Arizona Securities Division Administrative Proceedings

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.

The Arizona Constitution empowers the ACC to inspect and investigate as follows:

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:

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.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).

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.

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.

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:

11 U.S.C. § 523(a)(19) (emphasis added).

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).