Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-05-01467/USCOURTS-caDC-05-01467-0/pdf.json

Parties Involved:
Joseph Mizrachi
Petitioner
PAZ Securities, Inc.
Petitioner
Securities and Exchange Commission
Respondent

Document Text:

United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 16, 2006 Decided July 20, 2007

No. 05-1467

PAZ SECURITIES, INC. AND

JOSEPH MIZRACHI,

PETITIONERS

v.

SECURITIES AND EXCHANGE COMMISSION,

RESPONDENT

On Petition for Review of an Order of the

Securities and Exchange Commission

David Clarke, Jr. argued the cause for petitioners. With

him on the briefs was Deborah R. Meshulam.

Michael A. Conley, Senior Special Counsel, argued the

cause for respondent. With him on the brief were Brian G.

Cartwright, General Counsel, Jacob H. Stillman, Solicitor, and

Susan K. Straus, Attorney.

Before: GINSBURG, Chief Judge, and ROGERS and

KAVANAUGH, Circuit Judges.

Opinion for the Court by Chief Judge GINSBURG.

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GINSBURG, Chief Judge: PAZ Securities, Inc. and its

president, Joseph Mizrachi, petition for review of an order of the

Securities and Exchange Commission sustaining the decision of

the National Association of Securities Dealers to expel PAZ

from membership and to bar Mizrachi from ever associating

with any NASD member firm as sanctions for Mizrachi’s failure

to respond to the NASD’s repeated requests for information

from and about PAZ. We hold the Commission abused its

discretion in two ways: (1) it failed to address certain mitigating

factors raised by the petitioners, specifically, that their failure to

respond had no potential either to injure the investing public or

to benefit themselves monetarily nor did the information

requested relate to conduct potentially injurious to the public or

beneficial to themselves; and (2) it did not identify any remedial

— as opposed to punitive — purpose for the sanctions it

approved. Accordingly, we grant the petition and remand this

matter for the Commission to consider anew whether the

sanctions are excessive or oppressive in light of the factors

raised in mitigation and to consider for the first time whether the

sanctions serve a remedial purpose, as required by § 19(e)(2) of

the Securities Exchange Act of 1934, 15 U.S.C. § 78s(e)(2).

I. Background

Joseph Mizrachi was the president of PAZ Securities, Inc.,

which was a member of the NASD, a “self-regulatory

organization” registered with the Commission as a “national

securities association” under Section 15A of the Securities

Exchange Act of 1934, 15 U.S.C. § 78o-3. The NASD adopts

rules to regulate the conduct of its members, § 15A(b)(3)-(7),

and may enforce those rules by imposing disciplinary sanctions

upon member firms and persons associated with them,

§ 15A(b)(8)-(9).

In February 2003 the NASD began a routine on-site

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examination of PAZ and reviewed materials provided by Joseph

Mizrachi’s brother, Simon Mizrachi, in his capacity as vice

president of the firm. Joseph Mizrachi claims he was

unavailable at that time to respond to the NASD because he was

experiencing mental distress caused by marital difficulties and

was traveling abroad. Unable to obtain through Simon Mizrachi

everything it sought from PAZ, the NASD asked Joseph

Mizrachi and PAZ to provide additional written information.

Specifically, the NASD sent three letters to the petitioners

asking whether PAZ had implemented a continuing education

program; what investment banking or securities business the

firm had engaged in since February 2001; what specific duties

PAZ had assigned to, and what compensation PAZ had paid to,

certain individuals during the period 2000-2002; whether PAZ

had revised its written supervisory procedures as requested

(apparently by the NASD); why the NASD had not received the

firm’s 2001 audit on time; and whether PAZ had a written

expense sharing agreement with a company operated by Simon

Mizrachi that shared office space with PAZ.

The NASD sent the first letter on May 6, 2003 by overnight

courier to Joseph Mizrachi at the address listed for PAZ in the

NASD’s Central Registration Depository (CRD). On May 20,

2003 the NASD sent a second letter by express courier to the

same address requesting the same information. On July 23,

2003 it sent a third letter by first class and certified mail to the

address listed in the CRD for each petitioner. The return

receipts show that one “C.J. Mizrachi” signed for the letter sent

to PAZ’s registered address, but the return receipt card sent to

Joseph Mizrachi’s home address bears an illegible signature.

Joseph Mizrachi asserted before the Commission that he is not

C.J. Mizrachi, and C.J. Mizrachi is not further identified in the

record.

The petitioners do not contest that the NASD’s efforts to

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notify them comply with NASD Procedural Rule 9134, which

provides the NASD may send documents by first class mail,

certified mail, or courier to the address listed in the CRD. Under

NASD Procedural Rule 8210(d), a member of the NASD or

person to whom a request for information is directed is deemed

to have received that request when it is sent to the last known

business address of the member firm or the last known

residential address of a person associated with the firm, as

reflected in the CRD. Therefore, the petitioners had

constructive, if not actual notice of the three letters requesting

information from PAZ.

On August 14, 2003 the NASD Department of Enforcement

filed with the NASD Office of Hearing Officers a complaint

alleging the petitioners had failed to respond to a request for

information, in violation of NASD Conduct Rule 2110 and

NASD Procedural Rule 8210. The Department of Enforcement

simultaneously sent by first class and certified mail a Notice of

Complaint, with the complaint attached, to the addresses listed

in the CRD for PAZ and for Joseph Mizrachi. The Department

repeated this drill on September 12, 2003. Though the record is

unclear whether Joseph Mizrachi received either of the Notices,

he admitted that Simon Mizrachi told him about the complaint,

apparently no later than October 2003.

In September 2003 Simon Mizrachi hired Douglas

Westendorf, Esq. to represent the petitioners before the NASD.

Pursuant to a motion Westendorf filed on September 26, the

NASD gave the petitioners until October 20 to answer the

complaint. The petitioners, however, still failed to answer the

complaint, and on October 28 the NASD Hearing Officer found

them in default. In November the Department of Enforcement

moved for entry of a default decision and served the motion

upon the petitioners and Westendorf. On December 31 the

NASD Hearing Officer entered a default decision against the

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petitioners, expelling PAZ from membership in the NASD and

barring Joseph Mizrachi from ever associating with any NASD

member firm, the “standard” sanctions — absent mitigating

circumstances — recommended in the NASD Sanction

Guidelines (at 35).

On January 23, 2004 the petitioners belatedly responded to

the NASD’s request for information and moved to vacate the

default decision. In that motion, Joseph Mizrachi explained that

from January to August 2003 he had been traveling abroad to

visit family and to deal with emotional distress, for which he had

received counseling; from August 2003 to January 2004 he

claimed he had been traveling extensively for business. Joseph

Mizrachi claimed he and PAZ had relied upon Westendorf to

represent them and attributed their failure to respond to the

negligence of the attorney. The NASD Hearing Officer denied

the motion to vacate the default decision because the petitioners

had presented no evidence that their failure to respond was

attributable to negligence by Westendorf and therefore failed to

show good cause to vacate the default decision.

The petitioners appealed to the NASD’s National

Adjudicatory Council (NAC), arguing the sanctions imposed by

the Hearing Officer were unduly severe and should be reduced

upon the basis of three mitigating factors: (1) the petitioners’

misplaced reliance upon counsel to respond to the complaint; (2)

the unintentional nature of their failure to respond; and (3) the

nature of the information requested, which did not involve any

potential monetary gain to either of them. The NAC affirmed

the default decision, the sanctions, and the Hearing Officer’s

refusal to vacate the default decision. It found the petitioners’

failure to respond to the NASD’s requests for information were

not mitigated by the enumerated factors because Joseph

Mizrachi had at least constructive notice of the repeated requests

for information and the petitioners’ failure to respond was

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“tantamount to stonewalling and a willful refusal to comply,”

which had “undermined” the NASD’s ability to fulfil its

regulatory responsibilities. The NAC did not respond to the

petitioners’ contention that their failure to respond was

mitigated because the information requested did not relate to any

potential monetary gain to them, except to say, “We have

considered and rejected without discussion all other arguments

of the parties.”

Before the Commission, the petitioners argued the sanctions

should be reduced because their failure to respond to the

NASD’s information requests (1) was unintentional (Principal

Consideration No. 13, NASD Sanction Guidelines at 7); (2) did

not injure the investing public (Principal Consideration No.10,

NASD Sanction Guidelines at 6), nor did the information

requested relate to injurious conduct (violation-specific

Principal Consideration No. 1, NASD Sanction Guidelines at

35); (3) did not stand to benefit them monetarily (Principal

Consideration No. 17, NASD Sanction Guidelines at 7), nor did

the information requested relate to conduct of benefit to them

(violation-specific Principal Consideration No. 1, NASD

Sanction Guidelines at 35); and (4) was attributable to their

reliance upon counsel to respond to the complaint (Principal

Consideration No. 7, NASD Sanction Guidelines at 6). The

Commission first determined that Joseph Mizrachi actually

knew about the requests for information by September 2003 but

neither contacted the NASD nor delegated that task to another,

which undermined the petitioners’ claim that their failure to

respond was unintentional. Next, the Commission rejected the

petitioners’ contention that they reasonably relied upon counsel

because Joseph Mizrachi apparently neither followed up with

Westendorf about filing an answer to the complaint nor asked

anyone to keep him updated on the matter. Finally, in response

to the petitioners’ suggestion that the nature of the information

requested mitigated their failure to respond, the Commission

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said the “NASD’s requests were not as limited as [the

petitioners] contend”; they concerned generally “the nature of

PAZ’s investment banking and securities activities [and, more

specifically,] the duties and responsibilities of certain

individuals, and whether the firm had a written agreement

regarding shared expenses.” Moreover, “Even if the requests

had been limited” member firms and persons associated with

them “cannot second-guess NASD’s requests” because the

“NASD has a right to request information and require

cooperation.” The Commission emphasized the “importance of

complying with NASD’s information requests” because “[w]hen

members and associated persons delay their responses to

requests for information, they impede the ability of NASD to

conduct its investigations.” Because the petitioners had received

the standard sanction under the NASD Guidelines for failure to

respond to a request for information, and because the

Commission found that failure was unmitigated, the

Commission held the sanctions were neither excessive nor

oppressive.

II. Analysis

The petitioners argue the Commission abused its discretion

by affirming sanctions grossly disproportionate to their conduct

without considering certain mitigating factors and without

articulating a remedial rather than a punitive purpose for the

sanctions. Specifically, they contend the Commission did not

evaluate whether their failure to respond to the NASD’s requests

for information was mitigated because (1) it did not result in any

injury to the investing public (Principal Consideration No. 11,

NASD Sanction Guidelines at 6), (2) it did not have the potential

to benefit either of them monetarily (Principal Consideration

No. 17, NASD Sanction Guidelines at 7), and (3) the

information requested related to conduct neither potentially

injurious to the investing public nor potentially beneficial to

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*

 Section 19(e), 15 U.S.C. § 78s(e), provides:

(1) In any proceeding to review a final disciplinary sanction

imposed by a self-regulatory organization ... —

(A) if the [Commission] ... finds that such member,

participant, or person associated with a member has

... omitted such acts, as the self-regulatory

organization has found him to have ... omitted, that

such ... omissions to act, are in violation of ... the

rules of the self-regulatory organization ... and that

such provisions are, and were applied in a manner,

consistent with the purposes of this chapter, [then the

Commission,] by order, shall so declare and, as

themselves (violation-specific Principal Consideration No. 1,

NASD Sanction Guidelines at 35).

The Commission responds that it may review a sanction

only to determine whether it is excessive or oppressive and may

not determine de novo whether it is otherwise appropriate. See

Krull v. SEC, 248 F.3d 907, 911 (9th Cir. 2001) (“Although the

Commission reviews the record de novo, its review of the

sanction is narrower — the sanction may be modified or

canceled only if it is ‘excessive or oppressive’”). The

Commission emphasizes that the NASD Sanction Guidelines,

which absent mitigating circumstances call for the expulsion of

a member firm and the lifetime bar of an associated person for

failure to respond to a request for information, show the

sanctions imposed are not “grossly disproportionate.” The

Commission also asserts it considered each of the mitigating

factors raised before it, and it may not now be faulted for failing

to consider mitigating factors the petitioners did not raise before

it.

Pursuant to § 19(e) of the Securities Exchange Act of 1934*

,

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appropriate, affirm the sanction imposed by the

self-regulatory organization, modify the sanction in

accordance with paragraph (2) of this subsection, or

remand to the self-regulatory organization for further

proceedings; or

(B) if [the Commission] does not make any such

finding it shall, by order, set aside the sanction

imposed by the self-regulatory organization and, if

appropriate, remand to the self-regulatory

organization for further proceedings.

(2) If the [Commission] ... having due regard for the public

interest and the protection of investors, finds after a

proceeding in accordance with paragraph (1) of this

subsection that a sanction imposed by a self-regulatory

organization upon such member, participant, or person

associated with a member imposes any burden on competition

not necessary or appropriate in furtherance of the purposes of

this chapter or is excessive or oppressive, [then the

Commission] may cancel, reduce, or require the remission of

such sanction.

the Commission is to review de novo a disciplinary sanction

imposed by the NASD upon a member firm or a person

associated therewith to determine whether the sanction “imposes

any burden on competition not necessary or appropriate” to

further the purposes of the Act, or is “excessive or oppressive.”

See Otto v. SEC, 253 F.3d 960, 964, 966-67 (7th Cir. 2001) (“the

SEC conducts de novo review of the NASD’s sanctions”).

When evaluating whether a sanction imposed by the NASD is

excessive or oppressive, as we have stated before, “the

Commission must do more than say, in effect, petitioners are

bad and must be punished,” Blinder, Robinson & Co., v. SEC,

837 F.2d 1099, 1113 (D.C. Cir. 1988); at the least it must give

“[s]ome explanation addressing the nature of the violation and

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the mitigating factors presented in the record.” McCarthy v.

SEC, 406 F.3d 179, 189-90 (2d Cir. 2005) (reviewing

Commission decision affirming sanctions imposed by New York

Stock Exchange, a self-regulatory organization). The

Commission must be particularly careful to address potentially

mitigating factors before it affirms an order expelling a member

from the NASD or barring an individual from associating with

an NASD member firm — the securities industry equivalent of

capital punishment. Cf. Steadman v. SEC, 603 F.2d 1126, 1137-

40 (5th Cir. 1979) (“when the Commission chooses to order the

most drastic remedies at its disposal, it has a greater burden to

show with particularity the facts and policies that support those

sanctions and why less severe action would not serve to protect

investors”), aff’d on other grounds, 450 U.S. 91 (1981).

In this case the petitioners claim the Commission failed to

address several mitigating factors. Insofar as the petitioners

claim the Commission should have considered their previously

clean disciplinary record and that they did not attempt either to

mislead anyone or to conceal their present misconduct, their

arguments are forfeit because the petitioners did not raise them

before the Commission. 15 U.S.C. § 78y(c)(1). Insofar as the

petitioners preserved other claims, however, they are on solid

ground.

In the course of emphasizing in its decision the petitioners’

obligation to respond to the NASD’s requests for information

(the “NASD has a right to request information and require

cooperation from those persons it investigates”), the

Commission mischaracterized the petitioners’ argument, saying

they “suggest[ed] that the information requests were not

important because they focused on PAZ’s supervisory

procedures.” In fact, their argument was not that the

information sought was unimportant but rather that their failure

to respond to the NASD (1) was of no potential monetary

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*

 When Wright was decided, Section 19 authorized the Commission

itself “for the protection of investors ... to expel from a national

securities exchange any member or officer thereof” for certain

violations of the statute or of the rules and regulations thereunder.

Securities Exchange Act of 1934, Pub. L. No. 73-291, § 19(a)(3), 48

Stat. 881, 898-99 (codified at 15 U.S.C. § 78s(a)(3) (1940)). Although

the statute now calls for the sanction to be imposed in the first instance

by a self-regulatory organization, subject to review by the

Commission, that procedural change does not dilute the substantive

requirement that the sanction be remedial rather than punitive. See

§ 19(e)(2); McCarthy, 406 F.3d at 189-91 (holding Commission

abused its discretion by affirming exchange decision suspending

broker from membership without determining sanction was necessary

to protect investors).

benefit to them and (2) did not result in any injury to the

investing public, and that (3) the information requested did not

relate to injurious conduct or conduct of potential monetary

benefit to them.

In addition, pursuant to Section 19 of the Act, the

Commission was obliged — but failed — to review the sanction

imposed by the NASD with “due regard for the public interest

and the protection of investors.” 15 U.S.C. § 78s(e)(2). As the

Second Circuit explained in Wright v. SEC, 112 F.2d 89, 94 (2d

Cir. 1940), that provision “authorizes [the Commission to order]

expulsion not as a penalty but as a means of protecting investors

.... The purpose of the order is remedial, not penal.”*

 If the

Commission upholds the sanctions as remedial, then it must

explain why; furthermore, “as the circumstances in a case

suggesting that a sanction is excessive and inappropriately

punitive become more evident, the Commission must provide a

more detailed explanation linking the sanction imposed to those

circumstances if it wishes to uphold the sanction.” McCarthy,

406 F.3d at 190; see also Occidental Petrol. Corp. v. SEC, 873

F.2d 325, 338 (D.C. Cir. 1989) (“in order to allow for

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meaningful judicial review, the agency must produce an

administrative record that delineates the path by which it

reached its decision”). We do not suggest the Commission must

make an on-the-record finding that a sanction is remedial, but it

must explain why imposing the most severe, and therefore

apparently punitive sanction is, in fact, remedial, particularly in

light of the mitigating factors brought to its attention.

The Commission did state its view that the sanctions here

imposed by the NASD would “serve as a deterrent to others who

may be inclined to ignore NASD’s information requests,” but

such “general deterrence” is essentially a rationale for

punishment, not for remediation. Cf. Republic Steel Corp. v.

NLRB, 311 U.S. 7, 12 (1940) (“it is not enough to justify the

[National Labor Relations] Board’s requirements [of an

employer] to say that they would have the effect of deterring

persons from violating the [National Labor Relations] Act”

because the Board’s power “is remedial, not punitive”); United

States v. Bajakajian, 524 U.S. 321, 329 (1998) (“Deterrence ...

has traditionally been viewed as a goal of punishment”). Still,

we agree with the Second Circuit that, “[a]lthough general

deterrence is not, by itself, sufficient justification for expulsion

or suspension ... it may be considered as part of the overall

remedial inquiry.” McCarthy, 406 F.3d at 189. Here, however,

general deterrence was not considered as part of a larger

remedial inquiry; the Commission offered no other rationale

whatsoever. It simply held the sanctions were not excessive or

oppressive because the NASD had a right to the requested

information, the petitioners’ failure to respond was not

unintentional, and Joseph Mizrachi’s depression was not so

severe in August 2003 that he could not resume taking care of

business. Nowhere did the Commission advert to any purpose

other than “deterr[ing] others who may be inclined to ignore

NASD’s information requests.” Therefore, the Commission did

not adequately explain why the sanctions the NASD imposed

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upon the petitioners were not punitive rather than remedial.

III. Conclusion

The Commission abused its discretion by failing to address

certain mitigating factors the petitioners raised before it and by

affirming the severe sanctions imposed upon them by the NASD

without first determining those sanctions were remedial rather

than punitive. The petition for review is therefore granted and

the case is remanded to the Commission for further proceedings

consistent herewith.

So ordered.

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