Geman v. S.E.C., No. 01-9512.

• Citation: 334 F.3d 1183
• Decision Date: 07 July 2003
• Docket Number: No. 01-9512.
• Parties: Marc N. GEMAN, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1183

334 F.3d 1183

Marc N. GEMAN, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 01-9512.

United States Court of Appeals, Tenth Circuit.

July 7, 2003.

COPYRIGHT MATERIAL OMITTED

Donald T. Trinen, Esq., Hart & Trinen, LLP of Denver, Colorado, Attorneys for Petitioner.

Leslie E. Smith, Senior Litigation Counsel (Meyer Eisenberg, Deputy General Counsel, Jacob H. Stillman, Solicitor, and Kermit B. Kennedy, Special Counsel, with her on the brief), Securities and Exchange Commission, Washington, D.C., Attorneys for Respondent.

Before BRISCOE, HOLLOWAY and MURPHY, Circuit Judges.

On Petition For Review Of A Final Decision Of Teh Securities And Exchange Commission (No. 3-9032)

HOLLOWAY, Circuit Judge.

I

A. Overview and Basis for Jurisdiction

Mr. Marc Geman brings a petition for review of a disciplinary order issued by the SEC. Mr. Geman was a registered broker-dealer and investment adviser; he was also the chief executive officer of a firm called Portfolio Management Consultants, Inc. (the firm). In proceedings before an administrative law judge (ALJ), Geman was found to have violated several provisions of the securities laws, as described infra. In an opinion reviewing the ALJ's disposition (the SEC Opinion), the SEC affirmed all of the findings of violations but reduced the sanctions imposed.¹ Geman was barred from association with any securities or investment firm, but was permitted to apply for relief from that ban after three years, and Geman was fined $200,000. (The ALJ had imposed a lifetime ban and a fine of $500,000.) Separate proceedings against the firm and its president, based on the same events, had previously been settled.

Geman filed a timely petition for review. This court therefore has appellate jurisdiction under section 9 of the Securities Act of 1933, 15 U.S.C. § 77i; section 25(a)(1) of the Securities Exchange Act of 1934, 15 U.S.C. § 78y(a)(1); and section 213 of the Investment Advisers Act of 1940, 15 U.S.C. § 80b-13.

B. Background

Petitioner was chairman and CEO of the firm during the relevant time, October 1992 through April 1994.² The ALJ found that "Geman was responsible for operations of the broker-dealer part of the business, encompassing administrative and financial functions as well as compliance and trading." ALJ Decision at 3. The firm's primary business during that time was sponsoring a comprehensive "individualized managed account" service, which in the industry is called a "wrap fee" program. Under the wrap fee program, the firm's customers paid an "all-inclusive" fee calculated as a percentage of the customer's assets under management. In return, the firm provided brokerage, advisory, and custodial services.

The firm assisted its customers in creation of a written investment policy, in the allocation of assets, and in the selection of portfolio managers, but did not recommend specific securities. Decisions such as the selection of securities to buy or sell were made by the customers with the aid of portfolio managers who contracted with, but were independent of the firm. The portfolio managers had complete discretion in advising the firm's customers about their accounts. Trades were executed through the firm.³ The firm also monitored the performance of the accounts and distributed quarterly performance reviews. The firm had about 800 customers in the wrap fee program, with over $200 million in assets under management.

In its promotional literature, the firm represented that it would strive to ensure "best net price" and "best execution" for each transaction. Doc. 74 at 4. "The duty of best execution ... requires that a broker-dealer seek to obtain for its customer orders the most favorable terms reasonably available under the circumstances." Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 270 (3d Cir.1998) (en banc).⁴ Significantly, the firm specifically represented that it was undertaking fiduciary responsibilities to its customers, as in a promotional brochure which said: "[A]s an independent fiduciary, PMC is dedicated to providing the independent advisory and administrative services necessary to support you in meeting your unique and specialized goals and objectives." Doc. 74 at 3.

The enforcement proceeding grew out of a change in practice instituted by the firm after a period of heavy losses. Before October 1992 the firm had acted only on an agency basis; that is, it executed trades on behalf of its customers with third parties. But in October 1992, Geman directed the firm's traders to identify transactions in which the firm could profit by becoming a principal. Thus, for example, when a customer placed an order to sell a certain stock, the firm might buy the stock from the customer, rather than merely acting as an intermediary by arranging a sale to a third party. In this example, the firm would then "cover" by selling the stock it had just purchased from its customer. In each instance of principal trading, whether the customer's order was to buy or to sell, the firm would cover by completing an offsetting trade. The covering trades were always for the same number of shares of the same stock and were executed very promptly, always on the same day as the transaction with the customer of the firm.

The firm's traders were directed to evaluate each order to determine whether it was in the firm's interest to execute the trade as a principal or as an agent. The customer's price was always the "NBBO," the national best bid and offer price based on price quotations.⁵ If the traders thought it likely that the firm could execute a covering trade at a more favorable price by the end of the trading day, the firm would execute as principal. Over a period of about 18 months, the firm executed over 8,000 trades as principal and generated net profits of over $460,000, with two-thirds of its covering trades being profitable to the firm and one-third unprofitable.⁶

The firm obtained the customers' consent to a modification of the customer agreement to allow it to trade in the capacity of a principal by sending the customers a letter, approved by Geman, which included the language to be added to the agreement. The only explanation offered in the letter was that this and other changes to the customer agreement were the result of "new regulatory interpretations and technological improvement to [the firm's] system capabilities." Doc. 140. The letter went on to say that the modifications of the customer agreement were necessary to allow the firm "to fully utilize these automated systems." Id. There was no evidence that any technological improvements or new regulatory interpretations actually were related to the decision to engage in trading as a principal. There was no disclosure of the firm's intent to make profits from these transactions as principal. The letter said that there would be no changes to the fees charged.

Prior to March 1993, the firm reported the trades in which it participated as a principal through the Automated Confirmation Transaction service, a trade reporting service operated by the National Association of Securities Dealers (NASD). These reports included the time of each transaction. In 1992, the NASD informed the firm that these principal trades with customers could not be reported through its service because the trades were "riskless." Although Geman disagreed with the NASD's characterization of the trades as riskless (as he does in this appeal), he agreed to stop reporting the trades as the firm had been doing. From March 1993 to December 1993, no alternative procedure was implemented for recording the details of the firm's trades in the capacity of principal. Although the trades were not being reported, the firm continued to send its customers confirmation statements which included the following language: "your price is reported price difference is zero."⁷

C. The SEC's Opinion

The Commission, on review of the order of the Administrative Law Judge, noted that the firm had held itself out as a fiduciary. The Commission held that the firm's conduct was fraudulent because, contrary to the fiduciary's duty of full disclosure, the firm's disclosures regarding the change to principal trading were made "in a highly misleading manner." The purported reasons for the decision, changes in regulations and in technology, were not actually factors in the decision at all. The firm failed to disclose that the primary motivation was to earn profits and misleadingly represented that its fees would not be affected.

Another result of the firm engaging in trades as a principal, the SEC found, was that the customers were deprived of the opportunity to take advantage of "price improvement services" offered at the time by two of the wholesale dealers that the firm used in executing its trades. These price improvement services guaranteed that the customer's market order would be executed at the NBBO and offered the possibility of execution at better prices. The wholesale dealers were able to get these better prices for a small but significant portion of trades, somewhat less than ten percent. When the firm acted as principal in a trade with its customer, the customer had no possibility of benefitting from the price improvement service.

The SEC found that the "your price is reported price difference is zero" language in the firm's confirmation statements was deceptive in that it suggested that there was no difference between the customer's price and the price the firm obtained for itself in its covering trade, when in fact in most cases there was a difference. The SEC also held that the confirmations violated Exchange Act Rule 10b-10(a)(8)(i)(A), 17 C.F.R. § 240.10b-10(a)(8)(i)(A), a regulation requiring a dealer that is not a market maker, when trading for its own account, i.e., as a principal, to disclose in writing any "markup, markdown or similar remuneration it receives." SEC Opinion at 20. Finally, the SEC found that...