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Alan Jay Ochanpaugh was a registered
representative (for investment company/variable products) with Northwestern Mutual Investment Services, LLC
("Northwestern") from November 1994 until
early 2004.
In late 2003, Ochanpaugh and other individuals founded the Wisdom Mission
church, for which Ochanpaugh was named president --- a role he describes as that of a
senior pastor and counselor.
In December 2003, the leadership of Wisdom Mission developed a plan that called
upon church members to contribute an amount equal to their monthly mortgage payment, or similar
major indebtedness, plus a ten-percent "tithe" to Wisdom Mission.
Wisdom Mission would pay the member's bill, keep the tithe as a contribution,
and issue a letter to the member to support a tax deduction in the amount of the
entire contribution.
In early January 2004, after the bill-payment plan had
been operating for about one month, Wisdom Mission's leaders learned that it was
not permissible under federal tax law for members to deduct the portion of their
contribution used to pay the their bills. Wisdom Mission promptly returned the tithed portions and never issued any tax deduction
receipts with respect to the bill-paying program.
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Meanwhile, Ochanpaugh's supervisors learned of the program when a participant in
the bill-payment program attempted to deliver a check to Ochanpaugh at
Northwestern's office. Northwestern investigated Ochanpaugh's activities
with Wisdom Mission as a possible undisclosed outside business activity in
violation of both NASD Rule 3030 and Northwestern's internal policies.
Ochanpaugh
maintained that his activity was exempt from Northwestern's
disclosure requirements because Wisdom Mission was a non-profit, tax-exempt
church and his activity there was uncompensated and pastoral. Ochanpaugh claimed that he orally advised his
supervisor that he was involved in the founding of a church, but does not
dispute that he did not provide written disclosure of his involvement in Wisdom
Mission to Northwestern.
THE COVENANT OF SILENCE
Northwestern
supervisors asked that Ochanpaugh provide them with personal and contact
information regarding Wisdom Mission's members. However, all the leaders of Wisdom Mission are bound to observe
the
"Covenant of Silence" ("Covenant") which forbids the
disclosure of information regarding Wisdom Mission members or officers. When Ochanpaugh refused to
provide that information. Northwestern first suspended and then terminated him.
Northwestern reported its disciplinary action to NASD, disclosing that
Ochanpaugh was disciplined because he was suspected of violating NASD rules.
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NASD
Conduct Rule 3030:
Outside Business Activities of an Associated Person
No person
associated with a member in any registered capacity shall be employed
by, or accept compensation from, any other person as a result of any
business activity,
other than a passive investment, outside the scope of his relationship
with his employer firm, unless
he has provided prompt written notice
to the member. Such notice shall be in the form required by the member.
Activities subject to the requirements of Rule 3040 shall be exempted from
this requirement
Northwestern's policy on outside business
activities, as it applied
to charitable and related activities, provided that
"[p]ermission may be
assumed and no
written disclosure is required for appropriate, non-compensated involvement in
non-profit
organizations."
The firm's disclosure form further explained that
"[ilt
is not necessary to
disclose non-investment-related activity that is exclusively charitable, civic,
religious or
fraternal and is recognized as tax exempt."
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The NASD Investigates
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Upon receiving Northwestern's report, NASD investigated Ochanpaugh to determine whether he had violated NASD
Conduct Rule 3030. NASD issued several request for information under Procedural
Rule 8210, and Ochanpaugh provided responses--- among which were a
complete description of Wisdom Mission and a copy of the
church's Articles.
In reviewing certain Wisdom Mission bank statements provided by Ochanpaugh,
NASD staff identified three checks written against the account, each in an
amount approximately ten percent less than a contribution deposited to the
account shortly before the check was written. NASD staff subsequently requested
copies of these three checks in order to determine whether Ochanpaugh was being
compensated by the church. NASD also requested a signed statement "explaining which transactions
were part of the program to pay church members' bills."
Ochanpaugh failed to provide copies of the requested checks. Ochanpaugh
stated that:
- the checks
were the property of Wisdom Mission, not an NASD member, and NASD had no right
to them;
- Wisdom Mission leadership relied on their First Amendment rights and
their obligations under the Covenant and refused to violate their members'
privacy by producing the checks; and
- Ochanpaugh did not have the checks in his
possession and could not compel the Wisdom Mission leadership to surrender them.
Ochanpaugh did provide two letters from Wisdom Mission leaders responding to
several questions NASD raised about Wisdom Mission that Ochanpaugh was unable to
answer himself. These letters, uncontradicted in the record, state that
Ochanpaugh was insulated from the financial operations of Wisdom Mission and was
not allowed to, and did not, open mail addressed to Wisdom Mission at his post
office box. The letter from Christina Grell, the Wisdom Mission Scribe and
Treasurer at the time, states that Wisdom Mission would not release the checks
out of concern for its members' privacy, but would provide other information to
assist NASD. According to Grell, the checks were not related to the bill-paying
program but were disbursements to Wisdom Mission members in financial need.
According to Grell, none of the payees had been counseled by Ochanpaugh, nor
were they known to him. Moreover, Grell's letter states that the names of the
payees did not appear on a list Ochanpaugh provided to Grell of his customers
while he was employed by Northwestern. The other letter, from Wisdom Mission
Elder Nicholas Juergens, confirms the restrictions on Ochanpaugh's role with
respect to Wisdom Mission's finances and that Ochanpaugh did not open mail
addressed to Wisdom Mission that he picked up from his post office box.
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NASD
Procedural Rule 8210:
Provision of Information and Testimony and Inspection and Copying of Books
(a) Authority of
Adjudicator and Association Staff
For the purpose of an investigation, complaint, examination, or proceeding
authorized by the NASD By-Laws or the Rules of the Association, an
Adjudicator or Association staff shall have the right to:
(1) require a
member, person associated with a member, or person subject to the
Association's jurisdiction to provide
information orally, in writing, or electronically
(if the requested information is, or is required to be, maintained in
electronic form) and to
testify at a
location specified by Association staff, under
oath or
affirmation administered by a court reporter or a notary public if
requested, with respect to any
matter involved in the investigation, complaint, examination, or
proceeding;
and
(2)
inspect and
copy the
books, records: and accounts of such member or person with respect to any
matter involved in the investigation, complaint, examination, or
proceeding.
...
(c)
Requirement to Comply
No member or person shall fail to provide information or testimony or to
permit an inspection and copying of books, records, or accounts pursuant
to this Rule.
...
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NASD Bars Ochanpaugh
NASD ruled that the requested checks were within the scope of
Procedural Rule
8210 because Wisdom Mission was Ochanpaugh's alter ego and
because Ochanpaugh had possession and control of the requested checks
as a signatory to Wisdom Mission's bank account and as the addressee
on the account statements. NASD found that Ochanpaugh violated
NASD Rule 8210 by failing to comply with NASD's request to produce
copies of checks drawn on the account of a church with which
Ochanpaugh was associated. NASD suspended and then, after an
evidentiary hearing, barred in all capacities Ochanpaugh and also
assessed hearing costs of $2,183.71.
Ochanpaugh appealed the NASD's action to the Securities and
Exchange Commission (SEC).
SEC Review
The SEC preliminarily confirms its longstanding position that because NASD lacks subpoena power, its investigations of possible violations of
its rules by members or their associated persons depend on the cooperation of
such members and persons. Moreover, the SEC notes that its cases
consistently support a broad interpretation of NASD's authority pursuant to Rule
8210. 14/ However, the scope of Rule 8210,
while necessarily broad, does have limits. As relevant here, NASD's right to
inspect and copy a member or associated person's documents under Rule 8210
extends to "books, records, and accounts of such member or person." 15/ This case therefore presents the question of whether the requested checks
are books, records, or accounts of Ochanpaugh.
ALTER EGO
NASD presented only two reasons for concluding that the checks were within the
scope of Rule 8210.
1. NASD concluded that "Wisdom Mission was under the
control of, and served as the alter ego of [Ochanpaugh]."
In reaching that position, NASD
rejected Ochanpaugh's assertion that "documents affording him complete and
autonomous authority for Wisdom Mission were mere templates that did not
accurately reflect his role." Further, NASD found that "unsworn
statements by Ochanpaugh's associates . . . do not outweigh the express terms of
Wisdom Mission's organizational documents, which permitted [Ochanpaugh] to
comply with the staffs request."
The SEC was troubled by the NASD's analysis of the alter ego capacity
because it failed to comport with more traditional tests of whether a
corporation has a separate identity from its shareholders. In determining
whether to pierce the corporate veil, the SEC often looks to the practice of
courts, which examine
- the capitalization of the corporation,
- maintenance of
separate books,
- separation of corporate and individual finances,
- use of the
corporation to support fraud or illegality,
- honoring of corporate formalities,
and, over all,
- the good faith or sham nature of the corporation.
The SEC found that the NASD's did not address any of the above factors, and the record
did not
contain adequate evidence on which to perform such an analysis.
Consequently, on the basis of an alter ego theory, the SEC declined to make the required finding
under Section 19(e) of the Securities Exchange Act of 1934 that Ochanpaugh's
failure to produce the requested checks was a violation of Rule 8210.201
POSSESSION AND CONTROL
2. NASD concluded that the checks were within Ochanpaugh's possession and
control.
In reaching that position, NASD emphasized that Ochanpaugh:
- was a signatory on the bank account,
- was Wisdom Mission's president, and that
- his extensive powers over the operations of
Wisdom Mission as its president entitled Ochanpaugh to treat the corporation's
property as his own.
From this analysis, NASD concluded that Ochanpaugh had
possession and control over the checks, and NASD was therefore entitled to
inspect or demand them.
In support of its analysis, the NASD relied primarily on Joseph G. Chiulli.
However, the SEC found that Chiulli neither raises nor answers the question presented
in Ochanpaugh as to whether NASD Procedural Rule
8210 gives NASD the authority to request Wisdom Mission's documents. Notably,
the SEC distinguished Chiulli as a case in which the documents at
issue were inarguably those of a member firm, over which NASD had
authority to demand production. Wisdom Mission is not an NASD member
firm. to inspect them pursuant to Rule 8210.
Finding that Chiulli cannot help the NASD, the SEC then examines
Rule 8210 itself. Unfortunately, the rule does not explain how to determine if requested materials are
"of such member or [associated] person," and NASD's decision provides no
citation to authority, analysis or interpretation of the language of the Rule,
or discussion of the history of the Rule in support of its "possession and
control" theory of the scope of Rule 8210. Further, the SEC's own research
disclosed no case in which it had been faced with this precise issue nor any
discussion of it in any SEC release. Before accepting NASD's delineation
of the term "books, records, or accounts of such member or [associated]
person," the SEC believed a fuller exploration of the appropriate scope of Rule
8210 is required.
In other cases cited by NASD, the SEC found the holdings even less persuasive or relevant because
they treat generally an associated person's obligations under Rule 8210 without
addressing the issue of whether NASD has the authority under the rule to demand
production of documents that are not those of a member or a person associated
with a member. See Toni Valentine [Bill
Singer: should be "Valentino" --- for a detailed analysis of
this case visit this link], Securities Exchange Act Rel. No. 49255 (Feb.
13.2004), 82 SEC Docket 711; Paz Secs. Inc., Exchange Act Rel. No. 52693 (Oct.
28.2005), 88 SEC Docket 1880, appeal filed, 05-1467 (D.C. Cir. Dec. 22,2005);
Charles R. Stedman, 51 S.E.C. 1228 (1994); Joseph Patrick Hannan, 53 S.E.C. 854
(1998); Michael David Borth. 51 S.E.C. 178 (1992).
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Joseph
G. Chiulli
Exchange Act Rel. 42359 / January 28, 2000
Person
associated with former member firm of registered securities association
failed to preserve records of firm and failed to provide information
requested by association in connection with its investigation. Held,
association's findings of violation and sanctions it imposed are
sustained.
In
Chiulli, the
NASD sought records of a former NASD member firm. At issue was whether the
request for the records had been properly addressed to Chiulli, the former Chief
Executive Officer and Chairman of the Board of the member firm who had physical
possession of the documents, or to the firm's trustee in bankruptcy who had
legal control of them.
In resolving this question,
the SEC stated that Chiulli
promised personally, independent of [the
firn) . . . to provide the NASD
with access to the records it requested. Moreover, as an associated person,
Chiulli was responsible for responding directly to the NASD's request for information. He had the
[firm's] documents in
his physical possession and he cannot shift responsibility to the firm for his
own failure to provide access to the documents.
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Dramatic Pronouncement!
In nearly a quarter of a century of practicing law on Wall Street, I have rarely
seen as dramatic and important a pronouncement from the SEC as what
follows. I urge all firms and individuals subject to NASD's jurisdiction
to carefully read the SEC's admonition:
Rule 8210 is an essential cornerstone of NASD's ability to police the securities
markets and should be rigorously enforced. However, as noted above, the scope of
the Rule does have limits. There may be circumstances in which possession and
control of documents by an NASD member or associated person, together with some
other interest in the documents short of an ownership interest, may be
sufficient given the enforcement objectives of the NASD to trigger application
of the Rule. In other circumstances, the NASD's authority under the Rule might
not extend to documents that may belong to a third party, or that may contain a
third party's confidential information not closely related to securities trading
with a member or associated person, even if those documents were in the
possession and control of a member or associated person. We note that under the
Federal Rules of Civil Procedure, document requests or
subpoenas for documents expressly cover documents within the "possession,
custody and control" of the person to whom the request or subpoena is
directed. 241 The authority for the Federal Rules, however, stems from the
Supreme Court's power to prescribe general rules of practice and procedure for
cases in the United States district courts, 25/ while NASD's authority to
request documents pursuant to Rule 8210 stems from the contractual relationship
entered into voluntarily by NASD members and associated persons with NASD.
Moreover, the potential breadth of requests for documents under the Federal
Rules is circumscribed by the full panoply of procedural protections afforded as
part of the discovery process, including the right to object to the production
of requested documents, and the right to have such objection heard by a court,
an entity independent of the party requesting the documents. 26/ These
protections are not available when NASD makes a Rule 8210 request; in such a
case, the only recourse against possible overreaching by NASD is for the person
to whom the request is directed to refuse to comply, and to appeal any
consequent disciplinary action to the Commission. In light of these issues, in
an outside business investigation such as this, NASD should consider first
requesting the personal financial records of the associated person before
seeking the documents of a third person.
SEC Decision
The SEC found that Wisdom Mission's Articles identify Ochanpaugh's authority, as president,
to control all aspects of Wisdom Mission's operations, and the signature card
suggests that Ochanpaugh may be a person with some control over Wisdom Mission's
account. On the other hand, NASD had evidence that, as a matter of practice,
Ochanpaugh did not in fact have absolute control over Wisdom Mission. He was not
free to release confidential information
about members on his own. Ochanpaugh testified without contradiction that he was
a pastor and counselor who was insulated from any contact with Wisdom Mission's
financial operations and who was not permitted to open bank correspondence
delivered to his post office box. The letters from Grell and Juergens
corroborate Ochanpaugh's testimony.
At this juncture, the SEC would typically remand the case
back to NASD --- in essence, the SEC slaps the regulator on the wrist for
some sloppiness, provides it with a second chance to put the missing
pieces of the puzzle in place, and anticipates yet another appeal from the
Respondent (although likely on less firm ground). This doesn't
happen in Ochanpaugh!
While strongly suggesting that NASD undertake an in-house
review of its Rule 8210 policies, the SEC refuses to remand the
matter. It succinctly holds that NASD has not met its burden of proof
to support its finding that its request for copies of
checks drawn against Wisdom Mission's checking account was within the scope of
its authority pursuant to Rule 8210.
The SEC Ordered that
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the Bar from association with any NASD member in any capacity
imposed by NASD against Jay Alan Ochanpaugh be set aside; and
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the imposition of $2,183.71 in hearing costs imposed
on Jay Alan Ochanpaugh be set aside.
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IN
A NUTSHELL
Without
question, Ochanpaugh will go down as a major case on the often
prickly issue of the NASD's resort to Rule 8210 production demands.
There are few more testy issues between the regulator and regulated than
whether the NASD has the right to demand the production of certain
documents (or the extent of that demand). While Ochanpaugh presents
somewhat unique facts, the first chink in the armor now appears. Not
only does the SEC clearly step back from an overly expansive application of
the NASD's jurisdiction in this area, but the SEC also reprimands (albeit
in the polite way that one regulator upbraids another) the NASD for its
heavy-handed interpretations.
Ultimately,
the proposition is a simple one. NASD cannot simply demand the
production of documents from a third party based solely upon a perceived
"relationship" with an NASD member firm or registered
party. And while the NASD will be afforded great leeway by the SEC
--- out of consideration for the NASD's lack of subpoena power --- there
are limits on that largesse.
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