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Siegel v. Securities and Exchange Commission

January 12, 2010


On Petition for Review of an Order of the Securities & Exchange Commission.

The opinion of the court was delivered by: Edwards, Senior Circuit Judge

Argued September 14, 2009

Before: GARLAND, Circuit Judge, and EDWARDS and RANDOLPH, Senior Circuit Judges.

Opinion for the Court filed by Senior Circuit Judge EDWARDS.

This case involves a disciplinary action brought by the National Association of Securities Dealers ("NASD")*fn1 against Michael Frederick Siegel ("Siegel"). From October 1997 to June 1999, Siegel worked as a registered, general securities representative with Rauscher Pierce Refsnes, Inc. ("Rauscher"), a NASD member firm. In 2002, NASD's Department of Enforcement filed a complaint with NASD's Office of Hearing Officers ("OHO") charging that, during his tenure with Rauscher, Siegel violated NASD Conduct Rules when four of his clients -- Linda and Huntington Downer ("the Downers") and Dorothy and Barry Landry ("the Landrys") -- invested in World Environmental Technologies, Inc. ("World ET"), a speculative, start-up company in search of financing. World ET eventually failed and the Downers and Landrys lost their investments. In its complaint, the Department of Enforcement alleged that Siegel violated NASD Conduct Rules 3040 and 2110 when he "sold away," i.e., engaged in private securities transactions on behalf of his clients without providing prior written notice to Rauscher, and NASD Conduct Rules 2310 and 2110 when he recommended World ET to his clients without having any reasonable grounds for believing that his recommendations were suitable.

After a hearing, an OHO panel found that Siegel had engaged in the violations alleged. The panel imposed a six-month suspension and a $20,000 fine for the Rules 3040/2110 violations, and a six-month suspension and a $10,000 fine for the Rules 2310/2110 violations. The panel declined to impose restitution and the suspensions were to be served concurrently. See Dep't of Enforcement v. Michael Frederick Siegel, No. C05020055 (Apr. 19, 2004) ("Initial OHO Decision"), reprinted in 2 J.A. 463-79. The matter was appealed to NASD's National Adjudicatory Council ("NAC"). Following a remand to the OHO panel, see In re Michael Frederick Siegel, No. C05020055 (July 26, 2005) ("Initial NAC Decision"), reprinted in 2 J.A. 482-87, NAC affirmed the panel's initial findings, with two modifications. NAC ordered Siegel to serve his suspensions consecutively and ordered Siegel to pay restitution in the amounts of $300,300 to the Downers and $100,000 to the Landrys. See In re Michael Frederick Siegel, No. C05020055 (May 11, 2007) ("Second NAC Decision"), reprinted in 2 J.A. 497-521; In re Michael Frederick Siegel, No. C05020055 (Dec. 4, 2007) ("NAC Supplemental Decision"), reprinted in 2 J.A. 642-58. Siegel appealed to the SEC, which affirmed NAC's decision on all counts. In re Michael Frederick Siegel,Exchange Act Release No. 58,737 (Oct. 6, 2008) ("SEC Decision"), 2008 SEC LEXIS 2459, at *1-*58, reprinted in 2 J.A. 677-701.

In his petition for review to this court, Siegel's principal argument is that, because the SEC failed to properly assess the "cause" of the losses suffered by the Landrys and Downers, the agency's decision to uphold NASD's awards of restitution was an abuse of discretion. We agree. NASD General Principle No. 5, which the SEC purported to apply in this case, describes restitution as a "traditional remedy used to restore the status quo ante where a victim otherwise would unjustly suffer loss"; and it states that restitution may be ordered when a party "has suffered a quantifiable loss as a result of a respondent's misconduct." General Principle No. 5, FINRA Sanction Guidelines at 4 ("Principle 5"). The SEC completely failed to articulate any meaningful standards governing the level of causation required under Principle 5.

This case involves wealthy and sophisticated customers who were under no press of time to decide whether to invest; customers who invested specifically in furtherance of a desire to speculate; and a broker who did not profit from his wrongdoing and who has been fined and suspended for his violations. There is nothing in the SEC's decision to indicate why, in these circumstances, awards of restitution are appropriate under Principle 5. Indeed, the SEC's decision is incomprehensible insofar as it attempts to amplify any meaningful causal connection between Siegel's putative bad acts and the Downers' and Landrys' losses. And the SEC has cited no precedent, and we have found none, supporting restitution in a case of this sort. The SEC's judgment is fatally flawed for two reasons: First, the SEC's judgment is not supported by reasoned decisionmaking. Second, the SEC cites to no controlling precedent that includes reasoned decisionmaking supporting restitution under Principle 5 in a case of this sort. We therefore vacate the restitution order.

We reject Siegel's remaining challenges. Substantial evidence supports the SEC's findings that Siegel violated NASD's rules barring selling away and unsuitable recommendations. And the SEC did not abuse its discretion in imposing fines and consecutive six-month suspensions for Siegel's separate violations of Rules 3040/2110 and Rules 2310/2110.


A. Siegel's Involvement in World ET

Siegel has worked as a registered general securities representative since 1981. From October 24, 1997 to June 16, 1999, he was associated with Rauscher, a NASD member firm. In early 1997, before Siegel joined Rauscher, he had several conversations with representatives of World ET, where he learned of the company's burgeoning efforts to offer antibacterial services to the poultry and swine industries. World ET representatives advised Siegel that the company was seeking to acquire the formula for a product called "Nok-Out" that could kill 99% of bacteria, fungi, and viruses on contact. In December 1997, World ET purchased the formula via a promissory note.

Siegel subsequently agreed to join World ET's board, to serve as a consultant to the company, and to help it raise the capital necessary to go public. On November 24, 1997, Siegel submitted a written request to Rauscher's compliance department for approval to sit on World ET's board. The department approved Siegel's request, but noted that Siegel would "not be able to effect transactions in securities of [World ET]" if the company went public. Inter-Office Memorandum from Jill Ivancevich, Compliance Department, Rauscher Pierce Refsnes, Inc., to Michael Siegel (Nov. 24, 1997), reprinted in 1 J.A. 283.

B. Siegel's Involvement with the Downers and the Landrys

Siegel began managing investments for Huntington and Linda Downer in 1993. Huntington Downer was a prominent state legislator and former law firm partner, with experience in state budget and finance matters. Huntington Downer also had previously invested in speculative oil and gas ventures. The combined net worth of the Downers was between $1.5 million and $2 million. When Siegel joined Rauscher, the Downers transferred their holdings to a Rauscher account. Over time, the couple afforded Siegel significant discretion over their funds, providing him "complete authority" to do "what he wanted." Tr. of Hearing (Oct. 8-10, 2003), reprinted in 1 J.A. 49-50. The Downers acknowledged that they were "happy" with Siegel's representation. Id. at 50.

Siegel visited the Downers at their home in early 1997. The purpose of the meeting, according to Siegel, was to "bring them up to date" on the state of their investments. Id. at 188. The parties discussed personal matters, including Huntington Downer's interest in running for governor and Siegel's new radio show on investing. They also discussed World ET, Siegel's application to serve on the company's board, and the Nok-Out product. Siegel gave the Downers a Nok-Out sample to use on their cat's litter box. At some point during this meeting, Huntington Downer expressed an interest in investing with World ET. Siegel advised the Downers that they could not invest until the company went public, but Huntington Downer pressed Siegel to contact the company and inquire about investment opportunities. Siegel subsequently spoke with World ET representatives, who informed him that the Downers could invest $300,000 in World IEQ Technologies, Inc. ("World IEQ"), a purported subsidiary of World ET. Siegel relayed this information to the Downers, who asked Siegel to obtain the documentation necessary for them to invest.

On November 24, 1997, Siegel visited the Downers again, this time bringing documents related to the proposed World IEQ investment. The paperwork included a "Subscription Agreement" and a "Subscriber Prospective Offeree Questionnaire." Siegel did not review these documents prior to delivering them. As he later testified, had he done so, he would have seen that the offering documents were deficient. Both documents referenced an investment in a debenture, which is an unsecured bond. Neither document, however, included any information on interest rates or repayment terms. Moreover, the two documents were inconsistent in the limited investment information they provided. Huntington Downer promptly signed and returned the documents, but Siegel still declined to review the paperwork. He did, however, fax the documents to World ET. Later, on December 1, 1997, Siegel transferred $300,300 from the Downers' Rauscher account to a World IEQ bank account after receiving written authorization from the Downers to do so.

Within two weeks, World ET contacted Siegel to notify him that the World IEQ investment was no longer viable and that the Downers could receive a refund of their initial investment or transfer it to World ET. When Siegel relayed this information to his clients, Huntington Downer sought Siegel's advice on how to proceed. In response to this inquiry, Siegel told Downer: "I would rather be in the mother company if I had a choice." Id. at 251. The Downers subsequently opted to invest in World ET. They never received or signed any new documentation concerning the investment.

In November 1997, Dorothy and Barry Landry opened an account with Siegel at Rauscher. The Landrys had recently sold Ms. Landry's business and were looking to invest. They provided Siegel with $1 million in funds and afforded him significant independent investment discretion. In late 1997, Siegel met with the Landrys to complete the paperwork necessary to open their Rauscher account. At that meeting, Siegel raised the possibility of investing in World ET as "something [the Landrys] might be interested in" and that they should "take a look at." Id. at 123. The Landrys expressed interest, which Siegel relayed to World ET. Officials at World ET then sent along documentation for the Landrys to sign. Siegel delivered the offering documents to the Landrys, but he did not review them. As with the Downers, the documentation was deficient. The papers included a subscription agreement that described the purchase of one debenture "unit" at $100,000, but contained no maturity date for the debenture and no interest rate. World Environmental Technologies, Inc., Subscription Agreement, reprinted in 1 J.A. 313-15.

On Siegel's advice, the Landrys held onto the documents to review them over the next few months before making a final investment decision. On February 5, 1998, the Landrys directed Siegel to transfer $100,000 from their Rauscher account to their joint bank account. Six days later, the Landrys gave the signed documents and a $100,000 check to Siegel, who sent both to World ET. World ET negotiated the check, but the Landrys never received any documentation confirming their investment.

World ET was never approved to be publicly traded. The company made its last payment on the Nok-Out promissory note in October 1998. On August 28, 2002, World ET lost its rights to Nok-Out. On February 13, 2004, the Texas Secretary of State revoked World ET's corporate charter.

Siegel's direct involvement with World ET included signing a resolution authorizing its acquisition of Nok-Out; loaning the company $22,000 on January 14, 1998; entering into an employment agreement on January 27, 1998 to raise a minimum of $15 million for World ET in exchange for cash and company shares; and making an additional loan to the company of $20,166.01 on March 6, 1998. Neither Siegel, the Downers, nor the Landrys ever received any payment from World ET.

C. Disciplinary Proceedings Against Siegel

Broker-dealers who trade in securities are subject to the regulations covering national securities associations. During the events relevant to this case, NASD was a registered national securities association and acted pursuant to quasi-governmental authority to oversee the activities of its members and associated persons. As we explained in National Ass'n of Securities Dealers, Inc. v. SEC, 431 F.3d 803 (D.C. Cir. 2005):

Two provisions of the Exchange Act define NASD's quasi-governmental authority to adjudicate actions against members who are accused of unethical or illegal securities practices and the Commission's oversight of that authority. These are §§ 15A and 19. Section 15A, 15 U.S.C. § 78o-3, lays out the specific duties of a registered national securities association. It sets out disciplinary functions which NASD, as a registered national securities association, must perform. . . . 15 U.S.C. § 78o-3(b)(6). Where NASD members have allegedly violated either association rules or federal securities law, NASD has the authority to consider disciplinary action in the first instance. See 15 U.S.C. § 78o-3(b)(7). If NASD proceeds against a member, it must provide a minimum level of process, including notice of the specific charges and an opportunity to be heard, as well as a statement of subsequent findings. See 15 U.S.C. § 78o-3(h). Fair disciplinary procedures are a prerequisite for registration of a national securities association. 15 U.S.C. § 78o-3(b)(8).

Given the statutory requirements of § 15A, NASD . . . established an elaborate adjudicative arm to address disciplinary actions. . . . Where a complaint has been filed against members for violations of federal securities laws, the adjudication may take place before a NASD Hearing Panel [in NASD's Office of Hearing Officers]. . . . As noted above, Hearing Panel [i.e., OHO panel] decisions may be appealed to NAC, or they may be reviewed by NAC on its own initiative. . . .

Section 19, 15 U.S.C. § 78s, sets out the Commission's supervisory duties over all "self-regulatory organizations." NASD is a "self-regulatory organization" by virtue of the fact that it is a "registered securities association" under § 15A. See 15 U.S.C. § 78c(a)(26) (definition of "self-regulatory organization"). With respect to adjudications, the Commission's oversight begins with the obligation of self-regulatory organizations to notify the Commission of any final disciplinary sanction imposed on a member or associated person. 15 U.S.C. § 78s(d)(1). The statute also provides the Commission with plenary review powers. 15 U.S.C. § 78s(e). Once notified, the Commission may, on its own motion or on the application of any person aggrieved by the association's action, review NASD's disciplinary action. 15 U.S.C. § 78s(d)(2). . . . Section 19(e) authorizes the Commission to make an independent determination as to whether the violations found by the association occurred, and to change NASD's sanctions in whatever ways it deems appropriate. See 15 U.S.C. § 78s(e). The Commission may base its determination on the record compiled by the association, but it is not limited to that record and may adduce additional evidence.

Id. at 805-06.

On November 26, 2002, NASD's Department of Enforcement filed a complaint with NASD's OHO. The complaint alleged that Siegel violated NASD Conduct Rules 3040 and 2110 when he "sold away," i.e., engaged in private securities transactions on behalf of his clients without providing prior written notice to Rauscher, and NASD Conduct Rules 2310 and 2110 when he recommended World ET to his clients without having any reasonable grounds for believing that his recommendations were ...

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