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D.C. Cir. Affirms $310K Penalty Over Broker's Supervisory Violations

Wednesday, November 27, 2013

Nov. 26 -- The U.S. Court of Appeals for the District of Columbia Circuit Nov. 26 affirmed that the Securities and Exchange Commission did not abuse its discretion in penalizing a broker $310,000 for failing to supervise a subordinate who engaged in securities law violations (SEC v. Collins, D.C. Cir., No. 12-1241, 11/26/13).

Senior Judge Stephen F. Williams said the fact that the penalty was more than 100 times the amount the broker disgorged does not render it arbitrary or capricious.

State Restrictions

The court recounted that respondent Matthew Collins started work at Prime Capital Services Inc. in 2001. In due course, Collins was assigned to supervise broker Eric Brown, who sold financial products including variable annuities.

“Signs of lapses in Collins' supervisory responsibilities first appeared in August 2003,” when Florida regulators filed administrative charges against Brown for allegedly guaranteeing certain customers a 6 to 8 percent return on their investments. According to the court, Brown ultimately was stripped of his insurance license, but lied to Collins about the nature of the sanction.

Collins, in turn, “did not investigate; in fact he allowed Brown to continue marketing variable annuities, even after he learned in February 2004 that Florida had revoked Brown's license.” Meanwhile, the state reinstated Brown's license pending resolution of his appeal, on the condition that he not market annuities to persons over 65 who were not currently his clients.

However, the court said, Brown did not comply with the state restriction, For his part, Collins tried to conceal Brown's violations by falsely listing himself as the sales representative.

In particular, the appeals court said, Brown sold variable annuities to five elderly customers during the period his license was restricted, two of whom suffered substantial losses. The two customers complained to NASD, which led to a state investigation. Collins settled the state case by paying a $5,000 fine, and Prime Capital settled the NASD case by paying $125,000, to which Collins contributed $25,000. 

SEC Proceedings

In this case, in June 2009, the SEC instituted proceedings against Brown, Collins, and other Prime Capital employees. Ultimately, the commission found Collins liable on failure to supervise charges.

Unlike the administrative law judge, who found that Collins' misconduct satisfied third-tier criteria, the commission concluded that Collins properly was subject to second-tier penalties (39 SLD, 2/29/12). However, the appeals court said, it treated each of the five relevant sales as distinct, resulting in five penalties totaling $310,000.

The SEC also ordered Collins to disgorge sales commissions in the amount $2,915, but excused disgorgement of the commissions paid by the two customers whose NASD claim Prime Capital settled for $125,000. 

Arbitrary, Capricious

On appeal, Collins claimed the SEC abused its discretion in imposing a $310,000 civil penalty without adequate explanation. He also contended that the penalty was unconstitutional under the Eighth Amendment.

Addressing each argument in turn, the court said the “most serious strand” of Collins' claim that the penalty was arbitrary and capricious is his contention that the penalty marked “an unexplained departure from the Commission's practice of linking the penalty more closely with the disgorgement amount. Here, the civil penalty is over 100 times that amount,” the appeals court observed.

It acknowledged that Collins cited several federal court decisions “with fairly close approximation between penalty and disgorgement amount. However, the appeals court said, Collins “ma[de] no effort to hold constant the many other factors relevant to determining civil penalties.”

Looking only at the disgorgement amount, “the civil penalty here looks high relative to SEC precedents,” the court wrote. Nonetheless, it held that the penalty's relation to disgorgement does not render it arbitrary or capricious.”

First, the court noted, the disgorgement amount imposed directly on Collins understates his full disgorgement obligation. It pointed out that Collins was excused disgorgement of slightly more than $2,000 in commissions because of the $25,000 he contributed to the settlement of the NASD complaint.

“Second,” the appeals court wrote, “disgorgement obviously doesn't fully capture the 'harm' side” of proportionality between the gain or injury and the penalties imposed. “Full indicia of the injury inflicted by Collins and Brown, for example, include the entire $125,000 paid to settle the NASD complaint, of which Collins paid only $25,000.”

Third, the court said, harm to other persons is only one of several specific factors to be considered. The relationship between civil penalty and disgorgement is ”informative,” but “hardly decisive.” The court also noted the commission's conclusion that Collins' violation was “egregious” and that he blatantly failed to deal fairly with elderly, unsophisticated investors.

Finally, the appeals court said its rejection of Collins' claim that the agency's decision was arbitrary and capricious “goes most of the way to compelling rejection of the constitutional claim.” It said Collins cited only two cases in which a penalty was set aside for violating the Eight Amendment, “both featuring extremely large penalties contrasted with minimal harm.” The penalty in this case “does not belong in that small club.” 


Collins was represented by Robert G. Heim, Meyers & Heim LLP, New York (Erik S. Jaffe, Law Office of Erik S. Jaffe, Washington, on the brief).

The SEC was represented by Paul G. Alvarez (Michael A. Conley, Jacob H. Stillman, and Mark Pennington on the brief).

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