“Statutory disqualification”  as defined under Section 3(a)(39) of the Securities Exchange Act of 1934 (“the Exchange Act”), prevents a person under a statutory disqualification from associating with any FINRA Member Firm (“the Member” or “the Firm”), unless an MC-400 Membership Continuance Application (“MC-400 Application”) is granted or other conditions are met.  The Securities and Exchange Act (“SEC”) recently issued two decisions involving SD issues under Section 3(a)(39) – Gregory Acosta (“Acosta”) and Commonwealth Capital Securities Corp (“Commonwealth”).  In tandem, these cases provide certain practical considerations that must be considered in assessing: (1) What is a “statutory disqualification” (“SD”), and (2) How Firms must satisfy the extraordinarily high burden in providing a supervisory structure that will be approved by regulators in the MC-400 Application process.  In short, the Acosta decision shows that the precise outcome of the underlying proceeding (i.e. consent order, guilty plea, and disciplinary decision) determines whether an SD is present.  Commonwealth outlines supervisory and other criteria regulators will consider in determining whether to grant an MC-400 Application.  Members should carefully review these two recent decisions in assessing MC-400 Application and SD issues. 

Acosta underscores how the precise wording and findings of the disposition of the underlying matter is dispositive in the SD determination.  In Acosta, the California Department of Insurance (“Insurance Department”) issued an “Accusation” (essentially a complaint) in January 2018, alleging Acosta took out a $750,000 life insurance policy in the name of an elderly customer and named the Insurance Company as beneficiary without the customer’s knowledge.  Acosta initially denied the allegations but ultimately consented, without admitting to the allegations, in a “Stipulation” to have his and the Insurance Company’s licenses and licensing rights revoked. The Insurance Commissioner adopted the Stipulation and entered an order titled “California Order” (hereby, “the Order”).

On appeal from a FINRA determination that the Order constituted an SD,¹ the SEC set the SD determination aside and dismissed the proceedings.  The SEC determined that the Order was not “based on” Acosta’s violation of law and did not resolve allegations of fraudulent, manipulative or deceptive conduct.  Neither the Order nor the underlying Stipulation contained language regarding fraud or dishonesty.  Further, the specific Insurance Code section did not discuss fraud.  At most, the SEC found that Acosta simply consented to a revocation of his licenses, and agreed that, if proven to be true, the facts would be grounds for discipline for fraud or dishonesty.  However, the disposition of the proceedings, the Order itself, did not contain any such affirmative findings. Thus, because FINRA’s determination that Acosta is subject to an SD did not exist in fact, the SEC set aside that determination.

As an aside, the Acosta decision is also significant for jurisdictional reasons.  For the first time, the SEC recognized the right of registered representatives to self-initiate an appeal of FINRA’s SD determination directly to the SEC.  At the time the Order was entered Acosta’s Firm declined to submit an MC-400 Application to continue Acosta’s association with the Firm, and instead terminated its association with him.  After FINRA continued to maintain that Acosta was SD’d, Acosta appealed to the SEC.  Ultimately, the SEC rejected FINRA’s argument that only a Firm could appeal to the SEC upon the denial of an MC-400 Application, and held that an individual registered representative had the right to appeal individually to the SEC, where the representative was unable to find a Member to sponsor an MC-400 Application.

Commonwealth provides insight into the high level of supervisory structure required for an MC-400 Application to be granted. In Commonwealth, in contrast to Acosta above, the SEC agreed with FINRA and dismissed Commonwealth’s application for review.   On August 2016 FINRA found that Kimberly Springsteen-Abbott (“Springsteen-Abbott”), Chief Executive Officer (“CEO”) and Chief Compliance Officer (“COO”) of Commonwealth, violated FINRA Rule 2010 by improperly allocating business funds to her personal and non-business accounts, and imposed an industry bar. 

After receiving notice of her bar in August 2016 and during the subsequent appeals, Commonwealth filed an MC-400 Application with FINRA, seeking to permit Springsteen-Abbott to continue to associate with the firm.² The MC-400 Application noted that Springsteen-Abbott was an indirect owner of the firm, and represented that she would not actively engage in Commonwealth’s securities business, nor be compensated by the firm. Under the Application’s proposed supervisory plan, Springsteen-Abbott’s husband would supervise her to ensure that her activities complied with the submission.  FINRA’s National Adjudicatory Council (“NAC”) found that the submitted supervisory plan was inadequate, and further that Springsteen-Abbott’s continued association with the firm was not in the “public interest.”

The SEC agreed.  Using a variety of factors, it determined that Commonwealth’s supervisory plan was deficient because it failed to demonstrate the proposed supervisors could exercise effective supervision, and failed to show the plan was tailored to Springsteen-Abbott’s specific circumstances (i.e., the securities industry bar). The SEC found that having Springsteen-Abbott’s spouse supervise her would not be effective due to the lack of necessary independence and potential conflicts of interest. More problematic was the fact that Springsteen-Abbott owned Commonwealth, which employed her husband and the other proposed supervisor; theoretically, Springsteen-Abbott could take employment action against either of them.  In the end, the SEC agreed with FINRA that granting the MC-400 Application would not be in the public interest, and dismissed Commonwealth’s appeal. 

Acosta and Commonwealth provide a reminder to Members of facts and factors to consider when assessing thorny SD and MC-400 Application issues.  In particular, Firms must understand the precise procedural posture and ultimate outcomes of underlying proceedings that could result in an SD.  Moreover, when Members do elect to submit an MC-400 Application for a person with an SD, the supervisory structure must be specific and tailored to the disqualifying event, and particular focus must be given to the experience of the proposed supervisor.

1. FINRA determined that the Order met the definition of a decision “based on violations of any laws or regulations that prohibit fraudulent, manipulative, or deceptive conduct,” leading to the SD conclusion.  15 U.S.C. §§ 78c(a)(39)(F), 78o(b)(4)(H)(ii) of the Exchange Act.

2. Springsteen-Abbott’s bar was ultimately affirmed by the SEC in a February 2020 Order.

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