Shultz v. S.E.C., 78-2346
| Decision Date | 07 January 1980 |
| Docket Number | No. 78-2346,78-2346 |
| Parties | Fed. Sec. L. Rep. P 97,234 Howard J. SHULTZ, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent. |
| Court | U.S. Court of Appeals — Seventh Circuit |
Jeffrey R. Liebman, Chicago, Ill., for petitioner.
Elisse B. Walter, Securities and Exchange Commission, Washington, D. C., for respondent.
Before SWYGERT and WOOD, Circuit Judges, and CAMPBELL, Senior District Judge. *
This appeal arises from a final order of the Securities and Exchange Commission ("the Commission") affirming the disciplinary action taken by the Chicago Board Options Exchange, Inc. ("Exchange") against petitioner, Howard J. Shultz. The issues presented are:
1. Should the Commission's decision be reversed because of bias or the appearance of unfairness in the hearing granted petitioner by the Exchange?
2. Was there sufficient evidence to support the findings of the Commission?
3. Is Exchange Rule 8.7(a) unconstitutionally vague, and can Rules 4.1 and 8.7(a) be violated without the violation of another rule?
The Commission made an independent determination that petitioner had violated the Exchange rules. We find there was ample evidence to support its findings. Given the delicately-balanced position of a professional market maker, trading for his own account on the Exchange, we hold that Rule 8.7(a) is not unconstitutionally vague and that Rules 8.7(a) and 4.1 do not require the violation of another rule. Accordingly, the Commission's order is affirmed.
On July 19, 1976, the Business Conduct Committee of the Exchange initiated disciplinary proceedings against Howard Shultz, a registered market maker, and three other Exchange market makers. A market maker is a member of the Exchange who buys and sells options for his own account, in contrast to a broker member of the Exchange who acts as an agent for public investors by executing option trades on their behalf. The function of the market maker is to aid in maintaining a stable market by engaging in options transactions during temporary gaps in public supply and demand for options. 1
Shultz and the three other market makers were charged with violating Exchange Rule 4.1, requiring market makers to refrain from conduct inconsistent with just and equitable principles of trade; Exchange Rule 8.7(a), requiring market makers to engage in dealings reasonably calculated to contribute to the maintenance of a fair and orderly market and forbidding transactions that are inconsistent with that purpose; and Exchange Rule 4.2, prohibiting conduct in violation of another rule. 2
These charges were based on a series of circular transactions engaged in by petitioner and the other market makers on three separate days, transactions which left each in exactly the same position he had been in prior to the trades. 3 Each market maker purchased from and sold to another of the market makers a single Eastman Kodak "July 90" call option contract at the same price within an interval of one to two minutes. On each of the three occasions, the price at which the transactions were consummated was lower by $7/8 or $1 than the previous sale price for the option series. On each occasion the price of the security underlying the option varied by $1/2 or less on the New York Stock Exchange, its primary market. 4 In each instance the circular trade was followed by an offer to sell which further lowered the price of the option. Because no one purchased at the lower price, that offer to sell became the "final" offer at which the options market closed.
Petitioner Shultz and at least one of the other market makers who participated in the circular trades were "short" with respect to the option series. 5
Having found probable cause that a violation of the Exchange's rules had occurred, the Business Conduct Committee of the Exchange ordered disciplinary proceedings against the four market makers engaged in the circular trades. Shultz requested an evidentiary hearing. The remaining three market makers submitted offers of settlement which were accepted by the Business Conduct Committee, in which the allegations were neither admitted nor denied.
Six days prior to the hearing scheduled before the Committee, Shultz requested dismissal of the Exchange proceedings. In a letter to the Committee, Shultz' counsel stated that the proceedings had the appearance of unfairness and lacked due process because the Committee had accepted a settlement from John Moffat, one of the market maker respondents, which was conditioned on Moffat receiving no greater sanction or fine than that imposed upon "any of the other respondents" in this proceeding. Petitioner's request for dismissal was grounded on the assertion that the settlement provision required the Committee to impose upon Shultz a sanction and fine at least as great as Moffat's or, if it were to find no rule violations on the part of Shultz, having to reduce or eliminate the sanction already imposed on Moffat and announced to the media. Moffat had already served his suspension and paid his fine.
On receipt of the letter, Bruce Simpson, a member of the Committee, contacted prosecutor James Moylan and instructed Moylan that he or the Committee counsel were to poll the other members of the Committee in regard to Shultz' motion. Moylan subsequently advised Simpson that the majority opinion of the Committee was to deny petitioner's motion, and Moylan alone drafted the Committee's response, which was signed by the Committee counsel. The response stated that the offers of settlement would in no way influence the conduct of the Committee toward Shultz and that the Moffat settlement clause referred only to other respondents submitting settlement offers, not to a respondent who chose to have the Committee hear the charges against him.
On December 7, 1976, a hearing was held before the Business Conduct Committee, at which Shultz was represented by counsel. At the outset of the hearing Shultz renewed his dismissal request, stating that there was prejudgment and alleging that the drafting of the Committee's response to his initial dismissal request by prosecutor Moylan constituted impermissible commingling of the prosecutorial and adjudicatory functions.
Moylan stated that he had negotiated the settlement of the charges against Moffat, and that though the settlement provision upon which Shultz based his dismissal request stated that Moffat would not be penalized more severely than any other respondent, the provision pertained solely to the respondents who submitted settlement offers. Moylan stated further that he had drafted the letter denying Shultz' request for dismissal at the direction of the Committee after the decision had been made. The Committee decided to proceed with the hearing, reiterating that a decision was to be made based solely on what was presented at the hearing.
The Exchange's Director of Investigations presented documentary evidence establishing Shultz' participation in the circular trades. Shultz testified that he had been a professional in various phases of the securities industry for eleven years and that as a market maker, he considered himself a scalper. 6 He admitted engaging in the transactions at issue, but he stated that the pattern of circular transactions purchase and sale of an option contract within the space of one or two minutes was consistent with his trading patterns which frequently included "scratched trades." 7 Because of his daily volume of trades, petitioner stated he had no independent recall of the trades in question. He testified that none of the other market makers engaged in these transactions were his personal friends and that he had no acquaintance with them off the floor of the Exchange. He denied either soliciting or being solicited concerning these transactions. Petitioner also stated that because of the profitable nature of his business, he had no pressing need for money at the time of these transactions. When asked by various members of the Business Conduct Committee for an explanation of his reasons for entering into both a transaction to sell and a transaction to buy at the same price ($7/8 to $1 lower than the previous sale price for the option series) and then choosing not to buy again at the subsequent lower offer made immediately after these transactions, Shultz offered no explanation.
Bernard Carey, a board broker assigned to Polaroid options, Chairman of the Floor Officials Committee, and a member of the Board of Directors of the Exchange, testified as a witness for Shultz. He said that he had never seen the "triple reverse" pattern presented by the trades in question nor had he seen a scratch trade between market makers during closing rotation. Carey indicated that, if he had seen a triple reverse in Polaroid followed by a lower offer that was allowed to stand, he would have reported the transaction. 8 Gerald Wood, a floor broker in Eastman Kodak options and a member of several committees including the Floor Officials Committee, was also a witness for Shultz and stated that a series of transactions such as the ones in question would be an abnormal occurrence which he had never seen. Wood testified that, had he been aware of the pattern of the transactions when they occurred, he would have tried to stop them. Scott Schwab, a market maker in Polaroid options, testified that he frequently scratched trades, but had never seen a series of transactions like those in question.
In its decision the Business Conduct Committee found that Shultz had entered into the transactions alleged, and that the trades were not legitimate scratch trades or trades where prevailing market conditions could justify reversal of one's position. According to the Committee, trades involving only one lot, at or near the close of trading where a second trade was made with the same individual within a short time period, would have the appearance of...
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