A controversial selling-away case decided by the Securities and Exchange Commission
last month serves as a warning to brokers about getting ensnared in a tricky area of the law.
And it serves as a reminder of the risks that financial advisers face from overly aggressive enforcers.
The SEC last month threw out the case, which was brought by the Financial Industry Regulatory Authority
Inc. of New York and Washington against two Dallas-based brokers for PaineWebber Inc. of New York, James Browne and Kevin Calandro.
In dismissing the case, the SEC chided Finra enforcers for attempting a "novel interpretation" of Finra's selling-away rule.
"This was a junk case that never should have been brought," said Mr. Calandro's attorney, E. Steve Watson of E. Steve Watson Attorney at Law in Allen, Texas.
Finra, then known as NASD, charged the brokers in 2002.
It alleged that they engaged in a private securities transaction by soliciting clients to buy shares in e2 Communications Inc. of Dallas without the required prior notice and approval from their firm.
Both a Finra hearing panel and its National Adjudicatory Council upheld some of the charges.
But on appeal, the SEC said that "the record demonstrates that e2 itself solicited" the clients. "NASD points to no evidence that [the brokers] were involved in these ... purchases."
Finra attempted to suspend Mr. Browne for six months and fine him $25,000. It wanted a three-month suspension for Mr. Calandro and a $5,000 fine.
Those penalties were suspended during appeal and have now been dismissed. Finra can't appeal the case beyond the SEC.
Although vindicated, the brokers were nevertheless hurt, their lawyers say.
Mr. Browne, who was once one of PaineWebber's biggest producers, was fired from Lehman Brothers Holdings Inc. of New York in 2003 because of the Finra investigation, said his attorney, Brian Rubin, a partner at Sutherland Asbill & Brennan LLP in Washington.
Mr. Browne now works for a hedge fund.
Mr. Calandro, who worked with Mr. Browne, now works at SMH Capital Inc., a subsidiary of Sanders Morris Harris Group Inc. of Dallas.
"If this had been the federal government bringing the case, we would have sued under the Equal Access to Justice Act," Mr. Watson said.
That law provides for the awarding of some attorney fees to a party that prevails against an unjustifiable government action.
But the EAJA doesn't apply to non-governmental organizations like Finra, Mr. Watson said.
Finra spokeswoman Nancy Condon declined to comment on the case.
The relationship between e2, a developer of e-mail marketing software, and Mr. Browne and Mr. Calandro began innocently enough.
The company was founded in 1997 by Jeff Farris, an important client of the brokers. Mr. Farris had about $20 million invested with them — money earned from the prior sale of another software company.
Mr. Browne, the lead broker on the team, and Mr. Calandro began introducing a number of business contacts to Mr. Farris, according to the SEC's decision.
One friend and client of Mr. Browne's, a vice president at IBM Corp. of Armonk, N.Y., testified that he was so impressed with e2's technology that he established a marketing relationship between IBM and e2, and eventually became an e2 director.
Other clients Mr. Browne introduced to e2 included a commercial real estate broker, an executive at CompUSA Inc. of Dallas, a computer reseller and an insurance broker, the SEC said.
These and other clients pursued business relationships with e2, and many eventually bought stock in the company, the SEC said.
In appreciation for their help and in return for Mr. Browne's service as an advisory director, e2 on its own gave the brokers some shares in 2000. But after the dot.com bubble burst, e2 hit hard times.
In February 2002, "due in significant part to [Mr.] Browne's efforts," e2 consented to an involuntary bankruptcy, the SEC said. As a result, shareholders received more than $1 million.
"That really irritated [Mr.] Farris, I think," Mr. Watson said. That's when "a phantom 'Exhibit A' was floated into the NASD," he said.
Exhibit A was a spreadsheet of unknown origin that had the names of 75 purchasers of e2 preferred stock. A "source" column listed Mr. Browne or Mr. Calandro next to some of the investors, the SEC said.
Finra enforcers used the document in charging the brokers. Did Mr. Farris leak Exhibit A to Finra?
"This is total speculation on my part, but I think that's a distinct possibility," Mr. Watson said.
Mr. Farris, now a partner at Digital Efforts Corp. of Dallas, did not return calls for comment.
The origins of the document were never proven. Despite its unknown source, "I think the NASD just leaped on [Exhibit A]," Mr. Watson said.
The document was ultimately rejected as unreliable by a Finra hearing panel, the SEC said.
Finra's theory in going after Mr. Browne and Mr. Calandro was that, since startups like e2 often seek funding from various individuals involved with the company, the brokers should have known that introducing their clients to e2 would lead those clients to make investments in e2.
Mr. Watson said the decision will "cut down the boundaries" of prior selling-away cases that gave en-forcers wide latitude.
"I'm using it [the decision] a lot" in arguing other cases, said Jon-athan Kord Lagemann, a Chatham, N.Y.-based defense attorney who is not connected to the case.
"The moral here is ... there is value in forcing regulators to try their cases," said Pete Michaels, a defense attorney at Michaels Ward & Rabinovitz LLP in Boston who is not involved in the case.
E-mail Dan Jamieson at firstname.lastname@example.org.