May 30, 2012
In its Complaint in Securities and Exchange Commission, Plaintiff, v. North American Clearing, Richard L. Goble, Bruce B. Blatman, and Timothy J. Ward, Defendants (MDFL 06-08-cv-829-Orl-35-KRS, May 27, 2011), the SEC alleged that the Defendants had engaged in a fraudulent scheme to conceal North American Clearing's financial crisis and to illegally use customer funds to cover its operating expenses.
- North American: was a Florida corporation engaged in a general securities and clearing brokerage firm that has been registered with the SEC since 1995. Cleared about 40 correspondent brokers and transactions for more than 10,000 customer accounts with a value of more than $500 million.
- Richard L. Goble: North American's founder, sole owner, and a director.
- Bruce B. Blatman: North American's president since May 2007.
- Timothy J. Ward: North American's financial and operations principal ("FINOP") from August 2007 until May 21, 2008,
The Great Recession's Crush
The SEC's Complaint alleged that beginning in 2008, North American began experiencing a severe financial decline largely attributable to the loss of a large client who was struggling with its exposure to collateralized mortgage obligation securities and also to North American's multi-million dollar client losses derived from a pennystock. In response to those financial pressures, North American secured a bank loan using customer securities as collateral, which triggered regulations that required the clearing firm to increase the reserves held in its Exclusive Benefit of Customers Account ("EBOC Account). The SEC charged that in order to keep North American in business, the:
5. [D]efendants repeatedly engaged in fraudulent practices to hide its financial problems and gain access to funds to pay North American's daily business obligations.
6. Specifically, on several occasions in March and April 2008, the Defendants improperly sold customer money market funds and used those customer funds to pay North American's business expenses. Additionally, on May 13,2008, North American manipulated its processing system to overstate net customer money market purchases, which allowed North American to withdraw more than $3 million from the EBOC Account to pay down a portion of its bank loan.
7. On May 21, 2008, North American ceased securities operations because it was unable to make a required $1.4 million deposit before opening for business that day. Although North American still faces this capital deficiency, Goble notified North American's clients the same evening that North American would reopen for business within days, if not sooner. That night, Goble fired the firm's financial and operations principal, Ward, and North American opened again on May 22, 2008.
Defendants Blatman and Ward settled the SEC's charges against them by consenting, without admitting or denying the allegations, to permanent injunctions.
On July 16, 2008, the United States District Court for the Middle District of Florida entered a Judgment of Permanent Injunction and Other Relief against Defendant Timothy J. Ward. The Judgment, entered by consent, provided for a civil penalty and enjoined Ward from violations of Sections 17(a) of the Securities Act of 1933, Sections 10(b), 15(c)(3) and Rules 10b-5 and 15c3-3 of the Securities Exchange Act of 1934. In the Matter of Timothy J. Ward,Respondent (OIP, Securities Exchange Act Of 1934 Release No. 58337 / Administrative Proceeding File No. 3-13124, August 11, 2008), Ward entered into a settlement of the SEC's charges without admitting or denying the allegations. the SEC imposed a Bar from association with any broker or dealer.
On November 13, 2009, a judgment was entered by consent against Blatman, which provided for a civil penalty and permanently enjoined him from future violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; aiding and abetting future violations of Section 15(c)(3) of the Exchange Act and Rule 15c3-3 thereunder; and aiding and abetting future violations of Section 17(a) of the Exchange Act and Rule 17a-3. In the Matter of Bruce Blatman, Respondent (OIP, Securities Exchange Act Of 1934 Release No. 61096 / Administrative Proceeding File No. 3-13702, December 2, 2009) , Blatman entered into a settlement of the SEC's charges without admitting or denying the allegations. The SEC imposed a Bar from association with any broker or dealer.
Goble Goes To Trial
Following a five-day bench trial, Defendant Goble was found liable for committing fraud and aiding and abetting his clearing firm's violations of the Customer Protection Rule and books and records provisions of the Securities Exchange Act of 1934 . The District Court found that Goble and North American's executives made a substantial effort to conceal the firm's financial profits by, among other acts, Goble's direction of a so-called sham transaction by which North American falsely recorded a $5 million money market purchase, which artificially lowered the firm's reserve requirement under the Customer Protection Rule and allowed North American to improperly withdraw more than $3 million from its EBOC Account.
The District Court permanently enjoined Goble from violating Sections 10(b), 15(c)(3), and 17(a) of the Exchange Act and Rules 10b-5, 15c3-3, and 17a-3 thereunder. On its own initiative, the District Court enjoined Goble from attempting to secure any securities licenses or otherwise attempting to engage in the securities business. Goble was ordered to pay a reduced civil penalty amount of $7,500 based, in part, upon consideration that North American had been liquidated in a Securities Investor Protection Corporation bankruptcy proceeding.
On appeal to the 11th Circuit, Goble raised five distinct issues, asking whether:
1. the fake money market purchase in North American's internal books violates § 10(b) and Rule 10b-5;
2. he can be liable for aiding and abetting North American's violations of the Customer Protection Rule and the Exchange Act's books and records requirements if there is no underlying securities fraud;
3. the district court abused its discretion by permanently enjoining him from engaging in the securities business when the SEC did not seek this relief in its complaint;
4. the portions of the injunction restraining him from violating the securities laws are unenforceable "obey-the-law" commands; and
5.the district court should have drawn an adverse inference against the SEC because of the spoliation of evidence.
Was It Fraud?
As to the issue of whether Goble's acts constituted a violation of the federal securities laws anti-fraud provisions, the Circuit Court showed its hand early;
[W]e can easily dispatch the district court's and SEC's theory that the sham transaction would have been material to an investor's choice of broker-dealers. This court has said that "[t]he test for materiality in the securities fraud context is ‘whether a reasonable man would attach importance to the fact misrepresented or omitted in determining his course of action.'"Merch. Capital, LLC, 483 F.3d at 766 (quoting SEC v. Carriba Air, 681 F.2d 1318, 1323 (11th Cir. 1982)). We understand this "course of action" to mean an investment decision-not an individual's choice of broker-dealers . . .
We decline the SEC's invitation to expand our definition of materiality to capture Goble's misrepresentation. We hold that a misrepresentation that would only influence an individual's choice of broker-dealers cannot form the basis for § 10(b) securities fraud liability . . .
Moreover, even if Goble had made a material misrepresentation or omission, the Circuit Court admonished that such misrepresentations were not made "in connection with the purchase or sale of securities." As to the SEC's core allegation concerning the financial shenanigans attendant to the so-called sham transaction, the Circuit Court was similarly dismissive of the legal bases for such a charge:
Nor is the May 13th sham transaction the type of behavior meant to be forbidden by § 10(b). The SEC has labeled Goble's plan to make an improper withdrawal from the Reserve Account as § 10(b) fraud. But, the securities regulations directly implicated by this conduct are the Customer Protection Rule and books and records requirements of the Exchange Act, not § 10(b). Section 10(b) was not intended to protect investors from a broker-dealer's inaccurate records or an inadequate reserve fund. Because Goble's behavior was not the type of conduct meant to be forbidden by § 10(b), this weighs against finding that Goble's fake transaction was a "purchase" under § 10(b).
Furthermore, the alleged "purchase" did not involve a change of ownership, an exchange of value, or a promise to purchase a security. And, recording a fake transaction in North American's books had no effect on the broader securities market and would not impact an investor's decision to purchase a security. In light of all this, we do not consider the May 13th sham transaction to be a purchase within the meaning of § 10(b). . .
In summation, the Circuit Court reversed the District Court's judgment on the securities fraud claims because Goble's misrepresentation was not material and not made in connection with the purchase or sale of securities.
Aiding And Abetting
As to Goble's arguments concerning the Districtr Court's finding that he was guilty of aiding and abetting, the Circuit Court clearly rejects his positions and concurs with the District Court:
There is no question that primary violations of the Customer Protection Rule and the books and records requirements occurred at North American. And, the testimony offered at trial supports the district court's finding that Goble had knowledge of and assisted these primary violations. Ward testified that Goble ordered him to enter the sham money market transaction in North American's books despite Ward's counsel that this would violate the regulations. Goble also directed Ward to complete the interim reserve computation after the sham transaction was on the books. Based on this interim reserve computation, Goble signed a wire transfer request to move money out of the reserve account. These facts clearly show that Goble knew his actions surrounding the May sham money market transaction would violate the books and records requirements and the Customer Protection Rule and that he substantially assisted in the violation of these regulations. The district court did not err by finding him liable for aiding and abetting these violations.
The Circuit Court rejected Goble's spoilation of evidence allegations concerning the SEC's misconduct in allegedly shredding evidence.
In considering the propriety of the District Court's injunction against Goble, the Circuit Court was troubled by the somewhat conclusory language that barred him from the securities industry and restrained and enjoined him from violating cited rules without specifying the actual enjoined conduct:
Section 15(c)(3) of the Exchange Act and Rule 15c3-3. Defendant Goble is PERMANENTLY RESTRAINED AND ENJOINED from directly or indirectly (by use of any means or instrumentality of interstate commerce or of the mails) effecting transactions in, or inducing or attempting to induce the purchase or sale of, securities while in contravention of customer protection Rule 15c3-3, which requires a broker-dealer to maintain a customer reserve account with deposits in the amount computed in accordance with Rule 15c3-3a, in violation of Section 15(c)(3) of the Exchange Act (15 U.S.C. § 78o(c)(3)) and Rule 15c3-3 (17 C.F.R. § 240.17a-3).
Section 17(a) of the Exchange Act and Rule 17a-3. Defendant Goble is PERMANENTLY RESTRAINED AND ENJOINED from directly or indirectly failing to make and keep current accurate books and records relating to the securities business of North American or any securities firm in violation of Section 17(a) of the Exchange Act (15 U.S.C. § 78q(a)) and Rule 17a-3 (17 C.F.R. § 240.17a-3).
Given its reversal of the findings of guilty on the federal antifraud laws, the Circuit Court vacated the portion of the court's injunction restraining Goble from future violations of § 10(b) and Rule 10b-5, which would have left in place only the restraints against violating §§ 15(c)(3) and 17(a) and the accompanying regulations. Further, in reviewing the now eviscerated injunction, the Circuit Court stated that:
Goble correctly identifies these paragraphs as an "obey-the-law" injunction and is rightly skeptical of their validity. As the name implies, an obey-the-law injunction does little more than order the defendant to obey the law. . . [ the Circuit Court] condemn[s] these injunctions because they lack specificity and deprive defendants of the procedural protections that would ordinarily accompany a future charge of a violation of the securities laws . . .
The Circuit Court side stepped the issue of whether the Bar imposed by the District Court was appropriate by noting that since the finding of guilty on the underlying federal securities fraud charges were reversed, Bar would be vacated and that remedy was remanded back to the district court for reconsideration. The Circuit Court remanded with instructions that since the SEC had failed to request a Bar and the remedy was ordered on the District Court's own initiative, Goble should be afforded an opportunity to be heard on the propriety of the Bar.
In A Nutshell
In the Matter of the Securities and Exchange Commission v. Richard L. Goble (US Ct App 11th Cir, No. 11-12059, May 29, 2012), on appeal from the District Court for the Middle District of Florida, the 11th Circuit Court:
- affirmed the District Court's judgment that Goble aided and abetted North American's violations of the Customer Protection Rule and books and records requirements of the Exchange Act;
- reversed the District Court's conclusion that Goble committed securities fraud in violation of § 10(b);
- vacated portions of the District Court's court's injunction that:
- bar Goble from procuring a securities license, engaging in the securities business, or violating § 10(b) or Rule 10b-5, and
- address compliance with §§ 15(c)(3) and 17(a) of the Exchange Act because these paragraphs simply cross-reference the statutes and regulations; and
- remanded to the District Court for consideration in the first instance whether Goble's violations of the Customer Protection Rule and books and records requirements warrant the lifetime bar from the securities business. (The lower court was instructed to afford Goble an opportunity to be heard on the propriety of this relief; and the court should draft an injunction addressing compliance with §§ 15(c)(3) and 17(a) that allows Goble to understand his obligations under the injunction.
Bill Singer's Comment
As noted in an earlier column on this case, there's securities fraud and then there's fraud and then there's just plain old bungling, according to this dramatic decision. Given the swirling rumors around JP Morgan, MF Global, Goldman Sachs, Facebook, Morgan Stanley, and just about every other high-profile company that's had the recent misfortune of being the subject of rumors about alleged regulatory misconduct, this decision will likely be parsed and scrutinized by a lot of high-priced lawyers contemplating the same and similar defenses. This one may well be headed for the Supreme Court. Stay tuned!