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INSIGHT: Recent FINRA Disciplinary Decision Illustrates Limits of Hearsay Evidence

Aug. 21, 2019, 8:00 AM

Although brokers accused of misconduct frequently decry it as unfair, it is a fact of life that hearsay testimony is often admitted into evidence at Financial Industry Regulatory Authority disciplinary proceedings. There are limits, though, and a recent decision is a reminder that disciplinary panels will not always accept hearsay at face value.

First, what is hearsay evidence? Hearsay is an out-of-court statement, often by a nonparty to the case, offered as evidence in a trial to prove that what the speaker said is true.

As a basic example, imagine a case involving a car accident in which the victim wants to prove the traffic light was red at the time of the crash. If she herself saw that the light was red at the time, she may testify to that fact because it is based on her personal observation. If, on the other hand, her testimony is that someone else—a bystander to the accident, perhaps—told her that the light was red, she may not testify about what the bystander said in order to prove the color of the light.

There are number of important exceptions to this rule (among others, it does not apply to admissions by a party to a case) but as a general matter hearsay statements are not admissible in a courtroom trial.

FINRA Disciplinary Proceedings Differ

FINRA disciplinary proceedings are different. There is no general rule against hearsay evidence, and FINRA Enforcement staff (Enforcement) may, in many circumstances, use this evidence to prove its case. The issue can come to the fore in a number of ways, including cases where Enforcement seeks to introduce statements from customers who are not able or willing to testify at the hearing.

When Enforcement seeks to rely on facts from witnesses who are not present at the hearing, the obvious risk is that the accuracy of those facts cannot be directly tested under cross-examination.

To mitigate that risk, disciplinary panels evaluate hearsay statements for relevance and reliability when deciding what, if any, weight to give that evidence. That analysis can encompass a number of factors: For example, whether the declarant is biased and whether the hearsay is sworn or unsworn.

The most significant factor, though, is whether the hearsay testimony is corroborated by other evidence. Disciplinary panels routinely admit hearsay where the evidence is consistent with other facts in the case, on the theory that this corroboration tends to show the hearsay is reliable. This has included, among many other examples, testimony from a FINRA examiner about statements that a firm’s employees told the examiner during an on-site examination.

The flip side of the reliability analysis, though, is that panels can exclude or give limited weight to uncorroborated evidence. In one case, for example, FINRA’s National Adjudicatory Council (the NAC), considering an appeal from a hearing panel decision, rejected the use of on-the-record investigative testimony by the president of the respondents’ firm.

In that case, one of the issues was whether the respondents had violated the former NASD Rule 2315 (now FINRA Rule 2114) by recommending microcap stocks without the proper due diligence. The respondents disputed that their firm had tasked them with performing the due diligence. The firm’s president had said otherwise during his on-the-record testimony, though, and FINRA used a transcript of that testimony at the respondents’ hearing to show that they were, in fact, responsible for the due diligence.

The NAC rejected the president’s hearsay testimony as unreliable even though it was made under oath. The NAC noted facts that suggested the president may have been biased against the respondents. It also found that the testimony was incoherent and rambling in parts and not supported by any other evidence in the case. Having ruled that the testimony was unreliable, the NAC overturned the hearing panel’s finding that the respondents had violated Rule 2315.

Drawing the Line on Reliability

A case from earlier this year provides another illustration of where disciplinary panels may draw the line when evaluating the reliability of hearsay. In this case, a financial adviser was accused of stealing from a customer, including in one instance by accepting a signed, blank check that the adviser cashed for $22,000. The customer was elderly and suffered from dementia, and when his daughter noticed large transactions in her father’s account, she confronted the adviser and filed a complaint with his employer, which led to an investigation and ultimately a disciplinary proceeding.

At the hearing, the adviser maintained that he had permission to cash the check because the money was a loan from the customer. Enforcement, on the other hand, alleged that the customer meant to loan only $6,000 and thus by writing $22,000 on the check and cashing it, the adviser converted the customer’s funds.

The loan was not documented and the customer did not testify at the hearing, so aside from the adviser’s testimony, the only evidence of the amount of the loan was hearsay statements that the customer had made to his daughter and a compliance investigator who investigated the complaint to the adviser’s firm. The panel found these statements unreliable because they were inconsistent and, as a whole, strongly suggested that the customer’s recollection was confused and incomplete. The panel did not credit the customer’s statements and dismissed the case, and the NAC affirmed that dismissal in May.

This case raised other issues with the adviser’s conduct, and the NAC took pains to note that although Enforcement had not met its burden of proving the violations it alleged, its finding was not an endorsement of the adviser’s dealings with an elderly and vulnerable customer. Nevertheless, this case and others like it provide guideposts to help understand where hearsay will be too untrustworthy to be admitted.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

John Curley is a partner at Hoguet Newman Regal & Kenney LLP in New York. He focuses his practice on complex business and securities litigation, as well as securities-related regulatory investigations and proceedings, including investigations by FINRA.

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