Investment Advisers Barred Based On Vermont Sanctions

Mitchell M. Maynard, and Dorice A. Maynard, IA Act Rel. 2875, May 15, 2009

Time since appeal filed – 7 months 17 days
Time since last brief filed – 4 months 30 days
Pages – 17
Footnotes – 40

The Maynards (husband and wife) were barred for five years from associating with registered broker-dealers or investment advisers and other sanctions by state of Vermont. A Commission ALJ barred them from association with any investment adviser and the Commission upheld that decision on appeal.

Mitchell Maynard organized a mutual fund in 1998 and in 1999 formed an IA, Leveraged Index Management Co. (Limco) to manage another fund and registered with the Commission as an IA. Mitchell was president and treasurer of Limco and his wife Dorice was vice president of operations and marketing. She was primarily responsible for maintaining Limco's books and records but also assisted with marketing and solicited at least one advisory client.

Following a Commission exam of Limco that found numerous deficiencies Limco deregistered in early 2001. In 2002 Vermont brought charges and after a trial issued an order that found both Maynards had a substantive role in managing Limco. Vermont found that the Maynards had, among other things, misappropriated investor funds for their personal use, misrepresented Limco's performance, and failed to disclose a prior bankruptcy.

The ALJ barred the Maynards based on the Division of Enforcement's motion for summary disposition.

Because Limco was registered with the Commission at the time the events charged by Vermont occurred the Commission had jurisdiction over them regardless of whether or not Limco actually functioned as an investment adviser.

The Maynards complain that the SEC staff referred this matter to Vermont to evade the requirement in Commission proceedings that the staff exam report on which the proceedings are based be made available to them. In this case the staff did not provide the previous exam report to the Maynards as that exam was not the basis for the proceeding. The exam report did not include Brady material (material exculpatory evidence) because the Maynards were estopped from challenging the findings in the Vermont order. And because the decision by the Commission staff not to directly prosecute a case based on the earlier exam is a matter of prosecutorial discretion nothing prohibits the Commission from pursuing a separate remedy after it has foregone another.

Finally, because the Maynards were collaterally estopped from challenging the Vermont proceedings their due process rights were not violated because the ALJ did not hold an evidentiary hearing.

Comment

Nothing unusual here. One has to wonder why the Commission continues to write opinions in matters such as this that raise no issues of significance. If it was appropriate for the ALJ to act on a motion for summary disposition without a hearing, surely the Commission could manage to summarily affirm that decision unless unusual issues are raised.

James E. Franklin, Exchange Act Rel. 56649, October 12, 2007

Penny stock bar, collateral estoppel, unclean hands defense

Time from appeal to decision - 10 months, 7 days.

Time from last brief to decision - 6 months, 17 days.

15 pages.

Summary

The ALJ by summary disposition entered a penny stock bar based on Respondent's 2005 federal court injunction and imposition of third tier penalties of $770,000 following a jury trial.  The jury found that Franklin had violated Exchange Act Section 10(b), Securities Act Section 5, and the anti-touting provisions of Securities Act Section 17(b).  The violations occurred in connection with a pump and dump scheme in a number of stocks that featured an internet site that touted stocks he had previously acquired.  The scheme netted more than $4 million in profits.  Respondent personally reaped at least $831,000 in profits.  

While touting the stocks as good investments, Respondent was simultaneously selling his holdings.

Respondent's appeal of the district court injunction is pending.

The Commission ruled that Respondent is collaterally estopped from seeking both reconsideration of the prior civil verdict, but also the factual and procedural issues that were actually litigated and necessary to that decision.  Nor may Respondent raise alleged SEC staff misconduct in connection with the injunctive proceeding.  The Commission rejected Respondent's unclean hands defense, finding that the alleged staff misconduct did not prejudice his defense of the injunctive action.  For example, he claimed the staff had improperly disclosed its investigation to judgment debtors of his in an unrelated civil action.  Also rejected was his claim that the staff engaged in misconduct when it notified Respondent and his counsel during a telephone call that his testimony in his deposition in that matter raised issues of perjury.  

There was nothing improper in the Division of Enforcement not seeking a penny stock bar in the civil action, but instead bringing these proceedings to obtain one.  

The Commission found that a penny stock bar was in the public interest.  It found Respondent's violations egregious.  He touted stocks he had bought cheaply using false statements and personally sold them at the same time he was recommending them to the public as good investments.  The seriousness of his conduct is also demonstrated by the amount of penalty imposed by the district court.  Further, he acted with a high degree of scienter which is demonstrated by the steps he took to conceal his participating in the scheme by using a brokerage account held in the name of a Turks & Caicos company.  Finally, the conduct was not isolated, it involved seven stocks and was similar to conduct by him in yet another SEC injunctive action in which he was ordered to pay joint and several disgorgement of $889,000. Respondent's claim that the public interest is served by the injunctions, obviating the need for a penny stock bar is rebutted by the fact that the first injunction did not prevent a repeat of his conduct.  Given his history, a bar is the only way to prevent Respondent from future dealings in penny stocks.

Comment

The Commission includes a lengthy and detailed discussion of why a bar is an appropriate sanction.  This is a refreshing departure from past practice, and seems to indicate that the Commission has perhaps learned from recent D.C. Circuit Court opinions that it is required to fully articulate why the sanctions it imposes are appropriate.

However, speed continues to be an obvious issue.  This was a completely routine matter that raised no legal issues and presented few factual complexities.  Nevertheless, the Commission took more than 6 months to produce the opinion and allowed more than 3 1/2 months for briefing.  Surely, routine matters such as this can be handled more expeditiously.  Indeed, the length of time taken by the Commission to impose the sanction arguably belies the claim in the opinion that the public interest demands that Respondent be barred from participating in a penny stock offering because he is a recidivist.  Doesn't the public interest also require that the Commission act more promptly?  It is not as if the Commission or its staff is overwhelmed with appellate cases.  It has issued only 18 [note- since this was written the Commission added 2 earlier opinions to its web site - so the number so far this year is 20] opinions this year.

Key Points

• When a proceeding is based on a previous civil injunction, Respondent may not collaterally challenge the verdict or findings in that action.  As a result, he may not challenge in this proceeding evidentiary rulings by the district court.
• A pending appeal of the underlying injunction does not affect that injunction's status as the basis for administrative proceedings.
• The doctrine of unclean hands may not be invoked against a government agency bringing a public interest proceeding.  
• To be valid, an unclean hands defense must invoke egregious misconduct that rises to a constitutional level.
• Commission Routine Uses under the Privacy Act permit the staff to disclose the existence of an investigation if the staff believes such disclosure may aid the investigation.
• Critical factors in evaluating the appropriateness of a bar include the nature of the conduct, the likelihood Respondent's occupation will present opportunities for future violations, and whether the sanction will have a deterrent effect on others.
• Ordinarily, and absent evidence to the contrary, a bar is appropriate when Respondent has been enjoined from violating anti-fraud provisions.