Opinion ID: 4182911
Heading Depth: 2
Heading Rank: 3

Heading: scienter for zprim’s ads and newsletters

Text: To prove a violation of section 206(1) of the Adviser’s Act, the SEC must show the adviser acted with scienter. Steadman I, 603 F.2d at 1134. Scienter is “a mental state embracing intent to deceive, manipulate, or defraud.” Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27, 48, 131 S. Ct. 1309, 1323 (2011) (quotation omitted). “Scienter may be established by a showing of knowing misconduct or severe recklessness.” SEC v. Monterosso, 756 F.3d 1326, 1335 (11th Cir. 2014) (per curiam) (quotation omitted). Scienter can be established through direct or circumstantial evidence. Id. The scienter of a corporation is established by showing that the corporation’s officers or directors acted with scienter. See Thompson v. RelationServe Media, Inc., 610 F.3d 628, 635 (11th Cir. 2010) (“Corporations have no state of mind of their own; rather, the scienter of their agents must be imputed to them.”). 20 Case: 16-15322 Date Filed: 06/30/2017 Page: 21 of 32
The Commission found that Mr. Zavanelli (and thus ZPRIM) acted with scienter in publishing the false claims of GIPS compliance in ZPRIM’s ads and newsletters. Petitioners challenge this finding. Because the facts underlying each set of publications differ, we discuss the issue of scienter separately for each, and conclude the scienter findings are supported by substantial evidence.
Substantial evidence supported the Commission’s finding that Mr. Zavanelli (and thus ZPRIM) acted with scienter in making misrepresentations of GIPS compliance in the fall 2008 ads. In short, the evidence showed that Mr. Zavanelli knew the claims of GIPS compliance in the fall 2008 ads were false but approved them anyway. See SEC v. Carriba Air, Inc., 681 F.2d 1318, 1324 (11th Cir. 1982) (holding that scienter is established when the defendant “engaged in the dissemination of a known falsehood” (quotation omitted)). The record supports a finding that Mr. Zavanelli knew exactly what was required of an ad that claimed GIPS compliance. He testified that he read the GIPS requirements, including its advertising guidelines, “[n]umerous times . . . forward and backwards.” He even described himself as “an expert” on GIPS. Beyond that, Mr. Zavanelli clearly knew how to present GIPS-compliant investment returns in advertisements because he was responsible for “ensuring that 21 Case: 16-15322 Date Filed: 06/30/2017 Page: 22 of 32 marketing materials [were] GIPS compliant.” Indeed, from January to April 2008, ZPRIM published ads that contained the GIPS-required information. Then in the fall of 2008, Mr. Zavanelli approved the new, non-compliant ads. Mr. Bauchle testified that before these ads were published, he told Mr. Zavanelli they didn’t contain the return information required by GIPS. Yet Mr. Zavanelli ran the ads anyway. Indeed, he affirmatively directed Mr. Bauchle to leave the statement that ZPRIM is GIPS-compliant in the ad, even though he knew the investment returns in the ad did not comply with the GIPS advertising guidelines. In doing so, he “engaged in the dissemination of a known falsehood.” Carriba Air, 681 F.2d at 1324 (quotation omitted). There is also a strong inference of “intent to deceive” because the omitted GIPS-required returns resulted in covering up ZPRIM’s poor investment performance. Matrixx, 563 U.S. at 48, 131 S. Ct. at 1323. There is certainly sufficient evidence to support the Commission’s finding that the petitioners knowingly made false claims of GIPS compliance in the fall 2008 ads.
Substantial evidence also supported the Commission’s finding of scienter for ZPRIM’s false claims of GIPS compliance in the ads published in spring 2011. After the 2008 ads were published, the SEC notified ZPRIM that its ads falsely claimed compliance with GIPS and might violate the Advisers Act. With this 22 Case: 16-15322 Date Filed: 06/30/2017 Page: 23 of 32 letter, the SEC expressly put Mr. Zavanelli on notice that he needed to change the information on ZPRIM’s ads to meet the GIPS advertising guidelines. In response, ZPRIM made clear it understood what was required of it. The firm told the SEC it would take “[c]orrective action[]” by “chang[ing] our ads” to include the investment returns required by GIPS. Yet despite ZPRIM’s assurances, the firm published its 2011 ads without the GIPS-required information. Mr. Zavanelli concedes this omission made the claim of GIPS compliance “untrue,” and also concedes he conceived of and approved the spring 2011 round of “untrue” ads. This establishes that he acted with scienter. See Carriba Air, 681 F.2d at 1324.
It is similarly clear that Mr. Zavanelli acted with scienter in publishing the April 2009 newsletter. 7 Of course he had the same knowledge of the GIPS requirements in April 2009 as he had when he decided to publish the false claims of GIPS compliance in the fall 2008 ads. Beyond that, by this time ZPRIM had received an express warning from Ashland that if “[GIPS] compliance is being claimed” on ZPRIM’s newsletters, “the GIPS Advertising Guidelines need to be followed.” Despite this direct admonition from the firm’s GIPS verifier, Mr. Zavanelli—who wrote “most of the newsletter”—failed to include the GIPSrequired data in the April 2009 newsletter. This is sufficient to support the SEC’s 7 We do not address scienter for the December 2009 newsletter because, as discussed earlier, substantial evidence did not support a finding of materiality for that newsletter. 23 Case: 16-15322 Date Filed: 06/30/2017 Page: 24 of 32 finding that the petitioners knowingly published the false claim of GIPS compliance in the April 2009 newsletter. See id. D. REQUIRED MENTAL STATE FOR THE MORNINGSTAR REPORTS The Commission found ZPRIM liable for falsely stating in two Morningstar reports that it was not under SEC investigation. ZPRIM (through Mr. Bauchle) made this false statement in the report for the period ending September 30, 2010, and, again, in the report for the period ending March 31, 2011. The Commission found ZPRIM acted with negligence for the 2010 report and scienter for the 2011 report. ZPRIM challenges both findings. We conclude that both are supported by substantial evidence. 1. Negligence as to the 2010 Morningstar Report As set out above, violations of sections 206(2) and (4) can be established by a showing of negligence. Negligence requires a showing that the investment adviser failed to exercise “reasonable care.” Capital Gains, 375 U.S. at 194, 84 S. Ct. at 284 (quotation omitted). This record supports finding that Mr. Bauchle failed to act with reasonable care when he falsely reported to Morningstar in September 2010 that ZPRIM was not under SEC investigation. Mr. Bauchle was responsible for submitting ZPRIM’s information to the Morningstar database. He acknowledged he knew the Morningstar reporting form asked whether the firm was under SEC investigation. Thus, once the SEC sent 24 Case: 16-15322 Date Filed: 06/30/2017 Page: 25 of 32 ZPRIM a letter in August 2010 notifying it that the SEC was “conducting an investigation” into ZPRIM, Mr. Bauchle had a duty to update the Morningstar database to show the pending investigation. See Finnerty v. Stiefel Labs., Inc., 756 F.3d 1310, 1317 (11th Cir. 2014) (“[A] duty exists to update prior statements if the statements were true when made, but misleading or deceptive if left unrevised.”). Mr. Bauchle did not do this. As a result, the Morningstar report for the period ending September 2010 falsely showed investors that there were “No” “[p]ending SEC investigations” of ZPRIM. A person exercising a reasonable degree of care would have updated the form once the firm received express notice from the SEC of the pending investigation. Id. Thus, the record supports the finding that ZPRIM’s misrepresentation in the 2010 Morningstar report was negligent. 2. Scienter as to the 2011 Morningstar Report The record also supports the Commission’s finding that ZPRIM (through Mr. Bauchle) acted with scienter in failing to disclose the investigation in the 2011 Morningstar report. In October 2010, Mr. Bauchle gave investigative testimony as part of the SEC’s proceedings in this case, and counsel for the SEC specifically informed him that he was testifying in connection with the SEC investigation into ZPRIM. This shows Mr. Bauchle had direct, personal knowledge of the SEC investigation yet failed to disclose it in the 2011 report. He thus “engaged in the dissemination of a known falsehood.” Carriba Air, 681 F.2d at 1324 (quotation 25 Case: 16-15322 Date Filed: 06/30/2017 Page: 26 of 32 omitted). Also, Mr. Bauchle testified that the reason he “didn’t go back and change the [pending investigation] box” on the Morningstar form was “[b]ecause whenever we would get a new letter from the SEC, we would have a meeting and it was downplayed as [] being anything significant and so that box wasn’t changed.” The fact that Mr. Bauchle made a deliberate decision not to disclose the SEC investigation because the firm “downplayed” its significance supports a finding of an “intent to deceive” investors. Matrixx, 563 U.S. at 48, 131 S. Ct. at 1323. Thus, there is substantial evidence to sustain the finding of scienter regarding the 2011 Morningstar report. E. SANCTIONS The Commission imposed sanctions against both Mr. Zavanelli and ZPRIM. First, the Commission imposed an industry bar against Mr. Zavanelli. Second, the Commission ordered both petitioners to cease and desist their misconduct. Third, the Commission imposed civil penalties. Petitioners challenge each of these sanctions. For the reasons that follow, we affirm the Commission’s sanctions except those imposed for the violations related to the December 2009 newsletter. 1. The Industry Bar Against Mr. Zavanelli Under the Advisers Act, the Commission may impose an industry bar on an adviser if the Commission finds: (1) that the bar “is in the public interest,” and (2) that the adviser “willfully violated” or “willfully aided, abetted, counseled, 26 Case: 16-15322 Date Filed: 06/30/2017 Page: 27 of 32 commanded, induced, or procured the violation” of federal securities law. 15 U.S.C. §§ 80b-3(e)(5), (6) & (f). To determine whether a bar is in the public interest, the Commission considers the following: [T]he egregiousness of the defendant’s actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant’s assurances against future violations, the defendant’s recognition of the wrongful nature of his conduct, and the likelihood that the defendant’s occupation will present opportunities for future violations. Steadman I, 603 F.2d at 1140 (quotation omitted). As for the willfulness prong, a violation is “willful” if the adviser “intentionally commit[ed] the act which constitutes the violation.” Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000) (quotation omitted). The adviser need not “also be aware that he is violating one of the Rules or Acts.” Id. (quotation omitted). The Commission did not commit a “gross abuse of discretion” in imposing the industry bar on Mr. Zavanelli. Orkin, 31 F.3d at 1066. In assessing the “public interest” prong, the Commission analyzed the Steadman factors and found that each factor showed the bar would be in the public interest. In particular, the Commission found Mr. Zavanelli “acted with a high degree of scienter” because “[d]espite his knowledge and familiarity with GIPS, [he] flouted the requirements of the GIPS Advertising Guidelines”; his “conduct was recurrent,” continuing after “ZPRIM promised the previous year to take corrective action”; he “does not genuinely recognize the wrongfulness of his conduct”; and his “assurances against 27 Case: 16-15322 Date Filed: 06/30/2017 Page: 28 of 32 future misconduct” were not convincing because he “continues to provide investment advisory services.” The Commission then made the required finding of willfulness. The Commission found the “willfulness standard is satisfied because Zavanelli intentionally authored or approved the advertisements and investment reports containing the misrepresentations at issue.” Each of these findings is supported by the record. Thus, the Commission did not grossly abuse its discretion when it imposed the industry bar. Id. 2. Cease and Desist Order Under the Advisers Act, the Commission may issue a cease and desist order against any person it found to have violated the Act. See 15 U.S.C. § 80b-3(k)(1). Because the Commission found petitioners violated the antifraud provisions, the Commission was entitled to issue the cease and desist order against them. Id. The Commission also explained that a “cease-and-desist order will play a substantial remedial role with respect to ZPRIM considering that we have not revoked its registration as an investment adviser.” In light of these findings, it was not a “gross abuse of discretion” to issue the order. Orkin, 31 F.3d at 1066.
The standard for imposing monetary penalties is the same as for industry bars. See 15 U.S.C. § 80b-3(i)(1)(A). However, the factors for determining whether it would be “in the public interest,” id., are different from the Steadman 28 Case: 16-15322 Date Filed: 06/30/2017 Page: 29 of 32 factors. The Advisers Act lists the following factors for making the public interest determination: (A) whether the act or omission for which such penalty is assessed involved fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement; (B) the harm to other persons resulting either directly or indirectly from such act or omission; (C) the extent to which any person was unjustly enriched, taking into account any restitution made to persons injured by such behavior; (D) whether such person previously has been found by the Commission, another appropriate regulatory agency, or a selfregulatory organization to have violated the Federal securities laws, State securities laws, or the rules of a self-regulatory organization . . .; (E) the need to deter such person and other persons from committing such acts or omissions; and (F) such other matters as justice may require. Id. § 80b-3(i)(3). The Act also establishes a three-tier system of civil penalties, with each tier addressing increasingly serious misconduct and imposing progressively higher maximum penalties. Id. § 80b-3(i)(2). If the Commission applies the public interest factors listed in the Act and determines that some monetary penalty is warranted, the Commission must then decide which tier is appropriate. In this case, the Commission imposed second-tier penalties, which apply when the wrongdoing involves fraud or deceit. Id. § 80b-3(i)(2)(B). Specifically, the Commission imposed a maximum second-tier penalty on Mr. Zavanelli for each of 29 Case: 16-15322 Date Filed: 06/30/2017 Page: 30 of 32 his eight violations, totaling $570,000, and a single below-maximum second-tier penalty of $250,000 on ZPRIM. 8 Petitioners have not shown these penalties were a “gross abuse of discretion.” Orkin, 31 F.3d at 1066. In deciding whether to impose the monetary penalties, the Commission discussed each of the public interest factors. The Commission found, among other things, that the petitioners “repeatedly violated the antifraud provisions with scienter”; the misconduct was “especially serious because it involved attempts to promote their firm through false claims”; and “[t]here is a need to deter [petitioners] from committing future” violations. These findings are supported by the record, and the Commission appropriately gave them significant weight. Also, while acknowledging that the SEC did not offer evidence to quantify the harm caused by the petitioners’ misrepresentations, the Commission found the market was harmed insofar as the misrepresentations “denied investors the ability to make direct comparisons between ZPRIM’s performance and that of other investment advisers.” On this record, we cannot say the Commission grossly abused its discretion in its choice of monetary penalties. See id. Although we generally affirm the Commission’s imposition of monetary penalties, the amount of the penalties imposed here must be reduced by any 8 The maximum penalty for corporations is considerably higher than for “natural person[s].” 15 U.S.C. § 80b-3(i)(2)(B). 30 Case: 16-15322 Date Filed: 06/30/2017 Page: 31 of 32 amounts related to the December 2009 newsletter violations, which we vacate. Because the Commission’s order makes clear it assessed a $75,000 penalty on Mr. Zavanelli for the December 2009 newsletter, we vacate that portion of his monetary sanction. For ZPRIM, however, the Commission did not impose penalties for each violation, but instead a single $250,000 penalty. As a result, we vacate the ZPRIM penalty and remand for the Commission to determine the amount, if any, by which that penalty should be reduced.