On May 11, 2000, the Securities and Exchange Commission (SEC) issued a unanimous opinionIn the Matter of the Application of Jeffrey Ainley Hayden, which has import way beyond its limited size. In Hayden, the SEC reviewed disciplinary action taken by the New York Stock Exchange (NYSE)  and set aside the sanctions upon concluding that the NYSE did not act in a fair manner in prosecuting a a case involving matters emanating from the 1980s against a former registered representative. This case stands for the proposition that even if a defendant can't prove he was damaged by an SRO's failure to timely prosecute, the SEC still considers some SRO delays to be so improper as to be fundamentally unfair and requiring the setting aside of any negative findings and sanctions. 

Background 

Hayden entered the securities industry in 1977 with Reynolds Securities, Inc. and spent his entire career as a registered representative with the firm and its successor Dean Witter Reynolds, Inc., (DWR) until his resignation on July 18, 1997. In 1991 the NYSE became aware of alleged misconduct by Hayden from 1982 to 1990 through what it described as a "voluminous" sales practice examination report. On April 28, 1993 the NYSE received a Form RE-3 report from DWR disclosing that Hayden was the subject of an arbitration proceeding involving 12 former customers who were alleging unsuitable limited partnership recommendations. 

By letter dated May 25, 1993 the NYSE first advised Hayden that it was investigating him for possible sales practice violations. The NYSE first began its investigation of Hayden in May 1993 and subsequently filed charges against him in November 1996. Significantly, the conduct under scrutiny occurred between 1982 through 1990. 

Getting the timeline straight 

In 1997 a NYSE Hearing Panel (the Panel) found that between 1982 and 1990 Hayden recommended and purchased limited partnership investments for 17 customers without informing them of the risks underlying those investments. The Panel also found that forms for these customers' accounts contained inaccurate information regarding their financial situations, and that, in some instances, this information was omitted entirely from the forms. The Panel concluded that Hayden's conduct in making unsuitable recommendations and in making misrepresentations and omissions was inconsistent with just and equitable principles of trade pursuant to Exchange Rule 476(a) and that he violated Rules 17a-3 and 17a-4 under the Securities Exchange Act of 1934 and Exchange Rule 440 by providing inaccurate information in Dean Witter's books and records. 

Laches and Statute of Limitations

During the hearing Hayden denied the charges and asserted affirmative defenses including laches and the Statute of Limitations. The Panel Decision concedes that "[m]ost of the events described in the Charge Memorandum and presented to the Hearing Panel occurred well over five years ago. Motions to Dismiss based upon the Statute of Limitations of five years set forth in 28 U.S.C. Sec.2462 were submitted prior to and at the conclusion of the hearings. Both motions were denied." 

The Panel conceded that "a Respondent is [not] without rights," but nonetheless concluded that when a reportable event 

such as an arbitration, occurs years after the underlying misconduct, a hard and fast Statute of Limitations would undermine the system of self-regulation. 

Furthermore, the Panel noted that concerns as to whether Hayden was prejudiced by the passage of time were largely dispelled because, in significant part:

•  Witnesses had "clear memories of their conversations and dealings" 

• Some witnesses retained tape recordings of their conversations

On December 5, 1997, the Panel censured Hayden, barred him for six years from membership or association in any capacity with any Exchange member or member organization, and permanently barred him from selling limited partnerships. On June 4, 1998, the Exchange's Board of Directors sustained the Panel's decision on appeal. 

SEC Appeal 

In pursuing his appeal before the SEC, Hayden did not dispute the findings of violations made by the NYSE or argue that the sanctions were inappropriate; he argued only that, pursuant to 28 U.S.C. § 2642 and the Due Process Clause of the Constitution, the Exchange's disciplinary action against him is time-barred because the conduct in question occurred more than five years before the Exchange brought its proceeding. 

Section 2462 provides a general five-year limitations period applicable to government action for the enforcement of "any civil fine, penalty, or forfeiture, pecuniary or otherwise."  Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996), has applied this limitations period to certain SEC proceedings.   

In considering Hayden's defenses invoking  § 2642 and the Due Process Clause of the Constitution in support of a five-year bar on SRO proceedings,  the SEC concluded that because "we are dismissing for other reasons, we need not address these arguments." The SEC then rephrased Hayden's appeal as "a challenge to the viability of the Exchange's disciplinary proceeding given the delay in the underlying proceedings."  

In an interesting footnote, the SEC considered that the NYSE's charge against Hayden alleged that "[i]n or about 1991 and 1992 . . . Hayden falsely reassured" a customer that his investments were not a cause for concern. However, the SEC noted that the "Hearing Panel did not make findings regarding these allegations," and appears to have rejected the NYSE's Staff's efforts to recast the operative dates from the 1980s to 1991/1992. The SEC noted that the Panel determined liability based upon the conduct that occurred in the 1980s. 

Perhaps suffering from some pangs of conscience, the NYSE appeared to justify its dilatory handling of Hayden  by claiming that its notice of the sales practice violations didn't really arise until its receipt of the RE-3 in 1993. The SEC gave short-shrift to such posturing by noting that "the Exchange candidly notes in its brief, it was informed about significant misconduct by Hayden through a referral in 1991 to its Division of Enforcement of a "voluminous" sales practice examination report." Regardless, the NYSE's rationalization is not uncommon among regulators and is often described by defense attorneys as "bootstrapping." 

No Harm but Still a Foul?

The SEC noted that an exchange may not be registered with the SEC unless its rules provide for a fair procedure for the disciplining of members and persons associated with members.  Accordingly, the SEC reiterated its position that a fundamental principle governing all SRO disciplinary proceedings is fairness. Oddly, the SEC's conclusion is preceded by a preamble that cautiously concedes that it could not "find, as a factual matter, that Hayden's ability to mount an adequate defense was impaired by the Exchange's delay." If this had been a case resting solely upon the issue of laches, the SEC likely would not have found for Hayden, as that defense requires some proof of prejudice to the defendant.  Nonetheless, the SEC determined that the NYSE has "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." Accordingly, the SEC set aside the all of the NYSE's sanctions and findings against Hayden. 

Conclusion

Hayden  leaves a huge interpretive door open as to when the delayed prosecution of a regulatory matter  becomes inherently unfair. Nonetheless, the ruling is an important landmark in establishing the necessity for SROs to conduct themselves in ways that are fair to industry respondents. Hayden may not be the unrestricted application of Johnson to SROs, but it is a major step in the right direction.  This case stands for the proposition that even if a defendant can't prove he was damaged by an SRO's failure to timely prosecute, the SEC still considers some SRO delays as to be so improper as to be fundamentally unfair and requiring the setting aside of any negative findings and sanctions.