Document ID: s3://data.kl3m.ai/documents/govinfo/USCOURTS/USCOURTS-caDC-99-01029/USCOURTS-caDC-99-01029-0/pdf.json

Parties Involved:
Sharon M. Graham
Petitioner
Securities and Exchange Commission
Respondent
Stephen C. Voss
Petitioner

Document Text:

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United States Court of Appeals

FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued November 8, 1999 Decided August 18, 2000

No. 99-1029

Sharon M. Graham and

Stephen C. Voss,

Petitioners

v.

Securities and Exchange Commission,

Respondent

---------

On Petition for Review of an Order of the

Securities and Exchange Commission

---------

Ida Wurczinger Draim argued the cause and filed the

briefs for petitioners.

Susan S. McDonald, Senior Litigation Counsel, Securities

and Exchange Commission, argued the cause for respondent.

With her on the brief were David M. Becker, Deputy General

Counsel, Jacob H. Stillman, Solicitor, and Robert C. Stacy, II,

Attorney.

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Before: Ginsburg, Tatel, and Garland, Circuit Judges.

Opinion for the Court filed by Circuit Judge Garland.

Garland, Circuit Judge: Sharon Graham and Stephen Voss

petition for review of an order of the Securities and Exchange

Commission (SEC) sanctioning them for conduct relating to

trades executed for their customer, John Broumas. The

Commission found that Graham, a registered representative

with Voss' brokerage firm, violated section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated

thereunder by aiding and abetting Broumas in the fraudulent

trading of stock. The Commission further concluded that

Voss had failed reasonably to supervise Graham with a view

to preventing the securities violations. Graham challenges

the Commission's findings on several grounds; Voss' challenge depends solely upon the exoneration of Graham. Because we conclude that the Commission's decision was reasonable and supported by substantial evidence, we deny the

petition for review and affirm the SEC's order.

I

Voss is the owner and president of an independent discount

brokerage firm, Voss & Co., Inc. (VCI), located in Springfield,

Virginia. Graham began working in the securities industry in

1982 and joined VCI in September of 1984. She was a

registered representative,1 as well as VCI's cashier and back

office assistant. She was also VCI's primary "house" broker,

handling house accounts on a noncommission basis as well as

some 250 of her own accounts for commissions. See J.A. at

371-72.2 Graham spent the bulk of her time performing

__________

1 A representative is a person associated with a National Association of Securities Dealers (NASD) member firm who is engaged in

supervision, solicitation, or conduct of securities business. The

NASD requires that representatives of member firms register with

the Association and pass a qualifying exam. See 6 Louis Loss &

Joel Seligman, Securities Regulation 2809-11 & n.42 (3d ed. 1990).

2 At VCI, house accounts were not assigned to any particular

broker. Commissions on trades in these accounts were paid to the

firm rather than to the brokers executing the trades.

cashiering and back office duties. In February of 1990, she

received her principal's license.3 Graham's immediate supervisor, James Pasztor, was VCI's vice-president, general manager, and SEC compliance officer.

One of the firm's house accounts was a joint account in the

names of John Broumas and his wife, Ruth. Broumas' troubles began when the stock market crashed in 1987. To cover

his losses, he borrowed heavily and by May 1989 owed

roughly $2 million in personal loans and $1 million in mortgages. See id. at 180-85. Unable to borrow any more from

banks, Broumas launched upon a scheme that the SEC

described as "similar to check-kiting." Sharon M. Graham,

Release No. 34-40727, 68 S.E.C. Docket 1934, 1998 WL

823072, at *2 (Nov. 30, 1998).4

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Broumas held a substantial number of shares in the Class

A common stock of James Madison, Ltd. (JML), a holding

company for a family of banks with which he was affiliated.

Although JML stock was listed on the American Stock Exchange (AMEX), Broumas undertook a series of trades in the

over-the-counter market. Broumas arranged wash trades

and matched orders5 of JML stock among accounts in his own

name and in the name of nominees whose accounts he con-

__________

3 A principal is a person who is "actively engaged in the

management of the [NASD] member's ... securities business."

Markowski v. SEC, 34 F.3d 99, 101 n.1 (2d Cir. 1994) (internal

quotation omitted). An additional examination is required to become registered as a principal. See 6 Loss & Seligman, supra, at

2810-11 n.42.

4 For a description of the mechanics of a check-kiting scheme,

see Williams v. United States, 358 U.S. 279, 281 n.1 (1982).

5 "Wash trades," also called "wash sales," are "transactions

involving no change in beneficial ownership." Ernst & Ernst v.

Hochfelder, 425 U.S. 185, 205 n.25 (1976). "Matched orders" are

"orders for the purchase/sale of a security that are entered with the

knowledge that orders of substantially the same size, at substantially the same time and price, have been or will be entered by the

same or different persons for the sale/purchase of such security."

Id.; see Michael Batterman, 46 S.E.C. 304, 305 (1976).

trolled. Broumas directed these trades among at least 25

different brokerage accounts he controlled at 14 different

broker-dealers. In each case, he would instruct one broker to

buy and another to sell a specified number of shares at a

specified price, thus moving the stock from one of his (or his

controlled) accounts to another. See J.A. at 211. Neither

broker was told by Broumas that the other account also

belonged to or was controlled by him.

Broumas' stock was held in margin accounts.6 Under the

rules applicable to those accounts, Broumas could obtain the

proceeds from a sale one day after the transaction was

completed, but could wait at least five business days until the

settlement date to pay for the corresponding purchase. See

Graham, 1998 WL 823072, at *2; see also 12 C.F.R. s 220.4

(1989). When the settlement date arrived, Broumas sometimes executed another set of wash trades or matched orders

to obtain the funds he needed to make the payment--as if he

were playing a fiscal version of "musical chairs."7

As Broumas' financial situation continued to deteriorate,

"many of the broker-dealers with which he dealt ... bec[ame]

increasingly reluctant to extend him credit." Graham, 1998

WL 823072, at *2. Broumas then began to effectuate wash

and matched trades through accounts in the names of relatives and business associates. The trades in these nominee

__________

6 In a margin account:

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chase securities. The customer advances only a portion of

the purchase price and pays interest on the balance. The

broker maintains the securities purchased as collateral. If

the value of the securities declines, the broker may seek

more collateral for the protection of his "loan."

Liang v. Dean Witter & Co., 540 F.2d 1107, 1109 n.2 (D.C. Cir.

1976).

7 Broumas testified that the proceeds available to him during

the settlement period allowed him to "take care of my bank notes or

whatever was pressing me that day and then worry about how I

was going to handle the purchase price and the amount of the

purchase price a week later." J.A. at 209.

accounts were placed by Broumas or at his direction with

funds he provided and for his benefit. Between January 1,

1989 and June 30, 1990, Broumas effectuated 203 sets of wash

and match trades in JML stock, involving a total of 420

trades. Each trade typically involved the purchase and sale

of between 3,000 and 12,000 JML shares. See id.

Seventy-six of the directed trades were conducted by VCI,

and approximately 60 of those--an average of one every

week-and-a-half--were executed by Graham. At the beginning of 1989, Broumas' joint account at VCI held 37,500

shares of JML stock. From January 23, 1989 through May

24, 1990, Broumas instructed VCI to exchange a total of

644,800 shares. Although Broumas' account was a "house"

account, a rapport soon developed between Broumas and

Graham and he began to ask for her specifically. Generally,

Broumas would give Graham a specific number of shares to

trade, a particular limit price, the name of the firm ("contrabroker") that would execute the other side of the trade, and

the name of the broker he wanted her to contact at that firm.

After consulting the AMEX listing to verify that the order

price was within the listed bid and offer prices, Graham would

complete the trade. Broumas usually asked VCI to issue a

check for the proceeds the day after the sale. See id. at *3.

Graham observed that Broumas "had a peculiar way of

trading." J.A. at 306. Of the 100 house accounts she handled during this time, only Broumas directed trades, and only

Broumas traded in such large quantities. See id. at 285.

Because Broumas always identified the specific contact persons to call at the contra-brokers, Graham came to believe

that Broumas controlled the shares in the accounts or at least

"had connections" with them, id. at 382, although Broumas

never told her so and she "never asked him," id. at 286-87.

Finally, from her work as the firm's cashier, Graham noticed

that Broumas "never seemed to ... make any money on his

trades." Id. at 380, 383. Eventually, Graham asked Broumas directly why he traded in such a strange manner, and

Broumas answered that "he owed bank notes or bank loans

and that for him to sell the stock was an easier way for him to

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get the money to pay those loans, as opposed to having to go

to other means." Id. at 356-57; see also id. at 308.8

Due to Broumas' suspicious manner of trading, Graham

undertook special precautions to protect her firm's financial

interests. She knew that Broumas had financial problems,

that he had bounced checks, and that he often owed money on

his joint account. See id. at 288, 317, 343. As a consequence,

she feared that "Broumas' orders presented a financial risk to

the firm." Graham Br. at 14 (citing J.A. at 317). Graham

discussed Broumas' "peculiar way of trading" with her supervisor, James Pasztor, and, as a safeguard, generally sought

his prior approval for Broumas' trades--something she rarely

did with respect to her other house accounts. J.A. at 283-85,

316-17.

By early 1989, Broumas was having difficulty making timely payment for trades through his VCI joint account. Although he had five business days to pay for a purchase, both

Graham and Voss knew that VCI's clearing firm,9 U.S. Clearing Corp., had been required to obtain "quite a few" extensions of time. Graham, 1998 WL 823072, at *4 (quoting,

without citation, J.A. at 296). In March of 1989, the margin

supervisor for the clearing firm told Pasztor that Broumas

had received too many extensions, and that he thought Broumas might be "check kiting" through his brokerage account.

Pasztor agreed. See id. at *4 & n.17. As a consequence, the

clearing firm imposed restrictions on Broumas' account, and

directed Pasztor to bar trading unless the account already

contained cleared funds or stock. Pasztor informed Graham,

__________

8 At trial, Broumas claimed that he sold the shares to himself,

rather than to a buyer on the open market, because he "wanted to

maintain [his] position [in JML] at that price." J.A. at 212.

9 A clearing broker performs "back office services such as

clearing stock, handling customer funds, holding customer securities, dealing with transfer agents, and matching of trades with the

exchanges and market makers" for firms that do not have the

capacity to perform these functions. SEC Br. at 18 n.17; see, e.g.,

United States v. Russo, 74 F.3d 1383, 1386 (2d Cir. 1996).

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Voss, and Broumas that the account was restricted. See id.

at *4.

Thereafter, Broumas called Voss and asked to open a

second account, entitled "Les Girls," purportedly for a partnership between Broumas' wife and daughter. Voss agreed

to permit the opening of the new account, although he never

spoke to Broumas' wife or daughter and testified that he

"suspected" Broumas would be advising on the trading. J.A.

at 564. Graham completed the form to open the "Les Girls"

account, although she had never spoken to Broumas' wife or

daughter either. Graham conceded that she regarded the

account as belonging to Broumas, and that she knew he

placed all the trades. Although she believed Broumas had

opened the Les Girls account to prevent the restricted joint

account "from being closed out or his position sold out," id. at

295-96, Graham nonetheless continued to place directed

trades for him. Broumas directed 40 JML stock trades

through the Les Girls account; between March 21 and August 29, 1989, all of Broumas' VCI trades in JML stock were

effected through that account.

In February of 1990, Broumas began directing trades in

JML stock through yet another VCI account. These trades

were made through an already existing house account maintained by his friend and attorney, Lawton Rogers. Broumas

called Graham to direct trades through the Rogers account;

Graham would then call Rogers to confirm them. Graham

told Pasztor about the directed trades, who in turn told Voss.

Voss said he "didn't have a problem" with the trades because

Broumas and Rogers were "bosom buddies." Id. at 429.

At the beginning of April 1990, a check Broumas had given

VCI to pay for the purchase of JML shares was returned for

insufficient funds. Pasztor again restricted the joint account

and told Graham that Broumas could not trade without

cleared funds. Initially, Voss concurred. At the end of April,

however, Broumas invited Voss to lunch. Following the

lunch, Voss told Pasztor that Broumas could continue to

trade. Pasztor in turn informed Graham. See Graham, 1998

WL 823072, at *5.

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Eventually, Broumas became unable to satisfy his margin

calls and failed to pay for his last trade through VCI.

Although the firm liquidated Broumas' account, it suffered a

loss of over $60,000. See id. Broumas filed for personal

bankruptcy in early 1991. See id. at *2 n.3.

On September 27, 1991, the SEC filed a complaint in

district court alleging that, from January of 1989 through

July of 1990, Broumas violated the securities laws by executing wash trades in JML stock. See SEC v. John G. Broumas, Civ.A.No. 91-2449 (D.D.C.). Without admitting or denying the allegations, Broumas consented to the entry of a

permanent injunction against future violations. Subsequently, Broumas pled guilty to utilizing a check-kiting scheme to

meet margin calls. See United States v. Broumas, 69 F.3d

1178, 1179-80 (D.C. Cir. 1995).

On September 30, 1994, the SEC issued an administrative

complaint against Graham, Voss, and Pasztor in connection

with Broumas' trades from January 1989 through May 1990.

Graham was charged with willfully aiding and abetting Broumas' violations of two sections of the Securities Exchange Act

of 1934: section 9(a)(1), which prohibits the effectuation of

wash trades or matched orders

[f]or the purpose of creating a false or misleading appearance of active trading in any security registered on a

national securities exchange, or a false or misleading

appearance with respect to the market for any such

security,

15 U.S.C. s 78i(a)(1), and section 10(b) (and Rule 10b-5

thereunder), which makes it unlawful

[t]o use or employ, in connection with the purchase or

sale of any security registered on a national securities

exchange ... any manipulative or deceptive device or

contrivance ...,

id. s 78j(b). Pasztor and Voss were charged with violating

section 15(b)(4)(E) for failing reasonably to supervise Graham

"with a view to preventing" the violations. Id. s 78o(b)(4)(E).

The charges against Pasztor were severed from those against

Voss and Graham. The SEC subsequently found Pasztor

liable for failure to supervise and sanctioned him with a

three-month suspension. See James J. Pasztor, Release No.

34-42008, 70 S.E.C. Docket 1979 (Oct. 14, 1999).

The charges against Graham and Voss were heard before

an Administrative Law Judge (ALJ), who found Graham and

Voss liable on all charges, suspended them from association

with any broker or dealer for two and three months, respectively, and ordered Graham to cease and desist from future

violations. See Sharon M. Graham, Release No. 34-82, 60

S.E.C. Docket 2707, 1995 WL 769011, at *28 (Dec. 28, 1995).

On appeal, the SEC held that Broumas' trading did not

violate section 9(a)(1) because the specific manipulative intent

required under that section had not been established, and

hence that Graham did not aid and abet such a violation. See

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mission affirmed the ALJ's holding that Broumas' wash and

matched trades violated section 10(b) and Rule 10b-5 because

they operated as a fraud upon: a) the market for JML stock,

by creating a deceptive appearance of market activity; and

b) the brokerage firms through which Broumas traded, which

were induced to pay him money they would not have paid had

they known the sales were not bona fide. See id. at *5. The

Commission further affirmed the ALJ's findings that Graham

aided and abetted Broumas, and that Voss failed reasonably

to supervise, and it upheld the two- and three-month suspensions. See id. at *7, *9, *10. Graham and Voss petition for

review of the Commission's order.

II

The securities laws provide for judicial review of SEC

disciplinary proceedings in the courts of appeals. See 15

U.S.C. s 78y(a)(1). The Commission's findings of fact, "if

supported by substantial evidence, are conclusive." Id.

s 78y(a)(4); see Steadman v. SEC, 450 U.S. 91, 96 n.12

(1981). Its other conclusions may be set aside "only if

'arbitrary, capricious, an abuse of discretion, or otherwise not

in accordance with law,' 5 U.S.C. s 706(2)(A)." Wonsover v.

SEC, 205 F.3d 408, 412 (D.C. Cir. 2000) (internal quotation

omitted).

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Section 10(b) of the Securities Exchange Act of 1934 makes

it unlawful to use deceptive devices in connection with the

purchase or sale of securities. See 15 U.S.C. s 78j(b). Rule

10b-5, promulgated pursuant to section 10(b), specifically

provides that it is unlawful for any person, in connection with

the purchase or sale of any security:

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or

to omit to state a material fact necessary in order to

make the statements 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.

17 C.F.R. s 240.10b-5. Although variously formulated, three

principal elements are required to establish liability for aiding

and abetting a violation of section 10(b) and Rule 10b-5: (1)

that a principal committed a primary violation; (2) that the

aider and abettor provided substantial assistance to the primary violator; and (3) that the aider and abettor had the

necessary "scienter"--i.e., that she rendered such assistance

knowingly or recklessly. See SEC v. Fehn, 97 F.3d 1276,

1287-88 (9th Cir. 1996); Bloor v. Carro, Spanbock, Londin,

Rodman & Fass, 754 F.2d 57, 62 (2d Cir. 1985); SEC v.

Falstaff Brewing Corp., 629 F.2d 62, 72 (D.C. Cir. 1980);

Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir.

1980); see also SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir.

1992).

Graham contests all three of these elements: She contends

that Broumas' conduct did not constitute a violation of section

10(b) or Rule 10b-5, that she did not substantially assist such

a violation, and that she did not do so knowingly or recklessly.

Graham and Voss further argue that the SEC is estopped

from sanctioning them because the SEC and National Association of Securities Dealers (NASD) observed Broumas' trading and failed to alert petitioners to it or identify it as a

securities violation. Finally, Voss argues that because Graham is not guilty of aiding and abetting, he cannot be guilty

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of failing reasonably to supervise her. We consider these

arguments below.

A

The SEC based its conclusion that Broumas' trades constituted a fraud under section 10(b) and Rule 10b-5 on two

independent theories. First, it concluded that the trades

constituted a fraud on the market for JML stock by creating

a deceptive appearance of market activity. Second, it concluded that Broumas defrauded the broker-dealers through

which he traded by causing them to remit sales proceeds to

him that they would not have paid had they known the true

nature of the transactions. Although Graham challenges the

validity of the first theory,10 we need not resolve that dispute

because Broumas' trades clearly constitute violations under

the second.

As the SEC explained, Broumas, unable to obtain further

loans from banks, arranged wash trades and matched orders

"for the purpose of obtaining a float in a scheme similar to

check-kiting." Graham, 1995 WL 769011, at *4.11 Broumas'

scheme caused the selling brokers to pay him immediately

the anticipated proceeds from the contrived sales, payments

they would not have made had they realized that Broumas--

with his shaky financial condition--was also on the other side

of the transaction, promising to pay for the same stock within

__________

10 Graham disputes that Broumas' trades constituted a fraud on

the market. She argues, inter alia, that Broumas' trades were not

material because they constituted a small percentage of the total

volume of outstanding JML shares. The SEC counters that the

trades nonetheless made up a substantial proportion of the daily

volume of trades on the days they were reported.

11 Broumas acknowledged that he began wash trading because

he "didn't have the credit" to meet his existing obligations, J.A. at

174, and couldn't borrow money from a bank because he had

"reached [his] limit," id. at 213. He also testified that on many

occasions he sold JML stock to himself in order to meet margin

calls. See id. at 205.

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five days. See Graham, 1998 WL 823072, at *6.12 Indeed,

not only did Broumas fail to disclose that he was on both

sides of the transaction, but he also took affirmative steps to

hide that fact--by trading through the Les Girls and Rogers

accounts--when the clearing firm restricted trading in his

own account.13

As we have noted, although Broumas received payment for

the sale immediately, he did not have to make payment for

the "purchase" of the same shares until five days later. Were

he unable to make that payment--an eventuality his uncertain financial condition rendered likely and which ultimately

occurred--the selling broker (or the purchasing broker, if it

had paid over the funds to the selling broker and received the

stock) would be forced to cover the loss by selling the JML

shares. But there was no guarantee that those shares would

cover the amount advanced to Broumas by the broker--either

because the stock was no longer worth the price Broumas

himself had offered a week earlier,14 or because it had never

__________

12 See SEC v. Drysdale Sec. Corp., 785 F.2d 38, 42 (2d Cir. 1986)

(finding s 10(b) violation where, in order to honor its obligation to

resell securities on settlement date of reverse "repo," defendant

"had to purchase identical securities, something which its insolvency

may have rendered impossible"); see also A. T. Brod & Co. v.

Perlow, 375 F.2d 393, 397 (2d Cir. 1967) (upholding claim for fraud

against broker under s 10(b) where investors placed purchase order

with fraudulent intent to pay for securities only if their market

value increased by settlement date, and further noting that scheme

effectively resulted in "an involuntary extension of credit without

compliance with the margin requirements").

13 Broumas testified that he began asking Rogers to allow him

to direct trades through his account "[b]ecause I didn't have the

credit and my margin calls wouldn't permit me to trade with those

other brokers of mine." J.A. at 174; cf. United States v. Sayan,

968 F.2d 55, 61 (D.C. Cir. 1992) (affirming conviction for checkkiting and noting that "creating fictitious payees and forging endorsements" constituted a material part of the fraud, because "[i]f

[the defendant] had merely made the drafts payable to herself, the

bank would not have granted her immediate credit").

14 The price of JML Class A stock began to decline in February

of 1990. See Graham, 1995 WL 769011, at *2. On February 2,

been worth that amount in the first place.15 Indeed, something like this happened to VCI, which suffered a $60,000 loss

when forced to liquidate Broumas' account after he failed to

pay for his last transaction.16

Graham contends that Broumas' scheme cannot violate

section 10(b) because fraud on a broker is not fraud "in

connection with the purchase or sale of [a] security," as

required by the statutory language. 15 U.S.C. s 78j(b). To

constitute a violation of section 10(b), Graham maintains, "the

fraud must have been perpetrated upon an actual or potential

investor." Graham Br. at 27. As the brokers were never

parties to the securities transactions, but merely executed

__________

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1990, it closed at $6 per share. On May 24, 1990, it closed at $4 5/8.

See J.A. at 754-55. Broumas testified that around this time the

"stock dropped dramatically and I had to sell a lot of things. I was

finding it difficult to meet those interest payments and those loan

payments." Id. at 188.

15 We note that unlike a plaintiff in a private damages action,

the SEC need not prove actual harm. See Schellenbach v. SEC, 989

F.3d 907, 913 (7th Cir. 1993); SEC v. Blavin, 760 F.2d 706, 711 (6th

Cir. 1985).

16 In her reply brief, Graham contends that Broumas did not

defraud the brokers into paying him the proceeds of the JML sales

because he was "entitled" to the money. Graham Reply Br. at 8.

Graham claims that the funds Broumas received from the "sell side"

of the transaction were the sale proceeds of his own stock, and

therefore his own money. The selling broker, however, did not pay

Broumas out of the actual proceeds of the sale, but rather out of

"proceeds" it anticipated would be paid five days later. Unbeknownst to the broker, that payment would have to come from

Broumas himself, and, if Broumas were unable to pay, the selling

broker's recourse was against the JML stock--which may well have

been insufficient to cover what the broker had paid out. Of course,

if the transaction is viewed from the "buy side," there is even less

justification for regarding the money as Broumas' own, as the

purchasing broker extended Broumas credit on margin to purchase

the stock from the contra-broker.

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them, Graham contends that no violation of section 10(b) was

possible.

Graham's argument is foreclosed by the Supreme Court's

unanimous decision in United States v. Naftalin, 441 U.S. 768

(1979). There, the Court confronted the same challenge to a

criminal conviction under section 17(a)(1) of the Securities Act

of 1933, which makes it unlawful for any person "in the offer

or sale of any securities" to employ any device, scheme, or

artifice to defraud. 15 U.S.C. s 77q(a)(1). The defendant

had placed sell orders for stock he did not own, gambling that

he could make offsetting purchases at lower prices before he

was required to deliver the stock. Defendant did not dispute

that he defrauded the brokers who executed the orders, but

contended, as petitioners do here, that the statute "applies

solely to frauds directed against investors, and not to those

against brokers." Naftalin, 441 U.S. at 772.

The Court rejected the argument. It held that the statutory phrase, "in the offer or sale of any securities," was

intended to be "define[d] broadly," and is "expansive enough

to encompass the entire selling process, including the seller/agent transaction." Id. at 773. The "language does not

require," the Court said, "that the fraud occur in any particular phase of the selling transaction," or "that injury occur to a

purchaser."17 Id.

Turning to the statutory purpose, Naftalin emphasized that

"neither this Court nor Congress has ever suggested that

investor protection was the sole purpose of the Securities

Act." Id. at 775. Although "[p]revention of frauds against

investors was surely a key part ... so was the effort to

achieve a high standard of business ethics ... in every facet

of the securities industry." Id. (internal quotation omitted)

__________

17 The Court noted that the case would be different if it had

been brought by private plaintiffs, because the class of plaintiffs

who may bring private actions under Rule 10b-5 is limited to

purchasers or sellers. See Naftalin, 441 U.S. at 774 n.6; see also

United States v. O'Hagan, 521 U.S. 642, 664-65 (1997); Blue Chip

Stamps v. Manor Drug Stores, 421 U.S. 723, 751 n.14 (1975); SEC

v. National Sec., Inc., 393 U.S. 453, 467 n.9 (1969).

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(second alteration in original); see United States v. O'Hagan,

521 U.S. 642, 658-59 (1997) (reaching same conclusion regarding s 10(b) of the Securities Exchange Act). Moreover, the

Court continued, "the welfare of investors and financial intermediaries are inextricably linked--frauds perpetrated upon

either business or investors can redound to the detriment of

the other and to the economy as a whole." Naftalin, 441 U.S.

at 776.

Although Naftalin involved section 17(a)(1) of the Securities Act, rather than section 10(b) of the Securities Exchange

Act, the relevant language is virtually identical. Compare 15

U.S.C. s 77q(a)(1) ("in the offer or sale of any securities"),

with id. s 78j(b) ("in connection with the purchase or sale of

any security"). Indeed, the Court recognized an argument

that section 17(a)(1) might be narrower than section 10(b),

but held that "even if 'in' were meant to connote a narrower

group of transactions than 'in connection with,' " it would still

cover fraud against brokers. Naftalin, 441 U.S. at 773 n.4.

Naftalin's application to the broader wording of section 10(b)

is, therefore, a fortiori. This point is further confirmed by

the Supreme Court's subsequent description of Naftalin as

having "appl[ied] s 17(a) of the 1933 Act to conduct also

prohibited by s 10(b) of the 1934 Act," Herman & MacLean

v. Huddleston, 459 U.S. 375, 383 (1983), and by its recent

affirmation that section 10(b) "does not confine its coverage to

deception of a purchaser or seller of securities," O'Hagan, 521

U.S. at 651. See also SEC v. Jakubowski, 150 F.3d 675, 680

(7th Cir. 1998) (noting that Naftalin was "a case under s 17

of the 1933 Act, which requires proof that the fraud occurred

'in' an offer or sales of securities--a tighter link, one might

suppose, than 'in connection with' ") (citation omitted); A. T.

Brod & Co. v. Perlow, 375 F.2d 393, 396-97 (2d Cir. 1967)

(holding that s 10(b) and Rule 10b-5 apply to frauds against

brokers).

Graham also contends that there cannot have been an

actionable fraud in this case because the SEC charged owners

and brokers at the contra-firms with securities violations like

those of petitioners. "Clearly," Graham declares, "Broumas'

alleged aiders and abettors cannot also be his defrauded

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victims." Graham Br. at 26. This argument, too, is of no

avail.

First, even assuming that such a defense were valid, the

SEC did not charge all of the contra-brokers with securities

violations.18 Second, this purported defense has no application to the clearing firms--none of which played any role in

Broumas' scheme and one of which expressly tried to restrict

it. Broumas, assisted by Graham and Voss, established and

traded through the Les Girls and Rogers accounts specifically

to avoid those restrictions, thus deceiving the clearing firm

into making the advances necessary to execute his transactions. See Graham, 1998 WL 823072, at *3-*4; Richard D.

Chema, Release No. 34-40719, 68 S.E.C. Docket 1911, 1998

WL 820658, at *3 (Nov. 30, 1998) (concluding that Broumas

also defrauded another broker-dealer's clearing firm into

advancing funds); see also United States v. Russo, 74 F.3d

1383, 1388, 1390 (2d Cir. 1996) (upholding conviction under

s 10(b) where scheme involved generating false cash credits

from clearing broker).19

Finally, whatever the involvement of the brokers or owners, fraud on their corporate institutions is an independent

matter.20 As the Supreme Court recognized in Naftalin,

__________

18 Broumas' wash trades involved a total of 14 different brokerdealers. The VCI trades involved eight different firms, while the

SEC instituted administrative proceedings against four. See Graham, 1998 WL 823072, at *3 n.14.

19 Like the other brokers, the clearing firm was exposed to the

risk that funds it advanced might not have been repaid at the time

Broumas became insolvent. Although the clearing broker might be

able to recover against the introducing firm in the event of nonpayment, it would incur transaction costs in so doing--and there was

always the risk that Broumas' scheme would bankrupt one of the

broker-dealers involved. See Richard D. Chema, 1998 WL 820658,

at *4-*5.

20 Cf. Superintendent of Ins. v. Bankers Life & Cas. Co., 404

U.S. 6, 12 (1971) (holding that s 10(b) applies to fraud on corporation by controlling stockholder, and that "the fact that creditors of

the defrauded" corporation "may be the ultimate victims does not

fraud on brokerage firms affects more than the health of

those firms alone. See Naftalin, 441 U.S. at 776. When the

music stops, the firm left without a chair (payment or collateral) does not simply leave the game. "Losses suffered by

brokers," whether or not covered by insurance, "increase

their cost of doing business, and in the long run investors pay

at least part of this cost through higher brokerage fees." Id.

Equally important, fraud against brokers may "create a level

of market uncertainty that could only work to the detriment

of both investors and the market as a whole." Id. Accordingly, we have no warrant for overturning the SEC's determination that Broumas violated section 10(b) and Rule 10b-5.

B

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stituted a primary violation of the securities laws, the next

question is whether Graham substantially assisted Broumas

in that violation. We have no doubt that she did. Graham

placed 60 directed trades for Broumas, an average of one

every week-and-a-half during the 18-month period at issue.

She opened the Les Girls account and executed wash trades

from both that account and from the account of Lawton

Rogers. Such conduct is more than sufficient to constitute

substantial assistance. See SEC v. U.S. Envtl., Inc., 155 F.3d

107, 112 (2d Cir. 1998) (holding trader who recklessly executed manipulative buy and sell orders for customer liable as

primary violator).

Graham contends that this conclusion is inconsistent with

our decision in Zoelsch v. Arthur Andersen & Co., 824 F.2d 27

(D.C. Cir. 1987). She describes Zoelsch as a case in which we

dismissed an aiding and abetting claim against an accounting

firm, "which had issued an audit report with respect to

corporate financial statements" but had "played no role in the

use of certain figures from those statements in a prospectus

__________

warrant disregard of the corporate entity") (footnote omitted);

United States v. Saks, 964 F.2d 1514, 1518-19 (5th Cir. 1992)

(affirming finding of intent to defraud banking institution, notwithstanding bank officers' collusion with customer).

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and no role in the publication of any misleading financial

statements." Graham Br. at 31. In fact, the accounting

firm's relationship to the misleading financial statements was

even further removed than Graham describes,21 but the distance reflected in her description suffices to distinguish that

case from this one: unlike the accounting firm in Zoelsch,

Graham did play a role--and a substantial one--in Broumas'

deceptive trades.

Graham further contends that she may not be regarded as

substantially assisting Broumas since the execution of his

trades was merely a "ministerial" act on her part. She had

"no discretion" with respect to the handling of Broumas'

accounts, she asserts, because "once Mr. Pasztor approved a

trade, [she] could not refuse to execute it." Id. at 14. But

Graham did have discretion. A registered representative can

always refuse to execute a trade she knows may constitute a

securities violation. Cf. U.S. Envtl., 155 F.3d at 112 ("Like

lawyers, accountants, and banks who engage in fraudulent or

deceptive practices at their clients' direction, [the defendant

broker] is a primary violator despite the fact that someone

else directed the market manipulation scheme."). Of course,

doing so might have made Graham's career at VCI more

difficult, but fear of such consequences does not excuse a

violation of the securities laws.

C

The real question here concerns the third element of aiding

and abetting liability: did Graham assist Broumas with the

requisite scienter? We have held that knowledge or recklessness is sufficient to satisfy that requirement. See Kowal v.

MCI Communications Corp., 16 F.3d 1271, 1276 (D.C. Cir.

1994); SEC v. Steadman, 967 F.2d 636, 641 (D.C. Cir. 1992);

Zoelsch, 824 F.2d at 36; Dirks v. SEC, 681 F.2d 824, 844-45

(D.C. Cir. 1982), rev'd on other grounds, 463 U.S. 646 (1983).

__________

21 The defendant accounting firm had not issued the audit

report, but rather had provided information to another accounting

firm that had prepared the report. See Zoelsch, 324 F.2d at 34; see

also id. at 28-29, 35-36.

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We are satisfied that Graham acted with at least extreme

recklessness in aiding Broumas' stock-kiting scheme.

The SEC did not hold Graham reckless merely for executing stock trades. Rather, during the course of executing

some 60 trades, Graham noticed numerous suspicious circumstances. She observed that Broumas invariably specified the

contra-broker for his trades, rather than using American

Securities, the firm VCI typically contacted for over-thecounter trades in exchange-listed securities. Out of the more

than 300 accounts with which Graham worked, only Broumas

specified the contra-broker with whom to execute the trade,

and only Broumas traded in such large volumes. He also

detailed every aspect of the trade, including the specific

employee at the contra-broker with whom he wanted Graham

to speak. Cf. United States v. Corr, 543 F.2d 1042, 1046 (2d

Cir. 1976) (recognizing directed trades as evidence of manipulation). Graham testified that, as a result, she assumed

Broumas controlled the shares in the accounts or at least

"had connections" with them.

Perhaps most important, Graham recognized, and discussed

with Pasztor, the fact that Broumas had "a peculiar way of

trading." J.A. at 306. Although these were "big money

trades" involving thousands of shares, and although he was

repeatedly buying and selling and paying commissions on the

transactions, Graham realized that Broumas was not making

any money on the trades. See id. at 380. This economically

irrational trading was a large red flag. See Edward J.

Mawod & Co. v. SEC, 592 F.2d 588, 595 (10th Cir. 1979)

(holding that broker willfully aided and abetted manipulative

wash and match trades scheme when he "knew or had reason

to know that such trading was economically irrational").

At the same time that she was noting these trading peculiarities, Graham also knew that Broumas was experiencing

financial difficulties. She learned that he was buying and

selling JML stock as a method of borrowing money he needed

to repay bank loans. She knew that he was having trouble

paying for his trades on time, had received "quite a few"

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extensions on his joint account, and had bounced checks.

J.A. at 288, 296, 343. She knew that VCI's clearing firm had

imposed restrictions on his joint account. And she knew that,

with her help, Broumas was circumventing those restrictions

by trading in accounts nominally owned by others. Moreover, when it came to her own firm's financial interests,

Graham took special precautions to protect against financial

loss, seeking Pasztor's authorization on almost every trade

because "I couldn't take a chance of writing an order when

the man would owe thousands of dollars in his account." Id.

at 317. All of this provides more than the "substantial

evidence" necessary to support the SEC's finding of scienter

on the part of Graham.

In her defense, Graham notes that she "stood to gain

absolutely nothing from Broumas' scheme," since Broumas

traded through a "house account" for which she did not

receive commissions. Graham Br. at 27. It is true that lack

of opportunity for personal gain may suggest lack of motive,

which may in turn be relevant to the question of scienter.

But the absence of commissions does not necessarily negate

either motive or scienter. Graham may have gone along with

Broumas' scheme (or hidden her head in the sand) to please

her bosses or to keep her job. Or she may have done so

merely because she was reckless, regardless of any motive to

gain money or favor. Either way, the absence of commissions does not absolve her of responsibility. See U.S. Envtl.,

155 F.3d at 112 ("[A]s long as [broker], with scienter, effected

the manipulative buy and sell orders, [his] personal motivation for manipulating the market is irrelevant in determining

whether he violated s 10(b).").

Graham also points to the fact that she sought and obtained

approval for Broumas' trades from her immediate supervisor,

James Pasztor, who told her they were "fine." She "left it up

to my supervisor," she states, to "say that this was not

allowed." J.A. at 338. And she argues that this reliance

negates the scienter necessary for an aiding and abetting

violation. In support, Graham cites James L. Owsley, a case

in which the Commission excused the conduct of a broker

who, prior to selling his own stock in a company, was told by

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a firm official with whom he consulted that it was not

necessary to disclose those sales to customers he was asking

to purchase the same stock at the same time. See 51 S.E.C.

524, 528 (1993).

The SEC rejected Graham's reliance defense, noting that

she is an experienced professional who has an independent

duty to use diligence "where there are any unusual factors."

Graham, 1998 WL 823072, at *6-*7 & n.30 (quoting Alessandrini & Co., Inc., 45 S.E.C. 399, 406 (1973)). Registered

representatives are "under a duty to investigate," Hanly v.

SEC, 415 F.2d 589, 595 (2d Cir. 1969) (internal quotation

omitted), and "red flags and suggestions of irregularities

demand inquiry as well as adequate follow-up and review,"

Frederick H. Joseph, 51 S.E.C. 431, 438 (1993). See Wonsover, 205 F.3d at 411. Given the abundance of red flags here,

it would be very hard to characterize Graham's conduct as

anything but extremely reckless, regardless of the approvals

she received from Pasztor.

The Commission distinguished the Owsley decision on the

ground that, "[a]mong other things, ... [it] involved a single,

discrete inquiry and limited transactions." Graham, 1998

WL 823072, at *7 n.34. Nor did Owsley mention the presence of any suspicious circumstances or red flags. By contrast, this case involved 60 transactions over 18 months, with

Graham's involvement becoming increasingly more significant

(e.g., through the establishment of the Les Girls account and

the use of the Rogers account) at the same time that the

warning signs were becoming increasingly more prominent.

Graham's reliance on Pasztor, a VCI employee, also differs

substantially from the reliance at issue in SEC v. Steadman,

where we held that directors of a mutual fund company had

not been reckless in relying on a "formal, unqualified opinion

letter" from their outside counsel--an opinion also relied

upon by the funds' "disinterested independent auditor," a

major national accounting firm. 967 F.2d at 642. There

were no red flags in evidence in Steadman, nor were there

suspicious events creating reasons for doubt. Indeed, there

was no evidence at all that the directors were on notice of the

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violation at issue, which arose from a failure to register the

funds' securities under state Blue Sky laws, other than the

SEC's view that "[s]ophisticated professionals like Steadman

might be assumed to have come across [such] information ...

at some point during" their careers. Id.

Graham, by contrast, was not simply a professional who

should have known better. She was a professional who was

aware of her customer's financial difficulties, aware that he

was trading in a suspicious and economically irrational manner, and aware that he was trying to circumvent restrictions

that had been placed on his account--yet she assisted him

nonetheless. Cf. Wonsover, 205 F.3d at 411, 415 (holding, in

light of "several 'red flags,' " that broker's reliance on approval of firm and its lawyers did not negate finding that he acted

willfully). Accordingly, we reject Graham's reliance defense

and affirm the SEC's determination that she recklessly, and

substantially, assisted Broumas in violating the securities

laws.22

D

Finally, Graham and Voss argue that the SEC is barred by

principles of "equitable estoppel" and "administrative interpretation" from sanctioning them. They note that, "[f]rom

late 1988 through mid-1989, the NASD had several occasions

to review Broumas' directed trading in JML shares." Graham Br. at 33. The NASD concluded, petitioners assert,

"that so long as Broumas' trades were not reported to the

consolidated transaction reporting system of the exchanges,

__________

22 Commissioner Johnson dissented from the finding of liability

against Graham, solely on the ground that her reliance on the

advice of Pasztor and Voss was reasonable. See Graham, 1998 WL

823072, at *11-*12 (Johnson, Comm'r, dissenting). Even he, however, found the case an "exceedingly close call[ ]," which "necessarily depend[ed] on the facts and circumstances." Id. While each

SEC Commissioner may make his or her own factual determinations de novo, our standard of review requires deference to the

determinations of the Commission where they are supported by

substantial evidence.

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they were not manipulative." Id.23 They also claim that

"[t]he NASD sought the SEC's view with respect to this

administrative interpretation and the SEC concurred." Id.

And they further contend that during 1988 and 1989, the SEC

conducted its own examination of Broumas' trading, and "did

not perceive" securities violations. Id. at 34.

At the start, it is important to describe accurately what

transpired during the examinations in question. First, the

NASD did not give Broumas' trades anything like a clean bill

of health, and certainly did not do so in the form of an

"administrative interpretation." An examiner simply concluded, in an internal review, that because Broumas' trades

were not being included in the consolidated transaction reporting system, see supra note 23, they did not violate an

NASD rule that proscribes wash trades undertaken for the

purpose of creating the false appearance of market activity,

see NASD Manual, Sched. G, s 4(b) (1989). The examiner

was nonetheless troubled by the trades "because they didn't

smell right. There was something fishy about these trades

being prearranged, directed trades...." J.A. at 610; see

also id. at 616-17. The NASD referred the matter of Broumas' trading to the SEC for further investigation. See id. at

608, 618, 804.

The SEC's role was even less formalized, and is of even

less comfort to petitioners. The support petitioners cite for

the proposition that "[t]he NASD sought the SEC's view with

respect to this administrative interpretation and the SEC

concurred" is no more than the NASD examiner's testimony

that he spoke to someone at the SEC--whose name and title

he could not recall--who "basically agreed" with his evaluation. Id. at 610, 611. The support for petitioners' contention

that the SEC "did not perceive" securities violations in reviewing Broumas' trading is the testimony of an SEC examin-

__________

23 NASD rules require that most transactions in stocks listed on

the AMEX be reported on the "Consolidated Tape," NASD Manual,

Sched. G, ss 1(d), 2 (1989), which is the "consolidated transaction

reporting system for the dissemination of last sale reports in [such]

securities," id. s 1(b). Broumas' trades often were not reported.

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er, who said that after reviewing the NASD examination, he

decided that "no conclusion could be reached as to whether

any violative activities have occurred." Id. at 802. The SEC

examiner therefore recommended that a "further review of

Mr. Broumas's activities should be conducted in order to

determine if insider trading or a check kiting scheme was

being perpetrated." Id. at 803; see also id. at 659. Further

review by the SEC eventually did result in the complaints at

issue here.

Even in circumstances where the doctrine of estoppel is

applicable,24 the following elements, at least, must be established: that there was a "definite" representation to the party

claiming estoppel; that the latter "relied on its adversary's

conduct in such a manner as to change his position for the

worse"; and that the reliance was "reasonable." Heckler v.

Community Health Servs., 467 U.S. 51, 59 (1984) (internal

quotations and footnote omitted). Here, neither the NASD

nor the SEC made any representations at all to Graham or

Voss, and petitioners do not assert that they acted in reliance

on any such representations. Nor did either entity issue any

kind of opinion or "administrative interpretation" that might

have bound it, even as a matter of precedent, in a future

adjudication.25

__________

24 See Heckler v. Community Health Servs., 467 U.S. 51, 60

(1984) ("[I]t is well settled that the Government may not be

estopped on the same terms as any other litigant."); see also Office

of Personnel Management v. Richmond, 496 U.S. 414, 419, 421-22

(1990).

25 Of course, even if the NASD had done something to bind

itself, that would not have bound the SEC. As a private, nonprofit

corporation, the NASD conducts its own independent investigatory

and disciplinary actions, and is subject to limited review by the

SEC. See 15 U.S.C. s 78s; 6 Loss & Seligman, supra, at 2819-30.

There is "no statutory, regulatory, or historical reference to support

[an] argument that NASD discipline of its members was intended to

preclude ... disciplinary action by the SEC itself against a securities professional." Jones v. SEC, 115 F.3d 1173, 1179 (4th Cir.

1997).

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Instead, what we have in this case is nothing more than a

series of investigations into Broumas' trades, which ultimately

provided the SEC with sufficient understanding of the underlying scheme to file the complaint now before us. Neither

Broumas nor the petitioners can be said to have been cleared

along the way. And the SEC's failure to prosecute at an

earlier stage does not estop the agency from proceeding once

it finally accumulated sufficient evidence to do so.26

__________

26 See Investors Research, 628 F.2d at 174 & n.37 (rejecting

estoppel argument where there was "no evidence the Commission

learned all the facts of the violation" at early meetings with

petitioners); Capital Funds, Inc. v. SEC, 348 F.2d 582, 588 (8th Cir.

1965) (rejecting argument that the SEC was estopped because it

previously investigated but took no action); SEC v. Culpepper, 270

F.2d 241, 248 (2d Cir. 1959) (finding that routine examination

provided "no fact-basis for an estoppel" because "neither the Commission nor its staff directly or indirectly caused the defendants to

understand that it concurred in the legality of the [subject] sales");

G.K. Scott & Co., 51 S.E.C. 961, 966 n.21 (1994) ("A regulatory

authority's failure to take early action neither operates as an

estoppel against later action nor cures a violation.") (internal quotation omitted), review denied, 56 F.3d 1531 (D.C. Cir. 1995) (table

decision); cf. 15 U.S.C. s 78z ("No action or failure to act by the

Commission ... in the administration of this chapter shall be

construed to mean that the particular authority has in any way

passed upon the merits of, or given approval to, any security or any

transaction or transactions therein....").

In Klein v. SEC, 224 F.2d 861 (2d Cir. 1955), cited by petitioners,

the Second Circuit held that after an NASD committee had examined a broker's 50% markup and found no violation, it could not

sanction him for charging the same markup two years later because

the prior review "justified [the broker] in believing that a 50%

markup did not violate the Rules." Id. at 864. The court regarded

the NASD's earlier determination as "an interpretation of the Rules

on which [the broker] reasonably relied." Id. Klein is of no

assistance to petitioners, however, as they make no claim of reliance

on the SEC's initial investigation. In any event, the Second Circuit

subsequently appeared to limit Klein to actions of the NASD,

holding that because the SEC enforces an "Act of Congress," it

could not "be estopped even if it had acquiesced in" a transaction

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III

We conclude that substantial evidence supports the SEC's

determination that Graham aided and abetted Broumas' violations of section 10(b) and Rule 10b-5. Because Voss' defense

rested solely upon the exoneration of Graham, we also uphold

the SEC's determination that he failed reasonably to supervise her. The order of the SEC is

Affirmed.

__________

similar to the one it was now sanctioning. Culpepper, 270 F.2d at

248.

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