# Petition — Arthur Lipper Corp. v. Securities & Exchange Commission > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_2407%3A1 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition - **Published:** January 1, 1978 - **Citation:** 434 U.S. 1009 ## Text Supreme Court, U. S, ™ FILEQ .. | AUG 18 1977, MICHAEL RODAK, JR., CLERK ] IN THE preme Court of the United States OctToBER TERM, 1976 \ No. a0 «2735 ARTHUR LIPPER CORPORATION AND ARTHUR Lipper III, Petitioners, v. SECURITIES AND ExcHance CoMmMiIssION, Respondent. PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT JoHN A. DUDLEY SuLLIVAN & WORCESTER 1025 Connecticut Avenue, N.W. Washington, D.C. 20036 Attorney for Petitioners Passs or Brnon S. ADAMS PRINTING, Inc., Wasnineton, D. C. eta. ek ee INDEX TO PETITION Page CD cs Be ceed wane y es 2 gE ed ER Oe ee Ce ee ee 2 ssc cec ceeenbineetnnepans 2 STaTuTE aND Ruue INVOLVED ......... cc cc ccccccees 3 STATEMENT OF THE CASE ...............002. eet eens 3 SuMMARY OF ARGUMENT .......... ee : aed See 8 REaSoNS FOR GRANTING THE WRIT ................--- 9 Ce eee ee es 22 TABLE OF AUTHORITIES CasEs: Gordon v. New York Stock Exchange, 422 U.S. 659 DD ~c\ sh gn can gc aun dhbe Che eaeeeeneaenaees 4 Santa Fe v. Green, —— U.S. —— No. 75-1753, 97 S.Ct. fo Rr rrr rere 9, 16 Ernst € Ernst v. Hochfelder, 425 U.S. 185 (1976) .. 9,12, 14, 15 Sanders v. John Nuveen & Co., —— F.2d —— No. 75-1260 (C.A. 7, April 22, 1977) ............ 9, 15, 19 In re Steadman, [1977-78 Transfer Binder] Fep. Szc. + << 5 ¢ eA ree 12 IN THE Supreme Court of the United States OcToBER TERM, 1976 No. ARTHUR LIPPER CORPORATION AND ARTHUR Lipper III, Petitioners, v. SECURITIES AND EXCHANGE CoMMISSION, Respondent. PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT Petitioners, Arthur Lipper Corporation, an invest- ment banker and a securities brokerage firm which was a member of the New York and other national securi- ties and commodities exchanges, and Arthur Lipper III, its president and principal stockholder, respect- fully pray that a writ of certiorari issue to review a judgment and opinion of the United States Court of Appeals for the Second Circuit. The Court of Appeals (1) affirmed an order of the Securities and Exchange Commission (‘‘SEC’’) that found Petitioners had 2 aided and abetted IOS Ltd., a non-United States in- vestment manager of a group of non-United States investment companies, in arranging brokerage prac- tices which violated Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78(j), and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5, and (2) modified the SEC’s sanction by reducing Petitioners’ permanent expulsion from the securities business to a retroactive 12-month suspension. Petitioners seek a writ of cer- tiorari solely to review (1)—the SEC’s determination that Petitioners aided and abetted violations of Rule 10b-5. OPINIONS BELOW The opinion of the Court of Appeals (App 1a) °* is reported at 547 F.2d 171. The opinion of the SEC (App 29a) is unreported. JURISDICTION The judgment of the Court of Appeals was entered on December 10, 1976, a timely petition for rehearing filed by the SEC was denied on March 22, 1977. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). QUESTIONS PRESENTED 1. Whether a securities broker can be found by the SEC to be an aider and abettor in a deception vio- lative of the SEC’s Rule 10b-5 where the broker, in good faith and upon advice of qualified counsel, exe- cuted securities transactions in compliance with in- structions of the broker’s institutional customers (such *“* App-——’”’ refers to pages of the appendix of Petitioners. 3 instructions being customary and in accord with pre- vailing securities industry practices) without deter- mining whether the institutional customers and their investment manager had abided by their fiduciary responsibilities. 2. Whether the SEC can export to and impose in foreign lands its interpretation of American legal concepts of a “gross breach of fiduciary duty” (App 41a) so that Rule 10b-5 duties are imposed upon rela- tionships between foreign investment managers and foreign investment companies and their shareholders. 3. Whether due process is denied where the SEC is not required to shoulder the burden of introducing evidence in an administrative proceeding charging Pe- titioners with manipulative and deceptive practices. STATUTE AND RULE INVOLVED Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. 78(j), and Rule 10b-5 thereunder, 17 C.F.R. 240.10b-5, are set forth in the Appendix, p. 74a. STATEMENT OF THE CASE This case is a further chapter in the SEC’s continu- ous attempts, with the support of the Second Circuit courts, to expand a rule of law of the SEC’s own crea- tion, namely Rule 10b-5. The expansion of Rule 10b-5 in this case is twofold: (1) for the first time a securi- ties broker is required (at the risk of being found an aider and abettor) to determine whether its unaffili- ated institutional customers and the customers’ invest- ment manager are engaging in a breach of trust and (2) novel American concepts of fiduciary duties are 4 imposed wholesale to corporations incorporated and conducting business outside the United States. Petitioners were found to have been secondarily lia- ble as “aiders and abettors”’. The primary violator was said to have breached its fiduciary duty. The fiduciary was IOS Ltd., a Swiss-based, Panama incorporated investment manager of a group of foreign mutual funds, namely The Fund of Funds Ltd., and Regent Fund Ltd., two Canadian investment companies, and IIT, an investment company organized as a Luxem- bourg Trust. The cestui que are the shareholders of those foreign funds. The breach of trus. involved brokerage arrange- ments existing between the foreign investment com- panies and Petitioner Arthur Lipper Corporaticn, an American securities firm which was a member of the New York Stock Exchange (“NYSE”’), other national stock exchanges and the National Association of Se- curities Dealers (“NASD”).* Arthur Lipper Corpora- tion was conducting an institutional brokerage busi- s during a period of extended controversy among the NYSE. institutional investors and the SEC. The controversy involved such fundamental questions as justification for the very existence of the NYSE and, of particular relevance here, the amount and manner in which its members were compensated.’ The institutional brokerage practices challenged here by the SEC were the methods whereby members of the NYSE, who were acting as brokers in executing 2 The NASD is the self-regulatory association organized under Section 15A(a) of the Securities Exchange Act of 1934, 15 U.S.C. 780-3. * See Gordon v. New York Stock Exchange, 422 U.S. 659 (1975). ~ ee rae ee ee oe PLS Sole a ee 5 transactions, were permitted to share, at their cus- tomers’ direction, commissions with other members of the brokerage community, provided none of the com- mission dollars were shared with members’ customers, t.e., so-called give-up practices. During the period in question, 1967-1968, it is uncontested that give-up ar- rangements pervaded the entire securities industry. These years as the court below noted: - . . were years of considerable uncertainty as to the climate concerning give-ups; the Commission was torn between its desire to move away from uniform fixed commission rates, a movement which would eliminate the economic basis for cus- tomer-directed give-ups, and its belief that exist- ing give-up opportunities should be utilized by investment advisers for the benefit of shareholders in mutual funds. (App 24a) The salient facts are few and, for the most part, never in dispute. Arthur Lipper Corporation was or- ganized by Arthur Lipper III to engage in an institu- tional securities brokerage business. As a result of a 1967 settlement negotiated with the SEC, the IOS for- eign investment companies were required to execute transactions either through a foreign broker or through a U.S. broker with a foreign branch office. Arthur Lipper Corporation was organized with its principal office in New York City, became a member of the NYSE, other national securities exchanges and the NASD and opened branch offices in London and Geneva. An elaborate communications network was installed between the branch offices and New York. The IOS foreign investment companies became cus- tomers of Arthur Lipper Corporation. They were able to execute efficiently transactions in the United States 6 securities markets through the communications net- work. This communications network was also used by the IOS group to issue and receive instructions through Arthur Lipper Corporation to numerous other brokerage firms executing transactions at IOS’ direction. In accordance with the customary securities indus- try practices at the time, the foreign investment com- panies issued written instructions ordering Arthur Lipper Corporation and the other brokers to share commissions on transactions both executed on the na- tional securities exchanges and in the over-the-counter market. As is the custom for NYSE member firms exe- cuting agency transactions in the over-the-counter market, Arthur Lipper Corporation at all times charged only the NYSE mandated minimum commis- sion rate. Pursuant to the written instructions of the foreign investment companies Arthur Lipper Corporation shared over-the-counter commissions with Investors Planning Corporation (“IPC’’), a broker which was an 80% owned subsidiary of IOS. IPC was registered with the SEC and was a member of the NASD. The record shows that other brokers which were members of the NYSE received the same instructions from the foreign investment companies as those received by Arthur Lipper Corporation and shared commissions on over-the-counter transactions with IPC.‘ Arthur *The record demonstrates that the following brokers followed in- structions of the IOS related funds and ,like Arthur Lipper Corpo- ration, shared commissions with IPC on over-the-counter transac- tions: Ladenberg, Thalmann & Company; Glore, Forgan & Staats, Inc; Adams & Peck; Bear, Stearns; Emmanuel Deetjen & Co; Jessup & Lamont; Drexel, Harriman & Ripley ; George Robinson & Co; Baker, Weeks & Co.; Hertz, Warner & Co; Hertzfeld & Stern; and White, Weld & Co. The NYSE was aware of the practice fol- J fined. Write stern snisrcacnre Ces Ge Te en 7 Lipper Corporation and the other brokers were per- mitted to share over-the-counter commissions with IPC because IPC and the firms executing the transac- tions were all members of the NASD. During the period in question approximately $2.6 million in com- missions were shared between Arthur Lipper Corpora- tion and IPC, with the latter firm receiving approxi- mately $1.4 million. The SEC charged that IOS breached its fiduciary duty to the foreign investment companies by causing those foreign investment companies to direct Arthur Lipper Corporation to share over-the-counter commis- sions with a subsidiary of IOS. In its opinion the SEC found that IOS and Petitioners should have negoti- ated a 50% reduction in the customary NYSE com- mission rate charged by Arthur Lipper Corporation. Failure to negotiate this 50% reduction was a “‘gross breach of fiduciary duty” by IOS which Petitioners aided and abetted. (App 41a) The SEC expelled Pe- titioners permanently from the securities industry. (App 72a)° The Court of Appeals ignored the SEC’s theory that Arthur Lipper Corporation and IOS were required to negotiate a 50% reduction in NYSE commission rates. Judge Friendly, writing for the Court of Appeals, re- jected the SEC’s conclusion that over-the-counter com- mission sharing was per se fraudulent. However, relying on precedents in several Second Circuit de- lowsd by its members of sharing over-the-counter commissions with NASD members, and did not disapprove of the practice. There is no evidence in the record that any firm, exchange or self-regulatory body considered the practice improper. *The Administrative Law Judge had suspended Arthur Lipper Corporation only from over-the-counter trading for twelve months and Mr. Lipper from the securities industry for the same period. 8 cisions which have superimposed the common law of fiduciaries upon the SEC’s Rule 10b-5, Judge Friendly opined that IOS should have returned the shared commissions to the foreign investment compan- ies or reduced the advisory fee IOS charged the for- eign investment companies by the amount of broker- age commissions that IOS was able to recapture through its subsidiary, IPC. Since the SEC had pro- ceeded under another theory, no evidence was intro- duced in the administrative proceeding to establish whether or not the shareholders benefited from the commission sharing with IPC. In December 1976 the Court of Appeals reduced the permanent sanctions imposed by the SEC to twelve month suspensions of Petitioners from the securities business; the suspensions ran from the date of the SEC’s order, October 24, 1975. (App 72a) SUMMARY OF ARGUMENT The SEC instituted these proceedings in September 1969; its decision over six years later concluded that Petitioners should have negotiated a 50% reduced commission.’ The Court of Appeals disagreed and con- cluded that Petitioners made the proper commission charge but since IOS did not reduce its advisory fee, Petitioners aided and abetted IOS in its wrongdoing. On the other hand, if IOS had reduced its advisory fee, Petitioners conduct, which was exactly the same * Three of the six years involved an unexplainable lapse between the date oral argument was held before the SEC Commissioners and the date on which the decision was entered. The length of time dur- ing which the SEC Commissioners had the matter under advisement suggests that the issues, which were wholly legal in nature, were not readily ascertainable, even for the most sophisticated legal minds knowledgeable and trained in securities law. ; 4 ; 9 in either event, would have been laudable. It seems apparent that Petitioners should not be placed in peril contingent upon the actions of IOS, over which Peti- tioners had neither control nor influence. This is the issue which neither the SEC nor the court below faced. The Court of Appeals sought to “soften the blow” by reducing the SEC’s sanction and making the sus- pension retroactive. However, Petitioners are indelibly stained with a finding that they participated in a fraud—a finding which has an irrevocable effect on Petitioners’ reputation in an industry where reputa- tion is crucial. REASONS FOR GRANTING THE WRIT I. The Decision Below Is In Conflict With The Decisions Of This Court In Sania Fe v. Green, —— U.S. —— No. 75-1753, 97 S.Ct. 1293 (March 23, 1977), and Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976): It Aiso Conflicts With The Holding Of Sanders v. John Nuveen & Co., —— F.2d —— No. 75-1260 (C.A. 7, April 22, 1977). A. Santa Fe v. Green The decision below failed to consider the express language in Section 10(b) of the Securities Exchange Act of 1934 (“Act”) and, instead, relied on the Second Circuit’s ‘‘gloss” coated on Rule 10b-5 over the years. Section 10(b) of the Act authorizes the SEC to adopt rules outlawing manipulative or deceptive practices. The Court of Appeals simply accepted the SEC’s as- sumption that any breach of fiduciary duty constitutes fraudulent conduct in violation of Rule 10b-5. This Court, however, in the Santa Fe case held that conduct must be manipulative or deceptive to violate Rule 10b-5. This Court said (— U.S. —, slip op. at 10): 10 The language of §10(b) gives no indication that Congress meant to prohibit any conduct not involving manipulation or deception. Nor have we been cited to any evidence in the legislative his- tory that would support a departure from the lan- guage of the statute. ... Thus the claim of fraud and fiduciary breach in this complaint states a cause of «ction under any part of Rule 10b-5 only if the conduct allegead can be fairly viewed as ‘manipulative or deceptive’ within the meaning of the statute. The Petitioners’ conduct which the Court of Appeals found fraudulent was Arthur Lipper Corporation’s following written instructions from its customers to share over-the-counter commissions. But there was nothing unusual about such instructions. At that time institutional customers issued similar instructions to brokers executing their transactions in all markets. As long as the instructions provided for commission shar- ing with another bona fide member of the brokerage community, the executing broker was not acting in- consistent with the various rules of the NYSE and the NASD, the securities self-regulatery agencies. There was no rule of law which required executing brokers to determine whether investment managers and insti- tutional customers were living up to whatever fidu- ciary resposibilities they may have assumed towards shareholders of the institutional customers, particu- larly one, as is the case here, which is unaffiliated with the institutional customer and its investment manager. The gist of the breach of fiduciary duty is Judge Friendly’s belief that LOSS deceived the shareholders of tie foreign investment companies. Thus, it is im- plicit in the decision of the court below that if 10S had made arrangements to disclose in the prospectuses 11 of the foreign investment companies that IOS was receiving compensation in addition to that received for its services in furnishing investment advisory serv- ices, no deception would have existed.’ Although the prospectuses did not contain such disclosure, there is absolutely no evidence that Petitioners in any way joined in or ‘‘aided and abetted”’ the alleged deception. Even under United States fiduciary law, Arthur Lip- per Corporation, as an unaffiliated broker acting as agent for an investment company in executing transac- tions in the securities markets, has no obligation to police its customers’ activities to ascertain whether its customers and their fiduciaries have abided by their responsibilities. It is vitally important to understand, as conceded by the court below, that the give-up instructions were not fraudulent per se. This finding is, of course, at odds with the decision of the SEC. However, the Court of Appeals was faced with an evidentiary record, con- veniently ignored by the SEC, establishing that Arthur Lipper Corporation did precisely what was done by all other members of the NYSE. Accordingly, the Court of Appeals found unacceptable the SEC’s theory that Arthur Lipper Corporation and IOS could have negotiated a 50% reduction in the commission rate. There simply was no evidence that such negotia- tion could or ever did occur in the securities industry. Since IOS’ conduct was not fraudulent per se and since the only possible deception involved relationships between IOS, its foreign investment companies and their shareholders, Petitioners’ conduct cannot be vio- ’ This is wholly apart from the question discussed, infra, whether the SEC may expand Rule 10b-5 to apply to fiduciary relationships outside the United States. 12 lative of Rule 10b-5—clearly Petitioners played no ac- tive part in any alleged “deception’’. To the extent that the court below snared Petitioners in this Rule 10b-5 web, the decision conflicts with this Court’s hold- ing in Santa Fe. B. Ernst & Ernst v. Hochfelder In the recent Hochfelder case this Court held that scienter i.e., an intent to deceive, manipulate or de- fraud, was a necessary element in a violation of Sec- tion 10(b) and Rule 10b-5. Following a comprehensive review of the legislative and administra.ive history of the section and rule this Court stated (425 U.S. at 206) that “there is no indication that Congress in- tended anyone to be made liable for such [illicit] prac- tices unless he acted other than in good faith”. Hoch- felder involved a suit for damages under Rule 10b-5 in which this Court refused to hold an accounting firm liable in the absence of evidence of a fraudulent intent or at least reckless conduct. The court below indicated (App 15a) that it was assuming that the same element of scienter, which this Court found in Hochfelder was necessary to create liabilities for damages under Rule 10b-5, governs SEC administrative proceedings to revoke a broker’s li- eense.® The court below concluded, however, that in ® However, the validity of this assumption has been questioned by a recent decision of the SEC, In Re Steadman, [1977-78 Trans- fer Binder] FED. SEC. L. REP. (CCH) { 81,243. In that case, the SEC indicated that the scienter requirement of Hochfelder was inapplicable to SEC administrative proceedings involving Rule 10b-5, SEAR No. 13695, p. 17. In Hochfelder this Court left open the question of the necessity of the scienter requirement under Rule 10b-5 in actions other than an action for damages, 425 U.S. 13 charging the full NYSE commission rates on over-the- counter transactions and in rebating half of the com- missions to a subsidiary of IOS which retained the commissions paid to it, Petitioners’ conduct consti- tuted a “cunning device”. (App 19a) This was so, Judge Friendly wrote, because these commission pay- ments ‘“‘should have been turned over to the funds directly or applied to reduce the advisory fee”. (App 19a) No citation of authority accompanies these state- ments; for there is no rule of law, even United States fiduciary law, which necessarily required this result. No evidentiary record supports this finding. In fact, the IOS foreign investment companies experienced higher operating expenses than U.S. investment com- panies, although the fees charged were comparable. In any event, the executing broker’s responsibility to his customers ended when the broker carried out the cus- tomer’s instructions to share the commission with an- other broker. The apparent requirement by the Court of Appeals, that the executing broker second-guess his customer’s instructions, is unprecedented. Indeed, it is ironic that the Court of Appeals failed to discuss a proposed rule which the SEC had circu- lated for comment in early 1968.° The SEC’s proposed Rule 10b-10 would have been adopted under Section 10(b) of the Securities Exchange Act and would have achieved precisely the result suggested by the court below, t.e., an investment adviser which recaptures 193, N. 12. As evidenced by the Steadman decision, whether the SEC is bound by Hochfelder in its administrative proceedings, in- volves an important, current question of federal law, present in this case, which should be resolved by this Court. * Proposed Rule 10b-10, Securities Exchange Act of 1934 Release No. 34-8239, 33 Fed. Reg. 2393 (1968). 14 commissions through give-up practices would have been required under proposed Rule 10b-10 to offset the amount of commissions recaptured against the advi- sory fee charged. Nothing in the release which accom- panied the proposed rule, however, even suggests that the executing broker over whom the SEC has broad regulatory power, owed a responsibility to make cer- tain that the recipient of the shared commission did, in fact, return it indirectly to the customer. Moreover, Rule 10b-10 was not adopted. The NYSE banned all forms of give-up practices in December 1968. Obvi- ously, the SEC did not then believe that Rule 10b-5 banned give-up practices that did not result in the investment advisory fee offset; otherwise, the SEC would not have felt the need to propose a rule such as Rule 10b-10. In a real sense, the court below has promulgated the long-departed proposed Rule 10b-10 under an expan- sive “interpretation’’ of Rule 10b-5 and applied it ez post facto to Petitioners. In addition, in considering this Court’s decision in Hochfelder, the Court of Appeals concluded that ad- vice of counsel was not relevant in determining whether a violation of Rule 10b-5 occurred; advice of counsel was only relevant to the question of penalty. We dis- agree and contend that such a result runs counter to Hochfelder. Where a broker seeks out competent counsel to advise it concerning an extremely in- tricate area of the securities law, and such counsel determines that the broker may follow the prevailing industry practice until such time as the SEC makes it unlawful by rule, such conduct is highly relevant to whether the broker intended to engage in fraudulent conduct. In faet, the Court of Appeals ultimately 15 agreed that the advice rendered by counsel was cor- rect, at least to the extent that the SEC was wrong in saying that over-the-counter give-ups were fraudulent per se. Even though the SEC did not reach the ques- tion of counsel’s independence, the Court of Appeals rejected Petitioners’ reliance on advice of counsel on the grounds that this same counsel had represented IOS in other matters. The court never explains, how- ever, why this element should redound to the detri- ment of Petitioners or why their reliance on the ad- vice is evidence of a fraudulent intent on their part. A review of the evidentiary record establishes that Petitioners acted in good faith on the advice of well- qualified ** counsel and in accordance with then existing securities industry practices. The record shows, there- fore, that Petitioners did not intend to deceive, manip- ulate or defraud and the decision below conflicts with Hochfelder in this regard. C. Sanders v. John Nuveen & Co. John Nuveen involved a Rule 10b-5 class action suit by purchasers of short term commercial paper against a brokerage firm acting as underwriter of the commer- cial paper. This Court granted the broker’s petition for certiorari, vacated the order of the Court of Ap- peals affirming judgment against the broker and re- manded the case in the light of Hochfelder, 425 U.S. 185 (1976). On remand, the Court of Appeals for the Seventh Circuit found “the record is barren of any showing of actual intent to deceive, manipulate or de- fraud” (slip op. at 3); therefore the Court of Appeals *° Petitioners’ counsel! had served as a director of the SEC s divi- sion charged with the regulation of investment companies, as well as serving as the SEC’s Genera] Counsel. 16 held that the judgment could not rest on a violation of Rule 10b-5. The trial court had found that the broker’s investigation of the issuer was deficient and that an appropriate investigation would have revealed the is- suer’s fraud. The Court of Appeals held that, never- theless, the broker’s conduct was not reckless; at least to the extent such conduct rose to the level of ‘‘a lesser form of intent” (slip op. at 4) and hence the equiv- alent of scienter required for a Rule 10b-5 violation. The decisior. of the Court of Appeals for the Second Cireuit conflicts with this holding. The standard ap- plied by the court below was that Petitioners knew what they were doing 1.e., they knew they were sharing commissions with a broker who performed no services in return for those commissions. But the industry practice at that time was exactly that—executing brokers always followed their customer’s instructions to share commissions with other brokers. No one ever suggested that it was the executing broker’s duty to determine whether the broker receiving the shared commissions could lawfully receive them. The SEC never suggested that an unaffiliated executing broker had such a duty. Because of the N YSE’s fixed commis- sion rate structure (which Petitioners deplored, but to which they were irrevocably bound), it certainly was not negligent or reckless on Petitioners part to follow their customers’ instructions. Il. The Decision Below Expands Rule 10b-5 Fiduciary Concepts To Persons Operating Outside The United States. The Court of Appeals found that Petitioners’ juris- dictional arguments ignored the fact “that the fraud charged by the SEC was perpetrated in the United States by payments from one registered broker-dealer — 17 (Lipper Corp.) to another (IPC) in connection with the purchase and sale of securities in the United States over-the-counter market”. (App 13a) Peti- tioners did not ignore this; the Court of Appeals sim- ply engaged in the expediency of misstating a liti- gant’s argument. Keeping in mind that Section 10(b) of the Act requires a deception as a necessary element in a violation,” it is quite clear that the only persons who could possibly have been deceived were the share- holders of the foreign investment companies. The give- up instructions, it is recalled, were issued by author- ized representatives of the foreign investment com- panies. Therefore, Arthur Lipper Corporation’s cus- tomers were not deceived. Petitioners have been unable to discover the origin of the rule of law relied on by the Court of Appeals which imposes an obligation on the part of the mana- ger of foreign investment companies to tell sharehold- ers that additional compensation was being paid to it through shared brokerage commissions. First, one would assume that shareholders in a Ca- nadian investment company and a Luxembourg trust would not be governed by the common law fiduciary standards engrafted upon Rule 10b-5 by the SEC, with the aid and assistance of the Second Circuit. We cer- tainly believe that a citizen of Hong Kong who bought shares in the Luxembourg trust would be surprised to discover that the United States federal securities laws were applicable to his purchase of interests in the trust. Second, and most important, Petitioners’ juris- dictional argument, which the Court of Appeals mis- stated and hence avoided, is as follows: any deception '' See Santa Fe, supra. 18 in this factual context had to be related to the pur- chase of the securities issued by the foreign invest- ment companies. In other words, the real charge, which neither the SEC nor the court below articulated, is that the prospectuses of the foreign investment com- panies did not disclose tc prospective investors resid- ing outside the United States (and ultimately to the shareholders of the investment companies) that IOS was receiving compensation in addition to the com- pensation received in its capacity as investment adviser. Once this concept is accepted, it becomes readily clear that a necessary element is missing for a violation of Section 10(b) and Rule 10b-5. In connection with the purchase or sale of the securities of the foreign invest- ment companies there was no “use of any means or instrumentality of interstate commerce or of the mails, or of any facility of any national securities exchange” as is required by the express language of the Section and Rule. The U.S. jurisdictional means were not used in con- nection with the sale of the shares of the foreign in- vestment companies. The fact that the U.S. jurisdic- tional means were used in the purchase and sale of the portfolio securities of the foreign investment compan- ies is immaterial since no ‘‘deception” occurred with respect to the purchase and sale of the portfolio secur- ities. The alleged ‘‘deception’’ could only have oc- curred outside the United States in the offer and sale of the shares of the foreign investment companies; as the record of this case makes clear, a necessary ele- ment for a Rule 10b-5 violation is missing with respect to the shares issued by the foreign investment com- panies to their shareholders, namely use of U.S. juris- dictional means. 19 Both the SEC and the court below refused to ad- dress Petitioners’ contention ; and in avoiding it, were able to expand Rule 10b-5 to foreign jurisdictions. Moreover, as the evidentiary record shows, it was the acceptable and customary practice in Europe for an investment manager or banker, such as IOS, to charge an additional commission for the placing of orders with United States brokerage firms. Hence, consistent with this established practice, IOS would have been justified in charging a commission in addi- tion to the compensation it received as investment adviser. While this institutional practice may not be either customary or even permitted in the United States under national securities exchange regulations or the federal securities laws, such evidence demon- strates that IOS may not have engaged in a “decep- tion” of its shareholders. Ill. Petitioners Were Denied Due Process By The SEC Although it rejected the SEC’s “fraud per se” rule, the court below compounded the SEC’s denial of due process: it too ignored the evidentiary record. Because the SEC was convinced that commission sharing in the over-the-counter markets was inherently fraudulent in violation of Rule 10b-5, the SEC did not require its staff to develop an administrative evidentiary record which included any evidence that Petitioners had an intent to defraud. Indeed, the evidence clearly estab- lished that Petitioners did not intend to deceive any- one. Proof of scienter, a prerequisite for a violation of Rule 10b-5, (See Sanders v. John Nuveen & Co. supra, slip op. at 9) is absent from the record of this case. Petitioners introduced convincing evidence, com- pletely ignored by the SEC, that Arthur Lipper Cor- 20 poration did precisely what was done by all other members of the NYSE, that is: (1) members charged the NYSE commission rates in executing agency transactions in the over- the-counter market ; (2) this practice was in fact a requirement of the NYSE in order to prevent commission rate-cut- ting in the over-the-counter market for the same customer with whom the member was doing NYSE business ; (3) members readily shared commissions at a cus- tomer’s direction both on NYSE and over-the- counter transactions ; (4) the sharing of commissions on over-the-counter transactions was permissible with other mem- bers of the NASD and (5) the foreign investment companies received best execution of securities transactions through Arthur Lipper Corporation. The SEC had hoped that statements it had made in various studies and in a SEC staff letter would be acceptable proof of fraud. The statements announced simply that give-ups in the over-the-counter market were fraudulent because the commission rates in that market were negotiable. Although the court below re- jected such “proof”, Judge Friendly simply formu- lated a new theory: IOS should have returned the commissions to the foreign investment companies. Since this was not the SEC’s theory at the administra- tive trial, no evidence supports Judge Friendly’s speculation. 21 A fatal blow to Judge Friendly’s theory would be evidence that during this period the NYSE would have sought to revoke Petitioners’ membership in the NYSE for participating in a rebate arrangement to the customers of the brokerage firm—the foreign in- vestment companies. While neither Judge Friendly nor the SEC were overly concerned with the NYSE rules and regulations, Petitioners were in a different boat. However convoluted the NYSE interpretations may seem in hindsight (and Petitioners agree the whole commission rate structure of the NYSE was an odious relic of bygone days), nevertheless it is clear that: (1) Arthur Lipper III was a businessman de- pendent for his livelihood on adhering to those rules and interpretations of the NYSE which governed his brokerage arrangements and (2) IOS’ return of the commission dollars to the foreign investment com- panies would have been an unquestioned rebate Secondly, IOS did perform research and sales serv- ices for the foreign investment companies. The court below specifically stated that shared commissions could be used to pay for these services. (App 10a) Thirdly, Petitioners sought out the advice of an experienced and competent securities counsel—hardly the course of action of one bent on participating in a ‘cunning device”. Fourthly, the commission sharing payments were re- corded methodically and openly on the books and rec- ords of Arthur Lipper Corporation—books and rec- ords which are readily available for inspection at any- time without the necessity for a subpoena by the SEC, the NYSE and the NASD. One would suspect that a knowing participant in a “cunning device” would be less circumspect. 22 It has shocked the SEC to learn that “scienter” is to be a requirement of its own creation—Rule 10b-5. To require the SEC to actually introduce evidence that someone trapped in its administrative web intended to deceive the other party to the transaction will un- doubtedly precipitate the predictable anguished cries of budgetary shortcomings and a lessening of investor protections. The irony here, of course, is the inordi- nate amount of SEC time and money spent on protect- ing shareholders of foreign lands. In any event, Peti- tioners are U.S. citizens and, as such, are entitled to the constitutional protections of due process contained within Amendment V of the U.S. Constitution. The SEC has simply not met its burden of proof by intro- ducing evidence of deception and, by its failure, has denied Petitioners due process of law. CONCLUSION A businessman who follows in good faith the advice of well-qualified counsel and adheres to industry prae- tice should not be accused of aiding and abetting viola- tions of Rule 10b-5. It took the SEC and the court below seven years to define IOS’ wrongdoing and they disagreed. Petitioners’ involvement was completely in accordance with then existing business practices. The conduct attacked by the SEC was prevalent in the securities industry for a long period of time. Then, early in 1968, the SEC circulated for comment pro- posed Rule 10b-10 to require investment managers to return give-ups to their customers. The proposed rule was withdrawn when the NYSE banned all forms of give-ups. This was done because the NYSE did not want to see the development of a practice of invest- 23 ment managers offsetting their advisory fees by the amount of shared commission dollars; such arrange- ments would have been authorized rebates, an unac- ceptable gap in the NYSE fixed minimum commission rate structure. The banning of give-ups was seen by the NYSE as the election of the lesser of two evils. Although give-ups were banned in December 1968, the holding of the court below has far-reaching conse- quences for the brokerage community; the court below has placed undue burdens on relationships between brokers and their unaffiliated institutional customers. Despite the fact that the court’s decision, in effect, permits Petitioners to re-enter the securities business, it did not erase the stain of a Rule 10b-5 violation and the resulting irreparable harm to Petitioners’ reputa- tions in an industry where one’s business reputation is all important. In addition, the debris from the SEC’s action spreads far—even to the extent that the Internal Revenue Service has asserted that the commissions which Arthur Lipper Corporation shared with IPC are not deductible because the payments were illegal rebates. This visits a possible $761,195 tax claim upon Petitioners. This IRS position has immediate and “ar- reaching impact on the numerous highly-publicized eases the SEC is currently conducting against U.S. corporations and their officers who have engaged in allegedly ‘‘illegal’’ commercial and political payments, both domestic and foreign. Accordingly, Petitioners request that the writ of certiorari issue so that Peti- tioners may have an opportunity to be vindicated and ot the unjustified expansion of SEC Rule 10b-5 doctrine may be contained. Respectfully submitted, JOHN A. DUDLEY SULLIVAN & WORCESTER 1025 Connecticut Avenue, N.W. Washington, D.C. 20036 Attorney for Petitioners August 1977 a Sa am hd Mt me eee awit APPENDIX la APPENDIX UNITED STATES COURT OF APPEALS SECOND CIRCUIT Artuur Lipper Corporation and Arthur Lipper If, Petitioners, v. SEcuRITIES AND Excnance Commission, Respondent. No. 165, Docket 76-4067 Argued Oct. 21, 1976 Decided Dec. 10, 1976 Before Frrenpiy, Hays and Mutuiean, Circuit Judges. FRIENDLY, Circuit Judge: This petition to review a disciplinary order of the Se- curities and Exchange Commission (SEC), Securities Ex- change Act Release No. 11773 (Oct. 24, 1975), is the latest chapter in the extensive litigation resulting from the finan- cial debacle of IOS, Ltd., S.A. (IOS) and the off-shore funds for which it was investment adviser and distributor. See Bersch v. Drexel Firestone, Inc., 519 F.2d 974 (2 Cir.), cert. denied, 423 U.S. 1018, 96 S.Ct. 453, 46 L.Ed.2d 389 (1975); 1JT v. Vencap, Ltd., 519 F.2d 1001 (2 Cir, 1975). We deal here with an order under §15 of the Securities and Exchange Act, 15 U.S.C. §780, which revoked the broker-dealer registration of Arthur Lipper Corporation (Lipper Corp.) and barred Arthur Lipper III (Lipper), its principa! owner, from association with any broker or dealer. The order, dated October 24, 1975, was predicated on violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78}(b), and the Commission’s Rule 10b-5, 17 C.F.R. 240.10b-5, during 1967 and 1968. We confirm the decision that a violation occurred but modify the penalty to suspension for a period of 12 months from the effective date of the SEC’s order. 2a I. The Facts and Proceedings Before the SEC The complaint concerns transactions whereby at the di- rection of Edward M. Cowett, executive vice-president and director of IOS, Lipper Corp. turned over to IOS’s 80%- owned subsidiary Investors Planning Corporation (IPC), a registered broker-dealer and a member of the National Association of Securities Dealers, Inc. (NASD), a total of $1,450,000, out of the commissions earned by Lipper Corp. on over-the-counter (OTC) transactions for the account of three off-shore funds for which IOS or one of its affiliates was investment adviser. These were Fund of Funds, Ltd. (FOF), a Canadian corporation which invested chiefly in United States mutual funds and also was the sole owner of another investment company, FOF Proprietary Fund, Ltd. (FOF Prop.) ; International Investment Trust (IIT), organized under the laws of Luxemburg, which invested in companies throughout the world; and Regent Fund Ltd. (Regent), a Canadian investment company with invest- ments in both Canada and the United States. ITT and Re- gent had no American shareholders; FOF had some 3,000 of a total of over 100,000, although the shares so owned had been acquired without any registration of FOF shares under §6 of the Securities Act of 1933, 15 U.S.C. §77f. IOS had itself been a registered broker-dealer with its principal place of business in Geneva, Switzerland. In 1965, it acquired IPC, based in New York, apparently with a view to building up IPC, which had been operating at a loss, as a vehicle of IOS’s American securities business. This plan was shattered and a revamping of IOS’ method of doing business was compelled by a SEC order of May 23, 1967, accepting an offer of settlement of a proceeding it had brought on February 3, 1966 against IOS, Bernard Cornfeld (its organizer), Cowett and others. This order provided, so far as here pertinent, that IOS would with- draw its broker-dealer registration; that IOS, FOF, IIT and any investment company affiliated with any of them bo Pesan. Need an estates? BL EO Mek OR RE RE Al, be LONE ok i At ge SE SO DS nad 3a should conduct no activity subject to the SEC’s jurisdiction except as provided in the order; and, save for qualifica- tions not here material, that within 16 months IOS should dispose of its entire interest in IPC. The effect of the order was to require IOS to devise some method whereby orders for transactions on United States stock exchanges or in the OTC market would have to be placed with exchange or NASD members having offices abroad’ or with foreign broker-dealers who in turn would refer the orders to Amer- ican broker-dealers able to execute them. The order also furnished IOS an incentive to build up the value of its equity in IPC in order to increase the price it could obtain upon the required sale. Anticipating the settlement, Cowett approached Lipper, a partner in the New York Stock Exchange (NYSE) firm of Zuckerman, Smith & Co., to ascertain whether the firm would be interested in opening branch offices in Geneva and London, together with the extensive communications net- work that would be needed for the purpose of serving as coordinating agent for the flow of IOS brokerage trans- actions. The caer partners in Zuckerman, Smith & Co. de- clined the proposal although they were willing to have the firm act as clearing agent if Lipper decided to withdraw and form his own company, which would become a regis- tered broker-dealer and member of NYSE and NASD for the purpose desired by IOS. Lipper indicated his interest to Cowett, and proceeded to make the necessary arrange- ments. His compensation was to be in commissions earned on IOS generated transactions both on and off the ex- changes, as to which his company was to be in a favored position. The Constitution of the New York Stock Exchange re- quired Lipper Corp. to charge the three off-shore funds the fixed commissions then in effect on transactions exe- 1 Petitioners assert and the SEC does not dispute that all such offices were operated by members of the New York Stock Exchange. da cuted on that exchange and forbade any rebates to them. Until December 5, 1968, NYSE allowed customer-directed give-ups on NYSE transactions to other NYSE members. The record is silent how far IOS directed Lipper Corp. to make such give-ups; in any event the SEC makes no com- plaint against Lipper Corp. with respect to NYSE trans- actions. The conduct of which it does complain relates to OTC transactions for the three off-shore funds. As to these also Lipper Corp. charged the commissions provided by the NYSE minimum rate schedule. However, as Lipper anticipated, directions were received from Cowett to give up 50% of these commissions to IPC.? Pursuant to these instructions Lipper Corp., duriug the period from July 10, 1967, to August 5, 1968 remitted to IPC approximately $1,275,000, about 50% of the commissions paid it by FOF Prop., ITT and Regent Fund on OTC transactions.’ In addition, because cash was required for IPC before Sep- tember 30, 1968, in order to meet warranties in a subse- quently aborted contract for the sale of IPC, Cowett, as president of FOF Prop., by letter dated August 14, 1968, requested that, over and above the ‘‘reguiar’’ 50% give- * By letter dated June 29, 1967, Cowett, as president of FOF Prop., directed Lipper Corp. to give up to IPC ‘‘the maximum give- up (50%)’’ on commissions earned on OTC transactions for the account of FOF Prop. On July 11, 1967, as a representative of IIT Management Co., (S.A.), an IOS affiliate, Cowett gave similar writ- ten instructions with respect to OTC transactions for the account of IIT. By letter dated March 15, 1968, Cowett, as vice president of Canadian Fund Management Company Limited, also an IOS affili- ate, confirmed an earlier request for similar give-ups on OTC trans- actions effected on behalf of Regent Fund, Ltd. * The details were: Gross Commissions Give-Ups FOF Prop. $1,974,064 $ 950,821 IIT 636,423 312,175 Regent Fund 28,670 12,521 Total: $2,639,157 $1,275,517 SO ee RO Crs IE Weta iittiniainternitata tintin hb nace 8 a ri ree eee e © Pew ete ene ieee re eer nT ee aa 5a up, Lipper Corp. should make additional give-ups to IPC of $175,000 on or before August 30, 1968, and another $175,000 on or before September 30, 1968. Lipper demurred to the size of the request, telling Cowett that no more than an extra $175,000 should be paid. On August 28, Lipper Corp. sent this extra sum, bringing the total give-ups to IPC to some $1,450,000. The Commission found that neither IOS nor IPC rendered services to the funds in return for these give-ups. No disclosure of the Lipper Corp.-IPC give-ups was made to the shareholders of FOF (the sole owner of FOF Prop.), of IIT or of Regent Fund. No such disclosure was made directly to the directors of IIT or of Regent Fund. Apparently the most nearly complete disclosure occurred at a meeting of the board of directors of FOF held in Acapulco, Mexico, in April 1968, at which Lipper was pres- ent, when Allan F. Conwill, Esq., a director of FOF and counsel for it, IOS, Lipper Corp. and Lipper, informed the FOF directors of the arrangements outlined above; he also advised that Lipper Corp. was in effect required to charge the minimum NYSE commissions for OTC trans- actions; that there was no legal way for Lipper Corp. to refund any part of such commissions to FOF; that the SEC staff took the position that any give-up on OTC business was a fraud per se since there was no fixed rate commission structure on OTC transactions and willingness to give-up a part of the commission showed that the broker would have been willing to take less; but that he considered this position to be unfounded in law. There is no evidence that anyone suggested exploration by outsice counsel of the validity of Mr. Conwill’s view that Lipper Corp. had to charge the minimum NYSE commission on OTC trans- actions or that no way could be found whereby the share- holders of FOF would benefit from give-ups to IPC. Upon these facts and others that will be stated in our discussion, Chief Hearing Examiner, now Administrative Law Judge (ALJ), Blair found on June 11, 1971 that Lip- 6a per Corp. and Lipper had willfully violated and willfully aided and abetted violations of §10(b) of the 1934 Act and Rule i0b-5. Overruling both the assertion of the peti- tioners that no sanctions should be imposed and the staff’s contention that the registration of Lipper Corp. should be cancelled and Lipper should be permanently barred from the securities business, he determined that a suspension of one year from the effective date of the order would be the proper sanction as to both. Lipper and Lipper Corp. and the staff filed petitions for review by the Commission, which heard argument on August 28, 1972. By a decision filed on October 24, 1975, the SEC sustained the ALJ’s con- clusion with respect to violations but directed the drastic remedies of cancellation of Lipper Corp.’s registration and the permanent barring of Lipper from the securities business urged by the staff. Petitioners sought rehearing on the sole basis that three of the four Commissioners who participated in the decision had not been members at the time of argument. The petition for rehearing was denied on January 6, 1976. Securities Exchange Act Re- lease No. 11980. This petition for review followed. II. Liability Sections 15(a)(4) and (6) of the Securities Exchange Act authorize the SEC to suspend for a period not exceed- ing twelve months or to revoke the registration of any broker or dealer or to bar or suspend for a period not exceeding twelve months any person from being associated with a broker or dealer on various grounds. One is willful violation of any provision of the Act or any rule or regu- lation thereunder; another is willful aiding, abetting, coun- seling, commanding, inducing or procuring any such vio- lation. The familiar Rule 10b-5 reads as follows: It shall be unlawful for any person, directly or in- directly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any fa- cility of any national securities exchange, atts tn Paitin Jam areed M0) vb eS oO Te ES eS |e ee ee Ta (a) To employ any device, scheme, or artifice to defraud, (b) Te make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not mis- leading, or (c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person, in connection with the pur- chase or sale of any security. There is some initial surprise in seeing Rule 10b-5 in- voked where the fraud relates not, as in the usual case, to a particular securities transaction but to a course of deal- ing in securities regardless of their identity. However, the language of the Rule is broad enough to include the latter type of case and petitioners do not urge that the Rule has no application to a course of dealing where the fraud concerns the overall relation of broker and customer rather than the overvaluation or undervaluation of a se- curity sold or purchased. We see nothing in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), that would militate against appli- eation of the Rule in a situation like that here before us, though ‘‘the terms ‘purchase’ and ‘sale’ are relevant ve to the question of statutory coverage’’ even in other than private actions, SEC v. National Securities, Inc., 393 U.S. 453, 467 n.9, 89 S.Ct. 564, 572, 21 L.Ed.2d 668 (1969). Portions of the Commission’s decision seem to take the view, which had been the staff’s principal reliance at the hearing and was also stressed in the oral argument of counsel before us, that any give-up of a commission on an OTC transaction is per se a ‘‘device, scheme, or artifice to defraud.’’ In support of this the C.mmission points parti- cularly to two passages in its report of December 2, 1966, 8a on the Public Policy Implications of Investment Company Growth (hereafter PPI), H.R.Rep.No.2337, 89th Cong., 2d Sess. These are: A directed give-up of a portion of the commission charged for handling a transaction for a fund in the over-the-counter market would be a patent waste of investment company assets. Since the over-the-counter market in both listed and unlisted securities is a nego- tiated market, which is not governed by fixed prices or minimum commission rate schedules, any willing- ness of the executing broker or dealer to allow his customer to direct a give-up of a portion of his com- mission or markup to dealers in fund shares in and of itself shows that a lower price or commission could have been negotiated. and In the over-the-counter markets, where brokerage costs are subject to negotiation, give-ups of commissions to brokers who perform no necessary function in con- nection with a transaction have long been recognized as improper and illegal. Give-up practices have been tolerated in the exchange markets only because bro- kerage costs are fixed by the exchange minimum com- mission rate schedules. Id. at 178, 185 (footnote omitted).* * The Commission relies also on a July 18, 1966 letter from Irving M. Pollack, then Director of the Division of Trading and Markets, to the presidents of various stock exchanges and of the NASD. One sentence in the three and one-half pages of single spaced text of the letter, which expressed concern about the give-up problem gen- erally, said: In this connection, we consider it significant that ‘*give-ups’’ in the over-the-counter market have long been recognized to be improper and illegal. Pn anaes Mee 5: Radi bee tag os ARs Menard A dion es Se el eee One es ee er ee See Pe ee. ee ee eee betwee sro ln ‘ 7 j 4 7 9a Insofar as the Commission would attribute legal force to these statements in PPI, we must disagree. While the Report was transmitted to Congress by the Chairman of the Commission pursuant to §14(b) cf the Investment Company Act, it constituted informatio for the legisla- ture, not a rule having the force of law for the indus- try, as would a regulation adopted pursuant to 5 U.S.C. § 553. Indeed, we doubt whether these two passages from a 346 page report would qualify even as an ‘‘interpreta- tive rule’’ or a ‘‘general statement of policy.’’ In saying this we are quite aware of the importance attached to other portions of PPI in Moses v. Burgin, 445 F.2d 369, 383-84 (1 Cir.), cert. denied, 404 U.S. 994, 92 S.Ct. 532, 30 L.Ed.2d 547 (1971), and in Fogel v. Chestnutt, 533 F.2d 731, 734-37, 749 (2 Cir. 1975), cert. denied, —— U.S. —., 97 S.Ct. 77, 50 L.Ed.2d 86 (1976). However, those eases cited PPI as placing the mutual fund industry on notice that the SEC believed there were opportunities for advantaging stockholders that ought to be explored and explained to the disinterested directors, not as having in- dependent legal force. So here we regard the quoted statements from PPI as doing no more than warning the industry what position the Commission would be likely to take with respect to customer-directed give-ups in the OTC market. We are not persuaded that any such all encompassing across-the-board per se principle as stated in PPI would be sustainable in the absence of a Commission rule. It is true that the source of the practice whereby the man- agers of investment companies directed executing brokers Apart from the fact that the letter came from a staff member (albeit a high one) rather than from the Commission, we can hardly regard such an incidental statement, for which no explanation was given, as putting the entire industry on sufficient notice of the Commis- sion’s views. 10a to give »» a part of their commissions to other brokers who furnished services in selling investment company shares and in providing research lay in the inordinate profits a few executing brokers would receive under the fixed commission rate structure prevailing on the ex- changes. See Fogel v. Chestnutt, supra, 533 F.2d at 735- 36. We are not certain, however, that even after PPI, if the manager of an investment company determined that the interests of the company would be served by paying fixed commission rates on OTC business, with customer-directed give-ups to brokers who had furnished sales or research service, and disinterested directors, on full disclosure, had joined with others in a good faith determination that this was in the fund’s best interest, this would have violated Rule 10b-5. At least we would find it difficult to reach such a conclusion on this record, which contains no evidence that commissions on OTC agency business were in fact the subject of negotiation in 1967 or 1968; rather, as the Commission seemingly concedes in its opinion, a purchaser or seller unwilling to pay the fixed commissions generally charged on OTC business, because of the size of the transaction or for other reasons, would deal with a market-maker as a prin- cipal—a course which the 1967 settlement precluded IOS from following unless an American firm with an office outside the United States happened to be a market-maker in the particular issue in which IOS was interested. However, we find it unnecessary to decide whether the extreme position thus far discussed is sustainable. The Commission based its decision primarily on the ground that IOS and its affiliates committed a fraud on the funds by diverting to themselves, through IPC, rebates which belonged to the funds while IPC was doing nothing in return, and that Lipper and his company willfully aided and abetted this. The proposition that it is a fraud on the fund for a manager simply to pocket give-ups which © mA dal pect al a he ent Qe ie? hed PE ie Ie | | : lla he has diverted to himself is almost too clear for argu- ment. While there has been controversy, illustrated by the Moses and Fogel decisions, how far an investment adviser was bound to secure give-ups when these were attainable, there has been and could be no question that if these were obtained, they must be applied for the bene- fit of the fund, either by direct payment or as a reduction in the advisory fees. See statement of then General Coun- sel Loomis, Securities Exchange Act Release No. 8746 (Nov. 10, 1969); Provident Management Corp., 44 SEC 442, 447 (1970). We recognize that both statements came after cessation of the conduct here complained of, but the proposition needed no elucidation. See also Moses v. Burgin, supra, 445 F.2d at 376 n.11. It is no answer for petitioners to contend that they were in no position to police IOS’ exercise of its fiduciary responsibilities; they still were under no obligation to engage in conduct aiding IOS’ fraud on the funds. Starting from this position, we shall consider peti- tioners’ various attacks on the Commission’s conclusions. (1) Petitioners say that, as a practical matter, they were compelled to apply the NYSE minimum rate com- mission schedule on OTC transactions. Conceding that Article XV of the NYSE Constitution applied and legally could apply only to transactions on that exchange, they contend that NYSE looked with suspicion on the charg- ing of lower rates on OTC transactions since such rates, at least if below cost, might operate in practical effect as a rebate of a portion of the commissions charged the same customer on NYSE business. They point to evidence that in fact NYSE would require a member that charged less than NYSE minimum commissions on OTC business to provide cost justification and contend that, as a new member operating a complex and costly trans-Atlantic communications network, it could not have satisfied NYSE 12a that lower commissions on IOS generated OTC transac- tions were cost justified. We need not debate the solidity of the factual basis for the argument. Whatever force petitioners’ contention might or might not have if Lipper Corp. had retained the full commissions on OTC business and the complaint was that this amounted to a gouging of the funds, this was not what occurred. In fact Lipper Corp. did just what it claims NYSE prevented it from doing, namely, conduct OTC business at less than NYSE commission rates. Give- ups to the manager of an investment company on OTC transactions infringed the NYSE policy that members should not compete for business on a price basis as much —or as little—as the charging of lower commissions or give-ups to the investment company itself would have done. As the Commission said: The Lipper respondents claim to have been in fear of disciplinary action by the New York Stock Ex- change. But they have never explained why this fear did not restrain them from giving up to IPC. If the New York Stock Exchange’s rules had been appli- cable to these transactions, they would have prohib- ited commission-splitting with IPC as well as with the funds that paid those commissions. Putting the matter in another way, petitioners’ conduct either violated the spirit of the NYSE Constitution or it did not. If it did, they can derive no comfort from the argument that their acts were compelled by the NYSE Constitution; if it did not, they likewise gain no pro- tection. In any event, no NYSE practice could immunize con- duct assisting investment company managers effectively to pocket give-ups when the funds receive nothing in return. “= 13a (2) Petitioners argue that even though their conduct might have violated Rule 10b-5 if the three funds had been registered investment companies, a different con- clusion is compelled because here the payment of give- ups to the manager was at the expense of off-shore funds, only one of which had American shareholders. The ar- gument ignores that the fraud charged by the SEC was perpetrated in the United States by payments from one registered broker-dealer (Lipper Corp.) to another (IPC) in connection with the purchase and sale of securities in the United States over-the-connter market. We said in IIT v. Vencap, Ltd., supra, 519 F.2d 1017: We do not think Congress intended to allow the United States to be used as a base for manufacturing fraudulent security devices for export, even when these are peddled only to foreigners. Petitioners thus derive no support from so much of the decision in Bersch v. Drexel Firestone, Inc., supra, 519 F.2d at 992, as held that merely preparatory activity or non-feasance in the United States was not sufficient to trigger application of the securities laws in a class action for damages in the absence of effect on Americans. Also, in light of its language and our previous decisions, no- tably Schoenbaum v. Firstbrook, 405 F.2d 200, 207-08 (2 Cir. 1968), modified in other respects, 405 F.2d 215 (en banc), cert. denied, 395 U.S. 906, 89 S.Ct. 1747, 23 L.Ed. 2d 219 (1969), no discussion is needed to demonstrate the inapplicability of 4 30(b) of the Securities Exchange Act, 15 U.S.C. § 78dd(b), which exempts ‘‘any person insofar as he transacts a business in securities without the juris- diction of the United States.’’ Petitioners argue that char- acterizing the transaction as a fraud on the funds may displace otherwise applicable foreign law, since certain countries in which IOS and its affiliates operate would allow the manager of an investment company to receive l4a a commission for placing an order, in addition to the commission payable to the broker executing it. We do not think the result should differ on this account. Presumably the receipt of such commissions would have had to be reported by IOS and would thus have been known to existing shareholders of the funds and to persons soli- cited to buy their shares. Here IOS, through IPC, secretly pocketed the money. Moreover, we see no reason why the United States may not prescribe a rule for conduct within its borders even if another country having an interest might be less rigorous. See Bersch v. Drexel Fire- stone, Inc., supra, 519 F.2d at 985; Restatement of the Foreign Relations Law of the United States $17 (1965). (3) Little need be said in regard to petitioners’ con- tention that the arrangements for the payment of re- bates to IPC were adequately disclosed. Admittedly no disclosure was made directly to the boards of directors of IIT and Regent; the disclosure to the board of FOF was only that the arrangements were proper, with no attempt by independent directors to check this. Petition- ers contend they could not compel disclosure; perhaps not, but here again they were under no obligation to en- gage in conduct that would be fraudulent without it. Moreover, it is not within the competence of a board of directors of an investment company to sanction the per- petration of a fraud by the manager. Cf. Schoenbaum v. Firstbrook, supra, 405 F.2d at 219-20; Drachman v. Har- vey, 453 F.2d 722, 736-38 (2 Cir. 1972) (en banc). Indeed, it would seem that only a unanimous shareholder vote could ratify a fraud of this type even if approved by di- rectors. See Ballantine on Corporations § 71, at 177 (rev. ed. 1946); Cary, Cases and Materials on Corporations 591-92 (1969); Lattin, Jennings & Buxbaum, Corporations 821 (1968 ed.); Kennan v. Eshelman, 23 Del.Ch. 234, 2 A.2d 904 (Sup.Ct.1938); Continental Securities Co. v. Belmont, 206 N.Y. 7, 99 N.E. 138 (1912). An arrangement ec ee i a ee 15a like that here at issue, which was a bald diversion to the manager of sums belonging to the investment company, is quite different from the situation in Moses v. Burgin and Fogel v. Chestnutt, where there were some arguable reasons against seeking recapture so that a negative de- cision by the board of directors, after full disclosure to the independent directors and approval by them and their colleagues, might protect an adviser from liability, un- der the business judgment rule. See Fogel v. Chestnutt, supra, 533 F.2d at 750. (4) We find it convenient to treat together petitioners arguments on the scores of scienter, willfulness and re- liance on the advice of counsel. It would seem at first blush that since the relevant provisions of §15 of the Securities Exchange Act require a showing of willful violation or willful aiding and abet- ting, little would have been added by the recent holding in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), that ‘‘scienter’’ is a neces- sary element to establish liability in an action for damages under Rule 10b-5. However, ‘‘the Commission has con- sistently held under §15(b) that the term [‘willfully’’ in §15] does not require proof of evil motive, or intent to violate the law, or knowledge that the law was being violated. ... All that is required is proof that the broker- dealer acted intentionally in the sense that he was aware of what he was doing.’’ 2 Loss, Securities Regulation 1309 (1961). This view has been accorded judicial acceptance. As this court said in Tager v. SEC, 344 F.2d 5, 8 (2 Cir. 1965) : It has been uniformly held that ‘‘willfully’’ in this context means intentionally committing the act which constitutes the violation. There is no requirement that l6a the actor also be aware that he is violating one of the Rules or Acts.* Petitioners are thus right in contending that it is im- portant to determine what standard of culpability Hoch- felder imposes for a violation of Rule 10b-5 such as that here alleged, and specifically what the proper standard is in a disciplinary proceeding. The Hochfelder plaintiffs sought to hold Ernst & Ernst, an international accounting firm, liable as an aider or abettor of one Leston B. Nay, president of First Se- eurities Company of Chicago, a small broker. Nay had induced the plaintiffs to invest in allegedly high-paying ‘‘eserow accounts’? which he immediately converted to his own use. The accounts did not appear in First Se- curities’ books and records, payment having been made by personal checks payable to Nay or to a designated bank for his account. In urging that Ernst & Ernst was liable as an aider and abettor, plaintiffs ‘‘specifically dis- claimed the existence of fraud or intentional misconduct,’’ 425 U.S. at 190, 96 S.Ct. at 1380. The claim was that Nay had imposed a ‘‘mail rule’’ that no mail addressed to him or to First Securities to his attention could be opened by anyone other than Nay, even if it arrived in his absence; that if Ernst & Ernst had conducted a proper audit, they would have discovered the existence of this rule; that Ernst & Ernst should then have disclosed the rule, in reports to the SEC, as an irregular procedure that prevented an effective audit; and that this would have led the SEC to make an investigation of Nay that would have revealed his fraudulent scheme. The Supreme Court held that a mere claim of negligence did not suffice * The court cited, in addition to the Loss treatise, Gilligan, Will & Co. v. SEC, 267 F.2d 461, 468 (2 Cir.), cert. denied, 361 U.S, 896, 80 S.Ct. 200, 4 L.Ed.2d 152 (1959), and Hughes v. SEC, 85 US. App. D.C. 56, 174 F.2d 969, 977 (1949). 17a to support an action for damages under Rule 10b-5 but that scienter’’ must be alleged and proved.* Since plaintiffs had claimed ncthing more than negligence, the Court had no occasion to refine its definition of scienter beyond saying that the term ‘‘refers to a mental state embracing intent to deceive, manipulate, or defraud’’ and leaving open the question whether reckless behavior would suffice to meet that test, 425 U.S. at 194 fn. 12, 96 S.Ct. at 1381. Putting aside for the moment the defense of reliance on the advice of counsel, we do not regard Hochfelder decision as carrying the day for petitioners. The Court held that in order to create liability for damages under Rule 10b—5 and we assume in petitioners’ favor that the same standard governs proceedings under § 15 see fn. 6—there must be proof of intention ‘‘to deceive, manipulate, or defraud’’—not an intention to do this in knowing violation of the law. The Court reasoned that the language of 410 suggested that the section ‘“‘was in- tended to proscribe knowing or intentional misconduct,’’ * The Court left open ‘‘the question whether scienter is a neces- sary element in an action for injunctive relief under § 10(b) and Rule 10b-5.’’ 425 U.S. at 194 n.12, 96 S.Ct. at 1381. The Court said nothing about whether scienter is a necessary element in discipli- nary actions under § 15. These actions share with damage suits the quality of visiting serious consequences on past conduct, even though they also have a remedial effect. They thus differ from in- junctive proceedings, the objective of which is solely to prevent threatened future harm, although unlawful conduct is necessary— if not always sufficient—to demonstrate the reality of this threat. We therefore assume, arguendo, without deciding, that the Hoch- felder culpability standard applies in disciplinary proceedings. Cf. Jaffe, J udicial Control of Administrative Action 267-68 (1965) (“‘Revoeation, indeed, seems often to be used as a sanction not 80 much to control the respondent as to warn others, and thus it has significant penal’ components, even though the courts may choose to — its character by calling it a ‘civil’ remedy.’’) (footnote omit- 18a 425 U.S. at 197, 96 S.Ct. at 1383.’ It thought that use of such words as ‘‘manipulative’’ ‘‘device,’’ and ‘‘contri- vance’’ made ‘‘unmistakable a congressional intent to proscribe a type of conduct quite different from negli- gence,’’ 425 U.S. at 199, 96 S.Ct. at 1384. And it referred, 425 U.S. at 202, 96 S.Ct. at 1385 to the oft-cited testi- mony of a sponsor of the Act before the House Com- mittee on Interstate and Foreign Commerce that what be- came §10(b) says ‘Thou shall not devise any other cun- ning devices.’’ While that phrase could not be regarded as including negligence, it reads precisely on what peti- tioners did here—charging the full NYSE commission rates on IOS generated OTC transactions of rebating half of these to IPC, a subsidiary of IOS, knowing that * Indeed, even in the criminal context neither knowledge of the law violated nor the intention to act in violation of the law is gen- erally necessary for conviction. The first proposition seems implied by the rule ignorantia juris non excusat. Hall, Criminal Law 288 (2d ed. 1961). And the second, of course, follows from the first. Perkins, Criminal Law 745 (2d ed. 1969). See ALI, Model Penal Code §§ 1.13(12), 2.02(2)(a) & (b); Ellis v. United States, 206 U.S. 246, 257, 27 S.Ct. 600, 602, 51 L.Ed. 1047 (1907), where, in rejecting a claim that knowledge of the law was required for con- viction under a statute that included the word ‘‘intentionally’’, Justice Holmes said, ‘‘If a man intentionally adopts certain conduct in certain circumstances known to him, and that conduct is for- bidden by the law unmler those circumstances, he intentionally breaks the law in the only sense in which the law ever considers intent.’’ And see Tager v. SEC, supra, 344 F.2d at 8: We have recently held that a finding of actual knowledge is not necessary for finding criminal liability under § 24 of the Secu- rities Act, 15 U.S.C. § 77x for ‘‘willful’’ violations of §§ 5(a) and (c) and 17(a), 15 U.S.C. §§77e(a), (e), and 77q(a). United States v. Benjamin, 328 F.2d 854, 863 (2 Cir.), cert. denied, 377 U.S. 953, 84 S.Ct. 1631, 12 L.Ed. 497 (1964). As Professor Loss reminds us, ‘‘It is conceivable, therefore, that ‘willfully’ means something less in § 15(b) than it does in the penal provisions of the SEC acts.’’ 2 Loss [Securities Regula- tion] 1309. It is inconceivable that it means something more. OED A RENE tN ba te Ee la ne 19a IPC would retain the sums paid to it although these should have been turned over to the funds directly or ap- plied to reduce the advisory fee. It is no answer that pe- titioners may not have realized that this ‘‘cunning de- vice’’ was a fraud. We likewise reject petitioners’ argument that there was no violation of Rule 10b—5 because they acted on the advice of their counsel, Mr. Conwill. We are not re- quired to consider the Commission’s arguments that the conduct was so flagrant a fraud that advice of counsel could never be a defense or that such advice must be disregarded because Mr. Conwill informed petitioners that his advice ran counter to a position as to the illegal- ity of give-ups on OTC transactions taken by the Com- mission’s staff and indeed by the Commission in PPI. It is a sufficient answer that, with all respect for Mr. Conwill’s knowledge and experience, he was not in a position to give petitioners wholly disinterested advice and petitioners could not have reasonably have thought he was. Although Cowett of IOS apparently was the architect of the plan here attacked, Conwill was counsel for IOS and his primary concern lay, as petitioners must have known, in promoting its interests by assisting Cowett. Petitioners say it was natural for them to turn to him, since he was so familiar with IOS’ settlement with the SEC. But this familiarity could have been at the disposal of independent counsel retained by peti- tioners; alternatively petitioners could have retained Mr. Conwill and then had independent outside counsel check his advice. Petitioners also note that, in addition to being counsel for IOS, Conwill was a director of FOF so that they were justified in believing that he was Riv- ing proper heed to the interests of the funds. We cannot regard the wearing of this additional hat as relieving Conwill of the interest he had as IOS’ counsel in giving his sanction to an arrangement so advantageous to it. Pe- 20a titioners’ reliance on his advice goes not to the violation, but to the penalty. (5) The points that initially gave us most concern were petitioners’ claims that many other NYSE firms, includ- ine some of high reputation, made give-ups or conferred other benefits on IPC in connection with OTC transac- tions initiated by IOS and that the only other firms dis- ciplined in connection with IPC’s receipt of give-ups, Hertz, Warner & Co. and Dishy, Easton & Co., together with certain principals, were only suspended from cer- tain activities for short periods pursuant to set- tlement offers. Securities Exchange Act Releases No. 8874 and No. 8702. Petitioners’ argument is not simply a protest against selective enforcement. They claim that the prevalence of the practice of customer-directed give- ups on OTC transactions weighs heavily against the SEC’s contention that it was a violation of law. Examination of the record indicates that both the se- lective enforcement claim, to which in any event Oyler v. Boles, 368 U.S. 448, 454-57 (1962), would be a formid- able obstacle, and the prevailing practice argument are considerably overstated. The record does demonstrate that other firms gave up to IPC in connection with OTC transactions. However, the exhibits prepared from IPC’s books showing the corporation’s receipt of reciprocal and directed income were not confined to OTC give-ups, and it seems indisputable that the activity of Lipper Corp. in this regard was far greater than that of these other firms. More important, in the view we take of the case, namely, that the SEC was not obligated to predicate liability on the broad basis that any OTC give-up was a per se fraud but could and did rely on the fact that petitioners made give-ups to IPC, knowing that this was an 80%-owned subsidiary of IOS and that no sales or research service was furnished in return, the evidence is much less significant. For nothing in the record 2la shows that the other brokers who made OTC give-ups or conferred other benefits on IPC were aware of the latter facts. The evidence thus does not establish wide- spread belief in the legality of what petitioners did—for whatever bearing that might or might not have. The effect of the evidence of widespread give-ups and other benefits to IPC on OTC business, like the advice of coun- sel defense, goes rather to the penalty.*® IV. The Penalty As stated, the ALJ rejected the staff’s recommenda- tion that Lipper Corp.’s certificate of registration should be cancelled and that Lipper should be barred and instead proposed a 12 month suspension, a period which ex- pired in late October, 1976. The Commission adopted the staff recommendation. Wright v. SEC, 112 F.2d 89 (2 Cir. 1940), might ap- pear to be an obstacle to our altering the penalty chosen by the Commission. In Wright, review was sought of an SEC order expelling the petitioner from several national security exchanges and the court held that only one of * Petitioners raise the point, made in their unsuccessful petition to the SEC for rehearing, that they were denied due process because although three of the four commissioners then in office heard oral argument on August 28, 1972, only one of these, Commissioner Loomis, joined in the decision of October 1975—the other three participants in the decision not having been members of the Com- mission in August 1972; petitioners, however, do not urge that we remand for additional oral argument because of this. Rule 21(f) of the Commission’s Rules of Practice, 17 C.F.R. 201,21(f), allows a member who was not present at oral argument to participate in the decision on condition that he review the transcript of the argument and it is not contended that this was not done. There is no general constitutional right to oral argument before an administrative agen- cy, FCC v. WJR, 337 U.S. 265, 274-77, 69 S.Ct. 1097, 93 L.Ed. 1353 (1949), and the Commission’s rule represents a reasonable accom- modation of the interest—one almost essential in these days when many agency members serve so briefly. See Gearhart & Otis, Inc. v. SEC, 121 U.S.App.D.C. 186, 348 F.2d 798 (1965). 22a the two findings of violation was justified. Still, a ma- jority of the panel apparently thought that a reviewing court was ‘‘without power to supervise’ the Commis- sion’s choice of sanction, although Judge Swan, the au- thor of the opinion, disagreed : The petitioner urges that the order of expulsion is unduly harsh; that an order of suspension would have accorded investors all the protection they need. So far as appears this was Wright’s first infraction of the statute. For many years he has been operat- ing in Wall Street and his transactions in Kinner stock are the only blemish upon his reputation. There is nothing to indicate that he is an habitual manipu- lator or would be likely to try to manipulate the market in the future. To deprive him for all time of an opportunity to pursue his calling in a lawful manner does seem severe. But a majority of the court hold the view that we are without power to supervise the Commission’s discretionary determina- tion that expulsion of the petitioner is necessary and appropriate for the protection of investors. The writer of this opinion does not share that view, be- lieving that under the power conferred upon this court to ‘‘modify’’, as well as to affirm or to set aside an order in whole or in part, we may reduce the relief accorded investors. My own opinion is that the Commission should be directed to reduce it. 112 F.2d at 95-96.° ° The court then remanded to the Commission for its reconsidera- tion of the penalty in view of the holding that one of the alleged violations was insufficiently shown. See 112 F.2d at 96. On re- mand, the Commission adhered to its determination of expulsion, In the Matter of Charles C. Wright, 12 SEC 100 (1942), and this was upheld on further review, Wright v. SEC, 134 F.2d 733 (2 Cir. 1943). eee ee 23a Numerous cases in this circuit since Wright, however, while not expressly repudiating that decision, have as- sumed that Commission-ordered penalties are reviewable as to severity although none apparently considered the sanction under review so harsh as to require that it be set aside. See e. g., Berko v. SEC, 316 F.2d 137, 141-42 (1963); Tager v. SEC, 344 F.2d 5, 9 (1965); Hanly v. SEC, 415 F.2d 589, 598 (1969); Fink v. SEC, 417 F.2d 1058, 1060 (1969); Gross v. SEC, 418 F.2d 103, 107 (1969); Sinclair v. SEC, 444 F.2d 399, 402 (1971). See also Boruski v. SEC, 289 F.2d 738 (1961); Nassau Se- curities Service v. SEC, 348 F.2d 133, 136 (1965).*° Com- pare Jacob Siegal Co. v. FTC, 327 U.S. 608, 612, 66 S.Ct. 728, 90 L.Ed. 888 (1946). Reviewability of sanctions would seem to be authorized by application of the Ad- ministrative Procedure Act, see 5 U.S.C. §§551(10) & (13), 702, 706, the enactment of which adequately explains why Wright’s suggestion that an agency’s discretionary choice of sanctions cannot be altered has not been fol- lowed." See also Jaffe, Judicial Control of Administra- *° Courts in other circuits similarly have reviewed SEC sanctions on an abuse of discretion or arbitrary or capricious standard. See e.g., Nees v. SEC, 414 F.2d 211, 217 (9 Cir. 1969) ; O’Leary v. SEC. 424 F.2d 908, 912 (D.C.Cir. 1970) ; Beck v. SEC, 430 F.2d 673 ( 6 Cir. 1970) (setting aside four month suspension as a ** gross abuse of diseretion’’) ; Quinn & Co. v. SEC, 452 F.2d 943, 947 (10 Cir. 1971), cert. denied, 406 U.S. 957, 92 S.Ct. 2059, 32 L.Ed.2a 344 (1972). See also American Power Co. v. SEC, 329 U.S. 90, 112-13 67 S.Ct. 133, 146, 91 L.Ed. 103 (1946), where the Court stated that an SEC remedial action would be set aside ‘‘only if the remedy chosen is unwarranted in law or is without justification in fact,’’ a standard more recently applied to the review of an administrative sanction in Butz v. Glover Livestock Comm’n Co., Inc., 411 U.S 182, 93 S.Ct. 1455, 36 L.Ed.2d 142 (1973). sei . 7 Indeed, the Commission does not contend here that the order 18 IN any sense unreviewable, urging instead that judicial disturb- ance of such orders is limited to cases of abuse of discretion. Re- spondent’s Br. at 63. ) 24a tive Action 270-71 (1965)(‘‘It is not in accord with cur- rent concepts of justice that the exercise of such drastic powers [to revoke or suspend a license] should be total- ly beyond revision, particularly where exercised by our monolithic, policy-oriented agencies.’’); Schwartz & Wade, Legal Control of Government 270 (1972) (‘‘One of the limitations of the administrative expert is his tendency to single-mindedness and excessive zeal. The judges can stand apart from the tensions of the immedi- ate case and mitigate the enthusiasm of the expert by the community’s sense of justice.’’). Given our power to review SEC penalty determinations, our authority to limit such sanctions in appropriate cases seems neces- sarily to follow. Coming then to the question of the appropriateness of the Commission’s sanction, we think it was too se- vere.” Clearly it is unnecessary to prevent petitioners from again doing what they did, since all customer-di- rected give-ups have been abolished since December 5, 1968. The purpose of such severe sanctions must be to demonstrate not only to petitioners but to others that the Commission will deal harshly with egregious cases. Viewed in bald outline and in the light of hindsight, pe- titioners’ conduct may indeed seem egregious. But, as conceded by the Commission in an amicus brief filed in this court in Tannenbaum v. Zeller, No. 75-7503, the years 1967 and 1968 in which petitioners engaged in unlaw- ful give-ups were years of considerable uncertainty as to the regulatory climate concerning give-ups; the Com- *? Under the circumstances of this case we give little weight to the Commission’s protestations that persons once barred might be readmitted to the securities business under proper supervision. See Tager v. SEC, supra, 344 F.2d at 9. Whatever the force of this in the case of a registered representative, Lipper is hardly interested in returning to the business as a minor salesman in a large broker- age firm. Moreover, eight years have already elapsed since the con- duct of which the SEC complains. 25a mission was torn between its desire to move away from uniform fixed commission rates, a movement which would eliminate the economic basis for customer-directed give- ups, and its belief that existing give-up opportunities should be utilized by investment advisers for the bene- fit of shareholders in mutual funds. True, there was nothing in all this that should have induced a belief that give-ups could be utilized for the benefit of the adviser rather than of the fund. Still petitioners were living in a world of customer-directed give-ups, which many other competing brokers were directing to IPC. Moreover, they did act under the supervision of experienced al- though in our view not disinterested counsel and, while they knew exactly what they were doing, there is no evidence that they had any thought they were violating the law—unless, of course, it were the law that any give- up on OTC business was fraudulent, which they had been advised, perhaps correctly, was not true. We are moved also by the inordinately long time in which this proceeding has been pending, particularly the unexplained lapse of over three years from the argument to the de- cision of the Commission, the cloud that has hung over petitioners’ heads during this period and the tremendous disparity between the sanctions invoked against peti- tioners and that imposed on two other brokers whose violations were perhaps more clear. Finally, although the Commission is in no way bound by the views of the ALJ, FCC v. Allentown Broadcasting Corp., 349 U.S. 358, 75 S.Ct. 855, 99 L.Ed. 1147 (1955); Hiller v. SEC, 429 F.2d 856, 858 (2 Cir. 1970), some weight may prop- erly be given to his opportunity to observe Lipper and others who played a part in the acts here in question and in fashioning a remedy in light of that observation. Universal Camera Corp. v. NLRB, 340 U.S. 474, 492-97, 71 S.Ct. 456, 95 L.Ed. 456 (1951). If this statute author- ized suspension for a period longer than twelve months, and the Commission had exercised such authority to sus- 26a pend for say another twelve months, we surely would not interfere. But with the choices limited to a suspension of not more than twelve months or a revocation or bar, we consider that under the special circumstances of this case, selection of the latter was an abuse of discretion. The petition to review is therefore denied except that the sanctions shall be limited to suspension of Lipper Corp.’s registration for 12 months from the date of the Commission’s order and the barring of Lipper from as- sociation with any broker or dealer for the same period. ee — vie = 27a UNITED STATES COURT OF APPEALS SECOND CIRCUIT At a Stated Term of the United States Court of Ap- peals, in and for the Second Circuit, held at the United States Court House, in the City of New York, on the twenty-second day of March, one thousand nine hundred and seventy-seven. Present: HonorasLe Henry J. FRIENDLY Honorasce Paut R. Hays HonorasBLe Wititiam H. MuLiican Circuit Judges. 76-4067 ArtTHuR Lipper CorporaTion and ArtHur Lipper, III, Petitioners, v. Securities aND Excaance Commission, Respondent. A petition for a rehearing having been filed herein by counsel for the respondent (Securities and Exchange Commission) Upon consideration thereof, it is Ordered that said petition be and hereby is Denied. /8/ A. Dante, Fvusaro, A. Daniel Fusaro, Clerk 28a UNITED STATES COURT OF APPEALS SECOND CIRCUIT At a stated term of the United States Court of Appeals, in and for the Second Circuit, held at the United States Court House, in the City of New York, on the twenty- second day of March, one thousand nine hundred and seventy-seven. Docket No. 76-4067 ArTHUR LipPeR CORPORATION and ArtTHurR Lipper, III, Petitioners Vv. Securities anp Excuance Commission, Respondent A petition for rehearing containing a suggestion that the action be reheard en banc having been filed herein by counsel for the respondent, and a poll of the judges in regular active service having been taken and there being no majority in favor thereof, Upon consideration thereof, it is Ordered that said petition be and it hereby is DENIED. Judge Oakes dissents. /s/ Irvine R. Kaurman Irving R. Kaufman, Chief Judge 29a UNITED STATES COURT OF APPEALS, SECOND CIRCUIT ARTHUR Lipper Corporation and Arthur Lipper, ITI, Petitioners, v. SEecuRITIES AND ExcHance Commission, Respondent. No. 165, Docket 76-4067 Petition for Rehearing Dec. 27, 1976. Order Denying Petition for Rehearing March 22, 1977 DissENTING Opinion Apriz 1, 1977 A petition for rehearing containing a suggestion that the action be reheard en banc having been filed herein by counsel for the respondent, and a poll of the judges in reg- ular active service having been taken and there being no majority in favor thereof, Upon consideration thereof, it is Ordered that said petition be and it hereby is Dentep. Oakes, Circuit Judge (with whom Judge Mesk1LL con- curs): I dissent from the denial of rehearing en banc. Express- ing no opinion on the merits, it seems to me that this case raises sufficiently important questions of administrative law and the role of the courts therein, of general applica- bility, to warrant our careful consideration sitting en banc. Even assuming, as the panel opinion persuasively argues, that American Power & Light Co. v. SEC, 329 U.S. 90, 112, 67 S.Ct. 133, 91 L.Ed. 103 (1946), and Butz v. Glover Live- stock Commission Co., 411 U.S. 182, 93 S.Ct. 1455, 36 L.Ed. 2d 142 (1973), permit the reviewing court to vacate an ad- ministrative sanction, which is ‘‘ ‘peculiarly a matter for 30a administrative competence,’ ’’ 329 U.S. at 112, 67 S.Ct. at 146, it is difficult to see how the reviewing court may prop- erly substitute its judgment for that of the agency on such a matter. O’Leary v. SEC, 137 U.S.App.D.C. 420, 424 F.2d 908, 911-12 (1970); see K. G. Davis, Administrative Law Treatise § 30.10, at 250-52 (1958). Underlying precepts of administrative law would seem to require a remand for further agency consideration of the sanction if it has pre- viously abused its discretion. I am as intolerant of the agency’s delays in this case, and other agencies’ in other cases, as the distinguished author of the majority opinion, but I question seriously whether those delays justify taking a leap which has, except for one ‘‘sport,’’ Beck v. SEC, 430 F.2d 673 (6th Cir. 1970) (entire sanction set aside), not heretofore been taken, that is, the reviewing court’s sub- stituting its own judgment of what the sanction should be for that of the agency. See, e. g. Hanly v. SEC, 415 F.2d 589, 598 (2d Cir. 1969) ; Marketlines, Inc. v. SEC, 384 F.2d 264, 267 (2d Cir. 1967), cert. denied, 390 U.S. 947, 88 S.Ct. 1033, 19 L.Ed.2d 1137 (1968). If this is the unique case the panel opinion pictures it as—where the SEC had abso- lutely no choice under the statute, Section 15(b) (4), (6) of the Securities Exchange Act, 15 U.S.C. § 780(b)(4), (6), between a year’s suspension and a permanent bar—it would be one thing, but it seems to me it was entirely open to the Commission to impose a bar with leave to reapply, just as this court recommended to the Drug Enforcement Admin- istration in Sokoloff v. Saxbe, 501 F.2d 571, 576-77 (2d Cir. 1974). I fail to see any Commission rule or require- ment that readmission to the business be under supervision or, if it were, that this would be so terribly unfair to some- one who ignored his fiduciary obligations and violated the Securities Exchange Act and Rules thereunder. 3la SECURITIES AND EXCHANGE COMMISSION Washington, D.C. Securities Excuance Act or 1934 Rel. No. 11773/October 24, 1975 Admin. Proc. File Nos. 3-2156 and 3-2157 Tn the Matters of ArtHurR Lipper CorPorRaTION 140 Broadway New York, New York (8-13182) ArtTHuR Lipper, IIT 108, LTD, (S.A.) Geneva, Switzerland Investors PLaNNING CoRPORATION OF AMERICA (now known as CIP, Inc.) New York, New York (8-12374) Opinion of the Commission Broker-DEaLER PROCEEDINGS Grounds for Remedial Sanctions Recapture by Affiliate of Commissions on Investment Company Portfolio Transactions Through Give-Ups from and Reciprocal Arrangements with Unaffiliated Broker- Dealers Receipt of Money in Connection with Investment Company Portfolio Transactions Over-the-Counter Give-Ups Conflict of Laws—International Law Where manager of unregistered off-shore investment com- panies selected to execute companies’ over-the-counter portfolio transactions broker who paid portion of commis- sions on such business to manager’s subsidiary, held, 32a manager, aided and abetted by broker, violated Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder; and gravity of misconduct required that reg- istration of broker be revoked and that manager be barred. Where Securities Exchange Act’s antifraud provisions were violated in connection with portfolio transactions of unregistered off-shore investment companies executed in the United States, and where violators were registered broker-dealers, held, United States has jurisdiction to take remedial action. Receipt by Affiliate of Compensation in Connection with Purchase and Sale of Investment Company Property Deficient Investment Advisory Contract Misstatements in Prospectuses, Proxy Material and Other Documents Where registered broker-dealer who was mutual fund’s principal underwriter and investment adviser procured for itself rebates of fund’s brokerage commissions from unaffiliated brokers without rendering any brokerage serv- ices in return therefor, held, such broker-dealer and its unregistered corporate parent violated or aided and abetted violations of Securities Exchange Act’s antifraud provisions and of Sections 17(e)(1), 15(a)(1), 20(a), and 34(b) of the Investment Company Act and also of Rule 20a-1 under the Investment Company Act. APPEARANCES: Allan F. Conwill, of Willkie, Farr & Gallagher, John A. Dudley, of Sullivan & Worcester, and Howard 8S. Klotz, for Arthur Lipper Corporation and Arthur Lipper, III. 33a Calvin H. Cobb, Jr., Robert M. Goolrick, Edmund B. Frost, and W. John Amerling, of Steptoe & Johnston, for IOS, Ltd. (S.A.) and Investors Planning Corporation of America. Stanley Sporkin, Marvin E. Jacob, Robert M. LaPrade, Joanne Leveque and Robert L. Anthony, for the Division of Enforcement of the Commission. I. INTRODUCTION This case is about the once vast international financial complex controlled by IOS, Ltd. (S.A.) (‘‘TOS’’).? More specifically, it is about IOS’s handling of the large volume of brokerage business generated by the enormous pools of other people’s money under its management and about the way in which IOS used that brokerage business to serve its own interests rather than those of the investors who had entrusted their savings to it. The transactions in question were executed in the over-the-counter market and on the New York Stock Exchange. In 1967 and 1968, the period involved in this case, brok- ers executed all stock exchange orders at fixed rates. These rates varied with the price per share of the security. But the commission was calculated on a per share basis. The commission on an order for 10,000 shares of a given stock was exactly 100 times that on an order for 100 shares of the same stock. Brokers found it profitable and were eager to handle transactions for investment companies and other institutional customers because the cost of handling large orders did not increase proportionately with the commis- sions they were obligated to charge. This was so much the case that brokers were willing and anxious to execute large institutional orders for substantially less than the fixed minimum commission rate. Since the commission could not be reduced, brokers were willing, at the custom- * The initials stand for Investors Overseas Services. 34a er’s direction, to pay over part of the commission to other brokers within the rules of the stock exchange. Thus, large institutional investors had substantial amounts of so-called ‘fexcess brokerage’’ (i.e., that portion of the commission that the executing broker was willing to give up) at their disposal.’ Il. THE ADMINISTRATIVE LAW JUDGE’S INITIAL DECISIONS The administrative law judge before whom the hearings were held concluded that: 1. Brokers who executed transactions for, and who therefore received commissions from, members of the complex of mutual funds managed by IOS®* surren- dered portions of those commissions to an IOS sub- sidiary known as Investors Planning Corporation of America (‘‘IPC’’).* This was done at IOS’s direction. 2. Neither IOS nor IPC* rendered any brokerage services to the funds in whose commission disburse- ments they shared. *In theory, only the minimum rate of commissions was fixed. Brokers were free to go higher if they wished. And, in fact, broker- age houses sometimes charged more than the minimum on small transactions or even refused to handle them at all. By and large, however, the minimum was also the maximum. * A group of mutual funds under common management is called a ‘‘fund complex.’’ See Report of the 8.E.C. on Public Policy Im- plications of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess., 45-47 (1966) [hereinafter cited as Public Pol- icy}. See also Glazer, A Study of Mutual Fund Complezes, 119 U. Pa. L. Rev. 205 (1970). *IOS owned eighty percent of the outstanding IPC stock. After the events dealt with in this opinion, IPC changed its name to CIP, Ine. * Hereinafter sometimes referred to collectively as ‘‘the IOS re- spondents.”’ 35a 3. The money surrendered by the executing brokers to the IOS respondents belonged in equity and good con- science to the funds out of whose commissions it came. When the IOS respondents appropriated that money for themselves, they breached their fiduciary duties to the funds under their management. This breach of duty and the failure to disclose it to actual and pros- pective investors in those funds were in willful viola. tion of Section 10(b) of the Securities Exchange Act and Rule 10b-5 thereunder. 4. Fund of America, Inc. (‘‘FOA’’) was registered with us as an investment company under the Invest- ment Company Act. When the IOS respondents took a portion of that fund’s excess brokerage, they vio- lated various provisions of the Investment Company Act. 5. The IOS respondents’ violations were serious. It is in the public interest to bar IOS itself from association with a broker or dealer. But IPC’s situation is differ- ent. It is no longer controlled by or affiliated with IOS. Since its wrongdoing stemmed from its former relationship to IOS, a nine-month suspension of IPC’s broker-dealer registration is enough to satisfy the public interest. 6. Arthur Lipper Corporation (‘‘Lipper Corp.’’), a New York City broker-dealer, and during the relevant period, a New York Stock Exchange member firm and also a member firm of other domestic securities ex- changes registered with this Commission under the Securities Exchange Act, was organized to handle the large brokerage business for [OS-managed funds. Substantial portions of the commissions received from such business were surrendered to IPC. Thus, the Lipper firm was a knowing participant in the IOS 36a respondents’ fraudulent scheme. And so was its foun- der, president and controlling stockholder, Arthur Lipper, III. Lipper and his firm’ willfully aided and abetted some of the IOS respondents’ violations of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. 7. It would be in the public interest to suspend the Lipper firm from effecting transactions in the over- the-counter market for twelve months. During that period, Lipper himself should be suspended from as- sociation with any broker or dealer. An independent review of the record leads us to agree with the administrative law judge’s analysis.’ We are also in accord with his view that it is in the public interest to preclude IOS from associating itself with brokers or deal- ers in the future. But we see no need at this juncture for remedial action against IPC. And we also disagree with the administrative law judge about the nature of the sanc- tions against the Lipper respondents called for by the public interest. As to that, we agree with our staff that suspension is not enough and that the Lipper respondents ought to be barred from the securities business. Our reasons for so holding are stated below. Ill. THE 10S COMPLEX During the 1950’s and the 1960’s the basic trend in the American equity securities markets was upward. In those * Hereinafter sometimes referred to collectively as ‘‘the Lipper respondents. ’’ * The respondents petitioned for review of the administrative law judge’s decision. Our Division of Enforcement also sought review with respect to what it considers the gross inadequacy of the sanc- tions imposed on the Lipper respondents. After granting all of the petitions for review, we received briefs from all parties and heard oral argument. 37a years, the American mutual fund industry grew dra- matically." These developments led foreign investors to take a favorable view of American mutual funds, and fa- cilitated the sale of their shares abroad. IOS capitalized on this market.’ It did so by means of the so-called ‘‘off-shore fund.’’ That involved the forma- tion by IOS of investment companies in countries other than the United States.*° Those entities sold their shares outside the United States. But they invested the proceeds largely or wholly in United States securities, using our securities markets to do so. 1OS created off-shore funds, managed them after their creation, and sold their shares in many countries. During the period of concern to us here, IOS, a Pana- manian corporation that maintained its principal offices in Switzerland, controlled IPC, a large New York City-based United States broker-dealer registered as such under the Exchange Act. IPC had little or no general securities business. Its primary activity was the retail sale of mutual fund shares to Americans here in the United States. Like many other mutual fund retailers, IPC sold the public shares in many different mutual funds. But it had nothing whatever to do with the management of those funds. ® This theme was expounded at length in Public Policy. *IOS’s first idea was the fund holding company, The Fund of Funds (‘‘FOF’’) formed for the purpose of investing in American mutual funds registered and regulated under the Investment Com- pany Act and in publicly-held mutual fund management companies. See Public Policy 311-324. But by the time dealt with in this opin- ion the original concept had been broadened so that it included direct investment in the stocks and bonds of United States compa- nies engaged in industry and trade. © The name ‘‘off-shore’’ is said to reflect the fact that many of the funds were set up on the islands off the shores of the United States. Note, United States Taxation and Regulation of Off-Shore Mutual Funds, 83 Harv. L. Rev. 404, 405 n.10 (1969). 38a IPC, however, was more than a mere retailer of shares in mutual funds that were managed by others. It also had its own ‘‘in-house’’ fund for which IPC acted as invest- ment adviser and principal underwriter. This fund was FOA, a corporation organized under New Yor! law. There was nothing ‘‘off-shore’’ about FOA. It was just another domestic mutual fund. Like hundreds of similar funds, it was subject to the Investment Company Act and regis- tered with us under that statute as an open-end investment company. IPC’s domestic mutual fund retailing operation was much older than IOS. In April 1965, IOS bought a con- trolling interest in IPC’s going (albeit then unprofitable) retail mutual fund business." After that, IOS naturally wanted to make IPC profitable. One way of doing this was to build up IPC’s captive fund, FOA. As a mere merchandiser of shares in mutual funds con- trolled by others, IPC could expect only the retail dealer’s share of the sales charge plus some excess brokerage in- come funneled to it by the managers of the funds whose shares it was selling. But when IPC sold shares in FOA, it: “IOS attributed the losses to IPC’s ‘‘unimaginative’’ manage- ment. An IOS official testified that IPC was acquired because it ‘represented an opportunity for IOS to come into the United States market, building from a base of a reasonably large and well- established broker-dealer.’’ IPC had a 5,000-man sales force at the time of its acquisition by IOS. It appears that this sales force con- sisted for the most part of what a study by the staff of our Office of Economic Research described as ‘‘armies of salesmen who are be- lieved to be worthwhile even if they only sell themselves, their close friends, and their relatives.’’ S.E.C. Staff Report On the Potential Economic Impact of a Repeal of Section 22(d) of the Investment Company Act of 1940, p. A-49 (November 1972). See also id. at pp. A-63 - A-64 (referring to ‘‘legions of unproductive low-income salesmen’’). 39a 1. Kept the total sales charge since there was no un- affiliated wholesaler or principal underwriter with whom that charge had to be divided; and 2. Enhanced its advisory fee income because the sale of new shares increased the volume of assets on which the fee paid to IPC by FOA was based." So IOS made FOA grow.” It did that in two ways. First, it caused IPC’s sales force to push FOA and to deemphasize what had theretofore been that sales force’s primary pursuit, the sale of shares in mutual funds un- affiliated with IPC. Second, IOS put money from one of its own off-shore funds into FOA. IOS’s foreign mutual fund holding company, FOF," bought into FOA in a big way. From July 1965 to August 1966, FOF invested approxi- 72 Mutual fund sales charges tended to cluster around the 8.5 percent level. Thus, when an investor wrote a check for a thousand dollars to pay for a purchase of ‘‘load’’ fund shares, only $915 of that sum actually went to the fund for investment. The other $85 was consumed by the sales charge, which went to those who made the sale. During the relevant period, it was usual for principal un- derwriters to retain two percent of the investor’s total payment (or about 25 percent of the aggregate sales charge) for themselves. The balance went to the retail dealers and the salesmen who did the actual selling. Publie Policy 207-209. ** Over the long-run, this was much more important than sales charge revenues. Generally, the advisory fees that the adviser-un- derwriters receive for their managerial services are based on the size of the asset pools under management. Since the size of a mutual fund does not fluctuate nearly as much as the sale of new shares, the advisory fee provides a stable source of income. * FOA had only about $5 million in assets when IOS came into the picture. A year and a half later (on November 30, 1966) FOA’s assets were around $44 million. *® See n.9 on p. 5, supra. 40a mately $22 million in FOA. By mid-1966, FO! owned about 46 percent of FOA’s outstanding shares.” FOF’s investment in FOA was a highly-remunerative proposition for IOS. The benefits to FOF itself or its shareholders were more obscure, to say the least. By hav- ing one of its funds, FOF, invest in FOA, another IOS- managed fund, IOS: 1. Collected a sales charge on a sales charge—because the investor who bought FOF shares and who paid a sales charge to IOS at that time also bore the burden of the sales charge later paid by FOF to IPC (but in- uring, of course, to the benefit of IPC’s parent, IOS) when FOF purchased FOA shares from IPC, the ex- clusive distributor of those shares;’’ and 2. Received two advisory fees out of what was in eco- nomic reality a single pool of capital—IOS took an advisory fee from FOF in exchange for its services in putting FOF’s money into FOA, and through IPC it then took a second advisory fee from FOA for manag- ing FOA’s investments.” IV. THE 1956 PROCEEDING AND ITS AFTERMATH Soon after IOS’s acquisition of IPC, members of the Commission’s staff reported to the Commission that infor- Public Policy 313, Table VIII-1. The record shows that in January 1968 FOF still owned approximately 40 percent of FOA’s shares. ** There were so many entities in the IOS complex that the above text simplifies the corporate relationships involved. FOA’s under- writer was IPC, and FOA’s adviser was IPC’s wholly-owned sub- sidiary, Fund of America Management Corporation. ** As we said in Public Policy: Inherent in the fund holding company structure is a layering of costs including advisory fees, administrative expenses, sales loads, and brokerage fees, all of which serve to make a fund on funds a particularly expensive investment vehicle.’’ Public Policy at 318. 4la mation had come to their attention indicating that IOS’s assertedly off-shore funds were not wholly off-shore. Our staff believed that shares in those funds had been offered and sold to an appreciable number of Americans fraudu- lently and in violation of the Securities Act’s registration requirements.** To determine whether this was actually so and what remedial action, if any, was needed, this Com- mission, in February 1966, instituted an administrative proceeding against IOS and some of its affiliates.*” After the failure of its strenuous efforts to enjoin that proceed- ing on the ground that we had no power to conduct it,” IOS decided to settle. During settlement negotiations with our staff, IOS learned that settlement would require a material reduc- tion in the scope of its United States activities. IOS made an offer of settlement in which it undertook, among other things, to: 1. Divest itself of IPC within a specified time; 2. Cease selling securities to United States citizens and nationals wherever located, except, inter alia, for sales by IPC during its continued ownership of that entity ; 3. Make a rescission offer to Americans who held in- terests in FOF; 4. Withdraw its own broker-dealer registration and the registrations of those of its affiliates that were then registered with us as brokers and dealers; and 1° Our staff also believed that violations of the Investment Com- pany Act had been committed. *° Administrative Proceeding No. 3-497 instituted by order of February 3, 1966. This proceeding is referred to as ‘‘the 1966 pro- ceeding.’’ ™ See Fontaine v. 8.E.C., 259 F. Supp. 880 (D.P.R., 1966). 42a 5. Conduct all of its securities activities outside the United States. We accepted IOS’s offer on May 23, 1967, thus termi- nating the 1966 proceeding.” Before that time, IOS began to prepare for the day when it would have to dispose of IPC and place all orders for United States securities abroad through an independ- ent foreign brokerage firm or through an independent United States brokerage firm with a foreign branch office. IOS chose Lipper as a broker for the funds managed by it. At IOS’s instance, in March 1967 Lipper organized Lipper Corp., headquartered in New York, with branch of- fices in London and Geneva. He did so for the primary purpose of acting as a broker for the funds managed by IOS and after assurances from it of sufficient business from ‘‘IOS generated sources to cover the kind of invest- ment involved.’’ * The ‘‘investment involved’’ was needed to establish an elaborate communications network for transmitting the orders that the IOS-managed funds placed with Lipper Corp’s foreign branches to its .uain office in New York. Through this network those foreign funds continued to buy and sell United States securities in this country’s markets rather than those abroad. As for IPC, the settlement agreement granted IOS a period of time before it had to sell its shares of IPC, and this was ultimately accomplished in the fall of 1968. Of course, the price that IOS could expect to obtain for its IPC shares obviously depended on the latter’s earning power. IOS, therefore, had an especially strong incentive *2 IOS, Ltd. (8.A.), Securities Exchange Act Release No. 8083. ** From April 1967 through June 1968, Lipper Corp. received gross commissions of $11,372,000, $8,014,000 of which came from IOS-related business. 43a to improve IPC’s performance prior to the sale. The Lip- per respondents helped IOS to attain that objective. V. REBATES OF OVER-THE-COUNTER BROKERAGE COMMISSION A. The Facts and Their Legal Consequences Lipper Corp. handled the foreign funds’ over-the-coun- ter business on an agency business. For its services in this regard, Lipper Corp. charged the stock exchange commis- sion rate. But it kept less than half of the resulting gross commissions. The rest of them were paid over—‘‘given up’”’ in the jargon of the trade—to IPC. These give-ups by Lipper Corp. to IPC totaled about $1,450,000 from July 1967 to August 1968. In view of IOS’s relationship to IPC, that money was for all practical purposes given up to IOS. Since neither of the IOS respondents performed any brokerage function in connection with the over-the-coun- ter transactions handled by Lipper Corp., it is apparent that they did nothing in return for the income that they derived from those transactions. They simply caused the funds to divert $1,450,000 to them. Lipper Corp. was a mere conduit for the diversion. No extended discussion is required to demonstrate that this was a gross breach of fiduciary duty by the IOS respondents.” * It is true, of course, that IOS managed the funds and that this involved work. But IOS was getting a management fee for these services. 25 Investment advisers are fiduciaries. S.E.C. v. Capital Gains Research Bureau, 375 U.S. 180, 191 (1963); Arleen W. Hughes, 27 S.E.C. 629, 635-638 (1948), aff’d sub. nom. Hughes v. 8.E.C. 174 F. 2d 969 (C.A.D.C., 1949). And investment advisers to invest- ment companies are on the same footing. Rosenfeld v. Black, 445 F. 2d 1337 (C.A. 2, 1971), petition for cert. dismissed 409 U.S. 802 (1972) ; Brown v. Bullock, 194 F. Supp. 207, 229 (S.D.N.Y. 1961), 44a Such ‘‘disregard of trust relationships by those whom the law should regard as fiduciaries’’ was one of the evils that the Exchange Act sought to eliminate.** We therefore find, as did the administrative law judge, that the IOS respondents’ over-the-counter commission-splitting ar- rangements were a fraud on the foreign funds and on their shareholders.*’ It follows that the IOS respondents aff’d 294 F. 2d 415 (C.A. 2, 1961). See Provident Management. Corp., 44 S.E.C. 442, 447 (1970): ‘‘ Porteous and Lautsbaugh, as officers of Fund and as persons responsible for directing the execu- tion of its portfolio transactions, and Management by virtue of its position as investment adviser, were fiduciaries of Fund. As such, they were under a duty to act solely in the best interest of Fund and its shareholders. . . . While there is no proof that Fund did not receive the best caecution on its transactions, or that the exist- ence of the arrangement described resulted in additional] costs to Fund, once the reciprocal arrangements were made, it was improper for Porteous & Co. to keep for itself rather than confer on Fund the benefits attributable to Fund’s assets.’’; Consumer-Investor Plan- ning Corp., 43 S.E.C. 1096, 1100-1101 (1969) : It is clear that [re- spondents] .. . placed the purchase and sale of the Fund’s portfolio securities with those brokers who would pay over to them the largest extractable portions of the brokerage commissions thus yenerated and the most substantial other benefits. The payments and benefits received by them did not represent compensation for any services rendered to or benefits conferred upon the Fund, but rather consti- tuted a form of personal enrichment derived from the Fund’s port- folio transactions. By such blatant trafficking of the Fund’s busi- ness, respondents simply used their fiduciary positions in relation to the Fund to cause monetary and other benefits to inure to them- selves without regard to what was best for the fund... . The abuse of position aud conflict of interests inherent in the making of these arrangements was clearly inimical to the Fund and its sharehold- ers.’’ Delaware Management Co., 43 S.E.C. 392 (1967). *° H.R. Rep. 1383, 73d Cong., 2d Sess. 6 (1934). ** Respondents contend that their over-the-counter commission arrangements were disclosed to the directors of the foreign funds. Like the administrative law judge, we find this contention unsup- ported by the record. Three foreign funds were involved. The Lip- 45a willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Since the Lipper respondents knew about IOS’s rela- tionship to the foreign funds, and since their active assist- ance was an essential element of the scheme, they were clearly participants in the IOS respondents’ breach of trust. It follows that the Lipper respondents willfully aided and abetted the IOS respondents’ violations [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_2407%3A1. Public record. Not legal advice.