The SEC administrative forum is important and should not be neglected by the agency tasked with significant prosecutorial and adjudicatory power over broker-dealers, investment companies, investment advisers, and publicly filing companies. One should not forget that the SEC for all practical purposes invented the concept of insider trading in an administrative decision. The duty of broker-dealers to supervise has largely been developed in this forum. Such important concepts as the "shingle theory" holding broker-dealers to a duty of fair dealing with their customers was developed by the SEC in administrative disciplinary litigation.
SEC for some unknown reason does not post on its web site appeal briefs and pretrial and post trial briefs before Commission ALJs. Nor does it post decisions by its ALJ's on procedural matters. These are public documents and practitioners can only benefit from having access to the arguments of both the Division of Enforcement, FINRA, and respondents and appellants.
Jokes about transparency, full disclosure, and similar concepts should be avoided because irony does not seem to be appreciated at 100 F Street NE in Washington.
Unfortunately, the SEC's record in dealing with its adjudicatory responsibilities now is underwhelming. The Commission issued a total of forty eight decisions and orders this year. This is less than meets the eye because twenty four of those decisions dealt with routine procedural matters such as motions to reconsider.
So, the SEC completed only twenty four substantive appellate decisions in calendar year 2007. Fifteen decisions concerned appeals of NASD and NYSE disciplinary actions and only nine involved appeals of decisions by SEC administrative law judges.
Moreover, decisions on seemingly routine matters linger, often taking a year or more. Decisions on routine motions take weeks and months. Decisions on appeals from SEC administrative law judges and self regulatory organizations were completed in no less than six months and some decisions were labored on for more than a year. Indeed, in cases where the Division of Enforcement was seeking a bar from industry association based on a criminal conviction or fraud injunction in an earlier SEC enforcement case, the Commission never managed to complete its appellate review in less than 6 months. These kind of routine "follow-on" administrative proceedings would not appear to normally raise very tough issues that require months to dispose of - after all, it isn't difficult to decide that a felon convicted of fraud should not be allowed to associate with a broker-dealer or investment adviser with the ability to, in the words of an ancient Commission decision, "meddle with other people's money."
The SEC does not appear to be a believer in the aphorism that justice delayed is justice denied. Such lack of promptness is surprising given that it is clearly in the public interest to promptly resolve the disciplinary matters the SEC deals with. It almost goes without saying that it is in the public interest to discipline securities industry wrongdoers promptly.
The writing style of many of the opinions is at best turgid. Gone are the days when some staffer could pen language like this that described a fraudulent research report as "unalloyed by even a chemical trace of the truth." Bruce William Zimmerman, 46 SEC 509, 110 (1976). Or this revealing and very true description of the mind of a con-man, "we see a childlike credulity, an almost incredible naivete, a total indifference to prosaic and disconcerting facts, and a marked propensity to embroider the misrepresentations made to him by others with embellishments of his own devising." Richard C. Spangler, Inc., 46 SEC 238, 253 (1976).
Footnotes continue to proliferate. The wise practitioner will read the footnotes first as often the most significant matters are buried there.
The Commission seems to be responding to the demands of appellate courts and articulating in specific detail its reasons for imposing sanctions. Unfortunately, in many other instances it relies on a peremptory style heavily infected with ipse dixit disease. In other instances it has made major policy pronouncements with hardly any analysis or discussion. See particularly the Richard Kresge decision, which dramatically narrows the reach of Exchange Act Section 20(a) control person liability as well as the definition of a supervisor for purposes of Exchange Act liability.
The SEC has not used appropriately its ability to summarily affirm an ALJ's initial decision. See, for example the Jose P. Zollino matter (Exchange Act. Rel. 55107). There, the Commission took nine months to affirm an ALJ's bar (resulting from the Division of Enforcement's motion for summary disposition, i.e., there was no hearing) based on respondent's previous criminal conviction and anti-fraud injunction. Why should the Commission should spend nine months to write a twelve page opinion in a matter like this?
Likewise, the Commission denied a Division of Enforcement motion for summary disposition in America's Sports Voice, Inc., (Exchange Act Rel. 55511), a proceeding to revoke the registration of a delinquent filing company. The Commission simply opined, without explanation the bromide that "we have an interest in articulating our views on important matters of public interest" without bothering to explain what was in the public interest that needed articulation in this routine case.
The following is a brief summary of the more significant opinions issues by the Commission in 2007. Be warned however, some of these matters are included in this list because they deal with rather arcane procedural matters.
Richard F. Kresge, Exchange Act Rel. 55988
This is a classic failure to supervise case that includes a laundry list of things not to do as the president of a small broker-dealer. It contains strong guidance concerning supervisory duties. However, this is probably the Commission's most significant opinion because of its pronouncements, with virtually no analysis, limiting the scope of both control person liability and the definition of a supervisor.
The Commission held that one can have control person liability under Exchange Act Section 20(a) only if one personally participates in the violative conduct. This is a very significant statutory interpretation and policy ruling by the Commission. It was added almost as an afterthought at the end of the decision with virtually no discussion.
Also, in a footnote, the Commission implies that a person who cannot hire, fire, reward, or punish cannot be a supervisor for purposes of failure to supervise liability. If the Commission, actually means this, it has great significance.
Donner Corporation International, SECS., Exchange Act Rel. 55313
This matter involved glowing and canned "research reports" put out by a broker-dealer that were paid for by the issuers of the securities. The purported research ignored the fact that the issuers involved were in financial distress, going concern qualifications of their financial statements, and negative information available in filings with the SEC. The case is important not only for the guidance it provides about research reports, but also because much of that guidance applies across the board whenever a firm or registered representative recommends a security.
Firms are required to have policies and procedures concerning the preparation, review, and approval of published research. When making a recommendation, all material information about the security should be disclosed, particularly information bearing on financial condition, solvency, and profitability. It is simply not appropriate to disclose only selected positive information. Further, recommending a stock as a speculative investment does not insulate the seller from the duty to make full and accurate disclosure of all material information. Nor is the seller insulated from this duty by telling investors they should consult SEC filings for more details. Further, going concern qualifications by auditors are per se material and must be disclosed. Also, the opinion disposes of the claim that that research reports are not "in connection with" the offer, purchase, or sale of securities.
Finally, for you trial lawyers out there -- inculpatory investigative testimony given closer in time to the events in question will be given more evidentiary weight than contradictory trial testimony.
Stephen J. Horning, Exchange Act Rel. 56886
I will not comment extensively on this case because it was the last case I tried before I left the SEC. It is an interesting failure to supervise case that involved the SIPC liquidation of a small Denver firm after back office personnel embezzled several million dollars of customer money market funds. It should be studied by supervisors responsible for back office operations in order to identify practices to be avoided, particularly in the small firm context.
David Henry Disraeli and Lifeplan Associates, Inc. (Exchange Act Rel. 57027
This case dealt with the misuse of a the proceeds from a small private offering by an unregistered investment adviser. It includes a comprehensive discussion of why misuse of offering proceeds is always material regardless of whether or not individual investors testify to the contrary. It also notes that diversion of offering proceeds to pay personal expenses can not be cured by a general statement in offering documents that proceeds might not actually be used for the business purposes proposed.
Respondent was barred as an investment adviser, fined $85,000, and ordered to disgorge $84,300 plus prejudgment interest after he used $84,300 of a $100,000 private placement offering to pay personal living expenses. The lesson from this case is that investment advisers, whether registered or not, are held to the highest standards of disclosure and honesty when dealing with clients and even violations involving a relatively small amount of money and only a few investors will result in the most severe sanctions.
The Commission ruled that respondent had waived his claims of inability to pay disgorgement or penalties by failing to raise the issue before the trial judge. Further, although he submitted financial statements in support of his claim at the appellate stage, he did not support those statements with any underlying documentation of his claimed liabilities and debts.
Phlo Corp., et. al., Exchange Act Rel. 55562
The Commission declined to revoke the registration of a formerly delinquent issuer that had become current in its filigs. Many delinquent issuers facing revocation proceedings try, but few succeed.
The Commission seems to have dealt with a long-running evidentiary issue. Here it considered as evidence a statement in a respondent's Wells submission that she attempted to contradict at trial. Many Commission ALJ's have been reluctant to admit into evidence statements in Wells submissions. This ruling would seem to dispose of that issue.
The Commission restated it's prior rulings that: 1) there is no specific intent requirement needed to establish the "willful" element required by the Exchange Act; 2) aiding and abetting can be established by reckless conduct; 3) no scienter is required to violate the reporting provisions of Exchange Act Section 13.
David Disraeli and Lifeplan Associates, Inc., Exchange Act. Rel. 56045
No Virginia - you may not depose SEC staff to support claims of staff bias against you.
Warren E. Turk, Exchange Act. Rel. 55942
This was an appeal from a NYSE action that involved allegations that because NYSE had coordinated with both the SEC and DOJ that NYSE was a state actor and could not sanction Turk for invoking the Fifth Amendment in its investigation. The Commission remanded. It restated previous rulings that self regulatory organizations are not state actors and may therefore discipline an individual for failing to cooperate in an investigation who invokes the Fifth Amendment. However, here, it remanded to permit Turk to conduct discovery into the extent of cooperation between the SEC, DOJ, and NYSE. It did note, that mere cooperation between NYSE, SEC, and DOJ would not make NYSE a state actor and noted that the threshold for establishing NYSE as a state actor was high. However, the opinion is a complete muddle in its prescription for the scope of discovery on remand. On the one hand, it states that Turk should be given a "full opportunity" to conduct discovery. On the other hand, it admonishes that Turk should not be allowed to use discovery to conduct an aimless fishing expedition.
David A. Finnerty, et. al., Exchange Act Rel. 56765
This opinion sets out the standards the Commission will use in deciding motions for severance. Severance is not appropriate where there are common factual issues.
Morton Bruce Erenstein, Exchange Act Rel. 56768
The Commission used as precedent civil discovery cases dealing with the ability to obtain tax return information in deciding whether or not it was appropriate for the NASD to seek to obtain such data in an investigation. Those cases, however, do not provide for unfettered access to tax return information, but seem to require a heightened relevance standard. The Commission does not explain why it believes a civil discovery standard is applicable to investigations. Presumably the same standard will apply to its own staff investigations. There are some court of appeals decisions limiting the ability of investigators to obtain tax information that are not discussed in this opinion.
Michael Sassano, et. al., Exchange Act Rel. 56874
The Commission upheld an ALJ's order that the Division of Enforcement turn over to respondents a broad range of documents gathered pursuant to an "omnibus" formal order, not only those gathered in the specific investigation into their conduct. Although this is inside baseball at its worst, perhaps this will cause the Division to forego the use of such omnibus investigative orders in the future.
