Time since appeal filed - 10 months, 7 days
Times since last brief - 7 months, 5 days
Pages - 15
Footnotes - 33
Summary
This case is interesting because the Commission adopted a "destruction of the business" test for evaluating whether fines are excessive or oppressive (the statutory test) with virtually no discussion and citation to only one case which does not rule that to be the exclusive definition of the statutory terms.
NYSE requested that Shone-Ex (a member firm) submit data to it concerning short sale transactions through a so-called "blue sheet." The firm made an inaccurate response and was also sanctioned for failing to supervise its blue-sheet supervisory procedures. Blue sheets are a mechanism whereby the SEC, and other regulators request that firms supply trading data on selected trades, usually as part of a regulatory investigation. These requests and responses are now done electronically but in the distant past (for example when I first went to work for the SEC) they were done by a paper form on blue paper sent to the firm by the regulators (and hence the name "blue sheet"). Regulators traditionally use these forms to determine the names and account numbers of traders.
NYSE censured the firm and fined it $300,000. The Commission upheld the sanctions.
NYSE's blue sheet requests were in 2002 and 2004. Shon-Ex executes trades for an affiliated clearing firm, Schonfeld Securities. Both firms have the same CEO and compliance officer. Schone-Ex contracted with an independent data processing firm to file blue sheets with regulators. During the period in question, no one at the firm verified the accuracy of submissions made by the data processing firm even though copies were sent to the firm. In June 2004 NYSE discovered that blue sheet responses concerning 146 trades wrongly showed 100 short trades as long. Schone-Ex's CEO contacted the data firm, but it was slow to correct the reporting errors. In November 2004 the firm notified NYSE that it had submitted inaccurate blue sheet responses from June through October. Thus, the exchange did not obtain accurate data until November. The firm did not put into place procedures to ensure the accuracy of blue sheet responses until May 2005.
At trial, even Schon-Ex's expert agreed that the blue sheet system is a vital regulatory surveillance system.
Schone-Ex admitted that it submitted erroneous data to NYSE and did not maintain adequate procedures to verify the accuracy of data submitted on its behalf by the data processing firm. It noted that the trades were accurately recorded on its own books and that the errors were solely those of the data processing firm.
The primary challenge on appeal was Schone-Ex's claim that the penalty was excessive. Exchange Act Section 19(e) requires that the SEC sustain NYSE sanctions unless it finds that the sanction is excessive, oppressive or imposes an unnecessary or inappropriate burden on competition. In evaluating sanctions the SEC addresses "the nature of the violation and the mitigating factors." The SEC also evaluates the seriousness of the offense, the harm to the investing public, the potential gain to the broker, the potential for repetition, and the deterrent value on the offending broker and others. Further, the courts have directed that the SEC determine that sanctions are "remedial and not excessive or oppressive."
The Commission found that the record was unclear as to whether the NYSE investigation was hindered by the inaccurate submissions (indeed NYSE found that the harm to the investigation "should not weigh heavily" in assessing a penalty). It nevertheless concluded that the misconduct was "significant." In doing so the Commission noted the critical regulatory role of blue sheet responses. It further noted that the inaccurate data submitted covered trades over a several year period. The Commission found that Schone-Ex did not promptly and forcefully move to correct the problems or to put surveillance procedures into place.
Schone-Ex also complained that in supporting the sanctions, NYSE relied on sanctions in settled disciplinary actions against other firms. The Commission noted that NYSE rules specifically allow reference to prior disciplinary actions without exempting settlements.
Practitioners should note that the SEC also relies on settled SEC matters as precedent for substantive law. See, Carl L. Shipley, Release 34-10870, fn. 6 (June 21, 1974), 1974 SEC LEXIS 3113 ("A long series of such non-adjudicative orders issued in many cases may be significant for certain purposes as pointing to a settled administrative construction or practice. But an isolated order or two of [that type] is of no general import. Such cases are not to be confused with those in which we accept an offer of settlement, issue an order that makes findings, and imposes the sanction assented to by the settling respondent or respondents, and either together with the order or at a later time issue an opinion stating our views on the issues raised."). The Supreme Court has long recognized that "the interpretation of an agency charged with the administration of a statute is entitled to substantial deference." Blum v. Bacon, 457 U.S. 132, 141 (1982).
Another significant factor considered by the Commission was that Schone-Ex had three prior disciplinary actions, including one involving failure to supervise. The Commission noted that NYSE had also considered the disciplinary history of a subsidiary of the firm, but noted that it did not consider that matter.
Last, the Commission rejected Schone-Ex's claim that the fine was excessive. It noted that the firm had not established that the fine "threatens its business." Needless to say, this is a very high bar for a firm challenging a sanction to meet.
Comment
This case indicates that the Commission takes the failure of firms to submit accurate trading data to regulators very seriously. It will reverse a fine as excessive only if the firm can show that the penalty is so large as to "threaten [the] business" of the firm. Needless to say, this construction of the statutory words "excessive or oppressive" are ready made for appeal. The Commission justified its conclusion only by quoting from McCarthy v. SEC, 406 F.3d 179, 190 (2d Cir. 2005) ("a compelling argument can be made that suspending McCarthy now will not serve remedial interests and will work an excessive and punitive result - namely, the destruction of the brokerage practice McCarthy has built during several years of rule-abiding trading."). The fact that in McCarthy the Court found destruction of the business to be "excessive or oppressive" of course does not mean that only destruction of the business can be deemed "excessive or oppressive." Its willingness to adopt the destruction of the business test with no further discussion and analysis seems to run a significant risk of appellate reversal. So, once again we see an ipse dixit pronouncement from the Commission, this time in connection with a significant regulatory standard, namely when industry fines will be upheld.
