Vernazza v. S.E.C., 01-71857.
| Decision Date | 24 April 2003 |
| Docket Number | No. 01-71857.,No. 02-70016.,01-71857.,02-70016. |
| Citation | 327 F.3d 851 |
| Parties | Jerome B. VERNAZZA, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent. IMS/CPAS & Associates; Vernon T. Hall; Stanley E. Hargrave, Petitioners, v. Securities and Exchange Commission, Respondent. |
| Court | U.S. Court of Appeals — Ninth Circuit |
Sheldon M. Jaffe, Los Angeles, CA, for petitioner Jerome B. Vernazza.
Thomas D. Giachetti, Princeton, NJ, and Ashleigh C. Swayze, Stark & Stark, PC, Lawrenceville, NJ, for petitioners IMS/ CPAs & Associates, Vernon T. Hall, and Stanley E. Hargrave.
Eric Summergrad, Deputy Solicitor, and Mark Pennington, Assistant General Counsel Securities and Exchange Commission, Washington, DC, for the respondent.
On Petition for Review of an Order of the Securities & Exchange Commission. SEC No. 3-9042.
Before D.W. NELSON, WARDLAW and FISHER, Circuit Judges.
Petitioners Jerome B. Vernazza, Vernon T. Hall, Stanley E. Hargrave, and IMS/ CPAs & Associates ("IMS") seek review of an order of the Securities and Exchange Commission ("Commission") imposing sanctions for violations of several antifraud provisions of the securities laws. The Commission determined that the petitioners, who are investment advisers or persons associated with advisers, knowingly or recklessly made materially false statements and omissions to their clients and in their papers filed with the Commission. The Commission found that the petitioners falsely represented that they received no referral fees and had no financial interest in any of the recommendations they made to their clients. Because the Commission's findings are supported by substantial evidence, we deny the petition for review.
The facts are largely undisputed. Vernazza, Hall, and Hargrave are partners in IMS, a firm registered with the Commission as an investment adviser. Vernazza also was registered as an adviser, but withdrew his registration in 1997. Vernazza, Hall, and Hargrave also owned the accounting firm Hall & Vernazza, CPAs ("H&V"), which for all practical purposes was the same business as IMS.
World Money Managers ("World") — also a registered investment adviser — had operated as the adviser to the Tax Planning Federal Cash Fund ("Tax Fund"), to which H&V operated as the subadviser. In June 1992, World and H&V closed the Tax Fund due to unprofitability. Ordinarily, the closing costs for an investment fund are paid by the fund itself; in this case, H&V paid the $60,000 closing costs and obtained a loan from World to do so.1 The promissory note for the loan provided that H&V would repay the loan at a rate of $2,000 per month, with the full amount due by July 1, 1995.
The day after the loan was made, World and H&V entered into a Shareholder Servicing Agreement ("SSA"), the terms of which are central to this case. The SSA provided that World would pay H&V for services related to World's Permanent Portfolio Family ("PPF") of Funds, such as marketing the funds and providing tax advice to investors. A schedule to the SSA stated that compensation would be based on "time, effort, and complexity of services at an annual rate not to exceed" a series of percentages of "Additional Assets." "Additional Assets" was defined as the value of the investments in PPF funds made by clients of H&V or IMS. The percentage "caps" ranged from 0.25% to 0.6% of the Additional Assets, depending on which of the three PPF funds the client invested in, whether the client had been previously invested in the Tax Fund, and when the investment was made. The highest percentages were applied to investments made by former Tax Fund clients before June 30, 1995 — the day before the loan was due to be repaid. The SSA did not indicate any other basis, such as an hourly rate of pay, for determining H&V's compensation. The SSA also contained a minimum investment requirement whereby H&V would not be paid at all until its and IMS's clients had purchased at least $1,000,000 in PPF funds.
H&V's actual compensation from World was always the maximum amount payable under the SSA caps. Petitioners never sent World an accounting of hours worked, services performed, or hourly rates. The only accounting in the record is a list of the investments made by H&V and IMS clients, with the "Servicing Fee" determined by the percentages in the SSA.
According to Vernazza, the reason that H&V's compensation was determined by the caps is that H&V had performed services entitling it to more money than it could recover under the caps. As of the first bill sent to World, H&V had performed services entitling it to about $60,000, but because this amount was greater than the caps, it was paid only according to the caps and the extra amount was rolled over to the next period. This happened throughout the life of the agreement; Vernazza testified that H&V performed services worth a total of about $131,000, but that H&V's compensation was limited by the caps because the value of the services performed exceeded the amount payable under the caps. Vernazza stated that he billed the work at either $100 per hour or $250 per hour; he also stated that H&V had discussed a range of $150-200 per hour with World but had never agreed on a specific hourly figure.
The payments made by H&V to World on the $60,000 loan closely tracked the payments made by World on the SSA. H&V missed the first payment on the loan, a $12,000 payment due in January 1993. The payment finally was made on April 12, 1993, the day after H&V received its first SSA payment from World in the amount of $13,060. By September 5, 1993, World had paid H&V $24,431 under the SSA; H&V had in turn paid World $24,000 under the promissory note for the loan. H&V continued to be paid under the SSA until 1996.
During this period, petitioners made representations, in engagement letters to their clients, that they had no financial interest in and did not receive commissions for recommending PPF funds. Multiple engagement letters from IMS to its clients, for example, stated that "IMS warrants that they have not and will not receive any commission or any payment from, nor do they have any financial interest in, any recommendation made."
Vernazza and IMS also made similar representations in filings with the Commission; as investment advisers, Vernazza and IMS were required to file a "Form ADV" with the Commission and to update it annually. See 17 C.F.R. § 275.204-1(a). The form includes questions about potential conflicts of interest; if any apply to the adviser, they must be explained on Schedule F of the form. Part I, Question 21 asks whether the adviser "recommend[ed] securities to clients during its last fiscal year in which the [adviser] ... had any ownership or sales interest." Part II, Question 8(C)(3) asks whether the adviser "has arrangements that are material to its advisory business or its clients with a related person who is ... [an]other investment adviser." Part II, Question 9(D) asks whether the adviser "[r]ecommends to clients that they buy or sell securities... in which the [adviser] or a related person has some financial interest." Finally, Part II, Question 13(A) asks whether the adviser, or a related person, "receives some economic benefit ... from a non-client in connection with giving advice to clients."
IMS and Vernazza originally answered all of the above questions in the negative. In 1992, Vernazza changed his answer to Part II, Question 8(C)(3), stating that, under the SSA, H&V was paid by World for advisory and administrative support services according to "time, effort and complexity of services." IMS did the same, and also mentioned that H&V's compensation was capped at 0.5%-0.6% of the investment in each fund, although it did not mention that these percentages applied only to investments made by H&V/IMS clients. In 1993, IMS also amended the form to answer "yes" to Part II, Question 9(D), and gave a similar explanation of the SSA, including the same description of the caps. Neither Vernazza nor IMS made any other material amendments to the Forms ADV.
As advisers, Vernazza and IMS also were required to furnish clients with disclosure statements comprising the same information as Part II of the Form ADV. See 17 C.F.R. § 275.204-3. The disclosure statements for Vernazza, Hall, and Hargrave during 1993-94 all stated that they received no fees or commissions from anyone selling the investments they recommended. They explained that, under the SSA, H&V received compensation from World for advisory and administrative support services, but did not mention the caps.
On July 11, 1996, the Commission's Division of Enforcement initiated proceedings against the petitioners, alleging fraud in violation of both the Securities Act of 1933, 15 U.S.C. §§ 77a-77aa ("Securities Act"), and the Securities Exchange Act of 1934, 15 U.S.C. §§ 78a-78mm ("Exchange Act"), and several violations of the Investment Advisers Act of 1940, 15 U.S.C. §§ 80b-1 to 80b-21 ("Advisers Act"). After a hearing, an administrative law judge ("ALJ") found that the petitioners had committed the violations and issued a cease-and-desist order, suspended Vernazza's and IMS's registrations as advisers, prohibited Vernazza, Hall, and Hargrave from associating with any adviser for six months, and ordered disgorgement of the payments received under the SSA.2
The ALJ's order was reviewed de novo by the Commission, and it was, in large part, affirmed. The Commission found fraud in violation of several statutes and regulations, and false statements to the Commission in violation of Advisers Act § 207, 15 U.S.C. § 80b-7. The essential basis of all of these violations was that the petitioners had made materially false statements when they represented that they had no financial interest in, nor received any economic benefit from, the investment...
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