Œ This decision was originally released as an unpublished order.

Upon the Commission’s motion, we now issue it as a published

opinion.

In the

United States Court of Appeals

For the Seventh Circuit ____________

No. 05-2850

NICHOLAS T. AVELLO,

Petitioner,

v.

SECURITIES AND EXCHANGE COMMISSION,

Respondent.

____________

Petition for Review of an Order of the

Securities and Exchange Commission.

No. 3-10391r

____________

SUBMITTED MAY 26, 2006—DECIDED MAY 26, 2006

PUBLISHED JULY 21, 2006Œ

____________

Before POSNER, ROVNER, and WILLIAMS, Circuit Judges.

WILLIAMS, Circuit Judge. Nicholas T. Avello is a certified

public accountant who was sanctioned with a letter

of caution by the National Association of Securities Dealers

for submitting inaccurate financial reports. He now petitions for review of an order of the Securities and Exchange

Commission upholding the disciplinary action, arguing that

rules he was held to have violated do not apply to him, and
2 No. 05-2850

that, even if they do, the standard by which his conduct was

judged was too high. We deny the petition.

I. BACKGROUND

We briefly sketch the regulatory scheme that led the

NASD to focus on Avello. The NASD, a self-regulated

agency registered with the Commission as a national

securities association under the Securities and Exchange

Act of 1934, see 15 U.S.C. § 78o-3(a), adopts rules governing

the conduct of its members and enforces compliance with

federal securities laws and Commission rules and regulations. Otto v. SEC, 253 F.3d 960, 964 (7th Cir. 2001). One

Commission regulation, known as the net capital

rule, requires brokers and dealers to maintain a specified

level of net worth to protect their customers from the firm’s

potential insolvency. See 17 C.F.R. § 240.15c3-1. A firm’s

net worth is determined from books, records, and reports

that the NASD and Commission require members to keep

and submit. See 17 C.F.R. §§ 240.17a-3, 240.17a-5. Depending on whether the broker or dealer carries or clears

transactions on customer accounts, it is required to submit

either monthly or quarterly reports known as the Financial

and Operational Combined Uniform Single, or FOCUS

reports. 17 C.F.R. § 240.17a-5(a)(2). Under NASD rules, the

title of persons responsible for the accuracy of these reports

is “Limited Principal—Financial and Operations,” otherwise

known as a FINOP. NASD MANUAL, Membership and

Registration Rule 1022(b)(2). A FINOP is “associated with

a member,” and must be a natural person who is registered

with the NASD and has passed a qualifying examination.

Id., Rule 1022(b)(1); NASD MANUAL, Bylaws of the NASD,

Art. 1(dd). A FINOP’s duties include:

(A) final approval and responsibility for the accuracy of

financial reports submitted to any duly established

securities industry regulatory body;
No. 05-2850 3

(B) final preparation of such reports;

(C) supervision of individuals who assist in the preparation of such reports;

(D) supervision of and responsibility for individuals who

are involved in the actual maintenance of the member’s

books and records from which such reports are derived;

(E) supervision and/or performance of the member’s

responsibilities under all financial responsibility rules

promulgated pursuant to the provisions of the Act;

(F) overall supervision of and responsibility for the

individuals who are involved in the administration and

maintenance of the member’s back office operations; or

(G) any other matter involving the financial and operational management of the member.

NASD MANUAL, Rule 1022(b)(2).

Avello contracted to work as a FINOP for Hudson Knight

Securities, Inc. (HKS) and remained in that position from

1995 until 1997. During that period the NASD became

aware that HKS was experiencing difficulty meeting its

required level of net capital and began monitoring HKS.

Eventually the NASD determined that the firm had improperly accounted for certain items in its FOCUS reports

which, if properly accounted for, would have shown that the

firm had conducted business while below its required level

of net capital. When the NASD or its Department of

Enforcement believes that an associated person has violated

rules, regulations, or securities laws, it may request

authorization from the Office of Disciplinary Affairs to file

a complaint. Id., Procedural Rule 9211. If alleged to have

violated a statute or certain NASD rules, a respondent may

propose that the NASD’s Chief Hearing Officer select a

Market Regulation Committee Panelist for a Hearing Panel.

Id., Procedural Rule 9221(a)(3). And that’s what happened

here. In 1998 the Department filed a complaint against
4 No. 05-2850

Jonathan Webb, the Chairman and half-owner of HKS, and

Avello (but did not name the firm itself) that was later

vetted before a Hearing Panel.

The complaint alleged ten causes, only three of which

implicated Avello. The charges against Webb alone included

allegations that HKS, acting through him, effected securities transactions on days when it failed to maintain the

minimum required net capital; failed to maintain the level

of net capital Webb agreed to with the Commission; violated

rules and regulations requiring the accurate maintenance

and submission of books, records, and reports; and conducted business without employing properly qualified

principals required by NASD rules. The causes involving

Avello concerned only the financial reporting obligations;

the complaint alleged that HKS, acting through both Webb

and Avello, had failed to maintain its required level of net

capital, had kept inaccurate books and records, and had

filed inaccurate FOCUS reports. Those causes were based

on the firm’s violation of five rules: Exchange Act Rules

15c3-1, 17a-3, and 17a-5, and NASD Conduct Rules 2110

and 3110. Exchange Act Rule 15c3-1 is the net capital rule.

Rule 17a-3 requires brokers and dealers to keep various

books and records current, while Rule 17a-5 requires them

to file the FOCUS reports. See 17 C.F.R. §§ 240.15c3-1,

240.17a-3, 240.17a-5. NASD Rule 2110 requires members

to “observe high standards of commercial honor and just

and equitable principals of trade,” while Rule 3110 is the

NASD counterpart to the Exchange Act rule regarding the

proper keeping of books and records. The complaint did not

charge Avello with violating NASD Membership and

Registration Rule 1022(b)(2)—the NASD provision specific

to FINOPs.

Before any hearings were conducted, Avello stipulated

that five items were not accounted for properly in HKS’s

books, records, and reports. The first is a debt HKS owed to

American Express for charges incurred by HKS’s officers. At
No. 05-2850 5

the time, Avello believed that the underlying charges were

personal to the officers and thus did not record the unpaid

balance as a firm liability, though he acknowledged that the

account agreement with American Express—which he did

not read until later—made all charges the responsibility of

the firm as well as the individual cardholders. Second is a

$60,000 sole-recourse loan that Avello initially recorded as

a liability, but later removed from HKS’s books on Webb’s

word that it had been paid, even though it had not. The

third item is a lease agreement for office furniture and

equipment. Instead of reading the agreement and recognizing that the lease should have been capitalized and the

future payments recorded as a liability, Avello treated it as

a rental contract and recorded the monthly payments as

“rent” based on a bank debit memorandum with that

notation. Fourth, Avello included certain receivables,

technically called payment-for-order-flow receivables, owed

to HKS by another broker-dealer as allowable assets on the

firm’s FOCUS reports, even though he stipulated that they

should not have been treated as allowable assets. Finally,

Avello failed to account for debts HKS owed various vendors

and delivery services because the firm would not provide

him with complete and accurate information. When submitting the firm’s FOCUS report to the NASD, Avello highlighted these last debts in a letter, stating that he had not

been able to review any of the underlying documents and

was unable to verify the accuracy of the amounts reported.

Avello also stipulated to three more accounting errors

made as a consequence of Webb’s unsuccessful attempt to

increase HKS’s net capital. The first is a $50,000 note

executed by Webb on behalf of HKS that was paid down to

$47,000 by January 1996. Webb never disclosed the note to

Avello, so Avello never recorded it as a firm liability from

late 1995 through 1996 when Webb replaced the note with

a $50,000 revolving line of credit. Avello also booked as

good capital a $65,000 check drawn on Webb’s personal
6 No. 05-2850

checking account and deposited into HKS’s checking

account, even though at the time Avello booked the check

Webb lacked sufficient funds in his checking account to

cover it. Third is a $125,000 account at Smith Barney that

Avello booked as good capital even though it was not

because it was encumbered by a non-HKS officer’s authority

to withdraw funds from the account.

Although Avello stipulated to the improper accounting, he

denied responsibility for the resulting rules violations on

the ground that he had adequately performed his role as

FINOP. The Hearing Panel disagreed and held him liable

for all the accounting errors except those pertaining to the

$50,000 note, the American Express debt, and the $125,000

account at Smith Barney. With respect to the net capital

rule, the Hearing Panel concluded that Avello’s errors made

him responsible for four of the days when HKS conducted

securities transactions while its net capital was below the

required level. The Hearing Panel imposed a $5,000 fine,

$500 in costs, and a 30-day suspension.

A party dissatisfied with a decision of the Hearing Panel

may initiate what becomes a three-step process of appeal.

The first step is an appeal to the National Adjudicatory

Council (NAC). NASD MANUAL, Procedural Rule 9311. The

next is a petition for review by the Commission, 15 U.S.C.

§ 78s(d)(2), and then, if requested, we will review the final

decision of the Commission, 15 U.S.C. § 78y(a)(1).

Avello followed these steps, some more than once. Initially the NAC held Avello responsible for the same inaccuracies that the Hearing Panel did, though it added responsibility for the American Express debt that the Hearing Panel

had been willing to overlook. The NAC confirmed that

Avello was not responsible for the unbooked $50,000 note or

the account at Smith Barney, and further absolved him of

responsibility for misbooking Webb’s $65,000 check because

Avello could not have known the check was no good on the
No. 05-2850 7

date he booked it. The NAC therefore modified the Hearing

Panel’s decision, holding Avello responsible for only one

day’s net capital violation, rather than four, and setting

aside the 30-day suspension. On Avello’s petition for review,

the Commission conducted an independent review of the

record but ultimately agreed with NAC.

Avello then petitioned this court for review of the Commission’s decision. Before responding to Avello’s brief to this

court, the Commission moved to remand the case, having

discovered an error in the calculation of HKS’s net capital

position on the single date for which Avello was held

responsible. We granted the request. The Commission

remanded the case to the NAC to clarify Avello’s liability for

the net capital violation.

Upon further review the NAC concluded that it mistakenly had taken into account the unbooked $50,000 note

for which it had absolved Avello, and that ignoring that

liability he would not be responsible for any net capital

violation. The NAC did not completely exonerate Avello,

however, because it still considered him responsible for

the five accounting errors, though it did reduce the sanction

to a letter of caution, the minimal sanction under NASD

practice for a rules violation, see In re Martin Lee Eng,

Exchange Act Release No. 44224, 2001 WL 427969, at *3

(Apr. 26, 2001). Avello again petitioned for review by the

Commission. His petition raised for the first time additional

arguments related to his recordkeeping and reporting

violations, which the Commission deemed waived because

they could have been raised in the earlier proceedings. The

Commission therefore once again affirmed the findings of

the NAC and sustained the sanction.

II. ANALYSIS

This case has now made its way back to us. Our review is

limited to the Commission’s decision sustaining the NASD’s
8 No. 05-2850

sanctions and we treat the findings of fact as conclusive “if

supported by substantial evidence.” 15 U.S.C. § 78y(a)(4);

see Otto, 253 F.3d at 964. Avello’s brief lists some ten

issues, but we think he makes two principal arguments.

His first is that Exchange Act Rules 17a-3 and 17a-5 do

not apply to him because those rules literally apply to

brokers or dealers, not to FINOPs. He is correct that

Exchange Act Rules 17a-3 and 17a-5, “by their terms, apply

to broker-dealers, not to persons associated with brokerdealers.” Davrey Fin. Servs. Inc., Exchange Act Release No.

51780, 2005 WL 1323032, at *4 n.13 (June 2, 2005) (naming

Rules 17a-3 and 17a-4, but analysis is applicable to Rule

17a-5 because it too is limited to broker-dealers). Indeed, in

its brief the Commission concedes that HKS, not Avello,

violated the regulations. And in its decisions the Commission often attributes the violation of a rule to the securities

firm while characterizing the limited principal as responsible for the firm’s violations. See id.; In re William H.

Gerhauser, Exchange Act Release No. 40639, 53 S.E.C. 933,

938-40 (Nov. 4, 1998) (discussing net capital requirement as

firm’s obligation); In re Gilad J. Gevaryahu, Exchange Act

Release No. 33038, 51 S.E.C. 710, 710 (Oct. 12, 1993)

(referring to FINOP as “responsible for the firm’s failure to

comply” with net capital, recordkeeping, and reporting

requirements); In re George Lockwood Freeland, Exchange

Act Release No. 34-32192, 51 S.E.C. 389, 390 (Apr. 22,

1993) (same).

But Avello could violate Exchange Act rules indirectly

through NASD Membership Rule 1022(b). That rule, akin

to an accomplice-liability statute, incorporates violations of

other provisions. If Avello, as the FINOP, caused HKS to

violate an Exchange Act rule by maintaining inaccurate records or submitting inaccurate reports, then he

is responsible for the Exchange Act violation. Thus, because

HKS violated Exchange Act recordkeeping and reporting
No. 05-2850 9

rules, Avello was responsible for the violations under Rule

1022(b)(2).

Avello counters that he was never charged with violating Rule 1022(b) and so to hold him liable for violating

it contravenes the procedural safeguards prescribed by

15 U.S.C. § 78o-3(h)(1). True, the underlying complaint does

not reference Rule 1022(b), but Avello has not explained

how that omission has prejudiced him. See Rehman v.

Gonzales, 441 F.3d 506, 509 (7th Cir. 2006) (explaining in

immigration context that reviewing court will not set aside

agency decision on basis of claimed procedural error unless

mistake or error caused prejudice). Nor do we see how it

could have; the Hearing Panel first put him on notice of the

application of Rule 1022(b)(2) in 1999, yet Avello waited to

argue that he lacked notice of that rule until five years and

four rounds of review later. Anyway, the language of the

complaint, alleging that HKS violated the rules through

Avello, was enough to alert him to the NASD’s theory of

liability.

We turn then to his second main argument. Avello argues

that even if Rule 1022(b)(2) applies to him, he was held to

too high a standard under that rule. He asserts that he has

effectively been held to a standard of “strict liability” for

guaranteeing the accuracy of the firm’s reports when he

was simply “the hired hand used to perform the Firm’s net

capital calculations.” He suggests that a reasonableness

standard should govern and that his conduct should be

compared to what reasonable accountants (though we

suspect he means bookkeepers)—not auditors—do. The

Commission does not articulate a precise standard; in its

brief the Commission emphasizes the plain language of

Rule 1022(b)(2) making a FINOP responsible both for the

accuracy of the firm’s FOCUS reports and for supervising

the persons who generate the records underlying the

reports, but the Commission does not argue that Avello

could have been sanctioned for inaccuracies about which he
10 No. 05-2850

did not know and could not have known. Indeed, the

Commission points out that Avello was disciplined because

he booked information that he either knew to be incorrect

or with reasonable inquiry would have discovered to be

incorrect.

We need not decide, then, whether the Commission

could adopt or enforce a standard making a FINOP strictly

liable for inaccuracies in a firm’s FOCUS reports or the

underlying documentation. Avello himself proposes that

liability should attach for unreasonable conduct, and there

is substantial evidence to support that Avello acted unreasonably in accounting for the American Express bills, the

sole-recourse loan, the lease agreement for office furniture

and equipment, the receivables owed to HKS, and the

vendor and delivery service debts. With respect to the

American Express debt, the account agreement HKS had

with American Express stated that the charges were the

responsibility of the company as well as the individual;

Avello should have looked at the agreement to determine

whose responsibility the charges were, especially when he

discovered that the individual cardholders had been in

default on their payments for several months. There is no

explanation for Avello’s failure to continue booking the solerecourse loan as a liability; he had booked it as a liability

for several months in 1996 but then failed to book it as a

liability thereafter based on (what turned out to be a false)

representation by Webb that it had been paid. As for

Avello’s failure to capitalize the furniture lease and book

the overall liability rather than show the monthly payments

as rent, he admitted that he booked the lease as he did

based on a bank debit memo and that he would have

recorded it correctly had he taken the time to look at the

lease itself. Given that a FINOP must examine the underlying documentation before classifying an item, see

Gerhauser, 53 S.E.C. at 947 n.40, we find no fault with the

Commission’s determination that these were errors for

which Avello was responsible.
No. 05-2850 11

Likewise, the Commission’s determination that Avello

bore responsibility for two other inaccuracies is supported by the record. Avello had been twice informed by

NASD staff that the receivables were not the type that

could have been booked as allowable assets for purposes of

the firm’s net capital calculation. Yet for the following four

months he continued to book them as allowable assets.

Finally, Avello admitted that, despite knowing he was not

getting complete and accurate information from HKS

regarding various debts owed to vendors and delivery

services, he nevertheless submitted FOCUS reports that did

not include the debts as liabilities. Although he informed

the NASD by letter that he was unsure of the report’s

inaccuracy, he essentially violated one rule (requiring

accurate reports) to save the firm from violating another

(requiring quarterly reports). But if Avello found himself

unable to discharge his duties as FINOP, the proper course

was for him to resign, not to file reports with attached

caveats. See Freeland, 51 S.E.C. at 392. Thus, there was

substantial evidence to support the Commission’s determination that Avello failed to satisfy his duties as a FINOP in

these five instances.

Avello’s remaining arguments for a different standard

do not convince us to alter our view. That he disclaimed

responsibility for the accuracy of the firm’s books and

records in an engagement letter with HKS matters not; one

cannot contract out of statutory duties. See U.S. Sec.

Clearing Corp., Exchange Act Release No. 35066, 52 S.E.C.

92, 98 n.30 (Dec. 8, 1994). Nor are we persuaded that the

fact that he worked only four hours a month for HKS calls

for absolving him of liability. See Gevaryahu, 51 S.E.C. at

712-13. His policy argument that smaller firms will not

be able to afford FINOPs who perform the duties as diligently as required by NASD rules is irrelevant but, regardless, has no support in this record. All we know is that

Avello and HKS came to an agreement about how he was to
12 No. 05-2850

be compensated, and that in retrospect Avello believes the

contract price was too little for what the NASD expected of

him. Finally, despite his contention that a FINOP ought to

be treated as someone who simply compiles numbers,

rather than as an auditor, the requirements of a FINOP are

different than those of a bookkeeper. The position of a

FINOP is unique and governed solely by NASD rules. So

even though auditors examine underlying documents, the

Commission has decided that a FINOP should do so as well.

See Gerhauser, 53 S.E.C. at 947 n.40; In re James S.

Pritula, Exchange Act Release No. 40647, 53 S.E.C. 968,

972 (Nov. 9, 1998) (explaining that FINOP should have

ascertained whether check had been deposited before

treating it as asset).

Avello’s other arguments merit little discussion. He

argues that he could not have violated NASD Conduct

Rule 2110 because the Commission did not find that he

acted in bad faith. (As with the Exchange Act rules, Avello

is liable for the firm’s violation of Rule 2110 only through

Rule 1022 because Rule 2110 applies to “members,” which

Avello was not.) But the Commission does not require a

finding of bad faith when the predicate for violating Rule

2110 is the violation of another NASD or Exchange Act rule,

see In re Chris Dinh Hartley, Exchange Act Release No.

50031, 2004 SEC LEXIS 1507, at *10 n.13 (July 16, 2004);

Gerhauser, 53 S.E.C. at 942, and we have already explained

that substantial evidence supports that Avello was responsible for other violations. Avello’s arguments that the

Commission was required to find that he “controlled” a

person who committed a violation under 15 U.S.C. § 78t(a)

or that he acted “willfully” under 15 U.S.C. § 78o(b)(4) were

not presented until his return to the Commission after

remand and are accordingly waived. See United States v.

Parker, 101 F.3d 527, 528 (7th Cir. 1996) (“A party cannot

use the accident of a remand to raise in a second appeal an

issue that he could just as well have raised in the first
No. 05-2850 13

appeal because the remand did not affect it.”); W. Va. v.

EPA, 362 F.3d 861, 871 (D.C. Cir. 2004) (refusing to

consider arguments raised for first time after remand that

were not raised in agency rulemaking proceedings conducted prior to remand). His argument that he is not

responsible for HKS’s reports because they were submitted

by his corporation and not signed by him is frivolous

because a FINOP, as a “person associated with a member”

is, by definition, a natural person. See NASD MANUAL,

Bylaws of the NASD, Art. 1(dd).

We note that the various agency decisions recognize

Avello’s good-faith efforts at accurate financial reporting.

But those efforts do not excuse his failure to comply

with the duties of a FINOP, and that failure justifies the

lenient sanction upheld by the Commission. We therefore

DENY the petition for review.

A true Copy:

Teste: 

 ________________________________

Clerk of the United States Court of

Appeals for the Seventh Circuit 

USCA-02-C-0072—7-21-06