does not constitute factual or legal findings by NASD Regulation, Inc., nor does it reflect the views of NASD Regulation, Inc., or its staff.
Separately, respondents may submit a Mitigation Statement for consideration by NASD Regulation and the National Adjudicatory Council. Generally, such Statements are used to describe mitigating circumstances surrounding the violation for the decision maker to consider in its review of the terms of a settlement. Unlike Corrective Action Statements, Mitigation Statements are not attached to the AWC or public order.Respondents may also settle a matter after the complaint is filed by submitting an Offer of Settlement. While both Corrective Action and Mitigation Statements may be submitted to NASD Regulation in connection with Offers of Settlements, these Statements are not attached to the final Order Accepting the Offer of Settlement, which is filed with the SEC and available to the public.NASD Regulation will not accept Corrective Action or Mitigation Statements that deny the allegations or are inconsistent with the findings in the settlement. . .
FINRA AWCs permit the attachment of a Corrective Action Statement to demonstrate the steps taken by a respondent to prevent future misconduct subject to the understanding that such an attachment may not deny the charges or make any statement that is inconsistent with the AWC. Further the Corrective Action Statement does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA or its staff.
I am no fan of Corrective Action Statement and rarely, if ever, advocate their use. Given that the premise of an AWC is a settlement made without admitting or denying the findings, I don't understand why anyone would voluntarily submit a statement that typically makes admissions of facts and findings, promises to correct situations that have not necessarily been acknowledged or admitted to, and, in the end, simply draws more undesired attention to the matter. If you feel compelled to attach a Corrective Action Statement, then ask yourself if you might not be better advised to argue your case before a Hearing Panel and, if necessary, on appeal. If you conclude that the costs and/or risks of contesting the charges aren't worth it, then just sign the damn AWC and get over it.
Some think that a Corrective Action Statement gives you a parting shot at unfair regulation or an opportunity to put your own spin on the matter. I would suggest that you simply avoid the temptation. As with any post-game analysis, it's just not going to change the score. Moreover, if during subsequent examinations, a regulator finds that you engaged in similar misconduct to that discussed in your statement, or, it is alleged that you failed to implement the promised revised policies and procedures, your own words may prove blunt instruments used to beat you into submission.
I notice that some settling Respondents submit a Corrective Action Statement that details a proposed or in-place supervisory scheme at a current FINRA member firm -- which takes on the trappings of a proposed scheme of enhanced supervision of a statutorily disqualified individual attendant to the filing of a FINRA Membership Continuance Application (the "Form MC-400") http://brokeandbroker.com/PDF/MC400.pdf. I find this written proposal an ill-advised practice because most AWC Respondents are merely suspended and fined and are not subjected to any further regulatory constraints after their time is served and the dollars paid. If FINRA wants to impose specific supervisory conditions upon a settling Respondent or require the submission of an undertaking by the registered rep or member firm, then so be it. On the other hand, why any member firm would draft an extensive list of compliance Do's and Don'ts to which a suspended rep would be subjected upon his or her return to production baffles me. Frankly, I'm old school: Don't volunteer anything and don't answer questions that weren't asked.
I appreciate that some employer members think that memorializing an enhanced scheme of oversight for a settling registered person gives the firm a hedge against future misconduct but I don't agree with that premise. If a firm harbors such concerns about a particular associated person that the member feels compelled to memorialize in a FINRA settlement agreement an extensive, proposed supervisory protocol, then maybe that firm should terminate the individual. You think that's harsh? Just imagine what some customer's lawyer will do with that published list of proposed corrective actions if the stockbroker engages in disputed conduct. A savvy claimant's lawyer will cite all that voluntary language attached to an AWC about strict supervision as proof that the employer brokerage firm knew that the stockbroker was a compliance nightmare requiring enhanced oversight, which, it will be argued, did not occur in violation of the specific representations to a self-regulatory-organization as part of a disciplinary settlement. Yeah, I know, when I put it like that, it doesn't sound so good. Trust me, it will be put like just like that. Notwithstanding my opinions, Varma apparently determined that it was advisable to submit this Corrective Action Statement:
CORRECTIVE ACTION STATEMENTRE: FINANCIAL INDUSTRY REGULATORY AUTHORITY LETTER OF ACCEPTANCE, WAIVER AND CONSENT NO. 2014040164801TO: Department of EnforcementFinancial Industry Regulatory Authority ("FINRA")RE: Sandeep Varma, RespondentRegistered RepresentativeCRD No. 1926613This Corrective Action Statement is submitted by the Respondent. Ii does not constitute factual or legal findings by FINRA, nor does it reflect the views of FINRA, or its staff.To address the conduct within the above-referenced AWC. the following corrective actions have been taken by Mr. Varma:Mr. Varma will work closely with his broker-dealer's Compliance and Advertising Review Departments to ensure that any presentations created or used by Mr. Varma regarding Charitable Remainder Trusts ("CRTs") meet all FINRA disclosure requirements and that they specifically address the following:
- Any future seminar presentation created and used by Mr. Varma regarding CRTs will include a statement which relays that while capital gains tax is avoided at the point of sale of an appreciated asset within a CRT, income from the trust is taxable, and, depending on the performance of the assets in the trust and the nature of the returns of the assets held in the trust, some of that income may be taxed at capital gains tax rates.
- Any future seminar presentation created and used by Mr. Varma regarding CRTs will disclose that any illustrations or examples provided are for illustrative purposes only and are not intended as projections of possible performance; poor or negative performance of assets held within the CRT will negatively affect income from the trust, which in turn can affect the ability to pay insurance premiums on any insurance put in place to replace the value of assets gifted to a CRT; insurance policy death benefits are subject to the claims paying ability of the insurance company and such insurance policies may lapse if not properly funded or can lapse due to poor performance of sub-accounts within variable policies or lower interest rates in fixed insurance products . . .
So . . . lemme see if I got this. Varma's voluntary Corrective Action Statement asserts (now as a matter of written record) that his future CRT presentations will "meet all FINRA disclosure requirements." As if, what? Varma wasn't already obligated to comply with all FINRA disclosure requirements? Why re-state the obvious?
On top of agreeing in writing not to do what he already is required not to do, Varma now promises that his future CRT presentations will state that "while capital gains tax is avoided at the point of sale of an appreciated asset within a CRT, income from the trust is taxable." Since Varma was charged with not having made that exact statement and agreed to a fine and suspension in order to settle the charges, what's the point of voluntarily adding this tidbit? Similarly, what does he gain by volunteering in writing that any future CRT presentations will explain that illustrations or examples are only for illustrative purposes? Again, such an undertaking is already a compliance/regulatory requirement.
In nit-picking this and other Corrective Action Statements, I am merely trying to raise consciousness about what strikes me as a dubious undertaking to put in a voluntary writing what amounts to a promise to not commit murder -- as if you could commit murder but for your promising not to so in a Corrective Action Statement appended to an AWC?
If the addition of Corrective Action Statement moved the sanctions needle and achieved a lesser fine or fewer days of suspension, okay, that would be a worthwhile reason for putting your corrective actions in writing. In reality. the voluntary statement provided to FINRA does not accomplish that goal. All of which returns me to the lessons learned during some 36 years on the Street. Don't volunteer nuthin'. Don't put nuthin' in writing that may come back and bite you in the ass. Pay your fine. Do your time. Keep your mouth shut and take yer lumps.
2021 FINRA NAC Appeal
Perhaps the reality of the 2018 AWC percolated for a few years and Varma became incensed. Whatever his motivation, on January 29, 2021, Varma filed a Notice of Appeal with FINRA's National Adjudicatory Council ("NAC") seeking a hearing about his AWC. Varma argued to the NAC, he wasn't seeking to overturn the AWC but to remove the references to it on his FINRA BrokerCheck disclosures and on his Central Registration Depository record ("CRD"). In dismissing Varma's appeal, a NAC Review Subcommittee found that Varma had waived his right to appeal and that the NAC lacked authority to expunge an AWC from CRD.
2021 SEC Petition
All of which brings us to May 14, 2021, on which date Varma filed a Petition with the SEC seeking the federal regulator's review of the self-regulatory-organization's action. In the Matter of the Application of SANDEEP VARMA For Review of Action Taken by FINRA
In cutting to the chase, the SEC found in part that [Ed: footnotes omitted]:
(Opinion, SEC, '34 Act Rel. No. 98102; Admin. Proc. File No. 3-20317)
https://www.sec.gov/files/litigation/opinions/2023/34-98102.pdf
https://www.sec.gov/files/litigation/opinions/2023/34-98102.pdf
Though he repeatedly and consistently disclaims any challenge to the underlying AWC, Varma raises numerous collateral challenges to the AWC’s legitimacy, and he asserts that those alleged deficiencies warrant remand of this matter to FINRA so that it can consider his expungement claim “on the merits.” But such collateral attacks do not create authority under Section 19(d) for us to review an action. Because we lack authority to review FINRA’s action, we do not consider such merits claims here.
at Page 5 of the SEC Opinion
Further, the SEC disagreed with Varma's assertion that he had not waived his right to challenge the AWC when he entered into that very settlement:
[V]arma specified when entering into the AWC that he had “read and underst[oo]d” the AWC’s provisions; could “ask questions about it”; had “agreed to its provisions voluntarily”; and “specifically and voluntarily” waived, among other things, his right to appeal. Varma, like other settling parties, thus “relinquishe[d] any possibility of a more favorable outcome” in order to “achieve the certainty of avoiding a potentially worse outcome.” And Varma’s suggestion that he had ineffective assistance of counsel is not a basis for disturbing such a settlement.
at Page 6 of the SEC Opinion
Bill Singer's Comment
The Businessperson's Decision
Sometimes a businessperson's decision makes the most sense: Bite the bullet, pay the dollars, and do the time. You don't have to like it. Quite often -- you're right -- it's unfair and you're being treated unfairly. Life sucks. Then we die. On the other hand, the businessperson's rationale in sucking up an unpalatable settlement is that it makes sense (most of the time) to pay FINRA a $5,000 fine without admitting or denying the allegations rather than pay a lawyer $50,000, go to a hearing, lose the hearing, have a Panel find that you're a lying sack of crap, and have the Panel slam you with a $20,000 fine and six month suspension.
Controlling the Narrative
The main advantage of the AWC is that it's a settlement entered into without admitting or denying the findings; and for whatever that's worth, an AWC sort of allows you to control the "narrative." You can't deny the findings; however, you can say that you entered into the settlement on advice of counsel, who said it's cheaper and quicker than fighting it. The deck's stacked against you. It's a kangaroo court. Yadda, yadda, yadda. You need to walk a fine line here because you can't deny the findings and you probably don't want to admit to anything either. Be that as it may, underpinning the AWC is the fact that it's a settlement and you opted to avoid a hearing.
Varma's ongoing battle makes no sense to me. He put this mess to bed in 2018 via the AWC. If he was so outraged by the allegations, then he probably should have taken his case to a FINRA Office of Hearing Officers Hearing Panel -- and if he lost there (which seems a likely outcome given the persuasive fact pattern set out in the AWC), he could have appealed to FINRA's NAC. On the other hand, once you eschew your day in court, it's usually best to just get over it and move on.
Given that an AWC is often the byproduct of a businessperson's decision to cut costs, it allows you to avoid making negative admissions of misconduct, and you can do some damage control by negotiating a fine/suspension. As such, once the ink is dry on your signature, just pay the bucks, do the time, go fishing, buy several boxes of Oreos, and curse out FINRA until you get back to work after the suspension. What you shouldn't do and what I would likely counsel against is to:
- enter into an AWC settlement,
- submit a Statement of Corrective Action,
- (years later) appeal to the NAC, and
- (years later) petition the SEC.
Sometimes you just got to take your lumps. In Varma's case, the underlying misconduct set out in the AWC was "from September 2013 through February 2014." It is now 2023. About a decade after the fact, the AWC still has a 2018 handle but the SEC Opinion has a 2023 handle. I would have let this crap die a tortured death with the 2018 AWC. Now, the mess looks of recent vintage. Making matters worse, potential clients will see reference to a federal regulator.