D.L. Cromwell Investments v. Nasd Regulation, Docket No. 01-7301.

Citation279 F.3d 155
Decision Date01 February 2002
Docket NumberDocket No. 01-7301.
PartiesD.L. CROMWELL INVESTMENTS, INC., Lloyd Bierne, David S. Davidson, Eric S. Thomas, and Matthew Greenwald, Plaintiffs-Appellants, v. NASD REGULATION, INC., Defendants-Appellees.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

Martin P. Russo, Peekskill, NY, for plaintiffs-appellants.

Terri L. Reicher, Associate General Counsel, National Association of Securities Dealers, Inc., Washington, DC, John J. Flood, on the brief, for defendants-appellees.

Before MESKILL, JACOBS, and CABRANES, Circuit Judges.

JACOBS, Circuit Judge.

Plaintiffs-appellants D.L. Cromwell Investments, Inc. ("Cromwell") and individual Cromwell employees, all members of the National Association of Securities Dealers, Inc. ("NASD"), have been the subject of ongoing investigations both by NASD Regulation, Inc. ("Regulation"), which is an investigatory arm of the NASD, and by federal prosecutors. They have sued to enjoin NASD Regulation from compelling them — under threat of sanctions authorized by NASD Rule 8210 — to submit to on-the-record interviews, arguing that NASD Regulation is a willing tool of the prosecutors and that the compelled interviews would therefore violate their Fifth Amendment privilege against self-incrimination.

They appeal from the judgment of the United States District Court for the Southern District of New York (Kaplan, J.), rejecting the claim on the finding that Regulation was not a state actor subject to constitutional restraint, but was rather a private party conducting a private investigation. The preliminary injunction hearing was consolidated with the trial on the merits (over Cromwell's objection) after the district court heard testimony from witnesses for both Cromwell and NASD, and before the rendering of the decision.

On appeal, appellants argue essentially: (1) that they were prejudiced by the consolidation because in so doing the court denied their request for a necessary two-week delay to pursue discovery, and erroneously employed the merits-based "preponderance of the evidence" standard of proof rather than the less onerous "serious questions" standard available in preliminary injunction proceedings; and (2) that the district court erroneously held that because Regulation is not a state actor, it cannot be subject to the Fifth Amendment restraint.

I

Regulation is the regulatory arm of the NASD, a private, not-for-profit, self-regulatory organization registered with the Securities and Exchange Commission ("SEC"), of which appellants are members. Regulation is responsible for "conducting investigations and commencing disciplinary proceedings against [NASD] member firms and their associated member representatives relating to compliance with the federal securities laws and regulations." Datek Securities Corp. v. National Ass'n of Securities Dealers, Inc., 875 F.Supp. 230, 232 (S.D.N.Y.1995). Regulation's Division of Enforcement ("DOE") conducts regulatory investigations and disciplinary hearings, and imposes sanctions that are subject to multiple layers of administrative and judicial review, including appeals within the NASD, and appeal to the SEC under a de novo standard.

One group within the DOE — the Criminal Prosecution Assistance Unit ("the Unit") — assists federal and state authorities in their investigations of securities matters. The Unit's activities are self-contained, and it performs no other function. It is a small department consisting of a lawyer, an examiner, and an investigator. It is sometimes granted access (pursuant to court order) to grand jury materials, which it is required to shield from the rest of the DOE and to not divulge. Its one lawyer, Bruce Bettigole, is occasionally designated a Special Assistant United States Attorney as part of his duties. See 28 U.S.C. § 543 (providing for the appointment of special attorneys to assist United States attorneys).

Notwithstanding the separation of the Unit's duties from those of the DOE, there is some administrative overlap between it and the rest of DOE: Bettigole is subordinate to the Deputy Director and the Director of the DOE; Bettigole shares a secretary with a DOE lawyer; the workspace of the Unit's examiner and its investigator is surrounded by DOE staff; the Unit's telephone, fax, and computer services are shared with the rest of the DOE.

The facts as found by the district court and supported by the record, demonstrate that in October 1998, the DOE opened an investigation concerning Cromwell's involvement in the trading of shares in Pallet Management Systems, Inc. ("Pallet"). Soon after, the United States Attorney for the Eastern District of New York and the FBI opened their own investigations into the same transactions.

In November 1998, the FBI (as part of its investigation) asked the Unit for certain documents concerning Pallet, which the Unit was aware related to Cromwell's involvement in Pallet. The Unit turned over the documents.

In March 1999, a DOE lawyer and a DOE examiner went to Florida to inspect Cromwell's books and gather documents. Soon after, the FBI called the DOE lawyer, who conveyed general information to the FBI concerning the contents of the documents inspected in Florida. In response to a later formal request, the DOE allowed the FBI access to the Cromwell documents.

During the summer of 2000, the U.S. Attorney's Office for the Eastern District of New York and the DOE shared details about the progress of their respective investigations. Specifically, prosecutors divulged to the DOE information from a cooperating witness. Additionally, the DOE and prosecutors learned from each other that they were both investigating Pallet and Cromwell's involvement in Pallet.

At this time, the Unit was assisting the U.S. Attorney's Office in the U.S. Attorney's efforts to secure a search warrant for Cromwell's Brooklyn office. After execution of the warrant by the U.S. Attorney, Bettigole and another Unit staff member reviewed the seized documents to determine whether any were relevant to a separate, long-standing, criminal investigation in which the Unit was involved.

In November 2000, the DOE demanded certain documents from Cromwell. Cromwell responded that many of the requested documents had been seized by federal agents. A DOE staff member then asked Cromwell and the U.S. Attorney's Office for an inventory of the seized documents. Cromwell supplied an illegible copy of the inventory, and the U.S. Attorney's Office told the DOE that the Unit already had the list. The DOE soon obtained a legible inventory from the Unit, and later procured a number of the documents from the U.S. Attorney's Office.

In December 2000, the Unit helped the U.S. Attorney's Office prepare a grand jury subpoena for materials related to Pallet to be served on an entity called Fiserv. The terms of the subpoena allowed Fiserv to comply by electronic transmission, but because of a technological incompatibility between Fiserv and (both) the FBI and the U.S. Attorney's Office, Fiserv was allowed to comply by transmitting the information to the Unit.

Subsequently, the DOE served demands (pursuant to NASD Rule 8210) for on-the-record interviews of individual appellants. NASD Rule 8210 grants the DOE "the right to ... require a member ... to provide information orally, in writing or electronically ... and to testify at a location specified by [DOE] staff ... with respect to any matter involved in [an NASD] investigation." NASD Rule 8210(a)(1)(CCH). Appellants commenced this suit to enjoin those demands.

We review the district court's decision to consolidate the hearing for a preliminary injunction with a trial of the action on the merits under Rule 65(a)(2) for abuse of discretion. Abraham Zion Corp. v. Lebow, 761 F.2d 93, 102 (2d Cir.1985). We review the district court's findings of fact for clear error and its holdings of law de novo. White v. White Rose Food, 237 F.3d 174, 178 (2d Cir.2001).

II

Under Fed.R.Civ.P. 65(a)(2), "[b]efore or after the commencement of the hearing of an application for a preliminary injunction, the court may order the trial of the action on the merits to be advanced and consolidated with the hearing of the application." Cromwell argues that in this instance the consolidation of the preliminary injunction hearing with the trial on the merits was an abuse of discretion. See Abraham Zion Corp. v. Lebow, 761 F.2d 93, 102 (2d Cir. 1985).

In its strongest formulation, Cromwell's argument is that while it had a fair shot (even without discovery) at securing preliminary relief by raising sufficiently serious questions to show a balance of hardships tipping decidedly in its favor, see Jolly v. Coughlin, 76 F.3d 468, 473 (2d Cir.1996) (internal quotations omitted), it would have needed further weeks of discovery in order to support its heavier burden at a trial on the merits, and that the district court, therefore, should have put off its ultimate decision once the district court had determined that preliminary relief was not warranted, and granted Cromwell's request for an opportunity to pursue its discovery request.

The argument, however, is hard to square with Cromwell's contention, prior to the preliminary injunction hearing, that the question was urgent and could not be deferred. Thus, when Cromwell was seeking a prompt hearing, it argued that Regulation's Rule 8210 demands would cause irreparable harm — there and then — by forcing individual appellants to choose between foregoing their Fifth Amendment privilege (and risking criminal prosecution) or exposing themselves to NASD sanctions.1 See Bery v. City of New York, 97 F.3d 689, 693 (2d Cir.1996) (holding that a movant for a preliminary injunction "must first demonstrate that it is likely to suffer irreparable harm in the absence of the requested relief"). The irreparable harm was said to arise from individual appellants' refusal to submit to the impending testimony, and the...

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