SEC ALJ Corrects Dollars And Dates But Not Derision

April 15, 2015

More often than not, a Securities and Exchange Commission's ("SEC's) Administrative Law Judge's ("ALJ's") Initial Decision flies through to finality untouched. If you are a respondent in an SEC matter, however, there may be aspects of an Initial Decision that you think are wrong -- be that the calculation of damages or references to dates and events. There is a sense that once the Initial Decision has left the station that there's not much point in complaining because that train's on its way and gone. As an ALJ's recent Order demonstrates, it may still pay to take a shot at moving for reconsideration.

Manifest Errors In Computing Disgorgement

In the Matter of  Donald J. Anthony, Jr., et. al (SEC Order on Motions To Correct Manifest Errors of Fact in the Initial Decision, Admin Proc. Ruling Rel. 2528; Admin. Proc. File 3-15514 / April 9, 2015), Respondents Chiappone, Lex, Livingston, Mayer, and Rabinovich argued that the ordered amounts of disgorgement wrongly included certain trailing commissions, which were derived from transactions that had occurred before the cited February 1, 2008, date on which alleged misconduct began.

Making A Date

Respondent Guzzetti argued that the ALJ had wrongly asserted that he became a Branch Manager beginning in October 2006 rather than what he deemed the correct date of October 2008.

Deriding Off Into The Sunset

In addition to seeking the revision of the amount of disgorgement awarded against him, Respondent Lex argued that the ALJ had wrongly characterized a Financial Industry Regulatory Authority ("FINRA") Arbitration Panel as having "derided Lex for failing to diversify" a customer's holdings. Lex asserted that it was erroneous for the ALJ to ascribe to the arbitrators the term "derided," which he believed was an unwarranted inference.[Ed: yellow highlighting provided]:

Lex testified that his clients received their interest payments on time and were able to redeem their private placement investments from 2003 through 2007. Tr. 4890-91. Lex sold MS & Co. private offerings into July 2009. Tr. 1583; Div. Ex. 2, Ex. 4k (as attached to Div. Ex. 2). In 2010, FINRA suspended Lex's right to associate with a FINRA member firm; he was suspended for failing to pay an arbitration award owed to his former client Duckkyu Chang (Chang). Tr. 1538-39; Div. Ex. 482 at 10. In December 2009, a FINRA arbitration panel found Lex, along with MS & Co. and Smith, jointly and severally liable for $805,110 in compensatory damages following Chang's customer complaint. Div. Ex. 514; see also Div. Ex. 444. The arbitration panel concluded that there was "some definitive fault by . . . Chang and some fault by . . . Mr. Lex, Mr. David Smith, and [MS & Co.]," and derided Lex for failing to diversify Chang's holdings. Div. Ex. 514 at 3-4.

Page 37 of the Initial Decision. In the Matter of  Donald J. Anthony, Jr., et. al (Initial Decision, Admin. Proc. File 3-15514 / February 25, 2015).

Setting It Right

Following her consideration of the arguments, the ALJ:
  • ordered the Initial Decision amended as follows:
    • Chiappone disgorge $59,471, instead of $103,800;
    • Lex disgorge $169,375, instead of $335,066;
    • Livingston disgorge $700, instead of $1,120;
    • Mayer disgorge $29,518, instead of $34,962;
    • Rabinovich disgorge $109,695, instead of $158,542;

  • amended the start-date for Respondent Guzzetti's role as Branch Manger from October 2006 to October 2008; and

  • rejected the request by Respondent Lex to amend the term "derided."
Bill Singer's Comment

The arbitration referenced by Respondent Lex and in the Initial Decision appears to be In the Matter of the FINRA Arbitration Between Duckkyu Chang et. al, Claimants, v. McGinn, Smith & Co., Inc. et al, Respondents (FINRA Arbitration 08-04924, December 31, 2009), where the arbitrators note, in part [Ed. yellow highlighting provided]:

Dr. Chang and his wife as individuals and Dr. Chang in his role as trustee of Cumberland Pathology pension accounts appear to be intelligent, accomplished people.However, the Arbitration Panel finds no logical carryover from being very experienced at the practice of medicine or music theory or the use of Quicken software programs to account for small-business accounts receivable and accounts payable to any understanding of private placement prospectus.

Furthermore, Mr. Lex seems to be a conscientious broker and insurance salesman who McGinn, Smith & Company as the supervisor of Mr. Lex had necessary procedures and policies in place to carry out its duties to potential customers as they had standard education programs for brokers and Industry-standard supervision procedures for individual broker accounts.

. . .

Dr. Chang and Kee Mann Chang are found to be responsible for the consequences of their own investment decisions after their stating repeatedly verbally and in writing that they had the opportunity to read investment literature and query resources such as Mr. Lex about the risks and rewards of the subject private placement notes.

The fault of Mr. Lex. Mr. Smith, and McGinn. Smith & Company is derived from the over concentration of the Claimants' investments In these private placement notes.While Mr. Lex is certainly not responsible for preventing the Claimants from investing all of their funds into a single instrument, Mr. Lex and McGinn. Smith & Co. through Mr. David Smith [because Mr. David Smith oversaw Mr. Lex as the compliance officer for a large majority of the time period in question] could have just told Dr. Chang and Kee Mann Chang that McGinn. Smith & Co. would not play a part in these disproportionate investment actions as they developed. Mr. Lex and/or McGinn, Smith & Co. could have declined to conduct the sale of any more of these notes once the over-concentration reached a critical mass.

As to some counter-arguments presented to the arbitration Panel, the Panel finds the line of reasoning that these private placement notes were both diversified within each and the five or more notes were separately varied so there was not concentration,to be disingenuous.There are about a dozen or maybe two dozen small to moderately capitalized LLCs within these notes that are all either consumer service companies like residential alarm companies or discretionary-consumer goods companies like swimming pool supply firms or golf club accessory supply firms. A truly diversified portfolio would have some selections of small, mid and large capitalized businesses among the number of business areas such as some greater number of the 98 categories of businesses that Value Line created. Another counterpoint raised in the arbitration hearing with colored "pie-charts" depicting the percentage of the Chang's assets that were invested in these private placements, was that the Respondents concluded that the subject private placement notes were only 40 to 60% of the Claimants' total assets; this statement by the Respondents rings hollow. Of the liquid or near liquid assets Dr. Chang and Kee Mann Chang had, these subject notes were close to 90% of their net worth, and this aspect of the over-concentration is exacerbated by Mr. Lex only knowing a fraction of Dr. Chang's and Kee Mann Chang's total liquid/near liquid assets. . . .

Pages 3 - 4 of the FINRA Arbitration Decision,

In the FINRA Arbitration Decision, the arbitrators describe Lex as professionally conscientious and congenial; however, the arbitrators also found certain concentration arguments to be "disingenuous." Further, the arbitrators found that Lex's knowledge of the clients' assets "exacerbated" certain issues in dispute.  Whether such diverse terms as "conscientious" "congenial" "disingenuous" and "exacerbated" result in a gestalt that exceeds those disparate parts and rises to the level of the FINRA Arbitration Panel deriding Lex's conduct is, at best, debatable. The ALJ is, however, entitled to her opinion and conclusions  -- clearly such conduct is inherent in the role of being a trier-of-fact.

I believe it would have been more appropriate if the ALJ had avoided characterizing the FINRA arbitrators' findings as having "derided" Hobbs. It would seem a sounder approach if the ALJ quoted actual words or phrases critical of Hobbs from the FINRA Arbitration Decision rather than opting to characterize the arbitrators' findings and commentary in the SEC's Initial Decision.  If within the context of her having presided over the SEC's regulatory case involving Hobbs, the ALJ found his conduct to have earned her derision, then perhaps she should have so stated.  

There are times when a particular perspective of a criminal or civil decision is so obvious that it would seem indisputable that it is supportive or derisive. I'm not sure that the FINRA Arbitration Decision in Chang "derides" Hobbs as much as it finds his conduct came up short. You may disagree. I will respect the difference of opinion. I simply note that the ALJ could have easily acceded to Hobbs request by deleting "derided" and substituting something less inferential and more accurate along the lines that:

In finding some of Respondents' over-concentration arguments to be "disingenuous" and  to "ring hollow," the FINRA arbitrators found, for example, that Lex had "exacerbated" the over-concentration in the Changs' account because of his "only knowing a fraction" of their total liquid/near liquid assets.