S.E.C. v. Ficken

Citation546 F.3d 45
Decision Date20 October 2008
Docket NumberNo. 07-2532.,07-2532.
PartiesSECURITIES & EXCHANGE COMMISSION, Plaintiff-Appellee, v. Justin F. FICKEN, Defendant-Appellant, and Martin J. Druffner, Skifter Ajro, John S. Peffer, Marc J. Bilotti, and Robert E. Shannon, Defendants.
CourtUnited States Courts of Appeals. United States Court of Appeals (1st Circuit)

Dominick V. Freda, with whom Jacob H. Stillman and John W. Avery were on brief, for plaintiff-appellee.

Gary G. Pelletier, for defendant-appellant.

Before BOUDIN and DYK,* Circuit Judges, and DOMÍNGUEZ,** District Judge.

DYK, Circuit Judge.

The Securities and Exchange Commission ("SEC") filed a civil complaint against defendant-appellant Justin F. Ficken ("Ficken") and others in the United States District Court for the District of Massachusetts, alleging violations of 15 U.S.C. § 77q(a), 15 U.S.C. § 78j(b), and 17 C.F.R. § 240.10b-5. The SEC alleged that Ficken intentionally concealed his identity and the identities of his clients while trading shares of mutual funds, in order to mislead mutual fund companies into processing trades that they otherwise would not have allowed. The district court granted the SEC's motion for summary judgment against Ficken, finding no genuine issue of material fact as to any relevant issue, including scienter. SEC v. Druffner, 517 F.Supp.2d 502 (D.Mass.2007). We affirm.

I.

The federal securities laws ban fraud and other deceptive practices in connection with the purchase and sale of securities. See Securities Act of 1933 § 17(a), 15 U.S.C. § 77q(a) (prohibiting fraud and material misrepresentations or omissions in the offer or sale of securities); Securities Exchange Act of 1934 § 10(b), 15 U.S.C. § 78j(b) (prohibiting manipulative or deceptive practices in violation of SEC regulations in the purchase or sale of securities); SEC Rule 10b-5, 17 C.F.R. 240.10b-5 (prohibiting fraud and material misrepresentations or omissions in the purchase or sale of securities). A misrepresentation is material if there is a substantial likelihood that the misrepresentation would affect the behavior of a reasonable investor. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32, 108 S.Ct. 978, 99 L.Ed.2d 194 (1988). Proof of scienter is required to establish violations of § 17(a)(1), § 10(b), or Rule 10b-5, while negligence is sufficient to establish liability under § 17(a)(2) or § 17(a)(3). See Aaron v. SEC, 446 U.S. 680, 694-97, 100 S.Ct. 1945, 64 L.Ed.2d 611 (1980); SEC v. Fife, 311 F.3d 1, 9-10 (1st Cir.2002).

Scienter is an intention "to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194, and n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976). In this circuit, proving scienter requires "a showing of either conscious intent to defraud or `a high degree of recklessness.'" ACA Fin. Guar. Corp. v. Advest, Inc., 512 F.3d 46, 58 (1st Cir.2008) (quoting Aldridge v. A.T. Cross Corp., 284 F.3d 72, 82 (1st Cir.2002)). "Recklessness is `a highly unreasonable omission, involving not merely simple, or even inexcusable[] negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious the actor must have been aware of it.'" SEC v. Fife, 311 F.3d at 9-10 (quoting Greebel v. FTP Software, 194 F.3d 185, 198 (1st Cir.1999)).

The question here is whether defendant Ficken's conduct as a broker violated the securities laws. Ficken worked as a broker in a Boston branch office of Prudential Securities, Inc. ("PSI"), from October 1999 to September 2003. He purchased and sold mutual fund shares on behalf of customers. In doing so he engaged in market timing. "Market timing" is a mutual fund share trading strategy that "exploit[s] brief discrepancies between the stock prices used to calculate the shares' value once a day, and the prices at which those stocks are actually trading in the interim." Kircher v. Putnam Funds Trust, 547 U.S. 633, 637 n. 4, 126 S.Ct. 2145, 165 L.Ed.2d 92 (2006). The price of mutual fund shares is calculated at the close of U.S. trading, but in the case of a foreign stock exchange listed company, the share price calculation uses the latest foreign market closing prices. Because of time zone differences between the daily closings of the foreign and U.S. markets on which a mutual fund's portfolio of securities trades, someone engaging in market timing can buy or sell mutual fund shares based on the foreign markets' closing prices but utilizing information that becomes known after the foreign markets closed (information that will not be reflected in the foreign market closing prices until the next day).

Although market timing is not illegal, mutual fund companies often prohibit market timing in order to protect long-term shareholders from dilution and other adverse effects caused by rapid and repeated short-term market timing transactions.1 When a mutual fund company that prohibits market timing detects market timing, the mutual fund company often blocks future trades utilizing that broker's so-called financial advisor ("FA") number and/or the customer account number used in the market timing trade.

Ficken and other brokers at PSI were assigned FA numbers. These FA numbers allowed brokers to open customer accounts, execute trades, and track commissions. Each customer account had an individual number assigned to it, and each customer account number had an individual FA number assigned to it. Brokers used a customer's account number to submit mutual fund transactions on behalf of the customer. Ficken had at least seven FA numbers registered under his name alone or jointly with one or more of the brokers in his group at PSI, and his group eventually opened over 170 customer accounts for only five customers. Ficken and the brokers in his group at PSI used these FA numbers and customer account numbers in trading with over 50 mutual fund companies in amounts exceeding $1 billion.

While Ficken worked at PSI, several mutual fund companies suspected PSI brokers of market timing and consequently blocked trading under some of Ficken's FA numbers, customer account numbers, or both. It is undisputed that after mutual fund companies blocked Ficken's FA numbers or customer account numbers, Ficken then used new FA or customer account numbers, or both, to trade the companies' mutual funds.

The SEC's theory was that Ficken violated federal securities laws by utilizing new FA numbers and customer account numbers to evade mutual fund companies' restrictions on trading using existing FA and customer account numbers. Ficken's defense was that his use of new customer account numbers and FA numbers was not intended to mislead mutual fund companies or inaccurately identify customers and brokers, but was instead done for legitimate reasons.

Ficken resigned from PSI in 2003 following allegations that his group of brokers at PSI was involved in improper market timing activities. On October 1, 2003, he testified in a proceeding conducted by the SEC as part of its investigation of PSI. Ficken did not assert his Fifth Amendment privilege against self-incrimination in the proceeding. On December 17, 2003, Ficken testified in an investigation proceeding conducted by the National Association of Securities Dealers ("NASD"). The NASD (now succeeded by the Financial Industry Regulatory Authority) was a private self-regulatory organization with regulation and enforcement authority over securities firms under 15 U.S.C. § 78o-3. In the NASD proceeding, Ficken also testified but invoked his Fifth Amendment privilege against self-incrimination as to certain questions. In both the SEC and NASD proceedings Ficken sought to justify his practices as being legitimate, at least under some circumstances. For example, he testified that he used new FA numbers with the permission of the mutual fund companies and that he used new FA numbers to facilitate the splitting of commissions with other brokers or to accommodate clients' "technology" needs.

The SEC filed a civil complaint against Ficken and his co-defendants in November 2003. The SEC alleged in its amended complaint that Ficken attempted to evade market timing detection by using multiple FA numbers and multiple customer account numbers in order to "conceal [his] own identit[y] and the identities of [his] clients" and thus to "mislead[] the fund companies to process transactions they would otherwise have rejected." Pl. Am. Compl. ¶ 3. The SEC also alleged that Ficken "made false statements to the mutual fund companies by using fictitious names on the customer accounts" and "made omissions of material fact by failing to disclose to the fund companies that the numerous accounts" and FA numbers Ficken used in trading mutual fund shares belonged to the same brokers and customers whose trading activities "had previously been blocked" by the mutual fund companies. Id. at ¶ 18. When the SEC sought to depose Ficken as part of the present proceeding, Ficken asserted his Fifth Amendment rights and refused to be deposed.

The SEC moved for summary judgment. The SEC's motion for summary judgment pointed out that Ficken was well aware of the funds' policies.2 The SEC also relied on Ficken's e-mail communications with customers, which discussed his market timing and his blocked FA numbers and customer account numbers, to demonstrate Ficken's intent to mislead mutual fund companies into processing trades that he knew would violate the mutual fund companies' market timing and excessive trading restrictions. For instance, on October 30, 2001, Ficken sent an e-mail to one of his clients stating, "when using Seligman, it is crucial to implement some sort of fund rotation. They look carefully at accounts hitting the same funds over and over again." On February 4, 2002, Ficken sent an e-mail to the same client stating, "As I look for space within the Zurich Accounts, I am a bit weary as to which funds have been previously traded and...

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