Nassar & Co. v. Securities & Exchange Commission 566 F.2d 790

BAZELON, Chief Judge:

Both of these related cases involve an order of the Securities and Exchange Commission, entered February 12, 1976, which revoked the registration of Nassar, Inc. as a broker and dealer in securities, expelled it from membership in the National Association of Securities Dealers, Inc. and barred Mr. Nassar from association with any broker or dealer.1 No. 76-1278 is before us on a petition to review the Com*792mission’s order pursuant to Section 25(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78y(a).2 In No. 76-1536, Nassar appeals from a district court order dismissing for lack of jurisdiction his action which sought to have the Commission’s order declared null and void. Apart from the jurisdictional issue raised by the second case,3 the issues in the two cases are virtually identical. For the reasons expressed below, we vacate the Commission’s order and remand for further consideration.

After a consolidated hearing involving several parties,4 the administrative law judge found that petitioner and the others had “willfully” violated the antifraud provisions of the securities acts in connection with the sale of stock of Interamerican Ltd.5 On review, the Commission affirmed the ALJ’s finding that petitioner had violated these provisions by his participation in a “massive fraud” designed by Interameri-can’s promoter, Hausner. Hausner inflated the price of Interamerican stock by spreading the spurious claim that the company was ready to market an effective oral contraceptive whose “sustained release” feature made it suitable for sale in underdeveloped countries. In furtherance of this scheme, Hausner took pains to convince Nassar of the efficacy and potential profitability of this product.

Nassar’s allegedly unlawful activities occurred in his efforts to sell Interamerican stock to customers of his brokerage firm. Essentially, the Commission found that Nassar’s representations concerning the stock were unduly optimistic, lacked an adequate basis in fact, and were made on the basis of a wholly inadequate investigation. In addition, he was found to have made unwarranted predictions about the price to which the stock might rise. The Commission did not find, however, that Nassar was as culpable as Hausner. Indeed, “[f]or present purposes” the Commission accepted as true Nassar’s claim that he himself had been deceived by Hausner’s representations and had sustained heavy losses on purchases of Interamerican stock. J.A. 8.

After summarizing Nassar’s activities, the Commission found that he had “willfully” violated § 10(b) of the Exchange Act, Commission Rule 10b-5 implementing that section, and § 17(a) of the Securities *793Act. However, the Commission did not explain which activities violated which provision, or whether all of the activities violated both acts. Moreover, the Commission made no findings regarding Nassar’s scienter; indeed, the order contains no discussion of the mental state required to make out violations of these provisions. The Commission did refer to Nassar’s violation as being “willful” and his price quotations as being “reckless,” J.A. 16, but it failed to explain if it was using these terms in a technical or a descriptive sense. Similarly, the reasons for affirming the suspension of Nassar were not explained in detail, the Commission merely noting:

[W]e are unable to take a sanguine view as to the prospect of Nassar’s future honesty. To permit one so prone to irrational euphoria and blatant exaggeration to continue to meddle with other people’s money would be contrary to the public interest. J.A. 22.

These cases ensued. While review was pending, the Supreme Court issued its decision in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). The Court held that a private action for damages will not lie under § 10(b) of the Exchange Act and Commission Rule 10b-5 in the absence of any allegation of “scienter,” which it referred to as intent to deceive, manipulate or defraud. 425 U.S. at 193, 96 S.Ct. 1375.

The only substantive issue presented is whether, after Hochfelder, some form of scienter must be established in an administrative enforcement proceeding under § 10(b) and Rule 10b-5 as well as in a private action.6 Another panel of this court recently addressed this question and concluded that it should be resolved in the first instance by the Commission itself:

The applicability of the Hochfelder decision to enforcement actions brought by the SEC is a question that has not been decided by this court. In addition, we have before us only the views of the attorneys representing the Commission, and not the Commission itself, as to the applicability of the Hochfelder scienter requirement in actions of this type. We emphasize that we intimate no view as to the applicability of the Hochfelder scien-ter requirement to this case. We hold only that the actions of the petitioners must be re-evaluated in light of significant Supreme Court precedents7 rendered since petitioners’ case was decided by the Commission.

Collins Securities Corp. v. SEC, 183 U.S. App.D.C. 301, at 308, 562 F.2d 820, at 827 (1977). In deference to Collins Securities, therefore, we also remand this case to the Commission for reconsideration in light of Hochfelder.

The Commission attempts to distinguish Hochfelder on the ground that the case under review involves a violation of § 17(a). In Hochfelder, the Court recognized that on its face Rule 10b-5 covered behavior in which scienter was absent. Since the language of § 17(a) is virtually the same as that of Rule 10b-5,8 the Commission rea*794sons that an action under § 17(a) will lie even in the absence of an allegation of scienter. Hence, the Commission regards § 17(a) as adequate support for its order. However, the Commission’s order neither indicates which behavior violated § 17(a) nor whether violations of § 17(a) alone would have sufficed to support Nassar’s suspension. Although on remand the Commission may rest on § 17(a) alone, “[the] administrative order [now under review] can be affirmed on appeal only on the grounds on which the Commission relied.” KIRO v. FCC, 178 U.S.App.D.C. 126, 130, 545 F.2d 204, 208 (1976). Because the Commission’s discussion of § 17(a) is not separate from its discussion of § 10(b), we cannot affirm its result on the basis of § 17(a) alone.

Conclusion

We vacate the Commission’s order and remand the case to the Commission for reconsideration in light of this opinion and such further proceedings, if any, it deems appropriate. In connection with the remand, we note that Nassar maintains that the sanction ordered by the Commission is overly severe and hence arbitrary. We need not reach this issue at this time, since on remand the Commission may find no violation or may decide to impose a lesser sanction. However, should the Commission seek to reinstate this penalty it should articulate its reasons for doing so with greater particularity. The discussion in the order is simply too brief to enable this court to determine if the sanction ordered was based on a consideration of all the relevant factors and is in accord with Commission precedent.

The order of the district court in No. 76-1536 is affirmed. The petition for review in No. 76-1278 is granted and that case is remanded to the Commission for further consideration not inconsistent with this opinion.

LEVENTHAL, Circuit Judge,

concurring:

The SEC decision revoking Nassar’s registration issued prior to Ernst. 1 This court remands for reconsideration in the light of Ernst. I agree.

The pertinent consideration is not unrelated to the ruling in Collins Securities Corp. v. SEC, No. 75-2200, 183 U.S.App. D.C. 301, 562 F.2d 820 (1977), that an order revoking such registration must be based on “clear and convincing evidence.” While that question is not involved in this case,2 it identifies the care needed as a condition for revocation.

Even assuming that a scienter is needed for revocation of registration, that does not mean that what is required is the kind of subjective deceit that Ernst held to be required in an action for damages. As the Commission points out, a broker-dealer may be guilty of intentional misconduct if he deliberately commits certain acts even if he doesn’t know they are forbidden by the Act or regulations. In other words, there is no requirement of specific intent that includes a specific element of knowledge of the per*795tinent rule of law.3 A broker-dealer is under an obligation to learn the rule of law.

A difficult question is raised by the statement in the Commission’s opinion that Nas-sar was engaged in grossly reckless conduct4 and in failure to do any reasonable checking of assertions made to him by Hausner (J.A. 120).

Hanly v. SEC, 415 F.2d 589 (2d Cir. 1969), develops that standards for a securities dealer are strict, because, inter alia, “he implicitly represents that he has an adequate basis for the opinion he renders” and “[b]y his recommendation he implies that a reasonable investigation has been made . .” Id. at 596-97. See also Hiller v. SEC, 429 F.2d 856 (2d Cir. 1970).

In Ernst, the court explicitly refrained from deciding whether recklessness might be a basis of scienter for a damages action. 425 U.S. at 194 n. 12, 96 S.Ct. 1375. However, when we come to the SEC’s control over the broker-dealers, we are dealing with a group that is under intense regulatory control and scrutiny. The Commission serves an important public interest in imposing and monitoring its controls. This function often involves evidence that requires sophisticated and sensitive appraisal. As we pointed out in Collins Securities, supra, in explaining why we refrained from the requirement used in deportation eases that the evidence be “unequivocal”—

In the present case we have an administrative agency with a charter for protection of the public, and the function of evaluating with sophisticated sensitivity the conduct of those operating in a regulated industry. Two elements appear relevant to the standard we should impose here: (1) the type case (fraud); (2) the heavy sanction (deprivation of livelihood). Given those elements, typical of many SEC cases, and given the type of circumstantial proof on which the SEC most often must rely, it appears to us that the “clear and convincing evidence” standard is the proper standard here; it will require the SEC to reach a degree of persuasion much higher than “mere preponderance of the evidence,” but still somewhat less than “clear, unequivocal and convincing” or “beyond a reasonable doubt.” We think that the insertion of the word “unequivocal,” used by the Supreme Court in deportation-type cases, *796would require the SEC to meet a standard of proof in alleged market fraud cases which, given the circumstantial nature of the proof almost inevitably necessarily relied upon, would cause the regulatory agency to fail in its proof in any except the most exceptionally blatant case.5

It may be that the SEC will conclude that scienter for purposes of this kind of discipline must include intentional violation of a duty specifically imposed by a Commission rule or regulation, and also, and perhaps necessarily, include conduct amounting to gross recklessness when the Commission has imposed a duty to make a careful check.

The agency’s power to cope with broker-dealer recklessness can be expressed in terms of fraud,6 and even formally structured in fraud on the ground that the broker-dealer makes an implied representation that he has checked,7 which would be false if indeed he has not. But that is not a wholly satisfactory analysis, although it has been used in some instances, for I would suppose that the Commission has the power to discipline a broker-dealer who has not checked as required, even though misrepresentation might be negatived by advising his customers that he has not checked.

The law embraces a finding of fault in omissions, as in failure to perform a duty, and in failure to make a statement where silence is tantamount to concealment.

The concept that recklessness may serve as a surrogate for subjective intent is not new to the law. Indeed even for purposes of defining murder, recklessness may take the place of subjective intent.8

The fact that a further reflection and refinement is called for at this time should not set the Commission back in its objective of furthering the public interest. This is likely an instance where more ground may be covered with a slow start. While the Commission may resist many efforts to clasp Ernst, it can not free itself completely of the Court’s concerns. Refinement of doctrine is not a scruple, it is a necessity. Set in sound perspective, however, Ernst should not impede the Commission’s efforts to protect the public.