Opinion ID: 781798
Heading Depth: 2
Heading Rank: 1

Heading: The Commission's Findings of Fraud.

Text: 17 The Commission found fraud in violation of Securities Act § 17(a), 15 U.S.C. § 77q(a), and Exchange Act § 10(b), id. § 78j(b), and Rule 10b-5, 17 C.F.R. § 240.10b-5; fraud in violation of the Advisers Act § 206(1) and (2), 15 U.S.C. § 80b-6(1)-(2); 4 and false statements to the Commission in violation of Advisers Act § 207, id. § 80b-7. Advisers Act § 207 criminalizes willfully making false statements of material fact, or material omissions, in applications or reports to the Commission, such as a Form ADV. Id. Advisers Act § 206 prohibits advisers from, directly or indirectly, employing a scheme to defraud clients or engaging in practices which operate as a fraud upon clients. Id. § 80b-6(1)-(2). Exchange Act § 10(b) criminalizes employing deceptive devices in connection with the sale of securities in violation of Commission rules, id. § 78j(b); Rule 10b-5 prohibits, as such a deceptive device, the use of fraudulent schemes or business practices and prohibits making false statements of material fact or misleading material omissions. 17 C.F.R. § 240.10b-5. Securities Act § 17(a) criminalizes the use of fraudulent schemes or business practices and criminalizes obtaining money by making false statements of material fact or misleading material omissions. 15 U.S.C. § 77q(a). Although scienter is required for some of these violations, the element of a materially false statement is satisfied by essentially the same conduct for all of the statutes in question. 18
19 We have no trouble concluding that the petitioners made materially false statements when they claimed not to recommend securities in which they had an ownership or sales interest, not to receive economic benefits in connection with giving advice to clients, and not to recommend securities in which they had a financial interest. It is indisputable that potential conflicts of interest are material facts with respect to clients and the Commission. See, e.g., SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 201, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963) (noting that an investment adviser must fully and fairly reveal[] his personal interests in [his] recommendations to his clients). 20 Two aspects of the SSA created a financial interest for the petitioners to recommend PPF funds to their clients. First, the minimum investment provision created an incentive for the petitioners to convince their clients to invest a total of at least $1,000,000 in PPF funds; otherwise they would not have received any payment under the SSA. When a person's payment is contingent on his or her clients investing a minimum amount of money, that person has a financial interest in recommending the investment until that amount of money has been reached. 21 The second aspect of the SSA, the system of caps, continued to create a financial interest in recommending PPF funds even after the minimum investment provision had been satisfied. We need not decide whether the SSA caps facially created a financial interest because it is obvious that they did so in practice. As noted above, Vernazza indicated that H&V had performed work in excess of the compensation it was entitled to under the caps, and thus the balance was carried forward. At this point, as long as a balance was carried forward, H&V's compensation was wholly dependent on the amount of money invested by its and IMS's clients. When compensation is predicated entirely on the amount of money invested in a fund by a person's clients, that person has a financial interest in recommending that fund. The petitioners had a financial interest in recommending PPF funds, and their representations to the contrary were false statements of material fact. 22 Petitioners argue that the Commission erred by not crediting Vernazza's testimony that he put in substantial work under the SSA and kept records of this work, thus finding that the work performed under the SSA was minimal. As long as a balance was carried forward, however, the amount of work actually performed under the SSA is irrelevant. Petitioners still had a financial interest in recommending World's funds, even if they also needed to, and in fact did, perform other services under the SSA. 5 23
24 It is undisputed that scienter is a required element for violations of Securities Act § 17(a)(1), Exchange Act § 10(b) and Rule 10b-5, and Advisers Act § 206(1). Scienter is not required for the other violations of the Advisers Act. The parties do, however, dispute the meaning of scienter; the petitioners suggest that scienter requires specific intent to defraud. 25 In this Circuit, a violation of Exchange Act § 10(b) and Rule 10b-5 may be supported by knowing or reckless conduct, without a showing of willful intent to defraud. Nelson v. Serwold, 576 F.2d 1332, 1337 (9th Cir.1978); see also Howard v. Everex Sys., Inc., 228 F.3d 1057, 1063(9th Cir.2000). A similar showing is required for violations of Securities Act § 17(a)(1). See, e.g., SEC v. Dain Rauscher, Inc., 254 F.3d 852, 856 (9th Cir.2001). We apparently have never considered what constitutes scienter under Advisers Act § 206(1), but because its language is nearly identical to that of Securities Act § 17(a)(1), 6 we now hold that the same definition — knowing or reckless conduct — applies to Advisers Act § 206(1). 26 Citing the testimony of Vernazza, Hall, and Hargrave, the Commission found that each had knowledge of the caps under the SSA and that each had reason to know of the false statements made in the Forms ADV and disclosure statements. 7 The Commission held that the petitioners had a duty to disclose potential conflicts of interest accurately, and that even if the petitioners' failure to disclose was unknowing, it was reckless. The Commission found it implausible that the petitioners were ignorant of this duty, or that the failure to do so was merely an oversight, and therefore determined that the petitioners had the requisite scienter. 27 Petitioners argue that, because there is no direct evidence of their intent to defraud their clients, the Commission's finding of scienter lacks substantial evidence. We are not persuaded. The Commission identified the applicable standard of care correctly and had the requisite evidentiary basis to conclude that the petitioners were in violation. 28 The Commission correctly determined that the petitioners had a duty to disclose any potential conflicts of interest accurately and completely, and to recognize that the SSA created such a potential conflict. Although the Commission's determination of the duty of care is not the kind of formal interpretation that is entitled to Chevron deference, an agency's interpretation may merit some deference whatever its form, given the `specialized experience and broader investigations and information' available to the agency. Mead Corp., 533 U.S. at 234, 121 S.Ct. 2164 (quoting Skidmore v. Swift & Co., 323 U.S. 134, 139, 65 S.Ct. 161, 89 L.Ed. 124 (1944)). In this case, we defer to the Commission's experience and expertise in determining that investment advisers are knowledgeable enough to recognize that an arrangement such as the SSA creates potential conflicts of interest. 8 29 The Commission's determination that the petitioners either knowingly or recklessly violated their duties is supported by substantial evidence. The Commission is entitled to draw inferences from the evidence, including an inference that the petitioners' failure to disclose their potential conflict of interest was not merely an innocent oversight. As the Second Circuit determined in a similar context, the petitioners' arguments 30 misapprehend the nature of our review of an administrative agency's decision. Petitioners essentially argue that this court should draw inferences from the evidence contrary to those drawn by the Commission. In other words, they ask us to supplant the [administrative agency's] reasonable determinations. Cellular Tel. [ Co. v. Town of Oyster Bay ], 166 F.3d [490,] 494 [(2d Cir.1999)]. But based on the record ... we cannot say that the SEC lacked such relevant evidence as a reasonable mind might accept as adequate to support [its] conclusion. Universal Camera Corp. v. NLRB, 340 U.S. 474, 477, 71 S.Ct. 456, 95 L.Ed. 456 (1951) (quoting Consolidated Edison Co. v. NLRB, 305 U.S. 197, 229, 59 S.Ct. 206, 83 L.Ed. 126 (1938)) (internal quotation marks omitted). We thus uphold the SEC's finding of scienter. 31 Valicenti Advisory Servs., Inc. v. SEC, 198 F.3d 62, 65 (2d Cir.1999) (first and fifth alterations in original) (parallel citations omitted). The record supports the Commission's conclusion that the petitioners acted knowingly or recklessly in failing to disclose the required information and affirmatively misstating the nature of their agreement with World. 32