Opinion ID: 186545
Heading Depth: 2
Heading Rank: 1

Heading: Stock Manipulation

Text: 18 In the context of securities transactions, Section 10(b) prohibits the use of manipulative or deceptive device[s] or contrivance[s] in contravention of the SEC's rules, including Rule 10b-5. 15 U.S.C. § 78j(b). Rule 10b-5 prohibits the use of fraudulent devices in securities transactions. 17 C.F.R. § 240.10b-5(a). Matched orders and wash sales, both of which the SEC found here, may constitute violations under Section 10(b) and Rule 10b-5. A matched order is a securities purchase or sale entered with the knowledge that a reciprocal order of substantially the same amount would be entered at substantially the same time for substantially the same price. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 205 n. 25, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). Wash sales are transactions involving no change in beneficial ownership. Id. (internal quotations omitted). 19 Nearly all of Butchard's sales fit the definition of matched orders: Buyers recruited by Calandrella and Power purchased in quantities and at times that corresponded with Butchard's sales. Not having changed the shares' beneficial ownership, Power's trades among his own companies likewise meet the definition of wash sales. Neither Calandrella nor Power disputes these SEC findings. Calandrella quibbles with the SEC's characterization of his participation in the Katz and Nacht trades, but at root he does admit to his involvement with the trades. Power admits that he participated in both matched orders and wash sales. 20 But neither of these devices alone constitutes a securities violation. Section 10(b) (and, accordingly, Rule 10b-5) also requires a showing of intent and materiality. The parties disagree about what standard of intent applies under Rule 10b-5. Petitioners argue for a specific intent standard, but the SEC contends that recklessness should suffice. Petitioners point to Section 9(a)(1) of the 1934 Act, which expressly outlaws matched orders or wash sales conducted [f]or the purpose of creating a false or misleading appearance of active trading of a registered security on a national exchange. 15 U.S.C. § 78i(a)(1). They argue that a lower standard of intent under Rule 10b-5 would undermine Section 9(a)(1)'s specific intent standard. 21 Whereas Section 9(a)(1) requires a showing of specific intent, Rule 10b-5 generally requires only extreme recklessness. SEC v. Steadman, 967 F.2d 636, 641 (D.C.Cir.1992). Extreme recklessness is an extreme departure from the standards of ordinary care, . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. Id. at 642 (internal quotations omitted) (alteration in original). In other words, extreme recklessness requires a stronger showing than simple recklessness but does not rise to the level of specific intent. The difference between the standards could potentially have significant effects on the interplay between Section 10(b) and Section 9(a)(1) and SEC actions under each provision. Because we conclude that the SEC has not met its burden of proving scienter under either standard, we need not reach the question of what standard of intent should be applied to matched orders and wash sales under Section 10(b) and Rule 10b-5. 22 Treating each set of trades separately, we first look at Butchard's matched orders. After deciding to dump his Premier stock, Butchard conducted all of his sales in the public market based on the advice of counsel. The SEC questioned the need for public sales, though, suggesting Butchard could have avoided transaction costs by selling privately. The SEC noted that a public sale signals market activity to investors. It concluded that, in the absence of a transaction costs benefit, the only purpose for publicly reporting the sales would have been to create an appearance of market activity. On this reasoning, the SEC found that Power and Calandrella intended to manipulate the market. 23 Petitioners Calandrella and Power each dispute the SEC's conclusion and proffer alternative explanations for their actions. They contend that securities laws forced Butchard to sell publicly. At the very least, they say, Butchard's counsel advised him that, if he wanted to sell the stock, he could only do so in this fashion. Furthermore, they argue that a private sale would have incurred more transaction costs than a public sale. 24 We conclude that the SEC's findings are unsupported by the record evidence. The record shows that Butchard chose to sell his shares on the public market for reasons wholly independent of Calandrella and Power. The SEC made no finding that petitioners induced him to sell initially; neither did it find that they later coerced him into selling publicly. Indeed, other evidence suggests SEC rules required the trades to be made publicly. Testimony before the ALJ shows that Butchard's counsel advised him that he could not legally sell his shares privately because of their Regulation S restrictions. Although the SEC's brief suggests Butchard need not have publicly sold his shares, counsel at oral argument all but admitted otherwise. Having virtually conceded that Butchard's trades needed to be public, the SEC has essentially abandoned the main evidentiary leg propping up its findings. 25 Without evidence that Calandrella and Power induced Butchard's sales, some other evidence must exist to uphold the SEC's decision. The SEC suggests that Calandrella and Power colluded in arranging Butchard's sales, hinting that the alleged collusion included price setting. Although collusion is not necessary for a finding of intent, it is probative. Both Calandrella and Power challenge the SEC's insinuation, asserting that they did not collaborate at all on Butchard's trades, let alone on the prices of those trades. As support, they point to their well-known feud over Premier's management. 26 The SEC concluded — correctly — that a managerial rift between the two would not have precluded the possibility of cooperation in other areas. That conclusion, however, does not provide any affirmative evidence of actual collusion and certainly not evidence of collusion about something as specific as setting Premier's stock price. As its only evidence of collaboration, the SEC points to two facts: a single piece of testimony by Calandrella and the general pattern of Butchard's trades. The SEC reads far too much into Calandrella's testimony and explains far too little about the supposed trading pattern. 27 During the hearing, Calandrella was asked if he contacted Power or Hanifen Imhoff, the market-maker, about unexpected trades of Premier stock. Calandrella responded that he did inquire. He did not specify, however, that he talked to Power, and he only referred to unfamiliar trades. Standing alone, this vague colloquy does not establish any systematic collaboration between the two men. And even if the evidence does establish some level of cooperation between the two, it clearly does not establish manipulative price setting. 28 With respect to Premier's trading pattern, the SEC says very little. With no explanation, it announces that a pattern exists and that it suggests cooperation between Calandrella and Power. No pattern is immediately apparent from the record, however. The Commission's conclusion requires an explanation; without it, the SEC has acted arbitrarily and capriciously. See Jost v. Surface Transp. Bd., 194 F.3d 79, 85 (D.C.Cir.1999) (quoting Dickson v. Sec'y of Def., 68 F.3d 1396, 1404 (D.C.Cir.1995)). 29 The SEC cited other evidence for its finding. It argues before this Court that sales like Butchard's should have depressed Premier's share price: Large sales by the largest shareholder of a thinly traded company with poor fundamentals generally create downward pricing pressure. The SEC's brief concludes that Calandrella and Power therefore acted to buoy Premier's shares artificially by supplying buyers for Butchard's shares. Despite any merit the argument may have, the SEC has made it before the wrong tribunal. If this conclusion formed part of the SEC's reasoning, then it should have appeared in the SEC's opinion. See America's Cmty. Bankers v. FDIC, 200 F.3d 822, 835 (D.C.Cir.2000) ([ P ] ost hoc rationalizations cannot support an affirmance of an agency decision based on an otherwise invalid rationale.). 30 Turning to Power's wash sales and matched orders, the SEC offers a few unrelated propositions that it believes establish a pattern of intentional manipulation. In conclusory fashion, the SEC suggests that Power's cash-generating transactions could not have been worth the transaction costs. It also links Brian Power's transaction costs with the supposed manipulative intent of his brother. The SEC fails to articulate why the transaction costs were too high, and it makes no findings as to what level of costs would have made the trades unpalatable. Further, the SEC emphasizes that, at the end of the series of wash sales, Brian ended up with a large position in Premier stock, which the agency considers inconsistent with Brian's story that he suffered cash-flow problems that, in turn, motivated his participation in the wash sales. John testified, however, that the movement of cash between himself and his brother was a two-way street, in which money went to whoever needed it most. Thus, Brian's ultimate position in Premier stock is not inconsistent with the brothers' story, assuming that John had greater need of cash when the sales ended. The SEC's lack of explanation suggests the SEC found intent based on the mere existence of wash sales and matched orders. But the simple fact that a party has conducted a matched order or wash sale (or a series of them) does not establish manipulative intent of any kind. 31 The Commission asserts that a finding that petitioners acted recklessly can satisfy the scienter requirement, but the Commission does not appear to have made any factual findings to support this. In the securities fraud context, extreme recklessness is not a lesser-included form of specific intent. See Howard v. SEC, 376 F.3d 1136, 1143 (D.C.Cir.2004). The Commission made no findings that petitioners' actions were an extreme departure from a relevant standard of care, or that they would so obvious[ly] create a danger of misleading buyers or sellers that they must have been aware of [the danger]. Steadman, 967 F.2d at 641. 32 Because the record conflicts with the SEC's scienter findings under any standard of intent, its finding of a Rule 10b-5 violation for manipulation is not supported by substantial evidence.