Sartain v. S.E.C.

• Decision Date: 08 May 1979
• Docket Number: No. 76-2935,76-2935
• Parties: Fed. Sec. L. Rep. P 96,863 Thomas A. SARTAIN, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1366

601 F.2d 1366

Fed. Sec. L. Rep. P 96,863

Thomas A. SARTAIN, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 76-2935.

United States Court of Appeals Ninth Circuit.

May 8, 1979.

Robert D. Carrow (argued), Carrow & Forest, Novato, Cal., for petitioner.

Irving H. Picard (argued), Securities & Exchange Com'n, Washington, D. C., for respondent.

Petition to Review a Decision of the United States Securities and Exchange Commission.

Before DUNIWAY, CHOY and KENNEDY, Circuit Judges.

DUNIWAY, Circuit Judge:

Thomas A. Sartain petitions this court, pursuant to Section 25(a)(1) of the Securities Exchange Act of 1934, 15 U.S.C. § 78y(a)(1), to review an order of the Securities and Exchange Commission.

We affirm.

I. The Facts.

Sartain was involved with three entities: a holding company, Capital Planning Associates, Inc. (Planning Associates), a real estate investment trust, National Real Estate Fund (Real Estate), which was founded by Planning Associates, and a broker-dealer, Capital Planning Securities Co., Inc. (Securities), a wholly owned subsidiary of Planning Associates, formed to underwrite the sale of Real Estate's securities. Sartain served as President of Planning Associates, as one of its three directors, and, along with two other men, owned 90% Of its stock. He was one of Real Estate's three managing trustees, and in that capacity he took charge of Real Estate's day to day operations. He sold Real Estate's securities as a registered representative of Securities.

The Commission found Sartain responsible for three abuses in connection with Real Estate's securities, each of which violates a rule of the National Association of Securities Dealers (NASD). NASD is a registered association under § 15A(a) of the Securities Exchange Act, 15 U.S.C. § 78O -3(a). Its rules have been determined by the Commission to be "designed to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, . . . and, in general, to protect investors and the public interest . . . ." § 15A(b)6, 15 U.S.C. § 78O -3(b)(6). The Act also requires NASD to adopt rules which " . . . provide that its members and persons associated with its members shall be appropriately disciplined, by expulsion, suspension, fine, censure, or being suspended or barred from being associated with all members, or any other fitting penalty, for any violation of its rules." § 15A(b)(9), 15 U.S.C. § 78O -3(b)(9), now § 15A(b)(7), 15 U.S.C. § 78O -3(b)(7). The Commission has supervisory authority over disciplinary actions of NASD. § 19(e), 15 U.S.C. § 78s(e). The violations found are these:

First, when an issuer of a security and the broker selling that security are under common control, Section 13 of the NASD Rules of Fair Practice ¹ requires the broker to disclose the common control to its customers. Here, investors buying Real Estate shares through Securities were not told that Real Estate and Securities were under the common control of Planning Associates. Armstrong, Jones & Co. v. Securities and Exchange Commission, 6 Cir., 1970, 421 F.2d 359, 363.

Second, in talking with the public, Sartain emphasized that Real Estate shares were not a liquid investment, that Real Estate could not redeem its shares for cash, and that there was no organized market trading in its shares. Thus, when investors purchased Real Estate shares through Securities they would naturally assume that they were buying newly issued shares and that the money they were investing would go to Real Estate, in turn increasing the amount of its capital. In fact, Securities sold many of its customers shares belonging to earlier investors in Real Estate who had decided to get their money out. While such "cross trading" provided a service to the earlier investors, it became improper when Sartain and other of Securities' representatives failed to tell the later investors that Securities was selling them cross traded shares.

Still worse, a significant proportion of the cross traded shares belonged to Sartain himself and to other Planning Associates and Real Estate insiders. Prudent investors would certainly have been interested to learn that these insiders were liquidating significant portions of their own holdings. The Commission found that the failure to disclose these material facts with regard to the cross trading violated Section 1 of the NASD Rules of Fair Practice which provides that "A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade." See CCH NASD Manual P 2151.

Third, Section 12 of NASD's Rules of Fair Practice provides that a broker-dealer member such as Securities,

at or before the completion of each transaction with a customer shall give or send to such customer written notification disclosing (1) whether such member is acting as a broker for such customer, as a dealer for his own account, as a broker for some other person, or as a broker for both such customer and some other person. . . . CCH NASD Manual P 2162.

In other words, investors are entitled to know when their broker is dealing with them rather than for them. Here, Sartain and Securities failed to provide the Section 12 confirmations.

II. The Administrative Proceedings.

On May 16, 1974, an NASD District Business Conduct Committee filed a complaint against Sartain and others involved in Securities' sales of Real Estate securities. It alleged the three violations sustained by the Commission. It also charged that Sartain's three violations were manipulative, deceptive or otherwise fraudulent devices or contrivance in violation of the NASD's intentional fraud provision, Section 18 (CCH NASD Manual P 2168), and that Sartain had improperly arranged a short-term purchase and sale in order to secure a dividend for a favored customer.

After a hearing, NASD's Committee found that Sartain had violated the Rules of Fair Practice as charged. It censured Sartain and barred him from ever again having an association with an NASD member. The Committee explained that in fixing the penalty, it had "taken note of the dominant role of Thomas A. Sartain with regard to the activities" which it described as having "had the effect of perpetrating a fraud and deceit on the purchasers of this issue of securities." (R. 351.)

Sartain appealed to the Board of Governors of the NASD which gave him an opportunity to present new evidence at a second hearing. On April 14, 1975, the Board of Governors upheld all of the Conduct Committee's findings except its finding of intentional fraud. "Because of the serious nature of the remaining violations," the Board of Governors affirmed the penalties. (R. 514.)

Sartain then appealed to the Commission pursuant to what was then Section 15A(g) of the Securities Exchange Act, 15 U.S.C. § 78O -3(g), now § 19(d), 15 U.S.C. § 78s(d). After briefs, oral argument, and what it characterized as "a careful review of the record," ² the Commission issued its decision on July 7, 1976. It upheld all of the Board of Governors' findings except its finding of a violation with respect to securing a dividend for a favored customer, and also upheld the NASD's sanctions.

III. Substantial Evidence Supports the Commission's Findings.

The Commission held Sartain personally responsible for the violations on two grounds, that he either (1) directed Securities' activities giving rise to violations or (2) in light of his actual knowledge, access to information, and authority over Securities, he failed to direct it to stop engaging in the improper practices.

On appeal, Sartain raises three objections to the Commission's findings. He asserts that the evidence does not support the Commission's finding that Real Estate and Securities were in fact under common control. He asserts that the evidence does not support the Commission's finding that he directed or could have directed Securities so that it is fair to hold him personally responsible for the three violations. He asserts that in making the just challenged findings, the Commission erred by applying a preponderance of the evidence standard instead of requiring clear and convincing proof.

A. The Burden of Proof.

In arguing that the Commission should have required clear and convincing proof, Sartain relies upon Collins Securities Corporation v. Securities and Exchange Commission, 1977, 183 U.S.App.D.C. 301, 562 F.2d 820. Collins held that in a fraud case in which the Commission permanently barred a broker-dealer from the industry almost exclusively on the basis of inferences drawn from the evidence, rather than on direct evidence, the Commission should have used the clear and convincing standard. 562 F.2d at 822-26.

Here, too, the Commission has effectively barred Sartain from the industry. But even if we assume (we do not decide) that the severity of Sartain's penalty by itself required the Commission to demand clear and convincing proof, we cannot grant Sartain relief because he failed to raise the issue in a timely fashion. Section 25(c)(1) of the Act, 15 U.S.C. § 78y(c)(1), provides that

no objection to an order or rule of the Commission for which review is sought under this section, may be considered by the court unless it was urged before the Commission or there was reasonable ground for failure to do so.

Here, Sartain did not object to the Commission's use of the preponderance of the evidence standard while the case was before the Commission.

There is some merit in Sartain's contention that there was reasonable ground for his failure to raise the issue in that he could not have known for sure which burden the Commission would impose before reading the Commission's decision. However, under the Commission's Rules of Practice, a party in Sartain's position can urge his objection before the Commission by filing a timely petition for rehearing. See 17 CFR § 201.21(e). We need not decide whether 15 U.S.C. § 78y(c)(1) requires one...