In the

United States Court of Appeals

For the Seventh Circuit

____________

No. 03-3073

MONETTA FINANCIAL SERVICES, INC.

and ROBERT S. BACARELLA,

Petitioners,

v.

SECURITIES AND EXCHANGE COMMISSION,

Respondent.

____________

On Petition for Review of an Order of

the Securities Exchange Commission.

No. 3-9546

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ARGUED FEBRUARY 17, 2004—DECIDED NOVEMBER 30, 2004

____________

Before RIPPLE, KANNE, and WILLIAMS, Circuit Judges.

WILLIAMS, Circuit Judge. Monetta Financial Services, Inc.

(“MFS”), a registered investment adviser, and its president,

Robert Bacarella, seek review of a Securities and Exchange

Commission (“SEC or Commission”) order finding that MFS

violated Section 206(2) of the Investment Advisers Act by

failing to disclose that it allocated shares of Initial Public

Offerings (“IPOs”) to certain directors of its mutual fund

clients and that Bacarella aided and abetted in the violation.
2 No. 03-3073

While we agree with the SEC that MFS violated Section

206(2), we find that there is insufficient evidence to support

a finding that Bacarella aided and abetted the violation.

Likewise, we find that the sanctions the SEC imposed

against MFS were excessive.

I. BACKGROUND

Robert Bacarella is president and founder of Monetta

Financial Services, Inc., a relatively small investment adviser registered with the SEC. MFS advises both mutual

fund and individual clients. Its fund clients include Monetta

Fund and Monetta Trust, both registered investment companies organized by Bacarella. Among MFS’s individual

clients were Richard Russo, William Valiant, and Paul Henry

(collectively, director-clients), who, during the times relevant to this appeal, served as either directors or trustees of

the aforementioned fund clients. Monetta Fund and

Monetta Trust each had other directors and trustees who

were not MFS clients.

From February 1993 to September 1993, MFS, who had

been offered shares of IPOs from various broker-dealers, allocated shares in IPOs among its advisory clients, including

the director-clients and their respective funds. The directorclients earned a total of approximately $50,000 from the

IPOs. There is no indication that MFS allocated the shares

inequitably or that MFS or Bacarella benefitted from the allocations to the director-clients; however, MFS did not disclose

the fact that it allocated shares to the director-clients to the

non-client directors or trustees of the funds. After reading a

National Association of Securities Dealers (“NASD”) interpretive document, Bacarella began to question the propriety of

allocating shares of IPOs to “interested directors” and thus,

in July 1993, MFS stopped allocating IPO shares to direc-
No. 03-3073 3

1 Both Henry and Valiant were interested directors as defined by

Section 2(a)(19) of the Investment Company Act of 1940. 15 U.S.C.

§ 80a-2(a)(19).

2 The ALJ also found that the director-clients, with the exception

of Valiant, had violated the securities laws, but the directorclients are not before this court.

tors Valiant and Henry.1 In September 1993, MFS also

stopped allocating shares to Russo when Bacarella started

to question the appropriateness of IPO allocations to

directors generally.

Several months after MFS halted the allocations, the SEC

conducted a routine examination of MFS and, years later,

in February 1998, issued an Order Instituting Public

Administrative Cease-And-Desist Proceedings (“OIP”). The

OIP alleged violations by MFS, Bacarella, and the directorclients of Section 17(a) of the Securities Act of 1933 (“Securities Act”), 15 U.S.C. § 77q(a), Section 10(b) of the Securities Exchange Act of 1934 (“Exchange Act”), 15 U.S.C. §

78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5, thereunder. It

further alleged that MFS violated and Bacarella aided and

abetted MFS’s violations of Sections 206(1) and (2) of the

Investment Advisers Act of 1940 (“Advisers Act”), 15 U.S.C.

§ 80b-6(1) and (2), by failing to disclose the fact that

Monetta allocated IPO shares to director-clients. In December

2000, an Administrative Law Judge (“ALJ”) issued a decision finding that MFS and Bacarella had violated these

provisions.2

 MFS and Bacarella appealed the decision to the

SEC.

In June 2003, the SEC issued an order dismissing all

charges against MFS and Bacarella except the Section 206(2)

Advisers Act charge. Despite the dismissal of the majority

of the charges, the SEC imposed the same sanctions as the

ALJ. The sanctions include: (1) a cease and desist order

against both MFS and Bacarella; (2) a censure of MFS; (3)
4 No. 03-3073

3 Section 213(a) of the Advisers Act provides, in pertinent part,

that “[a]ny person . . . aggrieved by an order issued by the

Commission under [Section 206(2)] may obtain a review of such

order in the United States court of appeals within any circuit

wherein such person resides or has his principal place of business . . . .” 15 U.S.C. § 80b-13(a).

a 90-day suspension of Bacarella; and (3) civil money penalties of $200,000 against MFS and $100,000 against

Bacarella. MFS and Bacarella petition this court for review

of the SEC’s decision pursuant to Section 213(a) of the

Advisers Act.3

II. ANALYSIS

A. Standard of Review

We review deferentially the SEC’s findings of fact, recognizing that such findings are conclusive if supported by

substantial evidence. Otto v. SEC, 253 F.3d 960, 964 (7th

Cir. 2001). Substantial evidence includes “ ‘such evidence as

a reasonable mind might accept as adequate to support a

conclusion.’ ” Johnson v. NTSB, 979 F.2d 618, 620 (7th Cir.

1992) (citation omitted).

B. Section 206(2) Violation

MFS challenges the SEC’s conclusion that its failure to

disclose IPO allocations to director-clients violated Section

206(2) of the Advisers Act, which prohibits any investment

adviser from “engag[ing] in any transaction, practice, or

course of business which operates as a fraud or deceit upon

any client or prospective client.” 15 U.S.C. § 80b-6(2). MFS

argues that given the absence of a rule explicitly requiring

such disclosure and the fact there is no evidence that it allocated the shares inequitably, its failure to disclose the
No. 03-3073 5

allocations to the director-clients did not rise to the level of

“fraud or deceit” under Section 206(2). We disagree.

In SEC v. Capital Gains Research Bureau, Inc., 375 U.S.

180 (1963), the Supreme Court recognized that an investment

adviser’s failure to disclose material information constitutes

“fraud or deceit” under the Investment Advisers Act. Id. at

200 (“Failure to disclose material facts must be deemed

fraud or deceit within its intended meaning. . . .”). The

investment adviser in Capital Gains engaged in the practice

of “scalping,” i.e., purchasing securities before recommending them to clients and thereafter selling the securities to take

advantage of the increase in price that would follow the

recommendation. Id. at 181. The Court held that this practice amounted to “fraud or deceit” under the Advisers Act and

upheld the SEC’s imposition of an injunction requiring

disclosure to the adviser’s clients of his dealings in recommended securities. Id. at 181-82. In so holding, the Court

proclaimed that as a fiduciary, an investment adviser has

“an affirmative duty of ‘utmost good faith, and full and fair

disclosure of all material facts.’ ” Id. at 194 (internal

quotations omitted).

Here, the allocation of IPO shares to director-clients was

a material fact that MFS should have disclosed. Opportunities to invest in IPO shares are rare and therefore valuable

to investors. See Inv. Adviser Codes of Ethics, Rel. No. IA2256, 2004 WL 1488752, at *6 (July 2, 2004) (noting that

“[m]ost individuals rarely have the opportunity to invest in

[IPOs or private placements]”). Thus, when MFS allocated

some shares of the IPOs to its director-clients, it did so at

the expense of the fund clients, as the funds were thereby

allocated a smaller number of shares. In effect, MFS’s

allocation to both director-clients and fund clients placed

the parties in competition for the same shares. As the SEC

reasoned, this is particularly troublesome since MFS had an

incentive to favor the director-clients over the fund clients

when allocating the shares, given the directors’ duty to
6 No. 03-3073

monitor and police the fund’s relationship with its investment adviser. See 15 U.S.C. § 80a-15(c) (outlining directors’

duty to approve contracts with investment advisers); see also

Burks v. Lasker, 441 U.S. 471, 483 (1979) (noting the

directors’ role of reviewing and approving contracts between

mutual funds and their investment advisers).

That MFS did not, in fact, favor the director-clients over

the funds is of no consequence because the potential for

abuse nonetheless existed. See Capital Gains, 375 U.S. at

191-92 (noting that the Advisers Act evinced a “congressional intent to eliminate, or at least to expose, all conflicts of

interest which might incline as [sic] investment adviser—consciously or unconsciously—to render advice which

was not disinterested”). Capital Gains made clear that a

violation of the Advisers Act requires neither injury nor

intent to injure. Id. at 192. After all, the Advisers Act was

“directed not only at dishonor, but also at conduct that

tempts dishonor.” Id. at 200 (internal quotations omitted).

Furthermore, “[t]o impose upon the [SEC] the burden of

showing deliberate dishonesty as a condition precedent to

protecting investors through the prophylaxis of disclosure

would effectively nullify the protective purposes of the

statute.” Id.

Attempting to avoid the conclusion that its failure to

disclose the IPO allocations violated Section 206(2), MFS

points to rules the SEC promulgated in 2001 that only require directors to disclose IPO allocations when accompanied by special treatment. See Role of Indep. Dirs. of Inv.

Cos., Rel. No. IC-24816, 66 Fed. Reg. 3734, 3744 (Jan. 16,

2001). Because there is no evidence of special treatment

here, MFS argues that these rules suggest that it had no

duty to disclose the allocations. But these rules are of little

import, as they relate to directors’ responsibilities, rather

than the duties of an investment adviser such as MFS.

MFS also asserts that it acted in a manner consistent

with industry practice. Undoubtedly, allocations of IPO
No. 03-3073 7

shares to mutual fund directors were commonplace, but MFS

has not pointed to any evidence suggesting that investment

advisers’ non-disclosure of the allocations was also industry

practice. In any event, the mere presence of an industry

practice is insufficient to overcome the conclusion that MFS

violated Section 206(2). See SEC v. Dain Rauscher, 254 F.3d

852, 857 (9th Cir. 2001) (“The industry standard is a

relevant factor, but the controlling standard remains one of

reasonable prudence.”).

In the end, we agree with the SEC that MFS had a duty

to disclose the fact that it allocated IPO shares to the

director-clients. Its failure to do so constituted fraud or

deceit within the meaning of Section 206(2).

C. Aiding and Abetting

We now consider Bacarella’s argument that the SEC

erred by finding that he aided and abetted MFS’s violation

of Section 206(2) of the Advisers Act. The SEC will find one

liable for aiding and abetting where: (1) there is “a primary

violation; (2) the aider and abettor generally was aware or

knew that his or her actions were part of an overall course

of conduct that was improper or illegal; and (3) the aider

and abettor substantially assisted the primary violation.” In

the Matter of Monetta Fin. Servs. Inc., AP File No. 3-9546,

Rel. No. IA-2136, 2003 WL 21310330, at *4; see also SEC v.

Steadman, 967 F.2d 636, 647 (D.C. Cir. 1992) (applying the

same factors).

While we do not quarrel with the SEC’s conclusion that

Bacarella substantially assisted in MFS’s primary violation,

we agree with Bacarella that the SEC has not satisfied the

awareness requirement. The SEC has not provided any evidence suggesting that he was, in fact, aware that disclosure of

the IPO allocations was required. Even if, as the SEC contends and several courts have held, the awareness requirement can be satisfied by a finding of recklessness, see, e.g.,
8 No. 03-3073

Geman v. SEC, 334 F.3d 1183, 1195 (10th Cir. 2003); Graham

v. SEC, 222 F.3d 994, 1004 (D.C. Cir. 2000), it remains

difficult to see how this prerequisite has been met here. No

rules expressly required disclosure of the IPO allocations.

Moreover, the SEC did not find that MFS allocated the

shares inequitably—the presence of inequitable allocations

surely should have alerted Bacarella to the fact that disclosure, at the very least, was required. See Graham, 222

F.3d at 1006 (noting as significant the absence of red flags

in assessing one’s liability as an aider and abetter); see also

Howard v. SEC, 376 F.3d 1136, 1143 (D.C. Cir. 2004) (same).

Therefore, we cannot say that the SEC’s finding that

Bacarella was aware that disclosure was required and liable

for aiding and abetting MFS’s Section 206(2) violation is

supported by substantial evidence. Thus, we vacate the

portion of the SEC’s order finding Bacarella liable for aiding

and abetting.

D. Sanctions

Finally, we turn to MFS’s argument that the sanctions

the SEC imposed were excessive. This court will reverse a

SEC order prescribing sanctions upon a finding that the

SEC abused its discretion. Mister Disc. Stockbrokers v. SEC,

768 F.2d 875, 879 (7th Cir. 1985); see also WHX Corp. v. SEC,

362 F.3d 854, 859 (D.C. Cir. 2004) (noting that sanctions

orders should be reversed if “arbitrary, capricious, an abuse

of discretion, or otherwise not in accordance with law”).

Further, “[t]he fashioning of an appropriate and reasonable

remedy is for the Commission, not this court, and the

Commission’s choice of a sanction may be overturned only

if ‘it is found unwarranted in law . . . or without justification in fact.’ ” Steadman v. SEC, 603 F.2d 1126, 1140 (5th

Cir. 1979) (quoting Am. Power & Light Co. v. SEC, 329 U.S.

90, 112-13 (1946)); see also Vernazza v. SEC, 327 F.3d 851,

862 (9th Cir. 2003).
No. 03-3073 9

4 In imposing sanctions against MFS and Bacarella, the SEC

noted: “MFS, through Bacarella, ignored its fiduciary duty to

disclose material information to those entitled to its utmost

loyalty and good faith. Bacarella acted with scienter. Bacarella

made no effort to disclose these transactions to the remaining

directors and trustees and was not candid with the Commission’s

examiners. Bacarella’s actions and his testimony at the hearing

evince a lack of understanding of his fiduciary obligations. MFS’

and Bacarella’s insistence that, since no actual conflict existed,

they had no duty to disclose the information to the Fund Clients’

boards shows a lack of appreciation for MFS’ obligations as an

adviser to an investment company.” Monetta, 2003 WL 21310330,

at *9.

In assessing the appropriate sanctions, the Commision often

considers “the egregiousness of a respondent’s actions, the

isolated or recurrent nature of the violation, the degree of

scienter, the sincerity of a respondent’s assurances against

future violations, the respondent’s recognition that the

conduct was wrongful, and the likelihood of recurring

violations.” Monetta, 2003 WL 21310330, at *9.

Although the SEC’s opinion references these factors, the

opinion does not reflect that the SEC meaningfully considered

these factors when it imposed the sanctions.4

 In fact, many

of the aforementioned factors suggest that the sanctions are

excessive. To begin with, the conduct was not particularly

egregious: there was little indication that the allocations

were inequitable and no rules expressly required disclosure.

See WHX Corp., 362 F.3d at 860 (vacating sanction order

where no rule or formal Commission precedent prohibited

the behavior at issue). Second, the allocations took place a

decade ago, for an eight-month period, making it a fairly

isolated occurrence and suggesting that the likelihood of a

future violation is slight. See id. at 861 (noting the isolated

nature of the violation before finding the sanction excessive);

see also Johnson v. SEC, 87 F.3d 484, 490 n.9 (D.C. Cir.

1996) (commenting that five-year delay in instituting pro-
10 No. 03-3073

ceedings was not indicative of concern about future violations).

Third, MFS voluntarily ceased the allocations and MFS no

longer has individual clients, also making the possibility of

a future violation more remote. Finally, without explanation, the SEC imposed the same sanctions as the ALJ despite

the SEC’s dismissal of the majority of the charges. Taken

together, these factors suggest that the Commission abused

its discretion in sanctioning MFS.

We, therefore, vacate the SEC’s order imposing sanctions

and the portion of the SEC’s opinion which reasons that

sanctions are appropriate, and we remand to the Commission for reconsideration in a manner consistent with this

opinion of the sanctions imposed against MFS.

III. CONCLUSION

For the foregoing reasons, the petition for review is

GRANTED in part and DENIED in part.

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—11-30-04