Arizona Securities Division Administrative Proceedings


Arizona Securities Division Administrative Proceedings

What to expect and do if you have been named in an Arizona Corporation Commission Securities Division administrative action.

Please note that, while this article accurately describes applicable law on the subject covered at the time of its writing, the law continues to develop with the passage of time. Accordingly, before relying upon this article, care should be taken to verify that the law described herein has not changed.

I. The ACC and Its Securities Division.

Article 15 of the Arizona Constitution established the Arizona Corporation Commission (“ACC”). The role of the ACC includes, among others, public utilities regulation, facilitating the incorporation of businesses and organizations, railroad/pipeline safety and securities regulation. Accordingly, the ACC is organized into six separate Divisions:  Utilities, Corporations, Administration, Hearings, Legal and Securities.

The goals of the ACC Securities Division (“Securities Division”) are three-fold: (1) to ensure the integrity of the securities marketplace through investigative actions and registration and/or oversight of securities, securities dealers and brokers, investment advisers and investment adviser representatives; (2) to enhance legitimate capital formation; and (3) to minimize the burden and expense of regulatory compliance by legitimate business.

To accomplish these goals, the ACC Securities Division undertakes, among other duties, the following: (1) reviews prospective securities offerings to ascertain that full and fair disclosure is made to potential securities investors and that the terms of the securities offerings are not inherently fraudulent; (2) reviews applications of those securities dealers, salespersons, investment advisers and investment adviser representatives who are required to register with the Securities Division; (3) monitors the conduct of securities dealers, salespersons, investment advisers and investment adviser representatives; (4) investigates possible securities violations; and (5) initiates administrative or civil actions, or refers cases for criminal prosecution. Id.

The last two of these duties of the ACC, conducting investigations of possible securities violations and commencing administrative actions, and the powers and processes therein, are the subject of this article and discussed in detail in turn below.

II. The ACC Investigation.

A. The Powers. The ACC has the power to investigate pursuant to Arizona law, including both the state constitution and statutes. Polaris Int’l Metals Corp. v. Ariz. Corp. Comm’n, 133 Ariz. 500, 506, 652 P.2d 1023, 1029 (1982).

The Arizona Constitution empowers the ACC to inspect and investigate as follows:
The Corporation Commission, and the several members thereof, shall have power to inspect and investigate the property, books, papers, business, methods, and affairs of any corporation whose stock shall be offered for sale to the public and of any public service corporation doing business within the state, and for the purpose of the commission, and of the several members thereof, shall have the power of a court of general jurisdiction to enforce the attendance of witnesses and the production of evidence by subpoena, attachment, and punishment, which said power shall extend throughout the state. Said commission shall have power to take testimony under commission or deposition either within or without the state.
Ariz. Const. art. 15, § 4.

More specifically, the Arizona statutes allow the ACC to publically or privately investigate potential or actual securities violations as follows:
The commission, the director or other agent or agents designated by the commission may make such public or private investigations within or outside of this state as the commission deems necessary to determine whether any person has violated or is about to violate any provisions of this chapter or any rule or order hereunder, or to aid in the enforcement of this chapter, or to aid in prescribing rules and forms hereunder, and may at any time either prior to or subsequent to the registration of any securities or any dealer or salesman, investigate and examine into the affairs of any person issuing or dealing in or selling or buying or intending to issue, deal in or sell or buy securities or into the affairs of any person when the commission believes that such person is or may be issuing or dealing in or selling or buying securities.
A.R.S. § 44-1822. See also A.R.S. § 44-3132.

The Arizona statutes also give the ACC the power to subpoena testimony and records, including those from third parties, such as financial institutions, subject to non-disclosure, in order to enforce Arizona securities laws as follows:
A. For the purpose of investigations or hearings which, in the opinion of the commission, are necessary and proper for the enforcement of this chapter, any member of the commission, the director or any officer or officers designated by the commission may administer oaths and affirmations, subpoena witnesses, take evidence and require by subpoena duces tecum or by citation the production of books, papers, contracts, agreements or other documents, records or information, whether filed or kept in original form or electronically stored or recorded which the commission deems relevant or material to the inquiry.
B. The commission may issue and apply to enforce a subpoena in this state at the request of a securities agency or administrator of another state if the activities constituting an alleged violation for which the information is sought would be a violation of this chapter if the activities had occurred in this state.
C. In connection with the power to enforce the production of evidence by subpoena vested in the commission by Article XV of the Constitution of Arizona and the commission’s power to conduct private investigations pursuant to section 44-1822, the commission has the authority to order a financial institution not to disclose the existence or content of the subpoena to persons not affiliated with the financial institution other than to the financial institution’s legal counsel. The commission shall exercise such power if the commission finds it necessary or appropriate in the public interest or for the protection of investors.
A.R.S. § 44-1823. See also A.R.S. § 44-3133.

These constitutional and statutory provisions in Arizona give the ACC broad powers to conduct public or private investigations to determine whether any individual or corporation has violated or is about to violate any of the Arizona securities laws. Polaris, 133 Ariz. at 506, 652 P.2d at 1029. Indeed, such investigatory powers are “analogous in their breadth to those of the grand jury.” Id. at 506, 652 P.2d at 1029. As a result, “courts have given agencies wide berth in reviewing the conduct of administrative investigations” like those of the ACC. Id. at 506, 652 P.2d at 1029.

However, the Arizona Supreme Court has held that if an ACC “investigation becomes a tool of harassment and intimidation rather than a means to gather appropriate information, the appropriate court may intrude and stop the incursion into the constitutional liberties of the parties under investigation.” Id. at 507, 652 P.2d at 1030. For example, the ACC “may not constitutionally use its investigatory powers to harass, intimidate, and defame a business into leaving the state.” Id. at 507, 652 P.2d at 1030. In addition to the investigation being used for an improper purpose, such as to harass, a party may also resist the ACC’s subpoena on grounds that the inquiry is not within its scope of authority, the order is too vague, or the subpoena seeks irrelevant information. Carrington v. Ariz. Corp. Comm’n, 199 Ariz. 303, 305, 18 P.3d 97, 99 (Ct. App. 2000).

B. The Processes. The ACC will issue a subpoena to provide testimony and/or produce documents, and have it personally served upon the individual or corporation, often by the investigator assigned to matter. The individual or corporation will then have to appear at the time designated therein and/or respond to the subpoena within the amount of time designated therein, which is normally ten (10) days, unless an extension is obtained.

If one refuses to obey the subpoena, the ACC may seek an order from the Maricopa County Superior Court requiring the sought-after testimony or document production, and the court must issue the order, as well as an award attorneys’ fees if the refusal to obey was not substantially justified and other circumstances do not make an award of expenses unjust. A.R.S. § 44-1825(A), (C). The failure to obey the court order may result in punishment by the court as a contempt of court. Id. § 44-1825(A). See also A.R.S. § 44-134(A).

The ACC formal interview is not a deposition, but an examination under oath. A.A.C. R14-4-302(1). Accordingly, “[d]uring a formal interview, a witness shall not knowingly make any untrue statements of material fact or omit to state any material facts necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading.” A.A.C. R14-4-304(I).

The individual may be represented by a lawyer during the formal interview. A.A.C. R14-4-304(A). However, the lawyer cannot have represented another witness or person in the examination or investigation, be a material witness in the examination or investigation, or be the subject of the examination or investigation, unless permitted upon a showing that the representation is in the interest of justice and will not obstruct the examination or investigation. A.A.C. R14-4-304(B)-(C). “If a lawyer is not permitted to represent a witness . . . that lawyer’s partners or associates of the lawyer’s law firm are also precluded from representing the witness.” A.A.C. R14-4-304(C).

The lawyer’s role during the formal interview is limited to the following: (1) giving legal advice to the witness before, during, and after the formal interview; (2) questioning the witness briefly at the conclusion of the formal interview for the purpose of clarifying any testimony the witness has given; and (3) making summary notes during the formal interview solely for the use of the witness and the lawyer. A.A.C. R14-4-304(A), (D).

The formal interview may be recorded, but only by the Securities Division, and may be attended by ACC or Attorney General employees, members of law enforcement or any other state, federal or self-regulatory agencies authorized by the Securities Division, and any translators authorized by the Securities Division. A.A.C. R14-4-304(D)-(E). Further, the Securities Division may “exclude from a formal interview any person previously permitted to attend the formal interview, including a lawyer, whose conduct is dilatory, obstructionist, or contumacious.” A.A.C. R14-4-304(F).

A person who has produced documents or testified in connection with a formal interview is entitled, upon written request and proper identification, to inspect the witness’ own testimony on a date to be set by the Director of the Securities Division. A.A.C. R14-4-304(G). However, the Director of the Securities Division may delay the inspection of the record until the conclusion of the examination or investigation if the Director determines that earlier inspection may obstruct or delay the examination or investigation. Id.

The results from the ACC investigation will not necessarily remain confidential, and can later be used by the government against the individual or corporation as follows:

Information and documents obtained by the Securities Division in the course of an investigation are confidential, unless made a matter of public record. The Securities Division may disclose the information or documents to a county attorney, the attorney general, a United States Attorney, or to law enforcement or regulatory officials to be used in any administrative, civil, or criminal proceeding.

A person may “plead the Fifth” and refuse to attend the formal interview and testify before, or produce documents sought by, the ACC based upon the privilege against self-incrimination if it constitutes the compelled testimony or private papers of the person, which would be privileged evidence pursuant to either the Fifth Amendment of the U.S. Constitution or Article II, Section 10 of the Arizona Constitution, and the person claims the privilege prior to the production of the testimony or papers. A.R.S. § 41-1066(A). Therefore, an individual may refuse to give any information that might establish a direct link in a chain of evidence leading to his or her criminal conviction.

III. The ACC Administrative Action.

A. The Prehearing Process. If the Securities Division chooses to bring an administrative action against an individual or corporation, it will serve a Notice of Opportunity for Hearing (“Notice”) upon them, and they are known as the respondents. A.A.C. R14-4-302(3). See also R14-3-103(A), (D). Because Arizona is a community property law state, the ACC may also name as a respondent the spouse of any individual who allegedly violated Arizona securities law. See A.R.S. §§ 44-2031(C), 44-3291(C) (“The commission may join the spouse in any action authorized by this chapter to determine the liability of the marital community”).

The respondent may retain an attorney to represent him or her, although an individual may represent himself or herself, i.e., pro per or pro se.

However, an individual who is not an attorney may not represent anyone else, including his or her spouse. Id. Spouses may also need separate counsel to protect their separate interests.

A legal entity, such as a corporation or limited liability company, may be represented by a full-time officer, partner, member or manager, or employee, as long as: (1) the legal entity has specifically authorized such person to represent it in the particular matter; (2) such representation is not the person’s primary duty to the legal entity, but secondary or incidental to other duties relating to the management or operation of the legal entity; and (3) the person is not receiving separate or additional compensation (other than reimbursement for costs) for such representation. Id.

The Notice will set forth the following: (1) alleged securities law violations; (2) time frame in which to request a hearing; and (3) time frame in which to answer the Notice. See A.R.S. §§ 41-1601(B), 44-1972(D), and 44-3212(C). The respondent is entitled to a hearing. A.A.C. R14-4-306(B). See also A.R.S. §§ 41-1061(A), 44-1972(A)-(C), and 44-3212(A)-(B). The respondent must request a hearing in writing within ten (10) days after receipt of the Notice. A.A.C. R14-4-306(B). See also A.R.S. §§ 44-1972(D) and 44-3212(C). If the respondent fails to request a hearing, he or she will lose by default and the ACC may enter a final decision against the respondent. A.R.S. § 41-1061(D).

If the respondent properly requests a hearing, the ACC will set a date, time and place for the hearing, which will be held 20-60 days from the date of the respondent’s written request for hearing, unless otherwise provided by law, stipulated by the parties, or ordered by the ACC. A.A.C. R14-4-306(C). See also A.R.S. §§ 44-1061(A), 44-1972(E), and 44-3212(D)-(E). Before the hearing, the ACC may also schedule a prehearing conference to formulate or simplify the issues, obtain admissions of fact and documents, arrange for the exchange of proposed exhibits or expert testimony, limit the number of witnesses, consolidate the examination of witnesses, procedure at the hearing and such other matters, which may expedite the orderly conduct and disposition of the proceeding or settlement. A.A.C. R14-3-108.

The ACC, through the Director of the Securities Division, may also issue a temporary restraining order to cease and desist (“TRO”) against a respondent if it determines that “the public welfare requires immediate action.” A.A.C. R14-4-307(A). See also A.R.S. §§ 44-1972(C) and 44-3212(B). With a TRO, the respondent must immediately cease and desist from conducting any activity alleged by the ACC to be in violation of the Arizona securities laws as described in the TRO. The TRO will remain “in effect for 180 days or until vacated, modified, or made permanent,” whichever comes first, and the 180 days are “tolled from the date a hearing is requested until a decision is entered,” unless otherwise ordered by the ACC. Id. R14-4-307(A), (E).

With a TRO, the respondent has twenty (20) days to request a hearing. Id. R14-4-307(C). If properly requested, the ACC will set a date, time and place for the hearing, which will be held 10-30 days from the date of the filing of the respondent’s written request for hearing, unless otherwise provided by law, stipulated by the parties, or ordered by the ACC. Id. R14-4-307(D). If a request for hearing is not timely filed within, or after the hearing, the ACC may, by written findings of fact and conclusions of law, vacate, modify, or make permanent” the TRO. Id. R14-4-307(C)-(D).

If the respondent has requested a hearing, he or she must file an answer to the Notice (“Answer”) within thirty (30) calendar days after the date of service of the Notice. A.A.C. R14-4-305(A). In the Answer, the respondent must respond to each allegation made by the Securities Division by admitting or denying it; if an allegation is not denied, it is deemed admitted. Id. R14-4-305(B)-(E). The Respondent must also raise any applicable affirmative defenses in the Answer, or else they are deemed waived. Id. R14-4-305(F). Finally, the Answer must be signed by the respondent or the respondent’s attorney. Id. R14-4-305(B). However, a hearing officer may grant relief from the foregoing answer requirements for good cause shown. Id. R14-4-305(G).

The Rules of Practice and Procedure govern any action before the ACC, including any discovery and motions therein. See A.A.C. R14-3-101, et seq.; see also A.A.C. R14-3-101(A) (applying Arizona Rules of Civil Procedure if no procedure set forth in ACC rules). Prior to the hearing, the respondent may be able to obtain a copy of the ACC’s investigative file, with the exception of investigation reports, which can only be obtained in certain circumstances. See Alan Baskin, Anatomy of a Securities Enforcement Matter Before the Arizona Corporation Commission at 7. The parties, including the ACC and the respondent, can also take depositions of, and issue subpoenas, to witnesses. A.A.C. R14-3-109(O)-(P). See also A.R.S. § 44-1062(A)(4).

At any time prior the hearing, the respondent may enter into a settlement with the ACC, which is memorialized in a consent order. See A.R.S. § 41-1061(D). The ACC commissioners must approve the consent order at an open meeting. One disincentive to settling is that the ACC has adopted a policy of notifying other licensing agencies (insurance, real estate) of its actions, and thus clients’ other licenses may be at risk, especially when the following language is used in the consent order: “Respondents admit only for purposes of this proceeding and any other administrative proceeding before the Commission or any other agency of the state of Arizona the Findings of Fact and Conclusions of Law contained in this Order.” See Alan Baskin, Anatomy of a Securities Enforcement Matter Before the Arizona Corporation Commission at 10.

B. The Hearing Processes. The hearing is held before a hearing officer or administrative law judge (“ALJ”). A.A.C. R14-4-109(A). At the hearing, the respondent and its counsel must conduct themselves in the same manner as required before an Arizona state court. Id. R14-3-104(F). The hearing is open to the public. Id. R14-3-109(V). During the hearing, the ACC is not bound by the technical rules of evidence; the rules “will be generally followed,” but they “may be relaxed in the discretion of the Commission or presiding officer when deviation from the technical rules of evidence will aid in ascertaining the facts.” Id. R14-3-109(K).

At the hearing, the respondent is entitled to enter an appearance, introduce evidence, examine and cross-examine witnesses, make arguments, and generally participate in the conduct of the proceeding. Id. R14-3-104(A). See also Id. R14-4-109; A.R.S. §§ 41-1061, 41-1062, 44-1973, and 44-3213. The party who carries the burden of proof, usually the Securities Division (except to prove a securities exemption), presents its witnesses and evidence first, to support its allegations, with the respondent having the opportunity to cross-examine those witnesses, followed by the respondent to present its own witnesses and evidence to refute the allegations, with the Securities Division having the opportunity to cross-examine those witnesses. A.A.C. R14-4-109(G). The parties typically prepare briefs in lieu of closing arguments. See Alan Baskin, Anatomy of a Securities Enforcement Matter Before the Arizona Corporation Commission at 8.

After the hearing, the ALJ will submit a recommended opinion and order to the ACC commissioners, and provide the respondent with a copy. A.A.C. R14-3-110(B). Within ten (10) days after service of the recommended opinion and order, the respondent may file objections to the recommended opinion and order in the form of exceptions. Id. The ACC commissioners will consider the ALJ’s recommended opinion and order, and any of the respondent’s filed exceptions, and then make the final a decision at an open meeting, which must include findings of fact (based on the evidence and on matters officially noticed) and conclusions of law. See A.R.S. §§ 41-1061(G), 41-1063.

Notably, if the ACC orders restitution, it is not dischargeable in bankruptcy:
A discharge under section 727, 1141, 1228(a), 1228(b), or 1328(b) of this title [11 USCS § 727, 1141, 1228(a), 1228(b), or 1328(b)] does not discharge an individual debtor from any debt that:
(A) is for (i) the violation of any of the Federal securities laws (as that term is defined in section 3(a)(47) of the Securities Exchange Act of 1934 [15 USCS § 78c(a)(47)]), any of the State securities laws, or any regulation or order issued under such Federal or State securities laws; or (ii) common law fraud, deceit, or manipulation in connection with the purchase or sale of any security; and
(B) results, before, on, or after the date on which the petition was filed, from (i) any judgment, order, consent order, or decree entered in any Federal or State judicial or administrative proceeding; (ii) any settlement agreement entered into by the debtor; or (iii) any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor.
11 U.S.C. § 523(a)(19) (emphasis added).

C. The Post-Hearing Processes. The respondent may file an application for rehearing within twenty (20) calendar days after entry of the ACC’s decision or order. A.R.S. §§ 44-1974, 44-3214. But see A.A.C. R14-3-112(A) (“Except as provided in subsection (G), any party in a contested case before the Commission arising out of Title 10 or 44 of Arizona Revised Statutes, who is aggrieved by a decision rendered in such case may file with the Commission, not later than ten days after service of the decision, a written application for rehearing or review of the decision specifying the particular grounds therefor.”). Unless otherwise ordered, filing an application for rehearing does not stay the ACC’s decision or order, and the respondent must comply with it. A.R.S. §§ 44-1974, 44-3214. A rehearing may be granted for any of the following causes materially affecting the moving party’s rights: (1) irregularity in the proceedings before ACC or any order or abuse of discretion, whereby the moving party was deprived of a fair hearing; (2) misconduct of the ACC, its staff or its hearing officer, or the prevailing party; (3) accident or surprise that could not have been prevented by ordinary prudence; (4) newly discovered material evidence that could not with reasonable diligence have been discovered and produced at the original hearing; (5) excessive or insufficient penalties; (6) error in the admission or rejection of evidence, or other errors of law occurring at the hearing; and (7) that the decision is not justified by the evidence or is contrary to law. A.A.C. R14-3-112(C). If the ACC does not grant a rehearing within twenty (20) calendar days of receipt, the application is deemed denied. A.R.S. §§ 44-1974, 44-3214. See also § 41-1062(B).

The respondent may also appeal the ACC’s decision to the Maricopa County Superior Court pursuant to A.R.S. §§ 44-1981 and/or 44-3231, and those appeals are governed by A.R.S. § 12-901, et seq. In order to appeal, the respondent must file its complaint in the Maricopa County Superior Court within 35 days of service of the ACC’s decision. A.R.S. § 12-904(A). See also A.R.S. § 12-909(A) (requirements for complaint). Within ten (10) days after filing the complaint, the respondent must also file a notice of action with the ACC, who will then transmit the record to the court. Id. § 12-904(B).

Within twenty (20) days after service of the summons and complaint, the ACC and all other defendants must answer the complaint. A.R.S. § 12-907. The Rules of Procedure for Judicial Review of Administrative Decisions will apply to the case.

The superior court has broad powers with such an appeal. See A.R.S. § 12-911. The superior court’s review is limited as “[t]he court shall affirm the agency action unless after reviewing the administrative record and supplementing evidence presented at the evidentiary hearing the court concludes that the action is not supported by substantial evidence, is contrary to law, is arbitrary and capricious or is an abuse of discretion.” Id. § 12-910(E). However, the court must conduct a de novo review of the ACC’s application and interpretation of law. Ariz. Health Care Cost Containment Sys. Admin. v. Carondelet Health Sys., 188 Ariz. 266, 269, 935 P.2d 844, 847 (Ct. App. 1996).

If the respondent loses, the court may award the ACC its costs in a reasonable amount based upon the expense the ACC incurred in preparing the trial record. A.R.S. § 12-912. However, if the respondent prevails, he or she is entitled to an award of his or her fees and other expenses, which may include the attorneys’ fees incurred during both the appeal as well as the original ACC proceeding. See A.R.S. § 12-348(A)(2), (I).

Conclusion.

Based upon the foregoing, it is clear that an investigation or administration action brought by the ACC can be a very technical, tedious and time-consuming process, as well as an overwhelming and intimidating process given the ACC’s broad powers and employment of both the hearing prosecutor and officer.

An attorney specializing in securities matters will be able to provide a respondent with the proper legal advice and competent representation during the ACC investigation and action, and ensure compliance with the process and all of the procedural requirements.

If you have received a Subpoena or Notice of Opportunity for Hearing, feel free to contact Robert Mitchell at rdm@tblaw.com or at (602) 452-2730 to arrange a consultation to review the ACC’s claims and your potential defenses.

Robert Mitchell is widely respected among Phoenix securities attorneys and for more than two decades has been representing parties named in Arizona Securities Division administrative cases.
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