• Eleventh Circuit Reverses In Part Securities Fraud Judgment Against Clearing Broker in an Action Brought by the SEC
  • June 20, 2012 | Authors: Taraneh Fard; John P. Stigi
  • Law Firms: Sheppard, Mullin, Richter & Hampton LLP - Los Angeles Office ; Sheppard, Mullin, Richter & Hampton LLP - Los Angeles Office
  • In Securities & Exchange Commission v. Goble, 2012 WL 1918819 (11th Cir. May 29, 2012), the United States Court of Appeals for the Eleventh Circuit held that the recording of a sham transaction in the corporate books did not constitute “securities fraud” in violation of Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. § 78j(b), and Securities & Exchange Commission (“SEC”) Rule 10b-5, 17 C.F.R. § 240.10b-5, because “a misrepresentation that would only influence an individual’s choice of broker-dealers cannot form the basis for § 10(b) securities fraud liability.” In so holding, the Eleventh Circuit declined “the SEC’s invitation to expand [the] definition of materiality” to capture the misrepresentation.

    Richard Goble founded and controlled North American Clearing, Inc. (“North American”), a clearing broker for about forty small brokerage firms which cleared transactions for more than 10,000 customer accounts valued at more than $500 million. During late 2007 and early 2008, North American faced declining revenues, and allegedly struggled to meet its operating expenses and make required contributions to its cash reserve account as required by SEC regulations. Finally, in May 2008, Goble directed the CFO of North American to record a sham transaction — a $5 million money market purchase — to make it appear that North American could withdraw $3.4 million from its cash reserve account. Financial Industry Regulatory Authority, Inc. examiners discovered a discrepancy created by the sham money market purchase and demanded an explanation. An SEC enforcement action followed, charging that North American violated the Customer Protection Rule under Section 15(c)(3) of the Exchange Act, 15 U.S.C. § 78o(c)(3), codified in SEC Rule 15c3-3, 17 C.F.R. § 240.15c3-3, and the Exchange Act’s books and records requirements under Section 17(a) of the Exchange Act, 15 U.S.C. § 78q(a), codified in SEC Rule 17a-3, 17 C.F.R. § 240.17a-3. The SEC also charged Goble with violating Rule 10b-5 (in addition to aiding and abetting the firm’s alleged securities law violations).

    The SEC settled with North American, but not Goble personally. After trial, the United States District Court for the Middle District of Florida held that Goble’s actions concerning the sham money market transaction violated Section 10(b) and Rule 10b-5 (in addition to aiding and abetting the firm’s violations). The district court enjoined Goble from future violations of the securities laws and permanently restrained him from seeking a securities license or engaging in the securities business.

    On appeal, the Eleventh Circuit reversed the district court’s judgment on the Section 10(b) count, upheld the judgment on the aiding and abetting count and remanded for reconsideration of the injunctive relief and the bar.

    The Eleventh Circuit “easily dispatched” the SEC’s allegation that Goble’s recording of a sham transaction was a “material misrepresentation” under the Exchange Act. The Court held that the materiality test focuses on whether a reasonable person would attach “importance” to the fact misrepresented in determining a “course of action.” The Eleventh Circuited noted that it understood this “course of action” to mean an “investment decision — not an individual’s choice of broker-dealers.” Thus, “a misrepresentation that would only influence an individual’s choice of broker-dealers cannot form the basis for a §10(b) securities fraud liability.” The Eleventh Circuit also held that even if Goble had made a “material misrepresentation,” that misrepresentation was not made “in connection with the purchase or sale of securities,” even though it assumed, without deciding, that the money market fund was a security. The Eleventh Circuit also noted that even though the United States Supreme Court has instructed that Section 10(b) be construed “flexibly to effectuate its remedial purposes” (SEC v. Zandford , 535 U.S. 813, 819, (2002)), Goble did not engage in an actual “purchase” of a security for purposes of Section 10(b). Since the only “purchase” was a sham transaction, it was neither a “purchase” nor “the type of fraudulent behavior which was meant to be forbidden by the statute and the rule.”

    This decision reflects than an investor’s choice of broker-dealer is not “material” because it does not relate to an “investment decision.” In so holding, the Eleventh Circuit constricted the reach of Section 10(b) of the Exchange Act and tightened the standards for issuing an injunction, precluding “obey the law” orders which have long been a staple of SEC enforcement.