Gebhart v. S.E.C.

• Decision Date: 17 February 2010
• Docket Number: No. 08-74943.,08-74943.
• Parties: Alvin W. GEBHART, Jr.; Donna T. Gebhart, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

595 F.3d 1034

Alvin W. GEBHART, Jr.; Donna T. Gebhart, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 08-74943.

United States Court of Appeals, Ninth Circuit.

Submitted December 1, 2009.^*

Filed February 17, 2010.

Charles F. Goria, Goria, Weber & Jarvis, San Diego, CA, for the petitioners.

David M. Becker, Mark D. Cahn, Jacob H. Stillman, Randall W. Quinn, William K. Shirey, Securities and Exchange Commission, Washington, DC, for the respondent.

On Petition for Review of an Order of the Securities & Exchange Commission. SEC No. CRD1005905.

Before: HARRY PREGERSON, HAWKINS and RAYMOND C. FISHER, Circuit Judges.

FISHER, Circuit Judge:

Alvin W. and Donna T. Gebhart petition for review of an order by the Securities and Exchange Commission (SEC) sustaining a disciplinary action by the National Association of Securities Dealers (NASD).¹ The NASD found that the Gebharts, securities salespersons, committed securities fraud in violation of section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 by making false statements to clients in connection with the sale of promissory notes used to finance the conversion of mobile home parks to resident ownership. The SEC upheld the NASD's disciplinary action, concluding that the Gebharts acted with scienter because they made "representations to their clients despite not knowing whether they were true or false." We hold that the SEC applied the correct scienter standard and that substantial evidence supports the SEC's conclusion that the Gebharts acted with scienter. We therefore deny the petition for review.

I. BACKGROUND

Alvin Gebhart has been in the securities industry since 1983.² In 1994, he began working at Mutual of New York (MONY) in San Diego, where he sold annuities and mutual funds. While at MONY, Gebhart met Jack Archer, a fellow MONY salesperson. In 1995, Archer told Gebhart about a business venture, Community Service Group (CSG), run by James Scovie. CSG was in the business of converting mobile home parks to resident ownership. CSG purchased parks from the owners and then assisted residents in purchasing them. In late 1996, Scovie and another person, David Mounier, created MHP Conversions, LLC (MHP) to facilitate the conversion process. MHP issued promissory notes that were sold to individual investors to raise funds for CSG's purchase of the parks. The MHP notes had one-year terms with fixed interest rates of 18 percent for new investments and 14 percent for reinvested funds. Each note stated that it would "ultimately be secured by a deed of trust" on the particular park to be purchased with the funds, but that "[u]ntil such time as said deed of trust is recorded, the sole asset of [the issuer] will be a deed of trust for the property known as Eastern Trailer Park."

Archer told Gebhart about the MHP program and asked Gebhart whether any of his clients were interested in investing. Gebhart arranged for Archer to make a presentation of the MHP program to three of his clients, all of whom made investments in the program. Archer earned a sales commission, and paid half of the commission to Gebhart.

In early 1996, Gebhart moved from MONY to another financial services firm, Mutual Service Corporation (MSC), a broker-dealer and member of the NASD. His wife, Donna Gebhart, joined him at MSC and the two opened and operated a MSC branch in Rancho Bernardo, California, where they sold insurance and annuities and provided financial planning services to clients. In October 1996, Archer approached the Gebharts about selling MHP notes to their MSC clients. The Gebharts met with Archer for about 40 minutes. Archer told them that the MHP program had been approved by the compliance officer at Archer's firm, MONY. This was not true, however. Archer also told the Gebharts "that the parks were in good shape and he always assured us that they had a lot of equity in them. He said they [were] 45 to 55 percent leveraged."

The Gebharts conducted no independent investigation into the MHP program, either in 1996 or over the next four years, during which time they sold MHP notes to their clients. They failed to obtain any financial statements for CSG or MHP, ascertain who were the owners, officers or shareholders of CSG or MHP, determine what compensation would be paid to CSG or MHP or their officers, verify that trust deeds securing the notes were being recorded or obtain copies of recorded trust deeds. They visited two of the mobile home parks subject to the notes, but those visits do not appear to have served any useful purpose. When Archer would approach the Gebharts with the opportunity for clients to invest in a new park conversion, they conducted no independent analysis of the park in question. Rather, "[i]t was always our understanding that they wouldn't have done a conversion on a park that wasn't—had good cash flow and that would be a deal worth them doing." Although the Gebharts believed that their clients' loans would be secured by second trust deeds, they did not inquire why they were not first trust deeds or who held the first trust deeds. In lieu of an independent investigation, the Gebharts relied on Archer's representations. As Alvin Gebhart explained:

Throughout our four-year relationship, Mr. Archer continually stressed the strength of this program. Even in February [2000] when he spoke to Mr. Dave Mounier, the other principal [in MHP], he indicated that the parks were deep with equity. Donna and I had continuously interviewed Mr. Archer about the economics of this program. Initially, we were assured that the parks were financed only to 55% of value. Moreover, the monthly rents paid by the homeowners supplied working capital to Community Service Group. Indeed, we were assured that Community Service Group would not even consider a conversion of a park unless it had sufficient rents to pay all costs and interest to the Noteholders.

Donna Gebhart confirmed that she and her husband had simply relied on Archer's representations about the MHP program:

[Archer] basically explained the program [at the October 1996 meeting]. I don't remember all of the details, but he went over it and I just wanted to be sure that—I wanted to make sure that these notes or trust deeds were secured and he assured us many times that they were always secured.... I remember he sort of went through the program. I don't remember word-for-word what the man said, but he came to us and he was a pension administrator, a Pacific Life former manager, and we always looked at him as being probably further up in the—obviously more experienced in stuff than we had.

Between the Gebharts' meeting with Archer in October 1996 and CSG's collapse in 2000, the Gebharts sold nearly $2.4 million in MHP promissory notes to 45 of their clients, earning about $105,000 in commission fees.³ The sales were based on several statements by the Gebharts that, it later became clear, were false. The Gebharts told their clients that the MHP notes were a proven investment that offered substantial returns and were secured by recorded deeds of trust. They said that in the worst case scenario their clients would be part owners of the mobile home parks and would be able to recover their investments. In fact, the trust deeds were not recorded and the parks were significantly overencumbered. The Gebharts failed to disclose that their statements were based on information provided by Archer rather than their own, independent investigation.

CSG and MHP collapsed in the middle of 2000. In May, Scovie sent a letter to MHP noteholders explaining that an illness was forcing his absence from MHP and CSG. He disclosed that few of the deeds of trust purportedly securing the notes were recorded. In fact, there were approximately $3,670,000 in outstanding promissory notes, of which only $605,000 were secured by recorded deeds of trust. Gebhart admitted that "none of our clients' notes were recorded," and that the mobile home parks turned out to be "substantially overencumbered." At the time of MHP's collapse, the Gebharts' clients had over $1.5 million invested in outstanding MHP notes.⁴ MSC terminated the Gebharts' employment in August 2000.

As a result of these events, in 2002 the NASD's Department of Enforcement filed a complaint against the Gebharts for securities fraud.⁵ The NASD asserted that the Gebharts had made materially false and misleading statements to their clients, in violation of section 10(b) of the Securities Exchange Act of 1934, SEC Rule 10b-5 and NASD Conduct Rule 2120.⁶ A NASD hearing panel found that the Gebharts had acted in good faith and therefore rejected the fraud charges, but the NASD National Adjudicatory Council (NAC) reversed. The NAC found that the Gebharts had committed fraud, imposed a lifetime bar on Alvin Gebhart and imposed a one-year suspension and a $15,000 fine on Donna Gebhart. The SEC upheld the NASD decision in 2006.

The Gebharts petitioned for review of the SEC decision. We vacated and remanded in an unpublished decision, Gebhart v. SEC, 255 Fed.Appx. 254, 2007 WL 4144635 (9th Cir. Nov.21, 2007), out of concern that the Commission had applied a purely objective scienter standard that disregarded the Gebharts' actual state of mind. We remanded for reconsideration of the question of scienter and instructed the SEC to give careful consideration to the Gebharts' claims that, notwithstanding their objectively unreasonable conduct, they had acted in good faith.

On remand, the SEC once again determined that the Gebharts had acted with scienter and reaffirmed the NASD decision. The Gebharts have again petitioned for review. We have jurisdiction under 15 U.S.C. § 78y(a)(1), and deny the petition.

II. SCIENTER

The Gebharts challenge the SEC's finding of scienter on two bases. First, they contend that the SEC applied an erroneous legal standard for scienter. Second, they contend that the SEC's finding of scienter is not supported by substantial evidence. We reject...