Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-08-01136/USCOURTS-caDC-08-01136-0/pdf.json

Parties Involved:
Thomas A. Kaufman
Petitioner
Securities and Exchange Commission
Respondent

Document Text:

United States Court of Appeals 

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 5, 2009 Decided June 23, 2009 

No. 08-1134 

CHRISTOPHER H. ZACHARIAS, 

PETITIONER

v. 

SECURITIES AND EXCHANGE COMMISSION, 

RESPONDENT

Consolidated with 08-1136, 08-1141 

On Petitions for Review of an Order 

of the Securities & Exchange Commission 

Jeffrey J. Scott argued the cause and filed the briefs for 

petitioner Thomas A. Kaufmann. 

David A. Zisser argued the cause and filed the briefs for 

petitioner Christopher H. Zacharias. 

Thomas D. Birge argued the cause and filed the briefs for 

petitioner John A. Carley. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 1 of 32
2

Randall W. Quinn, Assistant General Counsel, Securities 

& Exchange Commission, argued the cause for respondent. 

With him on the brief were Andrew N. Vollmer, Acting 

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

L. Schiffrin, Attorney. Brian G. Cartwright, Attorney, entered 

an appearance. 

Before: GINSBURG, Circuit Judge, and WILLIAMS and 

RANDOLPH, Senior Circuit Judges. 

Opinion for the Court filed PER CURIAM. 

Opinion dissenting in part filed by Senior Circuit Judge

WILLIAMS. 

PER CURIAM1: The petitioners are John A. Carley and 

Christopher H. Zacharias, officers and directors of Starnet 

Communications International, Inc., and Thomas A. 

Kaufmann, a registered representative associated with Spencer 

Edwards Inc., a United States registered broker-dealer. They 

challenge the Securities and Exchange Commission’s finding 

that their participation in certain sales of unregistered 

securities violated §§ 5(a) and (c) of the Securities Act of 

1933, as well as the Commission’s imposition of substantial 

monetary disgorgement orders. See John A. Carley, Opinion 

of the Commission and Order Imposing Remedial Sanctions, 

Admin. Proc. File No. 3-11626, Securities Act Release No. 

8888, 92 SEC Docket 1693 (Jan. 31, 2008)(“SEC Opinion”). 

We affirm the SEC’s § 5 decision because the scheme at issue 

clearly involved an “underwriter,” which refutes petitioners’ 

theory that they properly relied on the Regulation S and 

§ 4(1 1⁄2) exemptions. The SEC also found that petitioners 

 

1

 Parts I, II, III, and IV.A of the opinion are by Senior Judge 

Williams; Part IV.B is by Senior Judge Randolph. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 2 of 32
3

Carley and Zacharias had failed to properly report the scheme 

on Starnet’s annual reports and that this omission violated the 

antifraud and reporting provisions of the securities laws. We 

will remand this issue to the SEC for it to explain its finding 

that the omissions involved a material fact. 

Two minor housekeeping matters: First, petitioner 

Zacharias was also found to have violated § 16(a) of the 

Exchange Act for failing to file a single report relating to a 

change in his share ownership. SEC Opinion at 34. The 

Commission did not impose any sanction for this violation, id. 

at 43 n.138, and Zacharias does not appeal the finding. 

Second, the Commission found that petitioners Carley and 

Zacharias committed a Rule 13a-11 violation, but it now 

admits the rule does not apply to the filings at issue here. See 

Respondent Br. at 50 (“The Commission’s mistaken finding 

of a Rule 13a-11 violation . . . should be set aside.”). We 

therefore set aside the finding. 

In Part I of the opinion we set forth the scheme in broad 

outline; Part II discusses the § 5 violations; Part III addresses 

the fraud and reporting violations; finally, Part IV addresses 

the SEC’s remedies. 

I.

The scheme was quite complex. We will address factual 

details where necessary in discussion of petitioners’ legal 

claims, setting out here simply a bird’s eye view. On one 

hand were seven foreign entities controlled by Alfred Peeper 

(collectively, “the Peeper Entities”), owners of several million 

shares in Starnet, which they had purchased and held pursuant 

to Regulation S, and which they could lawfully resell to the 

public. In addition, the Peeper Entities held warrants to 

several additional million shares—warrants that they had yet 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 3 of 32
4

to exercise and that, before the hatching of the scheme, they 

seemed unlikely to exercise because the warrants’ purchase 

prices exceeded the market price. Had the Peeper Entities 

exercised these warrants without a view to the distribution of 

the resulting shares to the public, then their resale of these 

shares would likely have been legal as well. 

On the other hand were petitioners Carley and Zacharias, 

who at the outset of the story held options to buy several 

hundred thousand Starnet shares. Sales to the public of shares 

acquired by exercise of their options would have been illegal 

unless a registration statement under § 5 had been in effect. A 

simple sale to the Peeper Entities, by contrast, would likely 

have been lawful had such a sale complied with certain 

holding periods as outlined in the SEC’s rules and not been 

part of any “chain of transactions . . . involving any public 

offering.” 17 C.F.R. §§ 230.144 (a), (d). 

Carley and Zacharias did not, however, have a 

registration statement filed. Instead, they arranged with the 

Peeper Entities that the latter would sell several million of 

their original and warrant shares and would replace them with 

shares from Carley and Zacharias, acquired by the latter 

through exercise of their options. (Kaufmann, along with 

Eugene G. Geiger, another registered representative 

associated with Spencer Edwards, handled key aspects of the 

sales.) 

Analyzing the events, the SEC in effect collapsed the 

transactions, and attributed the Peepers’ sales to petitioners. 

Specifically, the SEC found that Starnet had extended the 

period during which the Peeper Entities could exercise their 

warrants to enable the Peeper Entities to participate in the 

scheme. The Peeper Entities then exercised these warrants 

and “resold those shares, along with [their original shares] . . . 

in connection with a distribution in order to fund the option 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 4 of 32
5

exercises of the Starnet Option Holders.” SEC Opinion at 14. 

Because the Peeper Entities had exercised their warrants with 

the intention of distributing them to the public, the SEC 

concluded they were underwriters and were not exempt from 

the registration requirements of the securities laws. 

Furthermore, rather than view the option holders’ sales as 

somehow separate from the Peeper Entities’ illegal sales to the 

public, the SEC found that the option holders’ “sales to the 

Peeper Entities were a necessary and critical step in the 

overall distribution.” Id. at 15. Thus, because petitioners 

Carley and Zacharias had sold their option shares to the 

Peeper Entities and petitioner Kaufmann had executed these 

sales, the SEC concluded that they should be held liable as 

participants under §§ 5(a) and (c) of the Securities Act. As we 

shall see, that decision was a triumph of substance over form. 

Petitioners pose various legal challenges discussed below; to 

the extent that they raise “substantial evidence” objections not 

subsumed in the specific legal issues discussed, we reject such 

objections as frivolous. 

In addition, because Starnet did not disclose the existence 

of the scheme in its annual report filed with the SEC, the

Commission found that Carley and Zacharias violated § 17(a) 

of the Securities Act and § 10(b) of the Exchange Act (and 

Rule 10b-5 promulgated thereunder) (collectively, the “fraud 

violations”), as well as the reporting requirements of § 13(a) 

of the Exchange Act and various rules thereunder. Both the 

fraud and reporting violations turn on the SEC’s supposition 

that the scheme was a material fact for purposes of that report. 

All three petitioners now challenge the SEC’s 

conclusions regarding § 5 and the resulting monetary 

penalties. In addition, petitioners Carley and Zacharias 

challenge the SEC’s finding that they violated the antifraud 

and reporting requirements of the securities laws and its 

cease-and-desist order. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 5 of 32
6

II. 

 We review the SEC’s findings of fact and legal 

conclusions under the familiar principles of administrative 

law. The findings of fact are subject to a review for 

substantial evidence, see Wonsover v. SEC, 205 F.3d 408, 412 

(D.C. Cir. 2000), and the “other conclusions may be set aside 

only if arbitrary, capricious, an abuse of discretion, or 

otherwise not in accordance with law.” Graham v. SEC, 222 

F.3d 994, 999-1000 (D.C. Cir. 2000) (internal quotation marks 

omitted). 

 Sections 5(a) and (c) of the Securities Act prohibit the 

“sale” and “offer for sale” of any securities unless a 

registration statement is in effect or there is an applicable 

exemption from registration. 15 U.S.C. §§ 77e(a),(c). There 

is no dispute that the securities sold to the Peeper Entities and 

those sold by the Peeper Entities to the public were not 

registered under the Securities Act. SEC Opinion at 11. 

Petitioners, however, did not actually distribute any shares 

directly to the public. But we have previously held that for 

the purposes of § 5 the petitioners do “not have to be involved 

in the final step of the distribution to have participated in it.” 

Geiger v. SEC, 363 F.3d 481, 487 (D.C. Cir. 2004). Here the 

SEC, citing similar cases from other circuits, said that a 

person who was a “necessary participant” or “substantial 

factor” in the violation could be found liable. SEC Opinion at 

17. Once participation in an unregistered sale has been 

shown, the petitioners have the burden of proving an 

exemption to the registration requirements. See SEC v. 

Ralston Purina, 346 U.S. 119, 126 (1953) (“Keeping in mind 

the broadly remedial purposes of federal securities legislation, 

imposition of the burden of proof on an issuer who would 

plead the exemption seems to us fair and reasonable”); 

Geiger, 363 F.3d at 484 (same). 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 6 of 32
7

 Petitioners Zacharias and Carley claim exemption “under 

Section 4(1) of the Securities Act . . . through operation of the 

so-called ‘4(1 1⁄2)’ exemption.” Zacharias Opening Br. 36. As 

the Commission explained, “The Section 4(1 1⁄2) exemption is 

a ‘hybrid exemption’ not specifically provided for in the 

Securities Act that basically allows affiliates to make private 

sales of securities held by them so long as some of the 

established criteria for sales under both Section 4(1) and 

Section 4(2) of the Act are satisfied.” SEC Opinion at 14 

(internal quotation marks omitted). The SEC contends, and 

Zacharias and Carley accept, that the § 4 (1 1⁄2) exemption will 

not apply if an underwriter is in the picture. This is because, 

although “the term ‘4 (1 1⁄2) exemption’ adequately expresses 

[the relationship between § 4(1) and § 4(2)],” the actual basis 

“for private resales of restricted securities is § 4(1).” 

Ackerberg v. Johnson, 892 F.2d 1328, 1335 n.6 (8th Cir. 

1989). Section 4(1), in turn, exempts “transactions by any 

person other than an issuer, underwriter, or dealer.” 15 

U.S.C. § 77d(1) (emphasis added). Thus, if an underwriter is 

present, the § 4(1) exemption, and by extension the 4(1 1⁄2) 

exemption, cannot apply. See SEC v. Kern, 425 F.3d 143, 152 

(2d Cir. 2005) (“[I]f any person involved in a transaction is a 

statutory underwriter, then none of the persons involved may 

claim exemption under Section 4(1).”). So the § 4 (1 1⁄2) 

question boils down to Zacharias and Carley’s claim that the 

Peeper Entities were not underwriters. 

Petitioner Kaufmann also asserts an exemption that turns 

on whether or not an underwriter was present. He claims that 

the Peeper Entities’ sales to the public were exempt under 

Regulation S. That regulation provides two safe harbors from 

the registration requirements, one allowing for issuers to sell 

unregistered securities in certain offshore transactions, and the 

other for resales of such securities, as long as certain 

requirements are met. See 17 C.F.R. §§ 230.901-904. The 

SEC, in an attempt to combat abuses under Regulation S 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 7 of 32
8

whereby issuers funnel securities through foreign entities back 

to U.S. markets, has made clear that Regulation S will not 

apply to “[p]ublic resales in the United States by persons that 

would be deemed underwriters under Section 2(11) of the 

Securities Act.” Problematic Practices Under Regulation S, 

Securities Rel 33-7190 (June 27, 1995), 1995 WL 385849 

n.17 (June 27, 1995). Thus, like § 4(1 1⁄2), Regulation S turns 

on whether an underwriter is involved in the transaction. 

Unfortunately for petitioners, the SEC’s conclusion that 

the Peeper Entities were statutory underwriters is amply 

supported. Section 2(a)(11) of the Securities Act defines 

“underwriter” as “any person who has purchased from an 

issuer with a view to . . . the distribution of any security, or 

participates . . . in any such undertaking.” 15 U.S.C. 

§ 77b(a)(11). In the present case, the Peeper Entities 

exercised warrants for Starnet shares and soon sold them to 

the public, along with their remaining original stock. The 

only reason the Peeper Entities were able to exercise these 

warrants was the existence of the scheme, for the warrants 

would have expired, completely worthless, had not Starnet 

extended the time of their expiration. Though Zacharias and 

Carley claim the SEC lacked substantial evidence to support 

its finding that the warrant period was extended in order to 

effectuate the scheme, the SEC reasoned that Starnet extended 

the warrants’ term because the Peeper Entities’ original shares 

were not enough to offset the anticipated number of shares to 

be sold by Starnet’s option holders (including officers other 

than Zacharias and Carley). See SEC Opinion at 7-8. 

Petitioners, in fact, can point us to no other reason why 

Starnet might have offered the Peeper Entities what proved to 

be such a valuable extension. Furthermore, the Peeper 

Entities’ initial sales to the public were occasioned by the 

assurance that the shares would be replaced by those held by 

the Starnet officers. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 8 of 32
9

Thus, the Peeper Entities clearly “purchased Starnet 

common stock on the exercise of the warrants . . . with a view 

to the distribution of such shares,” making them underwriters. 

SEC Opinion at 14. Only by viewing the Peeper Entities’ 

sales to the public as somehow entirely separate from the 

officers’ sales to them, as petitioners urge us to do, could the 

Starnet officers’ sales possibly be considered “private.” But 

the record provides ample evidence that all of the sales were 

connected. See, e.g., Exhibit 67, Joint Appendix (“J.A.”) 956 

(a memorandum from Peeper’s attorney, Dennis Brovarone, 

explaining the details of the scheme). Thus we easily find 

substantial evidence and adequate reasoning to support the 

SEC’s conclusion that the Peeper Entities were underwriters. 

Zacharias claims a want of substantial evidence for the 

SEC’s finding that he “knew, or should have known” of the 

Peeper Entities’ sales to the public; this, he says, brings the 

§ 4(1 1⁄2) exemption back into the picture. To support the 

argument, he says that he did not know of the Peeper Entities’ 

later sale of the stock when he sold the shares, and believed 

that his sale to the Peeper Entities was a legitimate private 

transaction. 

The SEC offers two arguments in response. First, it 

claims that § 5 imposes strict liability on participants. In its 

opinion below, however, it left the issue obscure. It stated at 

the outset that “[a] showing of scienter is not required to 

establish a violation of § 5.” SEC Opinion at 11 (citing 

Swenson v. Engelstad, 626 F.2d 421, 424 (5th Cir. 1980), and 

SEC v. Universal Major Indus. Corp., 546 F.2d 1044, 1046-47 

(2d Cir. 1976)). But then it went on to find that “Carley and 

Zacharias knew, or should have known, of the Peeper Entities 

role as the conduit of shares of Starnet Common stock to the 

public.” SEC Opinion at 15 (emphases added). If the SEC 

were applying a strict liability standard, such a finding would 

have been unnecessary. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 9 of 32
10

Ultimately, we need not resolve the question of whether 

strict liability applies because we affirm the SEC’s finding 

that petitioner Zacharias knew or should have known of the 

Peeper Entities’ distribution to the public. Even if we accept 

Zacharias’s argument that he was not aware that the Peeper 

Entities would immediately resell his shares to the public, the 

SEC found that he and Carley “sold their Plan Shares to the 

Peeper entities to replace the Starnet shares that the Peeper 

Entities had owned and previously sold to the public on behalf 

of Starnet Option Holders.” SEC Opinion at 15. It was this 

involvement that served as the “necessary and critical step” in 

the scheme. Id. Zacharias’s only attack on the finding is a 

claim that it is “illogic[al]” for the SEC to say that his 

subsequent sale to the Peeper Entities was a necessary step in 

a prior sale by those entities. But the supposed “illogic” of 

this claim is undermined by the very presence of the scheme. 

The Brovarone memorandum, see Exhibit 67, J.A. 956, 

specifically lays out the process whereby the option holders’ 

subsequent sales to the Peeper Entities compensated the 

Peeper Entities for the initial sales to the public. While 

Zacharias notes that his sales were completed before the 

Brovarone memorandum was written, the SEC’s argument is 

not that the memorandum informed Zacharias but that it 

summarized a pre-existing plan and that Zacharias’s 

knowledge of the plan’s existence could be readily inferred. 

The finding that Zacharias knew or should have known of the 

sales to the public is therefore supported by substantial 

evidence. 

Thus, since we reject the application of the § 4(1 1⁄2) 

exemption and because petitioners Carley and Zacharias do 

not contest the SEC’s finding that they were “substantial 

factors” in the scheme, we may affirm the SEC’s conclusion 

that Zacharias and Carley were liable as participants in the § 5 

violations.

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 10 of 32
11

Apart from his Regulation S exemption claim, Kaufmann 

urges that the sales he executed from the Starnet officers to 

the Peeper Entities were exempt as private resales under Rule 

144. That Rule provides criteria for “determining whether a 

person is not engaged in a distribution,” thus creating a “safe 

harbor from the Section 2(a)(11) definition of ‘underwriter.’” 

Preliminary Note to Rule 144, 17 C.F.R. § 230.144. It 

explicitly limits the safe harbor to certain sales of “restricted 

securities,” id. § 230.144(b)(1)(i), and in turn it limits 

restricted securities to securities acquired from an issuer “in a 

transaction or chain of transactions not involving any public 

offering,” 17 C.F.R. § 230.144(a)(3)(i) (emphasis added). 

There is no dispute in this case that the Peeper Entities offered 

and sold their original Regulation S and warrant shares to the 

public, and, as we said before, the SEC reasonably found that 

the option holders’ “sales to the Peeper Entities were a 

necessary and critical step in the overall distribution.” SEC 

Opinion at 15. Rule 144 does not apply. 

Petitioner Kaufmann advances several additional 

arguments, independent of his exemption theories, as to why 

he did not violate § 5. First, he argues that he was not a 

statutory seller of securities for the purposes of § 5 because he 

did not solicit the public to buy any of the shares from the 

Peeper Entities accounts. Here he relies on Pinter v. Dahl, 

486 U.S. 622 (1988), where the Court, interpreting the 

language of § 12(1) of the Securities Act, making a § 5 

violator liable in rescission “to the person purchasing [a] 

security from him,” 15 U.S.C. § 77l(a), held that being 

“merely a ‘substantial factor’ in causing the sale of 

unregistered securities is not sufficient in itself to render a 

defendant liable under §12(1).” Pinter, 486 U.S. at 654. 

Because of the “purchas[e] . . . from” requirement, §12(1) 

liability “extends only to the person who successfully solicits 

the purchase, motivated at least in part by a desire to serve his 

own financial interests or those of the securities owner.” Id. at 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 11 of 32
12

647. As § 5 does not include the “purchas[e] . . . from” 

language or any equivalent, Pinter is plainly of no use to 

Kaufmann. SEC v. Phan, 500 F.3d 895, 906 n.13 (9th Cir. 

2007). See also Geiger, 363 F.3d at 488 (expressing doubt 

that “Pinter is on point” as applied to § 5 violations). 

 Kaufmann next argues that he was not a “substantial 

factor” in the sale of the securities to the public because his 

only role in the scheme was to sell the shares in the Starnet 

officers’ accounts at Spencer Edwards. The SEC found him a 

“substantial factor” because he accepted the orders to sell the 

Starnet officers’ stock, completed the Forms 144 in 

connection with these sales, and ensured that the Peeper 

Entities and their attorney, Dennis Brovarone, had appropriate 

funds wired to them. As the Peeper Entities would not have 

sold the shares to the public absent the sale of the Starnet 

officers’ stock to the Peeper Entities, and the Peeper Entities 

could not have engaged in their additional sales to the public 

without these transfers, the SEC’s finding is adequately 

supported. 

Kaufmann also claims that he properly relied on 

attorneys’ opinions that the sales from the Starnet officers to 

the Peeper Entities were proper and hence he did not willfully 

violate §§ 5(a) and (c). It appears to be an open question in 

this circuit whether reliance on the advice of counsel is a good 

defense to a securities violation, see SEC v. Savoy Industries, 

Inc., 665 F.2d 1310, 1315 n.28 (D.C. Cir. 1981), and the 

parties have not pointed us to any cases resolving the issue. 

Nor need we resolve it now, because even if counsel’s advice 

is a valid defense Kaufmann could not show that he had met 

the prerequisites, i.e., that he “(1) made a complete disclosure 

to counsel; (2) requested counsel’s advice as to the legality of 

the contemplated action; (3) received advice that it was legal; 

and (4) relied in good faith on that advice.” Id. Kaufmann 

points to several letters from various lawyers involved in the 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 12 of 32
13

scheme opining on the legality of portions of the transactions 

at issue in this case, but not one of them addresses the legality 

of the swap transaction that enabled the option holders to 

exercise their options through the Peeper Entities’ sales to the 

public. There is only one letter in the record that discusses the 

entirety of the transactions at issue here, one from attorney 

Brovarone, and at no point in that letter does Brovarone 

express any opinion on the legality of the scheme as a whole. 

See Exhibit 67, J.A. 956-57; SEC Opinion at 20. 

Finally, Kaufmann advances a procedural argument, 

claiming that the SEC’s denial of his motion to sever his 

proceedings from those of the other parties before the 

Commission denied him due process and a fair trial. 

Although “an agency does not have unlimited discretion to 

consolidate cases,” Kaufmann must show “prejudice from the 

Commission’s decision to consider his case along with those 

of others involved in the alleged fraud.” Nassar and Co. v. 

SEC, 566 F.2d 790, 792 n.4 (D.C. Cir. 1977). As evidence of 

prejudice, Kaufmann says that in denying his motion to sever, 

the SEC pointed to the fact that “Kaufmann has been charged 

with aiding and abetting the violations of the other 

Respondents,” John A. Carley, Order Denying Motion of 

Thomas. A. Kaufmann to Sever Proceedings 2, Admin. Proc. 

File No. 3-11626, Securities Exchange Act Rel. No. 50695 

(Nov. 18, 2004), while in fact the aiding and abetting charge 

was later rejected by the Administrative Law Judge. But the 

SEC referred to the aiding and abetting charge simply in 

determining that the case “involved common questions of law 

and fact,” id.; as “all the Respondents were involved in an 

integrated scheme to distribute unregistered securities,” id., it 

did involve such questions. 

Kaufmann also claims prejudice on the ground that the 

evidence against him was “impossibly compromised by the 

complex, sketchy and inconsistent evidence” against the other 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 13 of 32
14

respondents. But in making that claim Kaufmann relies on a 

proposition that torpedoes it, namely the ALJ’s 

acknowledgement that “[n]o single witness could fully explain 

the mechanics of the scheme.” John. A. Carley, Initial 

Decision 16, Initial Decision Release No. 292, Admin. Proc. 

File No. 3-11626 (July 18, 2005) (“Initial Decision”). The 

charges against Kaufmann were based on that scheme just as 

much as were those against the other respondents. 

III. 

Petitioners Carley and Zacharias advance numerous 

arguments in response to the SEC’s findings of fraud and 

reporting violations, only one of which we need to address 

here. The SEC found that Zacharias and Carley “violated the 

antifraud provisions of the federal securities laws when they 

omitted to disclose as a related-party transaction in Starnet’s 

1999 annual report the nature and extent of the plan to provide 

Starnet officers and employees with a way in which to 

exercise their [stock] options.” SEC Opinion at 33. In order 

to prove a violation of the fraud prohibition, it is necessary to 

show, among other things, that petitioners’ omission was of a 

material fact. See § 17(a) of the Securities Act, 15 U.S.C. 

§ 77q(a)(1); Section § 10(b) of the Exchange Act, 15 U.S.C. 

§ 78j(b); Rule 10b-5, 17 C.F.R. § 240.10b-5. Similarly, the 

basis for the SEC’s finding that Carley and Zacharias violated 

the Commission’s reporting requirements was that they 

“omitt[ed] material information from the applicable Starnet 

reports.” SEC Opinion at 33 (emphasis added). 

“[T]o fulfill the materiality requirement, there must be a 

substantial likelihood that the disclosure of the omitted fact 

would have been viewed by the reasonable investor as having 

significantly altered the total mix of information made 

available.” Basic Inc. v. Levinson, 485 U.S. 224, 231-32 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 14 of 32
15

(1988) (internal quotation marks omitted). The SEC’s finding 

of materiality was, in its entirety, as follows: 

The omitted disclosures were material because they had 

the effect of hiding the distribution through the Peeper 

Entities sales of unregistered Starnet securities to 

facilitate the exercise of options by Starnet officers in 

violation of Securities Act Section 5. Thus, the 

undisclosed sales could expose the company to claims of 

rescission under Securities Act Section 12. 

SEC Opinion at 32-33.

 Contrary to the SEC’s blanket assertion, it is far from 

clear that the scheme would have exposed Starnet to plausible 

claims of rescission (or damages in lieu of rescission). As we 

have seen, § 12(a)(1) of the Securities Act, 15 U.S.C. 

77l(a)(1), does provide for a rescission remedy against 

violators of § 5. But it provides that remedy only for “the 

person purchasing such security from” the violator. 15 U.S.C. 

77l(a). As a result, “remote purchasers are precluded from 

bringing actions against remote sellers.” Pinter, 486 U.S. at 

644 n.21. 

 Here the only direct purchasers from Starnet were the 

officers and employees who exercised their options and the 

Peeper Entities, which purchased stock via exercise of their 

warrants. While the Starnet officers and directors would have 

standing to bring a claim for damages in lieu of rescission, the 

nature of the scheme renders the probability that Starnet 

would have to pay any damages virtually nil. Section 12(a) 

allows recovery of “the consideration paid for such security 

with interest thereon, less the amount of any income received 

thereon.” 15 U.S.C. § 77l(a). As the scheme enabled the 

Starnet officers to resell and realize a substantial profit on the 

shares substantially simultaneously with their purchases, the 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 15 of 32
16

proper recovery would appear to be zero (even disregarding 

the company’s potential defense that the officers’ hands were 

unclean). 

As to the Peeper Entities, the unclean hands defense 

appears an insuperable obstacle. The SEC found that Mr. 

Peeper helped develop the scheme at issue in this case, SEC 

Opinion at 6, that he “controlled” the relevant Peeper Entities, 

id., and that these entities acted as “a conduit . . . for the 

distribution to the public [of Starnet shares],” id. at 14. 

Apparently bearing “at least substantially equal responsibility 

for the violations he seeks to redress,” Batemen Eichler, Hill 

Richards, Inc. v. Berner, 472 U.S. 299, 310-11 (1985), Peeper 

would appear barred unless preclusion of the suit would 

“significantly interfere with the effective enforcement of the 

securities laws and protection of the investing public,” id. 

Nothing suggests that such preclusion is likely. 

On appeal, the SEC offers no further explanation for why 

Starnet would be exposed to claims of rescission. Instead it 

argues that the “concealed dilution resulting from the public 

distribution of Starnet shares” made the omission material. 

See Respondent Br. at 40. As we do not accept appellate 

counsel’s post hoc rationalizations, Burlington Truck Lines, 

Inc. v. U.S., 371 U.S. 156, 168 (1962), this theory is not 

properly before us. 

We therefore grant the petition for review of the 

Commission’s decision on the fraud and reporting allegations. 

We leave it to the Commission on remand to address any of 

the petitioners’ remaining arguments on those violations. 

Furthermore, since the Commission based its cease-and-desist 

orders against Carley and Zacharias in part on “[t]heir failures 

to disclose material facts in violation of the antifraud 

provisions,” SEC Opinion at 41, we also leave those issues to 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 16 of 32
17

the Commission for such reconsideration as it may find 

necessary. 

IV. 

As we uphold the SEC’s § 5 findings, and its monetary 

sanctions against all three petitioners were based solely on the 

§ 5 violations, SEC Opinion 44, we must turn to their 

challenges to those remedies. We first consider Kaufmann’s 

arguments, then Zacharias’s and Carley’s. 

A. 

The Commission barred Kaufmann from association with 

any broker-dealer (with the right to reapply after five years), 

but he does not attack that order (except insofar as he 

challenges the Commission’s merits conclusion). He does 

attack the Commission’s disgorgement order against him, 

requiring him to disgorge half the total commissions received 

by Spencer Edwards for all the sales at issue here, arguing that 

it was excessive and not based on substantial evidence. He 

admits that the Commission had substantial evidence of the 

“total commissions generated by [the combined Peeper 

Entities sales and Starnet option holder] sales at the brokerage 

firm,” Kaufmann Reply Br. at 11-12, but claims the 

Commission erred in finding a 50/50 split of the commissions 

as between him and Geiger. 

On the 50/50 split issue, the Commission based its order 

on the ALJ’s finding of such a split. SEC Opinion at 45. The 

ALJ in turn based his finding on two key pieces of evidence. 

First, he cited a Commission decision in a prior case finding 

that during 1996 “Geiger generally received a 50% split of the 

joint commissions.” Initial Decision at 73 (citations omitted). 

Second, the evidence proffered by Kaufmann, “an unsigned 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 17 of 32
18

handwritten contract” that purported to show that his monthly 

split ranged from 45% to 24%, id., also said that expenses

would be split in the same proportion; yet, as the ALJ pointed 

out, Kaufmann claimed he paid 50% of the base salary of the 

assistant he shared with Geiger. Id. The Commission’s 50/50 

split decision was thus a “reasonable approximation [for 

division] of profits causally connected to the violation,” 

shifting the burden to Kaufmann to show otherwise. SEC v. 

First City Financial Corp., Ltd, 890 F.2d 1215, 1231-32 (D.C. 

Cir. 1989). 

In support of his critique Kaufmann points to an exhibit 

which illustrates that “Kaufmann handled the officers’ 144 

trades . . . and Geiger handled the Peeper entities trades.” 

Kaufmann Opening Br. at 32 (citing Exhibit TK-1, J.A. 522). 

But that division of labor is not necessarily controlling on how 

the commissions were split. Further, while Kaufmann asserts 

alternative ways of splitting commissions, the assertions 

appear mutually contradictory. He at one point claimed that 

they were based on “who generated the business,” but at 

another read the handwritten document as calling for splitting 

commissions “on a sliding scale that varied from month to 

month.” SEC Opinion, J.A. 261. Understandably, the SEC 

affirmed the ALJ’s finding that Kaufmann’s alternate 

explanations “lacked credibility,” id. at 46, and this court is 

“least inclined to second guess such [credibility] findings 

where, as here, the Commission affirmed the ALJ who, of 

course, heard the testimony in question.” Whitney v. SEC, 

604 F.2d 676, 683 (D.C. Cir. 1979). We affirm the SEC’s 

disgorgement order. 

Kaufmann also challenges the SEC’s imposition of a civil 

penalty of $110,000. He argues first that he only received 

$32,527 in commissions, an argument we have already 

rejected. Next he argues that his case is similar to other SEC 

decisions where a civil penalty was not imposed. But as we 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 18 of 32
19

have said in the past, “The Commission is not obligated to 

make its sanctions uniform, so we will not compare this 

sanction to those imposed in previous cases.” Geiger, 363 

F.3d at 488. Finally, he argues that the civil penalty was 

inappropriate because it will not “remedy ‘the damage caused 

to the harmed parties by the defendant’s action.’” Kaufmann 

Brief 33 (quoting Johnson v. SEC, 87 F.3d 484, 488 (D.C. Cir. 

1996)). But Johnson was directed at defining the word 

“penalty” for the purposes of applying 28 U.S.C. § 2462, 

which bars recovery of a “penalty” unless the action was 

“commenced within five years from the date when the claim 

first accrued.” See Johnson, 87 F.3d at 486-87 (internal 

quotation marks omitted). Here the SEC said that it did “not 

consider misconduct occurring before September 1, 1999, in 

determining to impose bars or civil penalties, but rather [has] 

based these sanctions exclusively on [Kaufmann’s] conduct 

during the five-year period preceding the issuance of the 

[charges against him].” SEC Opinion at 36. This would seem 

to take Johnson’s standard out of the picture;yet Kaufmann 

nowhere contradicts the SEC claim, nor offers any other 

reason why the Commission must be limited to sanctions 

designed to remedy “the damage caused to the harmed parties 

by the defendant’s action.” 

B. 

Finally, we turn to the disgorgement orders imposed 

against Zacharias and Carley. Under 28 U.S.C. § 2462, 

agencies may not impose civil penalties in an enforcement 

action initiated more than five years after the offender 

committed the illegal act. 3M Co. v. Browner, 17 F.3d 1453, 

1456-58 (D.C. Cir. 1994). The Commission initiated this 

action on September 1, 2004, more than five years after 

Zacharias and Carley’s illegal sales. Section 2462 therefore 

prohibited the Commission from imposing civil penalties on 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 19 of 32
20

either of them. The question is whether, as Zacharias and 

Carley argue, the Commission’s order requiring them to 

disgorge all profits (plus prejudgment interest) from their 

illegal transactions imposes a civil penalty on them. 

Zacharias and Carley think Johnson v. SEC, 87 F.3d 484 

(D.C. Cir. 1996), supports their position. Johnson, a 

brokerage firm manager, supervised brokers who stole 

roughly $140,000 from customers. The Commission imposed 

an order of censure and a six-month suspension on him in a 

proceeding commenced more than five years after the theft. 

Id. at 485-86. We held that the order was punitive, reasoning 

that it was not causally related to the wrongdoing and went 

well beyond restoring the stolen $140,000 to the customers. 

Id. at 491-92. Quoting Johnson, Zacharias and Carley say the 

disgorgement order against them was also punitive because it 

did not “remedy[] the damage caused to the harmed parties by 

the defendant’s action,” and did not wholly “restore the status 

quo ante.” Id. at 488, 491. 

Harm to third parties may be a useful measure of a 

violator’s wrongdoing. But “[w]hether or not [Zacharias and 

Carley’s] securities violations injured others is irrelevant to 

the question whether disgorgement is appropriate. The 

primary purpose of disgorgement is not to refund others for 

losses suffered but rather to ‘deprive the wrongdoer of his illgotten gain.’” SEC v. Bilzerian, 29 F.3d 689, 696 (D.C. Cir. 

1994) (quoting SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 

1978)); see SEC Opinion at 44-45. 

Petitioners’ other quotation from Johnson is part of this 

statement: “where the effect of the SEC’s action is to restore 

the status quo ante, such as through a proceeding for 

restitution or disgorgement of ill-gotten profits, § 2462 will 

not apply.” Johnson, 87 F.3d at 491. The full statement 

reflects the point – which petitioners ignore – that 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 20 of 32
21

disgorgement restores the status quo ante by depriving 

violators of ill-gotten profits. They also misread the statement 

to mean that all remedial sanctions must restore violators to 

the exact financial situation they were in before their wrongful 

acts. As we recognized in Johnson and as the Commission 

pointed out in this case, SEC Opinion at 44, the fact that 

defendants may suffer some loss is not sufficient to render a 

sanction punitive. Johnson, 87 F.3d at 488 (citing United 

States v. Halper, 490 U.S. 435, 447 n.7 (1989)). 

Our disgorgement cases uniformly hold that an “order to 

disgorge is not a punitive measure; it is intended primarily to 

prevent unjust enrichment.” SEC v. Banner Fund Int’l, 211 

F.3d 602, 617 (D.C. Cir. 2000); see Bilzerian, 29 F.3d at 696; 

SEC v. First City Fin. Corp., 890 F.2d 1215, 1231 (D.C. Cir. 

1989); see also Blatt, 583 F.2d at 1335. Disgorgement 

deprives wrongdoers of the profits obtained from their 

violations. Bilzerian, 29 F.3d at 696; Blatt, 583 F.2d at 1335;

SEC v. Lorin, 869 F.Supp. 1117, 1123 (S.D.N.Y. 1994). In 

theory, a disgorgement order might amount to a penalty if it 

was not “causally related to the wrongdoing” at issue. First 

City, 890 F.2d at 1231; cf. Am. Bus. Ass’n v. Slater, 231 F.3d 

1, 6 (D.C. Cir. 2000). Petitioners do not dispute that the order 

against them was causally related to their wrongdoing – the 

amount they had to disgorge was measured by the profits from 

their illegal transactions. Nor do they argue that the 

Commission had the burden to determine the hypothetical 

market value of the options they had been holding and then to 

offset their disgorgement by that amount. They merely assert, 

without factual support, that prior to the transaction they 

“owned shares of Starnet actually worth the amount for which 

it [sic] was sold.” Brief in Support of Petition for Review of 

Respondent Christopher H. Zacharias at 18 (Oct. 17, 2005). 

They make this statement in the context of their status quo 

ante argument, which the Commission properly rejected. SEC 

Opinion at 44-45. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 21 of 32
22

Our dissenting colleague would vacate the disgorgement 

order because the Commission did not deduct the value of the 

options from the disgorgement amount. Dissent at 4. But 

petitioners never asked the Commission to value the options 

or to perform the calculation the dissent contemplates, and 

petitioners’ briefs in this court never mentioned the issue 

discussed in the dissent.2

 We have no jurisdiction to consider 

an objection a petitioner did not make in the agency 

proceeding. 15 U.S.C. § 77i; see EEOC v. FLRA, 476 U.S. 

19, 22-24 (1986) (indicating that exhaustion requirements are 

jurisdictional and cannot be waived by the agency); Woelke & 

Romero Framing, Inc. v. NLRB, 456 U.S. 645, 665-66 (1982) 

(same).3 More than that, disgorgement need only be a 

 

2

 The record suggests why petitioners never pursued such relief. 

Securities laws in Canada, petitioners’ country of residence, barred 

them indefinitely from selling the shares redeemed from exercise of 

the options. The options were thus worth little or nothing to 

petitioners, especially in the short term. This is why Zacharias and 

his partners set up the illegal swap transaction. In addition, the 

effect of complying with U.S. law would likely have been 

substantial. Registration disclosures may have harmed Starnet’s 

share price because its gambling enterprise was illegal in one of the 

company’s principal places of business. A Canadian Mountie raid 

occurring shortly after petitioners’ options transaction led to 

Starnet’s share prices dropping sharply, never to recover. 

3

 The dissent views our decision as holding that “we are 

jurisdictionally barred from considering petitioners’ contentions, or 

at least some aspect of them.” Dissent at 6. But neither in this 

court nor in the administrative proceedings did petitioners ever 

make the “contentions” the dissent ascribes to them. Petitioners’ 

objection about the Commission’s failure to restore them to their 

status quo ante position rested on their contention that they should 

have been permitted to retain the entire value of the stock they 

obtained during the illegal transaction. As stated in the text, 

petitioners did not mention or even hint at the dissent’s contention 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 22 of 32
23

reasonable approximation of the profits causally connected to 

the violation. First City, 890 F.2d at 1231; Bilzerian, 29 F.3d 

at 697. Courts often “require the violator to return all profits 

made on the illegal trades.” First City, 890 F.2d at 1231; see 

also Elkind v. Liggett & Myers, Inc., 635 F.2d 156, 171 (2d 

Cir. 1980). It was not the Commission’s burden, sua sponte, 

to calculate the hypothetical value of the options and subtract 

the value from petitioners’ profits. See First City, 890 F.2d at 

1231. “Placing the burden on the petitioners of rebutting the 

SEC’s showing of actual profits . . . may result, as it has in the 

insider trader context, in actual profits becoming the typical 

disgorgement measure.” Id. at 1232. But the well-established 

principle is that the burden of uncertainty in calculating illgotten gains falls on the wrongdoers who create that 

 

that the Commission should have deducted the value, if any, of their 

options. 

Although Judge Williams quotes Carley mentioning his 

options, he does not include the sentences immediately following, 

where Carley argues that the Commission must “restore the 

valuable property rights in Starnet stock which Carley held at the 

time.” Carley Opening Br. at 19; see also Zacharias Opening Br. at 

39 (“Returning Mr. Zacharias to the status quo ante would require 

restoration of those shares [of Starnet] to him.”). The common 

theme of petitioners’ arguments is that they should not have to 

disgorge any money at all. To its credit, the dissent makes no such 

argument. The reason for the discrepancy is that petitioners’ 

argument, unlike the dissent’s, was not aimed at the Commission’s 

calculation of ill-gotten profits. Cf. Bilzerian, 29 F.3d at 697 

(resolving challenge to calculation of disgorgement amount). Their 

only argument was that in this particular case any disgorgement 

remedy would be punitive and therefore barred by the five-year 

statute of limitations. See, e.g., Zacharias Opening Br. at 37-40. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 23 of 32
24

uncertainty. Id.; Bilzerian, 29 F.3d at 697; see Johnson, 87 

F.3d at 488. 

For the foregoing reasons, we grant the petition for 

review with respect to Zacharias and Carley’s fraud and 

reporting violations, as well as the cease-and-desist orders 

based thereon, and remand for further proceedings. We deny 

the petition for review with respect to the § 5 violations and 

associated penalties. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 24 of 32
 

WILLIAMS, Senior Circuit Judge, dissenting in part: I 

respectfully dissent from Part IV.B of the court’s opinion, 

which rejects Zacharias’s and Carley’s petition for review of 

the SEC’s disgorgement order. 

We have explained in the past that “disgorgement may 

not be used punitively” and that it applies only to “property 

causally related to the alleged wrongdoing.” SEC v. First City 

Financial Corp., 890 F.2d 1215, 1231 (D.C. Cir. 1989). As a 

result, “the SEC generally must distinguish between legally 

and illegally obtained profits.” Id. See also Johnson v. SEC, 

87 F.3d 484, 491 (D.C. Cir. 1996) (explaining that it is not a 

punishment “where the effect of the SEC’s action is to restore 

the status quo ante, such as through a proceeding for... 

disgorgement of ill-gotten profits”). In First City we specified 

a sequence to be followed in such matters. We said that “the 

government’s showing of appellants’ actual profits on the 

tainted transactions at least presumptively satisfied” the 

government’s burden to show that “its disgorgement figure 

reasonably approximates the amount of unjust enrichment.” 

890 F.2d at 1232 (emphasis added). At that point, “the burden 

of going forward shifted to [appellants, who] were then 

obliged clearly to demonstrate that the disgorgement figure 

was not a reasonable approximation.” Id. Here (contrary to 

the panel’s assertion, Maj. Op. at 21), the SEC did not attempt 

even a superficial showing of petitioners’ profits; instead it 

pointed simply to their proceeds from the sales, after an 

arbitrary deduction of some costs but not others. The case 

should be remanded to the Commission to take the first step 

prescribed by First City. 

Our cases make clear that proceeds alone cannot normally 

be regarded an approximation of profits. In First City

appellants had violated § 13(d) of the Exchange Act by 

deliberately failing to disclose their accumulation of over five 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 25 of 32
2

percent of a company’s stock within 10 days. 890 F.2d at 

1217. As a result of their trades they received proceeds of 

$134.1 million, “resulting in a $15.4 million profit.” Id. at 

1220. The district court ordered disgorgement of a subset of 

this profit, $2.7 million, excluding increases in stock value 

occurring before appellants’ duty to reveal their purchases 

arose. The district court saw that subset as causally related to 

the violation, explaining that appellants’ purchases thereafter 

were “at an artificially low price due to their failure to make 

the section 13(d) disclosure.” Id. at 1221. We approved that 

reasoning. Id. at 1230. 

SEC v. Bilzerian, 29 F.3d 689 (D.C. Cir. 1994), is similar. 

Bilzerian had concealed his stock holdings and his financing 

capabilities in order “to create the impression that he was 

ready, willing and able to mount hostile takeovers.” Id. at 

692. As a result, he was found to have violated § 10(b) and 

§ 13(d) of the Exchange Act. The district court found, and we 

affirmed, that Bilzerian’s “misrepresentations inflated the 

price he received from the sale of the securities.” Id. at 696. 

As a result, the court “ordered Bilzerian to disgorge the 

difference between the price he received for the sale of his 

shares—inflated artificially by his false filings with the 

SEC—and the price the shares would have brought were it not 

for his untimely and misleading filings.” Id. at 697. Though 

the defendant challenged the amount of disgorgement ordered 

by the district court, we affirmed because the “court was 

careful to order disgorgement of the profits caused by 

[defendant’s] securities violations only.” Id. (emphasis 

added). As had the court in First City, the district court had 

started by subtracting the defendant’s purchase price of the 

stock from his final sale price (before making a further 

adjustment to avoid any disgorgement of legitimate 

appreciation). Id. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 26 of 32
3

Thus, in both Bilzerian and First City we affirmed 

disgorgement orders only when they were limited to an 

approximation of the profits received by the defendants 

attributable to their unlawful conduct. Neither First City nor 

Bilzerian treats an initial calculation of mere proceeds as 

adequate to force the defendants to provide an alternative 

calculation of actual profits. Rather, in both cases the court 

first deducted the entire cost of acquiring the stock used to 

perpetuate the fraud from the wrongdoer’s final proceeds, and 

then further reduced the disgorgement amount so that it 

reasonably approximated the profits actually caused by the 

fraud. 

Here, in purporting to restore the status quo ante, and 

even though it claimed to be following the sequential process 

outlined in our cases, see John A. Carley, Opinion of the 

Commission and Order Imposing Remedial Sanctions 43-44, 

Admin. Proc. File No. 3-11626, Securities Act Release No. 

8888, 92 SEC Docket 1693 (Jan. 31, 2008)(“SEC Opinion”), 

the SEC took a far different approach. Rather than making 

any attempt to deduct the entire cost of the stock or in any 

way calculate how the § 5 violations affected petitioners’ 

selling price, it focused only on their proceeds. When 

discussing petitioner Zacharias’s disgorgement order, it stated, 

“Zacharias sold [stock] in violation of Section 5 of the 

Securities Act. Disgorgement prevents Zacharias from 

retaining the proceeds of these illegal sales and as such serves 

a remedial rather than a punitive purpose.” See SEC Opinion

44 (emphasis added). Similarly, when discussing petitioner 

Carley’s disgorgement order, the SEC stated, “The amounts

Carley received through these sales are therefore ill-gotten 

gains that should be disgorged.” Id. (emphasis added). The 

SEC made no finding, as we did in both Bilzerian and First 

City, that petitioners’ conduct somehow influenced their 

stock’s cost or selling price. Indeed, the only evidence in the 

record that speaks to the price of the stock indicates that it was 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 27 of 32
4

the general rise in the price of technology stocks, coupled with 

Starnet’s drastic increase in net revenue, that led to its price 

explosion. See John A. Carley, Initial Decision 6, Initial 

Decision Release No. 292, Admin. Proc. File No. 3-11626 

(July 18, 2005). Were the SEC’s reasoning sound, the 

Commission in First City could have shifted the burden to 

appellants merely by noting the proceeds of $134 million. 

In essence, the SEC’s simulated computation of the status 

quo ante disregarded the property that petitioners supplied in 

return for the Starnet stock that was then sold in violation of 

§ 5—the options that had been legally registered and issued to 

them pursuant to Starnet’s Forms S-8. See SEC Opinion at 5. 

The Commission made no attempt to explain why it did not 

deduct the options’ value. Consider an economically 

equivalent transaction: suppose that instead of being paid in 

part with options, petitioners’ salaries had been equivalently 

higher and they had used the incremental cash income to 

purchase Starnet stock to funnel through the Peeper Entities to 

the public. In such a scenario, the SEC’s failure to deduct the 

cost would have represented a naked violation of the 

principles of First City and Bilzerian. 

To be sure, the fact that the cost of petitioners’ stock took 

the form of options made it harder to compute a restoration of 

the status quo ante. Application of those cases’ principle 

would require a calculation of the value of the options that 

petitioners could have legitimately and contemporaneously 

realized. The calculation might well have been difficult, and 

under our cases petitioners would have borne “the risk of 

uncertainty.” First City, 890 F.2d at 1232. (I note, however, 

that in order to show the effect of the employee stock options 

on the company’s net income, Starnet filed reports stating the 

fair value of the options calculated under methods approved 

by the Commission. See, e.g., Exhibit 442, Joint Appendix 

1332.) While the majority suggests various factors that might 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 28 of 32
5

have justified the SEC in assigning the options a zero value, 

see Maj. Op. at 22 n.2, the SEC Opinion’s pretend search for 

the status quo ante makes no mention of petitioners’ costs and 

simply asserts that their proceeds resulted from their § 5 

violation. We can affirm only on the basis of the 

Commission’s reasoning, see, e.g., SEC v. Chenery Corp., 318 

U.S. 80, 88 (1943), not on my colleagues’ speculations, 

however intuitively plausible and perhaps, in the end, correct. 

Though the Commission consistently referred to its 

disgorgement amount as an approximation of mere 

“proceeds,” it evidently made a deduction for the exercise 

price of the options and brokers’ fees, as the Commission only 

ordered disgorgement of the final amounts actually remitted to 

petitioners Carley and Zacharias in their brokerage accounts, 

which were net of these costs. If anything, this makes the 

Commission’s position even more obscure. The fact that it 

deducted some costs for obtaining the stock provides no 

answer for why it failed to deduct others. If the majority is 

right, and the SEC can simply point to proceeds without any 

explanation as to why certain costs of obtaining such proceeds 

are irrelevant, then it can simply pull a profit estimate out of 

thin air (e.g., gross proceeds) and thereby switch the burden to 

the petitioners to refine that calculation. Our case law, 

however, clearly requires that the SEC, on its own, make a 

“reasonable approximation of profits,” First City, 890 F.2d at 

1231, and not an entirely arbitrary one. 

The majority relieves the SEC of its burden to value the 

options on its own because “the burden of uncertainty in 

calculating ill-gotten gains falls on the wrongdoers who create 

that uncertainty.” Maj. Op. at 23-24. But none of the cases 

cited by the majority supports the proposition that uncertainty 

shifts the initial burden. Instead, the cases merely justify 

imprecision in that attempt so long as the attempt itself was a 

reasonable one. See First City, 890 F.2d at 1232 (explaining 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 29 of 32
6

that “the risk of uncertainty should fall on the wrongdoer 

whose illegal conduct created that uncertainty” only after the 

SEC’s showing of a reasonable approximation of actual 

profits); Bilzerian, 29 F.3d at 697 (same). 

I am somewhat puzzled by the panel’s suggestion that we 

are jurisdictionally barred from considering petitioners’ 

contentions, or at least some aspect of them. The court 

concedes petitioners properly raised, both before us and the 

SEC, the argument that the SEC’s order failed to restore the 

status quo ante. See Maj. Op. at 21. As the Commission’s 

“proceeds” analysis did not even allude to what petitioners’ 

gave up in exchange for the proceeds, it plainly made no 

effort at all to approximate the status quo ante—at least no 

non-frivolous effort. 

Even assuming arguendo that the SEC’s superficial 

discussion was enough to meet its burden under First City, the 

panel’s claim that petitioners did not adequately raise the issue 

of the consideration they provided turns on a quibble. Before 

the Commission they argued that the disgorgement should be 

zero, because they gave up their stock, which they asserted 

was “actually worth the amount for which it was sold” and 

whose value had been found by the administrative law judge 

to be based on Starnet’s “dramatic business success.” Brief in 

Support of Petition for Review of Respondent Christopher H. 

Zacharias at 18 (Oct. 17, 2005). As my analysis above 

indicates, I do not regard this analysis as complete, for it 

doesn’t address the obstacles to petitioners’ 

contemporaneously and lawfully realizing that value. But the 

Commission’s only response was to say that the stock was 

sold illegally, so that (non sequitur of the day!) petitioners 

must forego all proceeds. The Commission offered no 

argument as to how compliance with the requirement of filing 

a registration statement would have reduced petitioners’ 

proceeds; it stood simply on the raw fact of illegality. Before 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 30 of 32
7

us, though the majority claims otherwise, Maj. Op. at 22 n.3, 

petitioners’ attack on the SEC’s failure to restore the status 

quo ante has drawn our attention also to the value of the 

options, which were unequivocally theirs. “The options 

issued to Carley were valid and . . . Carley had a valuable 

property right in the options and then in the underlying stock 

subject to the options.” Carley Opening Br. 19. And, as the 

argument suggests, the value of the stock was mathematically 

tied to the value of the options, the only difference being the 

contractually prescribed exercise price. Even if we regard as 

extreme petitioners’ alternative calculation (showing no 

excess of illegitimate over legitimate proceeds), the SEC 

never attacked their calculation by pointing to obstacles to 

petitioners’ lawful realization of identical proceeds. Thus, 

again assuming that the Commission met its initial First City

burden, petitioners’ claim was enough to switch the burden 

back to the SEC to show why its order properly accounted for 

all property legally owned prior to the scheme. 

In discussing this same jurisdictional argument, the 

majority seems to suggest that the petitioners’ attack on the 

SEC’s order as failing to restore the status quo ante was 

somehow “not aimed at the Commission’s calculation of illgotten profits.” Maj. Op. at 23 n.3. But the majority correctly 

states that the very reason disgorgement is not a penalty is 

because “disgorgement restores the status quo ante by 

depriving violators of ill-gotten profits.” Maj. Op. at 21 

(emphases added). An attack on the SEC’s order as one that 

failed to restore the status quo ante, which was indisputably 

advanced below, see SEC Opinion at 44 (responding to the 

argument that “disgorgement would not return Mr. Zacharias 

to the status quo ante” (internal quotations omitted)), is 

therefore by definition an attack on the SEC’s calculation of 

ill-gotten profits. Petitioners’ argument, both before the 

Commission and us, has been that the SEC’s calculation of illgotten profits was flawed because petitioners would have 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 31 of 32
8

received the same profits even if they had acted lawfully. 

While it is true the petitioners argued they should not return 

any of their proceeds, that was because they claimed that the 

SEC’s calculation was inappropriate, not because of any 

notion that disgorgement can never be properly applied in the 

context of a § 5 violation, as the majority seems to suggest. 

Thus, I fail to see anything meaningful in the distinction the 

majority claims exists between the arguments advanced by 

petitioners and the arguments discussed here, see Maj. Op. at 

23 n.3, apart from the quibble over option value versus stock 

value. 

I would remand to the SEC for it either to explain why 

the mere presence of options, as opposed to cash, justifies its 

dispensing with the process outlined in First City and 

Bilzerian, or to make an initial calculation of the value 

petitioners could have legitimately and contemporaneously 

realized from their options. 

USCA Case #08-1136 Document #1186756 Filed: 06/23/2009 Page 32 of 32