Atlanta-One, Inc. v. S.E.C., ATLANTA-ON

• Decision Date: 12 November 1996
• Docket Number: ATLANTA-ON,No. 95-70360,INC,95-70360
• Citation: 100 F.3d 105
• Parties: , 96 Cal. Daily Op. Serv. 8187, 96 Daily Journal D.A.R. 13,620 ; Kevin M. McCarthy; Thom Blodgett, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 105

100 F.3d 105

65 USLW 2349, 96 Cal. Daily Op. Serv. 8187,

96 Daily Journal D.A.R. 13,620

ATLANTA-ONE, INC.; Kevin M. McCarthy; Thom Blodgett, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 95-70360.

United States Court of Appeals, Ninth Circuit.

Argued and Submitted June 6, 1996.

Memorandum Aug. 1, 1996.

Decided Nov. 12, 1996.

Thom Blodgett, Irvine, CA, for petitioners.

Allan A. Capute, Special Counsel to the Solicitor, Securities and Exchange Commission, Washington, DC, for respondent.

Petition to Review a Decision of the Securities and Exchange Commission. SEC No. 3-7688.

Before: WIGGINS, THOMPSON, and TROTT, Circuit Judges.

ORDER

The Memorandum disposition filed August 1, 1996, is redesignated as an authored Opinion by Stephen S. Trott, Circuit Judge.

OPINION

TROTT, Circuit Judge:

OVERVIEW

This is a petition for review of a Securities and Exchange Commission Decision holding that Petitioners Atlanta-One, Kevin McCarthy, and Thom Blodgett violated rules of fair practice by charging customers unfair commissions. Petitioners argue: 1) there is not substantial evidence to support the SEC's finding that Atlanta-One charged excessive commissions; 2) that they were denied due process; 3) that the National Association of Securities Dealers (NASD) and the SEC are attempting to "fix" the maximum rate of commission charged by a broker; and 4) that the SEC abused its discretion in affirming the sanctions against Petitioners. We deny the petition.

STANDARD OF REVIEW

The findings of the SEC as to the facts are conclusive if supported by substantial evidence. 15 U.S.C. § 78y(a)(4). If the evidence is susceptible to more than one rational interpretation, this court must uphold the SEC's findings. Eichler v. Securities Exch. Comm'n, 757 F.2d 1066, 1069 (9th Cir.1985). Sanctions imposed by the SEC are reviewed for an abuse of discretion. Sirianni v. U.S. Securities & Exch. Comm'n, 677 F.2d 1284, 1288 (9th Cir.1982).

DISCUSSION

I SEC's Finding of Excessive Commissions

Section 1 of Article III of the NASD Manual requires NASD members to "observe high standards of commercial honor and just and equitable principles of trade." NASD Manual p 2151. Section 4 of Article III of the manual states that a member:

[S]hall not charge his customer more than a fair commission or service charge, taking into consideration all relevant circumstances including market conditions with respect to such security at the time of the transaction, the expense of executing the order and the value of any service he may have rendered by reason of his experience in and knowledge of such security and the market therefor.

NASD Manual p 2154. ¹

In March 1995, following a de novo review of the record from the NASD's District Business Conduct Committee (DBCC) and the National Business Conduct Committee (NBCC), the SEC held that Atlanta-One's commissions were excessive. The following evidence supports this conclusion. In 252 of the 353 trades between April and November of 1990, or 71% of the trades, the commissions amounted to at least 40% of the customer's initial investment. Commissions exceeded 70% of the initial investment in several instances and ranged as high as 89%. Consequently, customers who were able to sell their options at a gain often lost money once commissions were taken into account. There were 141 transactions that showed a pre-commission profit, but after commissions were deducted those profits were wiped out in 40% of the cases. Customers realized an after-commission profit in only 84, or 24%, of the 353 transactions.

No reasonable broker could think it could fairly charge commissions so high as to make it almost impossible for the client to make money. The customer's objective in investing is to generate a profit, and a broker is expected to promote that objective. As summarized by the SEC:

Implicit in the concept of fair pricing of commissions is the notion that the commissions must not be so excessive as to make it unlikely that the customer's investment could appreciate sufficiently to compensate the customer for the commission and generate a profit.

SEC Decision at 5-6.

Petitioners argue that they provided unique and special services and incurred high expenses, which justified higher commissions. However, the evidence shows otherwise. The firm did not engage in its own research. Atlanta-One's staff did not generally meet with clients in person. The firm had little or no litigation expenditures or reserves. It did not incur advertising expenses except for the purpose of hiring its own employees. In sum, the firm simply incurred ordinary operating costs such as phone bills and employee salaries.

Atlanta-One contends that, as a small firm, it needed to charge higher commissions in order to stay afloat. However, the SEC rejected this argument, stating that if the sales of the highly speculative securities were too low to support the operating costs of the firm, the firm needed to make changes (i.e. lower salaries or diversify its product base) to generate a more efficient return. It could not try to cover its expenses by charging excessive commissions. As noted by the SEC, "the fairness to be considered is fairness to the customer, not the broker-dealer." As noted by the National Business Conduct Committee (NBCC) in its review of this case:

[E]ven if the respondents had demonstrated the existence of extraordinary costs, it is our view that respondents were not free to pass along those costs to the customers. Instead, if respondents' costs were so high that they could only be recouped through commissions that would all but eliminate customers' opportunity to make a profit on foreign currency options, respondents' only choice was to refrain from offering foreign currency options to the public.

NBCC Decision at 8.

Finally, Petitioners argue that because the commissions were disclosed they were allowable. However, Petitioners' disclosure of the commission rate is only one factor considered in determining the fairness of the commission, and it does not suspend the rule that the commission charged must not be excessive. See NASD Manual p 2154 (commenting that "disclosure itself" does not justify commission which is excessive "in light of all other relevant circumstances"); DBCC for District No. 2S v. Cornwall, Abbott & Gray, Inc., 1989 NASD Discip. LEXIS 71 (October 18, 1989) (finding that although commissions were disclosed, they were excessive and violated the Rules of Fair Practice). Often the investors who rely on a broker such as Atlanta-One lack the sophistication to understand the precise impact of the commission rate and its fairness, making the commissions' disclosure somewhat meaningless. This case does not present a "close call" of commissions that were slightly in excess of a fair rate. Instead, Atlanta-One charged commissions at a rate far exceeding a level that could be considered fair.

Thus, the evidence shows that Atlanta-One did not render special services, and it did not incur extraordinary expenses. Instead, the evidence indicates that Atlanta-One was charging exorbitant rates and taking advantage of unsophisticated investors. Thus, we conclude that substantial evidence supports the SEC's finding that Atlanta-One charged excessive commissions.

II Due Process Violations

Petitioners raise several arguments that their due process rights were violated. They argue: 1) that Atlanta-One did not have notice of what commission would be fair and that the NASD Manual is too vague to provide guidance; 2) that the NASD did not allow them to produce the testimony of their expert witness; and 3) that the NASD improperly shifted the burden of proof to Atlanta-One.

A. Lack of Notice and Guidance about Fair Commissions

Petitioners primary due process contention is that they did not have notice that the commissions they were charging were excessive. The SEC refutes this argument, finding that guidance as to what constitutes an unfair commission was available from the NASD's Rules of Fair Practice, from the NASD's mark-up policy, and from cases involving excessive trading and other violations where the investor's interests are subordinated to the interests of the broker or dealer.

In its decision below, the SEC stated:

Although the authorities available to Applicants at the time of the transactions at issue were not clear as to the direct applicability of the 5 percent guideline, the existence of the policy should have put Applicants on notice that commissions that were [in] significant multiples of that number might be considered unfair....

Even the most general proscriptions against gouging customers that may be gleaned from either mark-up or excessive trading cases placed Applicants on notice that grossly excessive commissions would not be tolerated consistent with just and equitable principles of trade.

SEC Decision at 6-7.

The 5% mark-up policy refers to principal transactions where a dealer is selling stock he owns to his customer. The NASD promulgated the 5% policy to provide a guideline as to what a fair spread or profit would be when the dealer marks-up the wholesale price of the stock. At the time of the transactions at issue here,...