# Petition — SEC v. ARTHUR LIPPER CORP (No. 77-291) > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/brief%3Amicro_IA40385004_2423%3A1 ## Record - **Collection:** Supreme Court brief - **Document type:** Petition - **Published:** January 1, 1977 ## Text Gu the Supreme Court of the Cited S OcToBER TERM, 1977 ne <> ws SECURITIES AND ExCHANGE COMMISSION, PETITIONER v. ARTHUR LIPPER CORPORATION AND ARTHUR Lipper, III PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT WADE H. McCREE, MJr., Solicitor General, Department of Justice, Washington, D.C. 20530. HARVEY L. PITT, General Counsel, PAUL GONSON, Associate General Counsel, JOHN M. MAHONEY, Special Oounsel, RICHARD M. HUMES, Attorney, Securities and Eachange Commission, Washington, D.O. 20549. } Page Quiche ballets ccicccctictwininacececbcetuessecercssce 1 ES ee 2 IE I, iin sitisinlinititatinjtibitininndimniiitiitis 2 RE - EB itttisccnietdbecesdeccssnne cctutesntinn 2 BREE ccunncvnncnsssencescencwnstantsbinbbcoubnte 2 Reasons for granting the petition__........-_..-.-------- 6 CI ctcictecwnnnneneeneneennttinnacsciniettinln 15 ABGUNEEE B 2nceccccewcwcccwnewocccenccswowcasaswcese 1A BQGUNEEE DB ccccscecccccscwee cn ceencsccccnccccccwccs 29A Appendiz © .....2.222022 222 n n-ne en eo ees. --- eee 30A ABQENEES DD cnnwntincccwcuctncccwecccnnccccccnccnsecus 31A Appeadis EB ...........~.---.-- 2-2. =~... 34A OD ee ne ee 80A CITATIONS Cases : Associated Securities Corp. v. Securities and Exchange Commission, 293 F.2d 738_.-.......--.---...-.__- 7 Berko v. Securities and Exchange Commission, 316 FOR BER cognnsamnceddnaguenneminanin eaten dinnnints 8 Butz v. Glover Livestock Commission Co., 411 U.S. BOD nnn ccc cen cosiitbemhtebetninttaoun 6-7, 8, 9, 11, 12, 14 Dishy, Easton & Co., Matter of, Securities Exchange Act Release No. 8702 (September 23, 1969) __._____ 12 Haltmier v. Commodity Futures Trading Commission, O06 FOE BIB ne ece ene geccemencmensnennsosen 7,12 Hanly v. Securities and Exchange Commission, 415 a ee 13 Tertz, Warner & Co., Matter of, Securities Exchange Act Release No. 8874 (April 29, 1970) _....._-.____ 12 Hiller v. Securities and Exchange Commission, 429 F.2d BBG one n ewww wn en een ewneeeeeooe------ 12 National Labor Relations Board v. J. H. Rutter-Rex I Ce TO GC eentmennacccnsennamasccocee 13 Cases—Continued nes Norris & Hirshberg, Inc. v. Securities and Exchange Commission, 177 F.2d 228, certiorari denied, 337 lee DR oi irce nino awintiohiiocpmeniindadumiaaibins 7 O’Leary v. Securities and Exchange Commission, 424 PEE We Rccccnsenacnenquaieanenebiienndaaa 7 Pierce vy. Securities and Exchange Commission, 239 a cniatnadatiicitnnansimmnaniptcciuiianiicagiiaiinlialues 7 Richard C. Spangler, Inc., Matter of, Securities Ex- change Act Release No. 12104 (February 12, 1976), 8 SE Dice mentine drtciecinvnowtnitnnantnbbiiibtilt 11 Tager v. Securities and Exchange Commission, 344 ee is ietentcpittnciiltscitaincgdelnmanndiplinneaisiaainnngateiians 8 Statutes and regulation: Securities Act Amendments of 1964, 78 Stat. 565_.____ 9 Securities emul Exchange Act of 1934, 48 Stat. 881, as amended, 15 U.S.C. (and Supp. V) 7@a et seq.: Section 10(b), 15 U.S.C. 78j(b)-------------- 3,4, 5 Section 15(b)(4)(E), 15 U.S.C. (Supp. V) TI GEREEED cecwnnecnnnedtuatndeanune 2,8,1A Section 15(b) (6), 15 U.S.C. (Supp. V) 780(b) Ne RT TES IE 2 2,8, 81A Section 25(a), 15 U.S.C. (Supp. V) 78y(a)-- 2,81A 17 C.F.R. 240.10b-5, Rule 108-5_.--------------____- 3, 4,5 Miscellaneous : Applications for Relief from Disqualification, Securi- ties, Exchange Act Release No. 11267 (February 26, 1975), 6 SEC Docket 346_..........----------.-- 12 Report of Special Study of Securities Markets, H.R. Doc. No. 95, 88th Cong., 1st Sess., Pt. 1 (1963) __..__ 9 Gn the Supreme Court of the Anited States OcToBER TERM, 1977 No. SECURITIES AND EXCHANGE COMMISSION, PETITIONER v. ARTHUR LiprpeR CoRPORATION AND ARTHUR Lipper, IIT PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT The Solicitor General, on behalf of the Securities and Exchange Commission, petitions for a writ of certiorari to review that portion of the judgment of the United States Court of Appeals for the Sec- ond Circuit that modified the Commission’s sanction. OPINIONS BELOW The opinion of the court of appeals (App. A, infra, pp. 1A-28A) is reported at 547 F.2d 171. The orders of the court of appeals denying the Commission’s pe- tition for rehearing and its suggestion for rehearing en banc, and the dissenting opinion from the order denying the petition for rehearing (Apps. C and D, infra, pp. 30A-33A), are reported at 551 F.2d 915. The opinion of the Securities and Exchange Commis- (1) 2 sion (App. E, infra, pp. 34A-79A) is reported at 8 SEC Docket 273. JURISDICTION The judgment of the court of appeals was entered on December 10, 1976 (App. B, infra, p. 29A). On March 22, 1977, the court denied the Commission’s timely petition for rehearing and suggestion for re- hearing en bane (Apps. C and D, infra, pp. 30A-33A). On June 13, 1977, Mr. Justice Marshall extended the time for filing a petition for writ of certiorari to and including August 19, 1977. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1). QUESTION PRESENTED Whether the court of appeals exceeded the proper scope of judicial review when, despite its affirmance of the Commission’s administrative findings that re- spondents had aided and abetted serious and willful violations of the federal securities laws, the court set aside the Commission’s exclusion of respondents from the securities business, and instead imposed a one-year suspension, STATUTES INVOLVED Sections 15(b)(4) (EF), 15(b) (6), and 25(a) of the Securities Exchange Act of 1934, 48 Stat. 895, 901, as amended, 15 U.S.C. (Supp. V) 780(b) (4) (E), 780(b) (6), and 78y(a), are set forth in App. F, infra, pp. 80A-82A. STATEMENT After a lengthy evidentiary hearing, the Securities and Exchange Commission, affirming the decision of its administrative law judge, found that respondents Arthur Lipper Corporation (“Lipper Corp.”), a reg- 3 istered broker-dealer, and Arthur Lipper III (“Lip- per”), the president and controlling stockholder of Lipper Corp., had aided and abetted violations of Section 10(b) of the Securities aml Exchange Act of 1934, 15 U.S.C. 78j(b), and Commission Rule 10b- 5 thereunder, 17 CFR 240.10b-5 (App. E, infra, pp. 34A-79A). The Commission revoked the registration of Lipper Corp. and barred Lipper from further as- sociation with any broker or dealer (id., at p. 77A).' The Commission found that the respondents had participated with IOS, Ltd., the investment adviser to certain mutual funds, in defrauding those funds and their shareholders of approximately $1.4 million. The fraud that the Commission found was that Lip- per Corp. at IOS’s direction, executed securities transactions in the United States over-the-counter securities murket for the mutual funds for which IOS was investment adviser; that Lipper Corp. charged the mutual funds commissions that were con- siderably in excess of its costs, and then remitted 50 percent of these commissions to an American sub- sidiary of IOS, the investment adviser; and that these remitted commission payments (known as give- ups) inured to the benefit of IOS, and were never fully disclosed either to the funds’ shareholders or to their directors. The Commission held that the undis- closed give-up payments violated IOS’s fiduciary du- ties to the funds in violation of Section 10(b) of the * The administrative law judge had recommended that Lipper Corp.’s registration be suspended for 12 months with respect to transactions in over-the-counter securities, and that Li be barred from association with any broker or dealer for same period (App. E, infra, p. 39A). 4 Securities Exchange Act and Rule 10b—5 thereunder, and that the respondents were active and knowing participants in the perpetration of that fraud (App. E, infra, pp. 48A-49A). With respect to the sanctions to be imposed, the Commission stated that because of the Administrative Law Judge’s “long experience and great acumen,”’ it had considered with “special care’’ his recommenda- tion of one-year suspensions for both Lipper and Lipper Corp., but had concluded that a more severe sanction was required. The Commission agreed with the Administrative Law Judge that “‘the Lipper re- spondents’ violations were serious and long continu- ing,’’’ and his finding that App. E, infra, p. 75A): Lipper * * * did nothing to ameliorate [the] fraudulent practice until his own * * * financial success [was] assured. The picture that emerges from the record is of a man intent on personal gain and willing to take the risk that the scheme by which he could reach his goal would not be found illegal. The Commission stated (App. E, infra, p. 76A) that “[w Je cannot be as sanguine as the administrative law judge about future derelictions of this sort by the Lipper respondents. What we have before us is not some isolated indiscretion.’’ The Commission con- cluded (id, at pp. 76A-77A ; tv o footnotes omitted) : * The Commission stated (App. E, infra, p. 764): “As we see it, the Lipper respondents were as culpable as IOS. In situations of this sort, the remitting broker and the receiving institutional manager are acting in pari delicto. Neither can accomplish his ends without the other. * * * Lipper Corp. owed its existence to IOS. And the Lipper IOS relationship was rooted in the over- the-counter give-ups that flowed from Lipper to IPC.” 5 Congress, in writing Section 15(b) of the Exchange Act, viewed past misconduct as the basis for an inference that the risk of probable future misconduct was sufficient to require exclusion from the securities business. Having been directed by the Act to draw that infer- ence whenever our discretion leads us to con- sider it appropriate, we must do so if the leg- islative aim is to be attained. We think the likelihood of future misconduct by the Lipper respondents sufficient to call for their exclu- sion from the securities business.” Moreover, as we have indicated in discussing IOS, that sanction will have a deterrent effect on other broker-dealers who may be inclined to par- ticipate in the fraudulent schemes concocted by investment company managers. 72 This is so even though it appears that some years have now elapsed since they were last engaged in the securities business. That obviated any need for speedy action by us. However, the Lipper respondents are still legally free to engage in the securities business. Since we believe that this would be incompatible with the public interest, we are con- strained to take appropriate preventive action. The court of appeals upheld the Commission’s findings that respondents had aided and abetted vio- lations of Section 10(b) and Rule 10b-5. The court held that respondents were central figures in a clever fraud—a fraud that was “almost too clear for argu- ment” (App. A, infra, p. 12A). However, the court rejected the Commission’s revo- cation of Lipper Corp.’s registration as a broker- dealer and the bar against Lipper’s future associa- tion with any broker or dealer as “too severe” (App. A, infra, p. 26A). The court stated (id., at p. 28A) 6 that under the Act the Commission’s choice of sane- tions was “limited to a suspension of not more than twelve months or a revocation or bar,’’ and that ‘‘under the special circumstances of this case, selection of the latter was an abuse of discretion.” The court accordingly “limited” the sanctions “to suspension of Lipper Corp.’s registration for 12 months * * * and the barring of Lipper from association with any broker or dealer for the same period’ (id., at p. 28A). REASONS FOR GRANTING THE PETITION In substituting a one-year suspension from the secu- rities business in place of the bar of respondents that the Commission concluded was necessary to protect investors, the court of appeals exceeded the proper scope of judicial review of agency sanctions, con- trary to the teaching of this Court in Butz v. Glover Livestock Commission Co., 411 U.S. 182. In that ease, which the court of appeals merely referred to in passing in a footnote (App. A, infra, p. 25A n. 10), the court of appeals upheld the finding of the Secretary of Agriculture that the company had vio- lated the Packers and Stockyards Act by short- weighing cattle, but set aside the Secretary’s suspen- sion for 20 days of the company’s registration under the Act. In holding that ‘‘the setting aside of the suspension was an impermissible judicial intrusion into the administrative domain” (411 U.S. at 183), the Court stated (411 U.S. at 185-186) : The applicable standard of judicial review in such cases required review of the Secretary’s 7 order according to the ‘‘fundamental princi- ple . . . that where Congress has entrusted an administrative agency with the responsibility of selecting the means of achieving the statutory policy ‘the relation of remedy to policy is pe- culiarly a matter for administrative compe- tence.’’’ American Power Co. v. SEC, 329 U.S. 90, 112 (1946). Thus, the Secretary’s choice of sanction was not to be overturned unless the Court of Appeals might find it “unwarranted in law or without justification in fact... . Id. “—lae-aae Similarly, the courts of appeals repeatedly have recognized that where the sanction of the Commission is authorized by statute, the courts should not sub- stitute their view of what is appropriate to protect the public interest for that of the Commission. F.g., O’Leary v. Securities and Exchange Commission, 424 F. 2d 908, 911-912 (C.A. D.C.); Pierce v. Securities and Exchange Commission, 239 F. 2d 160, 163 (C.A. 9); Associated Securities Corp. v. Securities and Ex- change Commission, 293 F. 2d 738, 741 (C.A. 10) ; ef. Haltmier v. Commodity Futures Trading Commission, 554 F. 2d 556, 563-564 (C.A. 2). Because “the invest- ing and usually naive public needs special protection in this specialized field,” Norris & Hirshberg, Inc. v. Securities and Exchange Commission, 177 F. 2d 228, 233 (C.A. D.C.), certiorari denied, 337 U.S. 867, ‘(flailing a gross abuse of discretion, the courts 8 no shouldxattempt to substitute their untutored views as to what sanctions will best accord with the regula- tory powers of the Commission.”’ Tager v. Securities and Exchange Commission, 344 F. 2d 5, 9 (C.A. 2). See also Berko v. Securities and Exchange Commis- ston, 316 F. 2d 137, 141 (C.A. 2). Under the rule of Glover Livestock and the other eases cited above, the court of appeals should have sustained the Commission’s sanctions and not sub- stituted its own view of the proper remedy for the expert judgment of the agency. 1. The Commission’s prohibition against respond- ent’s further participation in the securities business was not ‘‘unwarranted in law or .. . without justifi- cation in fact’’ (Glover Livestock, supra, 411 U.S. at 186). a. The Act expressly authorizes the Commission to “censure, * * * suspend for a period not exceeding twelve months, or revoke the registration of any broker or dealer if it finds * * * that such censure, * * * suspen- sion, or revocation is in the public interest” and that fully aided * * * the violation by any other person” of the Act or of a Commission rule or regulation thereunder (Section 15(b)(4)(E), 15 U.S.C. (Supp. V) 780(b) (4)(E)), and to censure, bar or suspend for not more than a year any person from being associated with a broker or dealer if the Commission finds “that such censure, * * * suspension, or bar is in the public interest’? and that such person has eom- mitted such violation (Section 15(b)(6), 15 U.S.C. (Supp. V) 780(b)(6). Although Congress has thus 9 left it to the discretion of the Commission to determine which sanction “is in the public interest,” the very range of sanctions the legislature has authorized—ranging from the relatively minor one of censuring to the ultimate one of barring from the business—reflects a congressional recognition that expulsion is gener- ally the appropriate sanction for a serious violation.’ As the commission correctly concluded in this case, the statutory scheme for sanctions indicates that where, as here, there has been serious misconduct, the proper “inference [is] that the risk of prob- able future misconduct was sufficient to require ex- clusion from the securities business’ (App. E, infra, p. 746A). Cf. Glover Livestock, supra, 411 U.S. at 187. The court of appeals did not question the serious- ness of the respondents’ violations, and it stated that * The legislative history of the Securities Act Amendments of 1964, 78 Stat. 565, which first authorized the Commission to bar persons from associating with a broker or dealer and to sus- pend a broker or dealer’s registration as an alternative to revok- ing it, supports this view. The 1964 amendments were the conse- quence of the Commission’s Report of Special Study of Securities Markets, H.R. Doc. No. 95, 88th Cong., Ist Sess., Pt. 1, p. 327 (1963) which concluded that “[f]or isolated instances of illegal selling in a large essentially well-run firm, the Commission’s sanc- tions [which then were limited to revocation of registration] may often be too severe to justify their use.” In granting the Commis- sion authority to use less severe sanctions, Congress presumably in- tended the agency to use them in cases where an isolated violation had occurred ; there is no suggestion, however, that Congress did not expect the Commission to continue to revoke the registrations of broker-dealers who had committed serious or long-continuing violations, or that it should refrain from barring from association with any broker or dealer a person who had committed such a violation. 10 if the Commission were authorized to suspend for 24 months and had done so, the court ‘‘surely would not interfere” (App A, infra, p. 28A). Congress, however, has provided that it is the Commission and not the reviewing court that is to determine in the particular case whether expulsion from the business rather than suspension “is in the public intrest’’. As we now show, the Commission was fully justified in concluding that expulsion was the appropriate remedy in this case. b. The Commission’s decision to exclude respondents from the securities business was not ‘‘without justifi- eation in fact.’’ To the contrary, the record fully supports that decision. As noted in the statement, the Commission found the respondents’ violations had been serious and long continuing, that respondents were as culpable as IOS, whose “serious” and ‘‘pervasive” misconduct led the Commission to bar it from association with any broker or dealer (App. E, infra, p. 74A), and that Lipper is “‘a man intent on personal gain and willing to take the risk that the scheme by which he could reach his goal would not be found illegal’ ” (¢d., at p. 75A). In view of the serious violations respond- ents had committed, the Commission was justifiably concerned about “future derelictions of this sort by the Lipper respondents’’ (id., at p. 76A), and rea- sonably concluded that ‘‘the likelihood of future mis- conduct by the Lipper respondents is sufficient to call for their exclusion from the securities business” (id., at pp. 76A-77A). This was a judgment that the ll Commission was entitled to make. The Commission also justifiably took account of the fact that this sanc- tion “will have a deterrent effect on other broker- dealers who may be inclined to participate in the fraudulent schemes concocted by investment company managers” (App. E, infra, p. T7A). Cf. Glover Live- stock, supra, 411 U.S. at 187-188.* 2. The reasons the court of appeals gave for reject- ing the Commission’s sanction, neither individually nor collectively, justify its action. They are essentially similar to those this Court held in Glover Livestock did not justify such an ‘‘impermissible intrusion into the administrative domain” (411 U.S. at 188). a. The court of appeals expressed concern over an alleged ‘‘disparity between the sanctions invoked against [respondents] and that imposed on two other broker dealers whose violations were perhaps more clear’? (App. A, infra, p. 27A). In rejecting a similar justification for judicial modification of an adminis- * With regard to the use of sanctions to effectuate statutory ob- jectives, the Commission has stated: “When we deal with these matters, we must weigh the effect of our action or inaction on the welfare of investors as a class and on standards of conduct in the securities business generally, If these proceedings are to be truly remedial, they must have a deterrent effect on others in the busi- ness who may otherwise be tempted to succumb to the lethal ad- mixture of mindless enthusiasm and overweening greed that so often brings fraud and deceit in its wake. Compare Arthur Lipper Corporation, Securities Exchange Act Release No. 11773 [cita- tion].” Matter of Richard C. Spangler, Inc., Securities Exchange Act Release No. 12104 (February 12, 1976), 8 SEC Docket 1257, 1268 n. 67. 12 trative sanction in Glover Livestock, this Court ruled that “[t]he employment of a sanction within the au- thority of an administrative agency is thus not ren- dered invalid in a particular case because it is more severe than sanctions imposed in other cases” (411 U.S. at 187). See also Hiller v. Securities and Ezx- change Commission, 429 F. 2d 856, 858 (C.A. 2): “[Wle cannot disturb the sanctions ordered in one case because they were different from those imposed in an entirely different proceeding.” Moreover, the sanctions in the two cases to which the court of appeals apparently referred resulted from settle- ments, not from SMA litigated decisions.’ b. The court stated (App. A, infra p. 27A) that it was moved “by the inordinately long time in which this proceeding [had] been pending’’—during which there was a “cloud” over respondents’ heads. But in Glover Livestock the Court held that it was improper for a reviewing court to substitute its judgment for the agency’s with respect to the sanction because of the adverse publicity resulting from the administra- tive proceeding. 411 U.S. at 188-189. Cf. Haltmier v. Commodity Futures Trading Commission, 554 F. 2d ° The court apparently referred to orders in two other proceed- ings that were attached to the respondents’ reply brief. See Matter of Dishy, Easton & Co., Securities Exchange Act Release No. 8702 (September 23, 1969) ; Matter of Hertz, Warner & Co., Securities Exchange Act Release No. 8874 (April 29, 1970). 13 556, 564 (C.A. 2), where the court noted that “per- sonal detriment * * * is suffered by many persons who commit derelictions resulting in civil or other sane- tions but [is outweighed by] ‘the necessity of protec- tion to the public * * *’”, Any delay in completing the administrative proceed- ing would not justify judicial modification of an otherwise valid sanction, which is designed to protect the public interest and not to punish the respondents for their wrongdoing. Cf. National Labor Relations Board v. J. H. Rutter-Rex Mfg. Co., 396 U.S. 258. The Commission’s delay in completing its proceedings in this case does not justify permitting respondents to return to the securities business, unless the Commis- sion first determines that they should be permitted to do so.° * See Applications for Relief from Disqualification, Securities Exchange Act Release No. 11267 (February 26, 1975), 6 SEC Docket 346. In that release the Commission enumerated certain factors which it would consider in the exercise of its discretion in determining whether to permit an individual’s re-entry into the securities business. The Commission stated : “The Commission recognizes that situations may exist where, in light of changed circumstances and after the passage of a period of time, it may appear appropriate to the Commission, in its dis- cretion, to permit a disqualified individual or firm to have the dis- qualification lifted if, in general, the applicant can make a showing satisfactory to the Commission that y into the securities business would be consistent with the interest [footnote omitted].” 6 SEC Docket id. at 346; see also Hanly v. Securities and Exv- change Commission, 415 F.2d 589, 598-599 (C.A. 2). 14 ce. Finally, the court gave some weight to the ree- ommendation of the administrative law judge that a one-year suspension would be appropriate. As the court itself recognized, however, “the Commission is in no way bound by the views of the ALJ” (App. A, infra, p. 27A). The determination of the appropriate sanction is a policy and not a fact-finding function, and it is one that Congress has given to the agency, not to its hearing officer. The Commission stated that it had considered the administrative law judge’s views with ‘*special care,” but coneluded that a more severe sanction was necessary ‘‘if the legislative aim is to be attained”’ (App. E, intra, p. T6A).’ 3. In Glover Livestock, the court of appeals appar- ently recognized the limited scope of judicial review of administrative sanctions (see 411 U.S. at 186), * The court referred to two other factors that apparently in- fluenced its decision. First, it noted that respondents’ violations occurred during a period of regulatory uncertainty about the legality of give-ups (App. A, infra, p. 27A). The give-aps as to which there was uncertainty, however, resulted from transactions on securities exchanges that required their member brokers to charge minimum commissions without regard to their costs in executing transactions. They were a far cry from the violations in this case, where all of the transactions occurred in the over-the- counter market in which there was no comparable minimum com- mission requirement. The court apparently recognized the distinc- tion, since it pointed out that even during that period there was nothing to suggest that the give-ups in this case were legal (éd., at p. 27A). Second, the court noted that respondents had acted on advice of counsel—but the court did rot believe that such counsel was “dis- interested” (id., at p. 27A). 15 but nevertheless exceeded the bounds of its author- ity by modifying the administrative sanction. This Court corrected the error. In ti present case the court of appeals similarly paid lip service to the standard of review, but again went beyond its author- ity by substituting its judgment for the Commission’s with respect to the sanction that the public interest requires. This Court should again correct the error. CONCLUSION The petition for a writ of certiorari should be granted. Respectfully submitted. Wape H. McCreg, Jr., Solicitor General. Harvey L. Prrtv, General Counsel, PavuL Gonson, Associate General Counsel, JOHN. M. MAHONEY, Special Counsel, Ricuarp M. HuMEs, Attorney, Securities and Exchange Commission. Aveust 1977. 243-942 - 77—--2 See 7. o8- ee Me bes Ce od APPENDIX A United States Court of Appeals for the Second Circuit No. 165—September Term, 1976. (Argued October 21, 1976 Decided December 10, 1976.) Docket No. 76-4067 ARTHUR LiprpER CORPORATION AND ARTHUR Liprer, ITI, PETITIONERS v. SECURITIES AND ExCHANGE COMMISSION, RESPONDENT Before FrignpLy, Hays and MULLIGAN, Circuit Judges. FRIENDLY, Circuit Judge: This petition to review a disciplinary order of the Securities and Exchange Commission (SEC), Securi- ties Exchange Act Release No. 11773 (Oct. 24, 1975), is the latest chapter in the extensive litigation result- ing from the financial debacle of IOS, Ltd., S.A. (IOS) and the off-shore funds for which it was in- vestment adviser and distributor. See Bersch v. Drezel Firestone, Inc., 519 F.2d 974 (2 Cir), cc rt. denied, 423 U.S. 1018 (1975); IIT 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 (1a) 2A Arthur Lipper Corporation (Lipper Corp.) and barred Arthur Lipper III (Lipper), its principal 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. §78j(b), and the Commis- sion’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. I. THe Facts, AND THE PROCEEDINGS BEFORE THE SEC The complaint concerns transactions whereby at the direction of Edward M. Cowett, executive vice-presi- dent and director of IOS, Lipper Corp. turned over to LOS’s 80%-owned subsidiary Investors Planning Cor- poration (IPC), a registered broker-dealer and a member of the National Association of Securities Dealers, Ine. (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 through- out the world; and Regent Fund Ltd. (Regent), a Canadian investment company with investments in both Canada and the United States. IIT and Regent had no American shareholders; FOF had some 3,000 3A 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. 6 77¢. 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, appar- ently with a view to building up IPC, which had been operating at a loss, as a vehicle for IOS’s American securities business. This plan was shattered and a revamping of IOS’s 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 pro- vided, 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 should conduct no activity subject to the SEC’s jurisdiction except as provided in the order; and, save for qualifications 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 trans- actions on United States stock exchanges or in the OTC market would have to be ,iu.ed with exchange or NASD members having offices abroad’ or with foreign broker-dealers who in turn would refer the orders to American 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. * Petitioners assert and the SEC does not dispute that all such offices were operated by members of the New York Exchange. 4a Anticipating the settlement, Cowett approached Lipper, a partner in the New York Stock Exchange (NYSE) firm of Zuckerman, Smith & Co., to ascer- tain whether the firm would be interested in opening branch offices in Geneva and London, together with the extensive communications network that would be needed for the purpose of serving as coordinating agent for the flow of IOS brokerage transactions. The other partners in Zuckerman, Smith & Co. declined the proposal although they were willing to have the firm act as clearing agent if Lipper decided to with- draw and form his own company, which would become a registered broker-dealer and member of NYSE and NASD for the purpose desired by IOS. Lipper indi- cated his interest to Cowett, and proceeded to make the necessary arrangements. His compensation was to be in commissions earned on IOS generated trans- actions both on and off the exchanges, as to which his company was to be in a favored position. The Constitution of the New York Stock Exchange required Lipper Corp. to charge the three off-shore funds the fixed commissions then in effect on trans- actions executed on that exchange and forbade any rebates to them. Until December 5, 1968, NYSE allowed customer-directed give-ups on NYSE trans- actions 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 complaint 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. How- ever, as Lipper anticipated, directions were received from Cowett to give up 50% of these commissions to 5A TPC.’ Pursuant to these instructions Lipper Corp., during the period from July 10, 1967, to August 5, 1968 remitted to IPC approximately $1,275,000, about 50% of the commisisons paid it by FOF Prop., ITT and Regent Fund on OTC transactions.’ In addition, because cash was required for IPC before Septem- ber 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 “regular’’ 50% give-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. * 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, at a representative of IIT Management Co., (S.A.), an IOS affiliate, Cowett gave similar written 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 affiliate, confirmed an earlier request for similar give-ups on OTC transactions effected on behalf of Regent Fund, Ltd. * The details were: Gross commissions Give-ups SP ites ondaciuitiandersneais $1, 974, 064 $950, 821 Sie adt, waitddisatibnididinaktedih bil 636, 423 312, 175 YS ee rriReer si Sep 28, 670 12, 521 Er nee 2, 639, 157 1, 275, 517 6a 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 present, when Allan F. Conwill, Esq., a director of FOF and counsel for it, IOS, Lipper Corp. and Lipper, in- formed the FOF directors of the arrangements out- lined above; he also advised that Lipper Corp. was in effect required to charge the minimum NYSE com- missions for OTC transactions; 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 transaction 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 explora- tion by outside counsel of the validity of Mr. Conwill’s view that Lipper Corp. had to charge the minimum NYSE commission on OTC transactions or that no way could be found whereby the shareholders 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 Ad- ministrative Law Judge (ALJ), Blair found on June 11, 1971 that Lipper Corp. and Lipper had will- fully violated and willfully aided and abetted viola- tions of § 10(b) of the 1934 Act and Rule 10b-5. Over- ruling both the assertion of the petitioners that no 7A sanctions should be imposed and the staff’s conten- tion 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 ‘he order would be the proper sanction as to both. Lip- per 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 conclusion 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 busi- ness 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 mem- bers at the time of argument. The petition for rehear- Sections 15(b)(4) and (6) of the Securities Ex- change Act Release No. 11980. This petition for re- view followed. Il. Liasmiry Section 15(b)(4) and (6) of the Securities Ex- change Act authorize the SEC to suspend for a period not exceeding twelve months or to revoke the registra- tion of any broker ox 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 pro- vision of the Act or any rule or regulation thereunder; another is willful aiding, abetting, counseling, com- manding, inducing or procuring any such violation. The familiar Rule 10b-5 reads as follows: It shall be unlawful for any person, directly or indirectly, by the use of any means or in- 8A strumentality of interstate commerce, or of the mails or of any facility of any national securi- ties exchange, (a) To employ any device, scheme, or artifice to defraud, (b) To make any untrue statement of a ma- terial fact or to omit to state a material fact necessary in order to make the statement made, in the light of the circumstances under which they were made, not misleading, 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 connec- tion with the purchase or sale of any security. There is some initial surprise in seeing Rule 10b-5 invoked where the fraud relates not, as in the usual case, to a particular securities transaction but to a course of dealing in securities regardless of their identity. However, the language of the Rule is broad enough to include the latter type of case and peti- tioners 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 security sold or purchased. We see nothing in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723 (1975), that would militate against application of the Rule in a situation like that here before us, though ‘‘the terms ‘purchase’ and ‘sale’ are relevant ... to the question of statu- tory coverage” even in other than private actions, SEC v. National Securities, Inc., 393 U.S. 453, 467 n.9 (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 argu- ment of counsel before us, that any give-up of a com- 94 mission on an OTC transaction is per se a “device, scheme, or artifice to defraud.” In support of this the Commission points particularly to two passages in its report of December 2, 1966, on the Public Policy Implications of Investment Company Growth (here- after PPI), H.R. Rep. No. 2337, 89th Cong., 2d Sess. These are: A directed give-up of a portion of the commis- sion 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 negotiated market, which is not governed by fixed prices or mini- mum commission rate schedules, any willingness of the executing broker or dealer to allow his customer to direct a give-up of a portion of his commission or markup to dealers in fund shares in and of itself shows that a lower price or P commission could have been negotiated. an In the over-the-counter markets, where broker- age costs are subject to negotiation, give-ups of commissions to brokers who perform no neces- sary function in connection with a transaction have long been recognized as improper and il- legal. Give-up practices have been tolerated in the exchange markets only because brokerage 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 the various stock exchanges and of the NASD. One sentence in the three and one-half pages of single spaced text of the letter, which expresed concern about the give- up problem generally, said: 10a Insofar as the Commission would attribute iegal 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) of the Investment Company Aet, it constituted informa- tion for the legislature, not a rule having the force of law for the industry, 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 “interpretative rule” or a “oeneral 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 (1971), and in Fogel v. Chestnult, 553 F.2d 731, 734-37, 749 (2 Cir. 1975), cert. denied, U.S. (1976), 45 LW 3250. However, those cases 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 disinter- ested directors, not as having independent 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. “In this connection, we consider it significant that give-ups in the over-the-counter market have long been recognized to be im- proper and illegal.” 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 explana- tion was given, as putting the entire industry on sufficient notice of the Commission’s views. 114A We are not persuaded that any such all encom- passing across-the-board per se principle as stated in PPI would be sustainable in the absence of a Com- mission rule. It is true that the source of the practice whereby the managers of investment companies di- rected executing brokers to give up a part of their commissions to other brokers who furnished services in selling investment company shares and in provid- ing research lay in the inordinate profits a few ex- ecuting brokers would receive under the fixed commis- sion rate structure prevailing on the exchanges. See Fogel v. Chestnutt, supra, 533 F.2d at 735-36. We are not certain, however, that even after PPI, if the man- ager of an investment company determined that the interests of the company would be served by paying fixed commission rates in OTC business, with cus- tomer-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 com- missions 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 pur- chaser 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 principal—a course which the 1967 settlement precluded IOS from fol- lowing 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. 12a 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 he has di- verted to himself is almost too clear for argument. 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 benefit of the fund, either by direct payment or as a reduction in the advisory fees. See statement of then General Counsel 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 con- duct aiding IOS’s fraud on the funds. Starting from this position, we shall consider peti- tioners’ various attacks on the Commission’s conclu- sions. (1) Petitioners say that, as a practical matter, they were compelled to apply the NYSE minimum rate 134 commission 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 suspi- cion on the charging of lower rates on OTC trans- actions 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 evidenc. “Lat 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 that lower commissions on IOS gen- erated OTC transactions were cost justified. We need not debate the solidity of the factual] basis for the argument. Whatever force petitioners’ con- tention might or micht 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 in- fringed 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 —— Tespondents claim to have been in fear of disciplinary action by the New York Stock Exchange. But they have never explained why this fear did not restrain them from giving 144 up to IPC. If the New York Stock Exch rules had been applicable to these transac they would have prohibited commission ting with IPC as well as with the fund: paid those commissions. Putting the matter in another way, petitioners duct either violated the spirit of the NYSE C tution or it did not. If it did, they can deri comfort from the argument that their acts were pelled by the NYSE Constitution; if it did not likewise gain no protection. In any event, no NYSE practice could imn conduct assisting investment company managers tively to pocket give-ups when the funds r nothing in return. (2) Petitioners argue that even though their duct might have violated Rule 10b-—5 if the three had been registered investment companies, a ¢ ent conclusion is compelled because here the pay of give-ups to the manager was at the expen off-shore funds, only one of which had Ame shareholders. The argument ignores that the — charged by the SEC was perpetrated in the U States by payments from one registered broker-« (Lipper Corp.) to another (IPC) in connection the purchase and sale of securities in the U States over-the-counter market. We said in J, Vencap, Ltd., supra, 519 F.2d at 1017: We do not think Congress intended to the United States to be used as a base for ufacturing fraudulent security devices export, even when these are peddled on foreigners. Petitioners thus derive no support from so mu the decision in Bersch y. Drerel Firestone, Inc., s nge’s ions, split- that con- nsti- e no com- they nize ffee- -elve con- ands ffer- nent e of ‘ican raud ited aler with Lited l’ v. llow nan- for y to h of pra, 15a 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, notably 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 (1969), no discussion is needed to demon- strate the inapplicability of § 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 jurisdiction of the United States.” Petitioners argue that characterizing the transaction as a fraud on the funds may displace otherwise applicable foreign law, since certain coun- tries in which IOS and its affiliates operate would allow the manager of an investment company to receive 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 LOS and would thus have been known to existing shareholders of the funds and to persons solicited to boy 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 border even if another country having an interest might be less rigorous. See Bersch v. Drexel Firestone, 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’ contention that the arrangements for the payment of rebates to IPC were adequately disclosed. Admittedly 2 13-942—77——_3 164 no disclosure was made directly to the boards of directors of IIT and Regent; ti disclosure to the board of FOF was only that the arrangements were proper, with no attempt by independent directors to check this. Petitioners contend they could not com- pel disclosure; perhaps not, but here again they were under no obligation to engage in conduct that would be fraudulent without it. Moreover, it is not within the competence of a board of directors of an invest- ment company to sanction the perpetration of a fraud by the manager. Cf. Schoenbaum vy. Firstbrook, supra, 405 F.2d at 219-20; Drachman vy. Harvey, 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 direc- tors. See Ballentine on Corporations §71, at 177 (rev. ed. 1946); Cary, Cases and Materials on Corpo- rations 591-92 (1969); Lattin, Jennings & Buxbaum, Corporations 821 (1968 ed.); Keenan v. Eshelman, 23 Del. Ch. 234, 2 A.2d 904 (Sup. Ct. 1938); Con- tinental Securities Co. v. Belmont, 206 N.Y. 7 (1912). An arrangement 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 seek- ing recapture so that a negative decision by the hoard of directors, after full disclosure to the inde- pendent directors and approval by them and their colleagues, might protect an adviser from liability, under the business judgment rule. See Fogel v. Chest- nutt, supra, 533 F.2d at 750. (4) We find it convenient to treat together peti- tioners’ arguments on the seores of scienter, willful- ness and reliance on the advice of counsel. 17A 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 abetting, little would have been added by the recent holding in Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976), that “seienter” is a necessary ele- ment 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 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 Hochfelder 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 Securities Company of Chicago, a small broker. * The court cited, in addition to the Loss treatise, Gilligan, Will & Co., 267 F.2d 461, 468 (2 Cir.), cert. denied, 361 U.S. 896 (1959), and JZughes v. SEC, 174 F.2d 969, 977 (D.C. Cir. 1949). 18a Nay had induced the plaintiffs to invest in allegedly high-paying “escrow accounts’? which he immediately converted to his own use. The accounts did not appear in First Securities’ books and records, payment hav- ing been made by personal checks payable to Nay or to a designated bank for his account. In urging that Krnst & Ernst was liable as an aider and abettor, plaintiffs “specifically disclaimed the existence of fraud or intentional misconduct,” 425 U.S. at 190. The ¢laim 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 to support an action for damages under Rule 10b-5 but that “scienter” must be alleged and proved.’ Since plaintiffs had claimed nothing more than negli- gence, the Court had no occasion to refine its defini- tion of scitenter beyond saying that the term “refers to a mental state embracing intent to Ceceive, manipu late, or defraud” and leaving open the question whether reckless behavior would suffice to meet that test, 425 U.S. at 194 fn. 12. * 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. The Court said nothing about whether scienter is a necessary element in disciplinary actions 19a Putting aside for the moment the defense of reliance on the advice of counsel, we do not regard the Hochfelder decision as carrying the day for petition- ers. The Court held that in order to create liability for damages under Rule 10b-5—and we assume in peti- tioners’ favor that the same standard governs pro- ceedings 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 §10 sug- gested that the section ‘‘was intended to proscribe knowing or intentional misconduct,” 425 U.S. at 197.’ It thought that use of such words as ‘‘manipula- 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 injunctive pro- ceedings, the objective of which is solely to prevent threatened future harm, although unlawul conduct is necessary—if not al- ways sufficient—to demonstrate the reality of this threat. We therefore assume, arguendo, without deciding, that the //och- felder culpability standard applies in disciplinary proceedings. Cf. Jaffe, Judicial Control of Administrative Action 267-68 (1965) (“Revocation, indeed, seems often to be used as a sanction not so much to control the respondent as to warn others, and thus it has a significant ‘penal’ component, even though the courts may choose to mask its character by calling it a ‘civil’ remedy.”) (footnote omitted). 7 Indeed even in the criminal context neither knowledge of the law violated nor the intention to act in violation of the law is generally necessary for conviction. The first proposition seems implied by the rule ‘gnorantia juris non excusat, Vall, 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 (1907), where, in rejecting a claim that knowledge of the law was required for conviction under a statute that included the word “intentionally”, Justice Holmes said, “If a man intentionally adopts certain conduct in certain circum- 204 9 tive,’ “device,” and “contrivance” made ‘‘unmistak- able a congressional intent to proscribe a type of con- duct quite different from negligence,’’ 425 U.S. at 199. And it referred, 425 U.S. at 202, to the oft-cited testi- mony of a sponsor of the Act before the House Com- mittee on Interstate and Foreign Commerce that what became § 10(b) says ‘*Thou shall not devise any other cunning devices.” While that phrase could not be regarded as including negligence, it reads precisely on what petitioners did here—charging the full NYSE commission rates on IOS generated OTC transactions and rebating half of these to IPC, a subsidiary of TOS, knowing that IPC would retain the sums paid to it although these should have been turned over to the funds directly or applied to reduce the advisory fee. It is no answer that petitioners may not have realized that this *‘cunning device” 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 required to consider the Commission’s arguments that the conduct was so flagrant a fraud that advice stances known to him, and that conduct is forbidden by the law under those circumstances, he intentionally breaks the law in the only sense in which the law ever considers intent.” And see Zager 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 Securities Act, 15 U.S.C. § 77x, for ‘willful’ violations of $$ 5(a) and (¢) and 17(a), 15 U.S.C. $$ 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 Regulation] 1309. It is incon- ceivable that it means something more.” 214A 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 illegality of give-ups on OTC transactions taken by the Commission’s staff and indeed by the Commission in PPI. It is a sufficient answer that, with all respect for Mr. Conwill’s knowl- edge and experience, he was not in a position to give petitioners wholly disinterested advice and petitioners could not have reasonably have thought he was. Al- though 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, sinee he was so familiar with 1OS’s settle- ment with the SEC. But this familiarity could have been at the disposal of independent counsel retained by petitioners: alternatively petitioners could have retained Mr. Conwill and then had independent out- side 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 beliving that he was giving proper heed to the in- terests of the funds. We cannot regard the wearing of this additional hat as relieving Conwill of the in- terest he had as IOS’ counsel in giving his sanction to an arrangement so advantageous to it. Petitioners’ 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, including some of high reputation, made give-ups or conferred other benefits on NPC in connection with OTC transactions initiated by IOS and that the only 22a other firms disciplined in connection with IPC’s re- ceipt of give-ups, Hertz, Warner & Co. and Dishy, Easton & Co., together with certain principals, were only suspended from certain activities for short pe- riods pursuant to settlement offers. Securities Ex- change Act Releases No. 8874 and No. 8702. Peti- tioners’ argument is not simply a protest against selective enforcement. They claim that the prevalence of the practice of customer-dealer give-ups on OTC transactions weighs heavily against the SEC’s con- tention that it was a violation of law. Examination of the record indicates that both the selective enforcement claim, to which in any event Oyler v. Boles, 368 U.S. 448, 454-57 (1962), would be a formidable 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 ex- hibits prepared from IPC’s books showing the corpo- ration’s receipt of reciprocal and directed income were not contined to OTC give-ups, and it seems in- disputable 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 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 widespread belief in the legality 234 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 counsel defense, goes rather to the penalty.* ITV. PENALTY As stated, the ALJ repected the staff’s recommen- dation that Lipper Corp.’s certificate of registration should be canceled and that Lipper should be barred and instead proposed a 12 month suspension, a period which expired in late October, 1976. The Commission adopted the staff recommendation. Wright v. SEC, 112 F.2d 89 (2 Cir. 1940), might appear 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 8 Petitioners raise the point, made in their unsuccessful petition to the SEC for rehearing, that they were denied due process be- cause 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 2 member who was not present at oral argument to participate in the decision on condition that he review the transcript of the argu- ment, and it is not contended that this was not done. There is no general constitutional right to oral argument before an administra- tive agency. FCC v. WJR, 337 U.S. 265, 274-277 (1949), and the Commissioner's rule represents a reasonable accommodation of the interest—one almost essential in these days when many agency members serve so briefly. See Gearhart & Otis, Inc. v. SEC. 348 F.2d 798 (D.C. Cir. 1965). 24a that only one of the two findings of violation was justified. Still, a majority of the panel apparently thought that a reviewing court was “without power to supervise” the Commission’s choice of sanction, although Judge Swan, the author 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 operating 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 manipulator 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 major- ity of the court hold the view that we are with- out power to supervise the Commission’s discre- tionary determination that expulsion of the petitioner is necessary and appropriate for the protection of investors. The writer of this opinion does not share that view, believing 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 reconsider- ation of the penalty in view of the holding that one of the alleged violations was insufficiently shown, See 112 F.2d at 96. On remand, the Commission adhered to its determination of expulsion, Jn 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). 25a Numerous cases in this circuit since Wright, how- ever, while not expressly repudiating that decision, have assumed 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); Stnclair v. SEC, 444 F.2d 399, 402 (1971). See also Boruski v. SEC, 289 F.2d 738 (1961); Nassau Securities Serv- ice v. SEC, 348 F.2d 133, 136 (1965). Compare Jacob Siegel Co. v. FTC, 327 U.S. 608, 612 (1946). Review- ability of sanctions would seem to be authorized by application of the Administrative 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 can- not be altered has not been followed.” See also Jaffe, ” Courts in other circuits similarly have reviewed SEC sane- tions on an abuse of discretion or arbitrary or capricious standard. See, e.g.. Vees 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 “gros= abuse of discretion”); Quinn & Co. v. SEC, 452 F.2d 943, 947 (10 Cir. 1971). cert denied, 406 U.S. 957 (1972). See also Ameri- can Power Co. v. SEC, 329 U.S. 90, 112-13 (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 Buéz v. Glavres Livoalack Comm'n Co., Inc. 4M U.S. 182 (1973). " Indeed, the Commission does not contend here that the order is any sense unreviewable, urging instead that judicial disturbance of such orders is limited to cases of abuse of discretion. Re- ~pondent’s Br. at 63. 26a Judicial Control of Administrative Action 270-71 (1965) (‘It is not in accord with current concepts of justice that the exercise of such drastic powers [to revoke or suspend a license] should be totally beyond revision, particularly where exercised by our mono- lithic, 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 im- mediate case and mitigate the enthusiasm of the ex- pert 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 necessarily to follow. Coming then to the question of the appropriateness of the Commission’s sanction, we think it was too severe.” Clearly it is unnecessary to prevent petition- ers from again doing what they did, since all customer- directed give-ups have been abolished since Decem- ber 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, petitioners’ conduct may indeed seem egregious. But, as conceded by the Commission in an amicus brief filed in this court in Tannenbaum ‘* 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 Vager 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. 27A v. Zeller, No. 75-7503, the years 1967 and 1968 in which petitioners engaged in unlawful give-ups were years of considerable uncertainty as to the regulatory 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 customer-directed give-ups, and its belief that existing give-up opportunities should be utilized by investment advisers for the benefit of share- holders 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. More- over, they did act under the supervision of experi- enced although 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, par- ticularly the unexplained lapse of over three years from the argument to the decision of the Commission, the cloud that has hung over petitioners’ heads during this period and the tremendous disparity between the sanctions invoked against petitioners and that im- posed on two other brokers whose violations were perhaps more clear. Finally, although the Commis- sion is in no way bound by the views of the ALJ, FCC vy. Allentown Broadcasting Corp., 349 U.S. 358 (1955) ; Hiller v. SEC, 429 F.2d 856, 858 (2 Cir. 1970), some weight may properly be given to his opportunity 2SA 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. Vv. NLRB, 340 U.S. 474, 492-97 (1951). If this statute authorized suspension for a period longer than twelve months, and the Commission had exercised such au- thority to suspend 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 association with any broker or dealer for the same period. APPENDIX B 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 tenth day of December, one thousand nine hundred and seventy-six. Present: Hon. HENry J. FRIENDLY, Hon. Pau R. Hays, Hon. Wituiam H. MULLIGAN, Circuit Judges. 76-4067 ARTHUR LIPPER CoRPORATION AND ARTHUR LIPPER, III, PETITIONERS v. SECURITIES AND ExCHANGE COMMISSION, RESPONDENT A petition-for-review of orders of the Securities and Exchange Commission This cause came on to be heard on a certified list of items comprising the record of the Securities and Exchange Commission and was argued by counsel Upon consideration thereof, it is now hereby ordered, adjudged and decreed that the petition be and it hereby is denied except that the orders be and they hereby are modified in accordance with the opin- ion of this court. A. DANTEL Fvsaro, Clerk, by: ViIncENT A. CaRLIN, Chief Deputy Clerk. (294A) APPENDIX C 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. Present: Hon. HeNry J. FRieNpLy, Hon. Pau R. Hays, Hon. Wittiam H. MUuuican, Circuit Judges. 76-4067 ARTHUR LiprerR CokPoRATION AND ARTHUR Lipper, ITT, PETITIONER v. SECURITIES AND EXCHANGE COMMISSION, RESPONDENT A petition for a rehearing having been filed herein hy counsel for the respondent (Securities and Ex- change Commission) Upon consideration thereof, it is Ordered that said petition be and hereby is Denied. A. DANIEL Fvsaro, Clerk. (830A) APPENDIX D ArTHUR LipPpER CORPORATION AND ARTHUR Lipper, III, PETITIONERS v. SECURITIES AND ExCHANGE COMMISSION, RESPONDENT No. 165, Docket 76-4067. United States Court of Appeals, Second Circuit Petition for Rehearing Dec. 27, 1976 Order Denying Petition for Rehearing March 22, 1977 Dissenting Opinion April 1, 1977 A petition for rehearing containing a suggestion that the action be reheard en bane 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. OAKES, Circuit Judge (with whom Judge MESKILL coneurs) : I dissent from the denial of rehearing en bane. Ex- pressing no opinion on the merits, it seems to me that this ease raises sufficiently important questions of administrative law and the role of the courts therein, (31A) 243-942— 774 32A of general applicability, to warrant our careful con- sideration 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 Livestock Com- mission Co., 411 U.S. 182, 93 S.Ct. 1455, 36 L.Ed.2d 142 (1973), permit the reviewing court to vacate an administrative sanction, which is “ ‘peculiarly a mat- ter for administrative competence,’” 329 U.S. at 112, 67 S.Ct. at 146, it is difficult to see how the re- viewing court may properly 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. C. Davis, Administrative Law Treatise § 30.10, at 250-52 (1958). Underlying precepts of ad- ministrative law would seem to require a remand for further ageney consideration of the sanction if it has previously abused its discretion. I am as intolerant of the ageney’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 substituting its own judgment of what the sanction should be for that of the agency. See, e.g. Hanly v. SEC, 415 F.2d 589, 998 (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 absolutely no choice under the statute, Section 15(b)(4), (6) of the Securities Ex- change Act, 15 U.S.C. § 780(b)(4), (6), between a 3A 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 En- forcement Administration in Sokoloff v. Saxbe, 501 F.2d 571, 576-77 (2d Cir. 1974). I fail to see any Commission rule or requirement that readmission to the business be under supervision or, if it were, that this would be so terribly unfair to someone who ignored his fiduciary obligations and violated the Securities Exchange Act and Rules thereunder. APPENDIX E SECURITIES ExCHANGE Act oF 1934, Release No. 11773/ October 24, 1975 Admin. Proce. File Nos. 3-2156 and 3-2157 In the Matters of: ArTHUR Lipper Corporation, 140 Broadway, New New York, New York (8-13182) Artuur Lipper, IIT, IOS, LTD. (S.A.), Geneva, Switzerland INvestors PLANNING CorPoRATION OF AMERICA, (now known as CIP, Ine.) 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-U ps Conflict of Laws—International Law (34A) 35A Where manager of unregistered off-shore invest- ment companies selected to execute companies’ over- the-counter portfolio transactions broker who paid portion of commissions on such business to manager’s subsidiary, held, 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 registration of broker be revoked and that manager be barred. Where Securities Exchange Act’s antifraud provi- sions were violated in connection with portfolio trans- actions of unregistered off-shore investment companies executed in the United States, and where the 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 com- missions from unaffiliated brokers without rendering any brokerage services 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 Invest- ment Company Act and also of Rule 20a-1 under the Investment Company Act. Appearances : 36a Allan F. Conwill, of Willkie, Farr & Gallapher, John A, Dudley, of Sullivan & Worcester, and Howard S. Klotz, for Arthur Lipper Corporation and Arthur Lipper, ITT. Calvin H. Cobb, Jr., Robert M. Goolrick, Edmund B. Frost, and W. John Amerling, of Steptoe & John- son, 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.) (“I1OS”).’ 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, brokers 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 "as 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 in- ' The initials stand for Investors Overseas Services. 37A stitutional customers because the cost of handling large orders did not increase proportionately with the commissions 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 customer’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 ‘‘excess broker- age” (i.e., that portion of the commission that the executing broker was willing to give up) at their disposal.’ II. 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 * surrend- ered portions of those commissions to an IOS sub- sidiary known as Investors Planning Corporation of ?In theory, only the minimum rate of commissions was fixed. Brokers were free to go higher if they wished. And, in fact, brok- erage houses sometimes charged more than the minimum on small transactions or even refused to handle them at all. By and large, the minimum was also the maximum. * A group of mutual funds under common management is called a “fund complex.” See Report of the SEC on Public Policy Impli- cations of Investment Company Growth, H.R. Rep. No. 2337, 89th Cong., 2d Sess., 45-47 (1966) [hereinafter cited as Public Policy]. See also Glazer, A Study of Mutual Fund Compleves, 119 U. Pa. L. Rev. 205 (1970). 38a 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. 3. The money surrendered by the executing brokers to the IOS respondents belonged in equity and good conscience 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 prospective investors in those funds were in will- ful violation of Section 10(b) of the Securities Ex- change Act and Rule 10b—5 thereunder. 4. Fund of America, Ine. (*“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 asso- ciation with a broker or dealer. But IPC’s situation is different. 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 sat- isfy the public interest. 6. Arthur Lipper Corporation (“Lipper Corp.”), a New York City broker-dealer, and, during the rele- * 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 respondents.” 39a vant period, a New York Stock Exchange member firm aud also a member firm of other domestic securi- ties exchanges 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 respondents’ fraudulent seheme. And so was its founder, president and controlling stockholder, Arthur Lipper, ITI. 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-9 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 association 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 LOS from associating itself with brokers or dealers 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 sanctions against the Lipper respondents called for by the public interest. * 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 sanctions imposed on the Lipper respondents. After granting all of the petitions for review we received briefs from all parties and heard oral argument. 40A As to that, we agree with our staff that suspension is net enough and that the Lipper respondents ought to he harred from the securities business. Our reasons for so holding are stated below. lil. THE 10S COMPLEX During the 1950's and the 1960's, the basic trend in the American equity securities markets was upward. In those years, the American mutual fund industry grew ‘lramatically.. These developments led foreign investors to take a favorable view of American mu- tual funds, and facilitated the sale of their shares abroad. LOS capitalized on this market.’ It did so by means of the so-called *‘off-shore fund.’’ That involved the formation 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. LOS created off-shore funds, managed them after their creation, and sold their shares in many countries. * This theme was expounded at length in Public Policy. * 1OS's first idea was the fund holding company, The Fund of Funds (“FOF”) formed for the purpose of investing in American intitual funds registered and regulated under the Investment Com- pany Act and in publicly-held mutual fund management com- panies, See Public Policy 311-324. But by the time dealt with in thix opinion the original concept had been broadened so that it included direct investment in the stocks and bonds of United States companies 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 Offshore Mutual Funds, 83 ary. L. Rev. 404, 405 n. 10 (1969). 41a During the period of concern to us here, IOS, a Panamanian corporation that maintained its prin- cipal 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. 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 investment adviser and principal under- writer. This fund was FOA, corporation organized under New York 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 registered with us under that statute as an open-end investment com- pany. IPC’s domestic mutual fund retailing operation was much older than IOS. In April 1965, LOS bought a controlling interest in IPC’s going (albeit then un- profitable) retail mutual fund business.” After that, 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 42a IOS naturally wanted to make IPC profitable. One way of doing this was to build up IPC’s captive fund, PFOA. As a mere merchandiser of shares in mutual funds controlled by others, IPC could expect only the retail dealer’s share of the sales charge plus some excess brokerage income funneled to it by the managers of the funds whose shares it was selling. But when IPC sold shares in FOA, it: 1. Kept the total sales charge since there was no unaffiliated 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.’ of Economic Research described as “armies of salesmen who are believed to be worthwhile even if they only sell themselves, their close friends, and their relatives.” SEC Staff Report On the Po- tential Economic Impact of a Repeal of Section 22(d) of the In- vestment 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”). ** 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 underwriters 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. Public Policy 207-209. * Over the long-run, this was much more important than sales charge revenues, Generally, the advisory fees that the adviser- underwriters 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. 43a 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 unaffiliated with IPC. Second, IOS put money from one of its own offshore 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 approximately $22 mil- lion in FOA. By mid-1966, FOF owned about 46 percent of FOA’s outstanding shares.” FOF’s investment in FOA was a highly-remunera- tive proposition for IOS. The benefits to FOF itself or its shareholders were more obscure, to say the least. By having one of its funds, FOF, invest in FOA, another IOS-managed fund, IOS: 1. Collected a sales charge on a sales charge—he- cause 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 inuring, of course, to the benefit of IPC’s parent, IOS) when FOF purchased FOA shares from IPC, the exclusive distributor of those shares; " and 2. Received two advisory fees out of what was in economic reality a single pool of capital—IOS took * 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. S Seen. 9 on p. 5, supra. 16 Public Policy 313, Table VIII-1. The record shows that in January 1968 FOF still owned approximately 40 percent of FOA’s shares. 1T There were so many entities in the IOS complex that the above text simplifies the corporate relationship involved. FOA’s under- writer was IPC, and FOA’s adviser was IPC’s wholly-owned sub- sidiary, Fund of America Management Corporation. 44a an advisory fee from FOF in exchange for its serv- ices in putting FOF’s money into FOA, and through IPC it then took a second advisory fee from FOA for managing FOA’s investments.* IV. THE 1966 PROCEEDING AND ITS APTERMATH Soon after 1OS’s acquisition of IPC, members of the Commission's staff reported to the Commission that information had come to their attention indi- cating that [OS'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 appreci- able numbers of Americans fraudulently and in viola- tion of the Securities Act’s registration requirements.” To determine whether this was actually so and what remedial action, if any, was needed, this Commission, in February 1966, instituted an administrative pro- ceeding against IOS and some of its affiliates.” After the failure of its strenuous efforts to enjoin that pro- ceeding on the ground that we had no power to conduct it,” LOS decided to settle. During settlement negotiations with our staff, IOS learned that settlement would require a material reduction in the scope of its United States activities. ** 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 in- vestment vehicle.” Public Policy at 318. '® 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. SEC, 259 F. Supp. 880 (D.P.R., 1966). 45a TOS made an offer of settlement in which it under- took, 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 interests 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 5. Conduct all of its securities activities outside the United States. We accepted IOS’s offer on May 23, 1967, thus terminating 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 independent 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., head- quartered in New York, with branch offices 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 investment involved.”** The “investment involved” *2 JOS, Ltd. (S.A.), Securities Exchange Act Release No. 8083. ** From April 1967 through June 1968, Lipper Corp. received gross commisisons of $11,372,000, $8,014,000 of which came from IOS-related business. 46A 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 main 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 in 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 de- pended on the latter’s earning power. IOS, therefore, had an especially strong incentive to improve IPC’s performance prior to the sale. The Lipper respondents helped IOS to attain that objective. V. REBATES OF OVER-THE-COUNTER BROKERAGE COMMISSIONS A. The facts and their legal consequences Lipper Corp. handled the foreign funds’ over-the- counter business on an agency basis. For its services in this regard, Lipper Corp. charged the stock ex- change commission 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 Au- gust 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-counter transactions handled by Lipper Corp., it 47a 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 diver- sion. 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. SEC v. Capital Gains Re- search Bureau, 375 U.S, 180, 191 (1963) ; Arleen W. Hughes, 27 SEC 629, 635-638 (1948), aff'd sub. nom. Ilughes v. SEC 174 F.2d 969 (C.A.D.C., 1949). And investment advisers to investment companies are on the same footing. Rosenfeld v. Black, 445 F. 2d 13387 (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), affd 294 F.2d 415 (C.A. 2, 1961). See Provident Management Corp., 44 SEC 442, 447 (1970: “Porteous and Lautsbaugh, as offi- cers 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 execution on its transactions, or that the exist- ence of the arrangement described resulted in additional costs to Fund, once the reciprocai arrangements were made, it was im- proper for Porteous & Co. to keep for itself rather than confer on Fund the benefits attributable to Fund’s assets.”; Consumer- Investor Planning Corp., 43 SEC 1096, 1100-1101 (1969) : It is clear that [respondents] . . . 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 com- missions thus generated 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 constituted a form of personal enrich- ment derived from the Fund’s portfolio transactions. By such bla- 243-942—77——_5 48a 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 elimi- nate.” We therefore find, as did the administrative law judge, that the IOS respondents’ over-the-counter commission-splitting arrangements were a fraud on the foreign funds and on their shareholders.” It tant trafficking of the Fund’s business, respondents simply used their fiduciary positions in relation to the Fund to cause mone- tary and other benefits to inure to themselves without regard to what was best for the Fund .... The abuse of position and conflict of interests inherent in the making of these arrangements was clearly inimical to the Fund and its shareholders.”; Dele- ware Management Co., 43 SEC 392 (1967). *° I1.R. Rep. No. 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 Lipper-IPC give-up arrangements are claimed to have been dis- cussed at a meeting of one of the three boards. But what about the boards of the other two funds? No disclosures are expressly claimed to have been made to them. As to the disclosures made to the one fund, we agree with the administrative law judge that they cannot be deemed to have been adequate. But even if they had been adequate so far as the directors were concerned, it seems to us that in view of IOS’s controlling influence over these entities, the disclosure required in this situation was disclosure to the share- holders actual and prospective. Moreover, the administrative law judge pointed out that the person making the purported disclo- sures was a principal in the scheme to defraud the foreign funds. Cf. Schoenbaum v. Firstbrook, 405 F. 2d 200, 211-212, reversed in part on other grounds en bane 405 F. 2d 215 (C.A. 2, 1968), cert. denied sub nom. Manley vy. Schoenbaum, 395 U.S. 906 (1969) : “In general, if the corporation’s agents have not been deceived, neither has the corporation, However, as in other situations gov- erned by agency principles, knowledge of the corporation’s offi- cers and agents is not imputed to it when there is a conflict between 49a follows that the IOS respondents willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. Since the Lipper respondents knew about IOS’s relationship to the foreign funds, and since their active assistance 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 10S respondents’ violations.” Respondents advance various arguments, based upon then existing rules and practices in the securi- ties markets which, they claim, justify their activi- ties. To these we now turn. Respondents claim that the rules of the New York Stock Exchange required the funds to bear over-the- counter brokerage costs that are conceded to have been high. They argue that: 1. As a New York Stock Exchange member, Lipper Corp. was bound to adhere to that organization’s minimum commission rate schedule. 2. The anti-rebate rules that the exchange adopted for the purpose of preventing its members from cut- ting rates in underhanded ways precluded Lipper from returning any excess brokerage to the funds themselves. the interests of the officers and agents and the interests of the corporate principal. [Citations omitted. ] Therefore, a corporation may be defrauded in a stock transaction even when all of its di- rectors know all of the material facts, if the conflict between the interests of one or more of the directors and the interests of the corporation prevents effective transmission of material informa- tion to the corporation, in violation of Rule 10b-5(2).” See also Pappas v. Moss, 393 F. 2d 865 (C.A. 3, 1968). 28 See Provident Management Corp., 44 SEC 442, 448 (1970). 5OA 3. There were only two choices. One was for Lipper to retain for himself all of the brokerage that the New York Stock Exchange had thrust into his un- willing hands. The other was to divide it with IOS. In no event could the funds’ over-the-counter brokerage costs have been any lower than they actually were. This argument, although perhaps superficially ap- pealing, is, upon analysis, unavailing. The New York Stock Exchange had no jurisdiction over commission rates in over-the-counter transactions. The over-the- counter market during the relevant period was, and it still is, “a negotiated market . . . not governed by fixed prices or minimum commission rate sched- ules.” * Therefore, “any willingness of the executing broker . . . to allow his customer to direct a give-up of a portion of his commission . . . in and of itself shows that a lower . . . commission could have been negotiated.” The New York Stock Exchange’s anti-rebate policies are clearly not relevant here. Those policies applied only to transactions on that exchange. What they pro- hibited was the division of commissions paid for such transactions with those who were not themselves mem- bers of the New York Stock Exchange.” The trans- actions involved herein were not New York Stock 2° Public Policy 178. Although the practice was to charge the New York Stock Exchange minimum rate on over-the-counter transactions executed on an agency basis, no rules legally binding on Lipper required this. A violation of the National Association of Securities Dealers’ Rules of Fair Practice might have been in- volved, however, if the commission charged was in excess of the New York Stock Exchange minimum. *° Public Policy 178. *t Public Policy 170. 51a Exchange transactions.“ Nor was IPC a New York Stock Exchange member. The Lipper respondents claim to have been in fear of disciplinary action by the New York Stock Exchange.” 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 applicable to these transactions, they would have prohibited commission-splitting with IPC as well as with the funds that paid those commissions. Moreover, the New York Stock Exchange had no jurisdiction over IPC. There is nothing in the record to show that the exchange would have been discon- ** The New York Stock Exchange’s vice president in charge of member firms testified that “The New York Stock Exchange mini- mum commission applied to New York Stock Exchange trades; not over-the-counter trades.” The following colloquy then ensued : “Q. To what extent does the New York Stock Exchange feel it has the authority to establish rates in the over-the-counter market ? A. We don’t feel that we have any authority to establish rates in the over-the-counter market.” ** The New York Stock Exchange official previously referred to did testify that very low over-the-counter charges might in certain circumstances be deemed impermissible rebates. But he made it clear that he was talking about over-the-counter commissions that were below the cost of doing business. He further testified as fol- lows on redirect examination by Division counsel : “Q. Now Mr. Bishop, is it a requirement of the New York Stock Exchange that the minimum New York Stock Exchange [sic] be charged by member firms in executing over-the-counter tratisac- ‘ tions, even though the minimum New York Stock Exchange Com- mission exceeds the cost of executing the transaction ? A. No.” ** Lipper testified : 7 “Q. Weren’t you concerned that the New York Stock Exchange might consider the payment of commissions earned in the over-the- counter market, for Fund of Funds portfolio transactions, to IPC,’ as violative of their anti-rebate rules? . A. Nosir, I was not concerned.” 52a certed had IPC returned Lipper’s give-up money * to the funds.” Hence the administrative law judge was clearly correct when he held that: “There was no requirement of the NYSE that its members charge NYSE rates on over-the-counter transactions and Cowett [I[OS’s executive vice presi- dent and the principal architect of the give-up scheme] and Lipper, both highly sophisticated in the financial world, knew or should have known the limi- tations of the NYSE rules. It was permissible for Lipper Corporation to charge less on the funds’ over- the-counter transactions and, contrary to respond- ents’ position, the record evidences a willingness by Lipper Corporation to be content with 50% of the amounts actually charged the funds on such trans- actions. In this connection, it is also clear from the record that Cowett was not interested in negotiating for a lower rate but in having Lipper Corporation give up 50% of the funds’ commission payments to IPC so that the latter would obtain additional reve- nues.”’ %5 During the relevant period, the New York Stock Exchange permitted one of its members to manage a large investment com- pany complex without receiving any management fee. The partners in that firm viewed the brokerage income that they derived from the complex’s portfolio transactions as sufficient in itself to com- pensate them for their services. There is no indication that the Exchange considered this arrangement an impermissible rebate. See Public Policy 106-109. %6 Whatever the New York Stock Exchange’s sentiments might or might not have been, the money having come from the funds in the first place, and IPC having done nothing to earn it, there was no way in which the ICS respondents could lawfully keep it. Moses v. Burgin, 445 F.2d 369, 376 n. 11 (C.A. 1, 1971), cert. denied 404 U.S. 994 (1971). 53A Respondents say that customer-direeted give-ups were widespread and generally regarded as legitimate in 1967 and 1968. They are right about that. But their conclusion that this justifies the activities here in- volved, however, is unfounded because the customer- directed give-ups referred to, which were in the ex- change market, differed from the present case in two critical respects. First, they did not involve fiduciaries diverting their beneficiary’s funds into their own poc- kets. Secondly, they represented a form of competi- tion for lucrat'ye institutional business that prevailed under the rigid fixed commission rate system which existed in the exchanged markets only. Exchange rules fixed minimum commissions at a rate which often exceeded the amount for which a broker was willing to execute a transaction. Exchange rules also prohibited any rebate of commissions to the customer. Under this regime, brokers sought to at- tract lucrative institutional business by offering vari- ous inducements to institutional customers. These in- cluded, particularly in the case of mutual funds, a willingness to give-up a portion of the commission to broker-dealers designated by the fund management, who were engaged in selling fund shares. Such give- ups represented additional compensation to these deal- ers for their selling activities. The exchanges chose not to regard this as a rebate. While this practice was questionable and was abolished by the exchanges in December 1968, it was permitted prior to that time as a means by which fund managers could obtain something of value for their excess commissions. In the over-the-counter market, no fixed commission rate was imposed. The National Association of Se- curities Dealers, Inc., the self-regulatory body for the O4A over-the-counter market, was and is prohibited by law from maintaining fixed commission rates. The cus- tomer-directed give-un was not prevalent in that mar- ket and was, indeed, regarded as improper, if not illegal. As the Commission noted in December 1966: “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.” ” Respondents point to the fact that it was the usual practice in agency transactions in the over-the-counter market to charge the New York Stock Exchange com- mission rates. This appears to be correct.” The con- clusion which respondent derive from this, that price competition for execution services did not exist in the over-the-counter market any more than in the ex- change market, does not follow. Nor does it further follow that because give-ups were accepted in ex- change transactions, they were therefore also accept- able in over-the-counter transactions. Although on small over-the-counter brokerage trans- actions the New York Stock Exchange commission was utilized as a familiar measure of a proper charge for the service, institutions were not required to, and usually did not, pay the high exchange commission on large over-the-counter transactions. They simply dealt directly over-the-counter market makers and were charged a mark-up substantially less than the applic- able exchange commission.” Consequently, on insti- ** Public Policy 178. %* See Report of Special Study of Securities Markets of the SEC, H.R. Doc. No, 95, pt. 2, 88th Cong., Ist Sess. 624 (1963) (hereinafter cited as Special Study). %* Jd. at 627. But on the exchange, the transaction could not, of course, be executed for less than the minimum commission, 554 tutional transactions in the over-the-counter market there were no excess commissions to be disposed of by using customer-directed give-ups, and customer-di- rected give-ups were not utilized in that market. Respondents argue that because the Commission’s 1967 consent order precluded IOS from dealing di- rectly with market makers, the 1O0S-managed funds had to pay excessive commissions and IOS had to di- vert the excess into its own pocket. The Commission, of course, did not intend such a result, and the order clearly does not provide for such. Nothing in the 1967 order required the funds to pay, or Lipper to charge, excessive commissions.” If for any reason an institution wished to execute an over-the-counter trade with a broker-dealer firm as agent rather than as principal, this could be done, and the commission could be negotiated, as IOS and Lipper might have done here. Respondents claim to have relied on the advice of counsel, and they did have opinions of counsel which supported their course of conduct. Although neither ignorance of the law nor reliance upon counsel’s opin- ions can make unlawful conduct legal, advice of coun- * Respondents appear to suggest that the practice of charging the stock exchange commission on over-the-counter transactions was not merely a practice, resorted to for convenience where ap- propriate, but rather reflected some type of agreement or con- spiracy among broker-dealers to charge that rate under all circum- stances. We can hardly assume the existence of such an agree- ment, particularly in view of the fact that, if practiced in the over-the-counter market where no statute affords the slightest justification for rate fixing, it would have been a flagrant viola- tion of the antitrust laws. 243-942—77——6 56A sel is often a weighty mitigating factor.“ This is par- ticularly true where the law is obscure or changing, or where the issues are technical and specialize [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_2423%3A1. Public record. Not legal advice.