Schellenbach v. S.E.C.

• Decision Date: 17 March 1993
• Docket Number: No. 92-1254,92-1254
• Citation: 989 F.2d 907
• Parties: Fed. Sec. L. Rep. P 97,378, 25 Fed.R.Serv.3d 1215 Peter W. SCHELLENBACH, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 907

989 F.2d 907

Fed. Sec. L. Rep. P 97,378, 25 Fed.R.Serv.3d 1215

Peter W. SCHELLENBACH, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent.

No. 92-1254.

United States Court of Appeals, Seventh Circuit.

Argued Dec. 7, 1992.

Decided March 17, 1993.

Marvin Green (argued), Anne Jentry-Green, Chicago, IL, for petitioner.

Jacob H. Stillman, Lucinda Burwell (argued), Judith R. Starr, S.E.C., Office of the General Counsel, Washington, DC, for respondent.

Before CUMMINGS, POSNER, and FLAUM, Circuit Judges.

CUMMINGS, Circuit Judge.

Peter W. Schellenbach does not dispute a finding of the Securities and Exchange Commission that he wrote bad checks and falsified reports to create the illusion that his Chicago securities firm, Brook Investments, Inc. ("Brook"), was solvent. However, Schellenbach contends that his punishment--including a $50,000 fine, censure, and lifetime ban on his acting in any principal, supervisory or managerial capacity with any member-firm of the National Association of Securities Dealers ("NASD")--is too severe. He also suggests that he wouldn't have been prosecuted in the first instance but for a plot among "rogue" NASD staff members who sought to make themselves look good at his expense. Under petitioner's theory, the NASD reneged on a promise not to prosecute his violations of the securities laws only after staff members learned that the FBI was interested in the case. Schellenbach's punishment must be affirmed, however, because he has no proof of any such conspiracy, and because, even if he did have proof, the intent of NASD staff members is irrelevant; the SEC, not the NASD, imposed the sanctions petitioner appeals.

This Court has jurisdiction to hear appeals of final SEC orders under Section 25(a)(1) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78y(a)(1). Because the SEC lacks the resources to police the entire securities industry, it relies on participants in the markets to govern themselves. NASD is a registered association of securities broker-dealers that is charged under the Exchange Act with "provid[ing] a fair procedure for the disciplining of members and persons associated with members * * *." Exchange Act § 15A(b)(8), 15 U.S.C. § 78o -3(b)(8). Under NASD procedures, an NASD Regional District Business Conduct Committee ("District Committee") conducts hearings, makes findings and imposes penalties against members who break rules. Mister Discount Stockbrokers, Inc. v. SEC, 768 F.2d 875, 876 (7th Cir.1985). These judgments are reviewed by the NASD Board of Governors, and then by the SEC itself under Section 19(d)(2) of the Exchange Act, 15 U.S.C. § 78s(d)(2). Since the Commission reviews NASD penalties from scratch--conducting an independent review of facts and law--this Court will "consider errors in [NASD] proceedings 'only if and to the extent that they infected the Commission's action by leading to error on its part.' " Shultz v. SEC, 614 F.2d 561, 568 (7th Cir.1980) (quoting R.H. Johnson & Co. v. SEC, 198 F.2d 690, 695 (2d Cir.1952), certiorari denied, 344 U.S. 855, 73 S.Ct. 94, 97 L.Ed. 664). The Commission's findings of facts are conclusive if supported by substantial evidence, 15 U.S.C. § 78y(a)(4), and this Court will reverse the Commission's imposition of sanctions only if the SEC abused its discretion. Mister Discount, 768 F.2d at 879.

Petitioner Schellenbach, now an employee with the Merrill Lynch securities firm, was president, majority shareholder and financial and operations principal of Brook, a former member of NASD. According to SEC findings which Schellenbach does not dispute in this appeal, Brook's finances began to falter in early 1986. By July of that year the firm's net capital had fallen below the required minimum for the second time in six months. Schellenbach started writing checks to Brook from his personal account, supposedly to purchase receivables. The purchases were listed on Brook's financial statements as cash. It was a scam; the receivables were worth nothing or much less than Schellenbach had paid for them, and Schellenbach did not have the money in his account to cover the checks. The bank did not dishonor the checks because Schellenbach sold the receivables back to Brook after a few days for roughly the same amount that he had bought them. This system allowed petitioner to mislead investors and regulators and foster the illusion that Brook was financially sound.

Schellenbach also tried to deceive regulators between February and November 1986 by not recording on Brook's accounting ledger routine operating expenses and amounts due Brook's clearing firm. And Schellenbach both failed to file and filed inaccurate reports with the NASD because he knew that NASD officials would order him to shut down Brook if they learned about the firm's capital deficiencies. The scheme collapsed in November 1986 when an infusion of outside capital that Schellenbach had hoped for failed to materialize, and the firm closed its doors. Brook was booted out of the NASD in October 1987 for failing to pay its fees to the association. Schellenbach maintains that no Brook customer lost money because of his activities. Not all parties were pleased, however. According to the testimony of Schellenbach and his lawyer before the District Committee, twenty-three people lost their investments in the firm (including Schellenbach who claims to have lost $200,000). Petitioner charges that three of these "owner-investors undertook to drive [him] out of the securities business if he did not make good their lost investments" (petitioner's brief at 4). These three, according to Schellenbach, vented their rage against him by lodging complaints with the IRS, FBI, SEC, NASD, and the attorney general and secretary of state of Illinois.

When Schellenbach ended his affiliation with Brook, the NASD undertook a "termination investigation" as required by Article IV, Section 3(a) of the NASD Manual and By-laws (respondent's app. at 2-A). On March 11, 1988, Eugenia T. Sampat, an NASD supervisor, sent a letter to Brook signaling the end of this investigation ("Sampat letter"). The letter said in part:

At its recent meeting, the District Business Conduct Committee reviewed the report of this investigation and determined that no action was warranted regarding the activities of the Registered Representative or your firm in connection with this termination. In this regard, the termination has been processed and the temporary "hold" placed on the registration during the investigation has been removed.

(Petitioner's app. at 26). This letter did not end Schellenbach's legal troubles. In the summer of 1988, presumably because of prompting by the disgruntled investors, the FBI began an investigation of Brook, though criminal charges were never filed. Some time later Schellenbach learned that he was also under investigation by the NASD. Petitioner and NASD officials discussed a settlement, but they could not agree and both parties now dispute which side made the overture. In any event, the NASD responded to the failed negotiations by beginning formal disciplinary proceedings against Schellenbach with the filing of a five-count complaint. The District Committee, NASD's front-line investigative and disciplinary panel, found that Schellenbach had violated the NASD Rules of Fair Practice under Article III, Section 1 ("A member, in the conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade") and Article III, Section 18 ("No member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance") (respondent's app. at 3-A). The NASD Board of Governors affirmed the findings of the District Committee after an independent review; the Committee censured Schellenbach, fined him $50,000, barred him for life from acting as a principal in NASD-member activities, and barred him from non-principal activity for sixty days (see petitioner's app. at 16-24). Petitioner appealed to the SEC, which also conducted an independent review. On December 4, 1991, the Commission affirmed the sanctions imposed by the NASD. It is this ruling that petitioner now appeals.

Schellenbach makes a series of arguments why he should not have been prosecuted by the NASD. He first contends that the NASD was bound by the District Committee's seeming exoneration of him in the Sampat letter. Yet petitioner cites no cases to support the proposition that the NASD may not reopen an investigation or that its doing so subjects him to double jeopardy. His only authority is Section 19(e)(1)(A) of the Exchange Act, which requires that the SEC, in applying a sanction, must ensure that "such provisions are, and were applied in a manner, consistent with the purposes of this title." 15 U.S.C. § 78s(e)(1)(A). Schellenbach suggests that this language requires the SEC to "reconcile the District Business Conduct Committee's first exoneration decision with the same Committee's subsequent findings against Schellenbach * * * " (petitioner's brief at 14). Section 19(e)(1)(A), however, says only that sanctions must be applied "consistent with the purposes of this title;" it does not say that the NASD must be consistent if, indeed, reopening an investigation is an indication of inconsistency. Nor does the Constitution's double jeopardy clause apply to civil proceedings. Breed v. Jones, 421 U.S. 519, 528, 95 S.Ct. 1779, 1785, 44 L.Ed.2d 346 (1975). Thus even if the Sampat letter signaled that the NASD had closed its investigation of Schellenbach, the NASD was perfectly free to reconsider the matter absent some due process violation.

More to the point, the NASD did not reopen its investigation of Schellenbach because the investigation was never closed to begin with. The Sampat letter applied only to the "termination" of Schellenbach's affiliation with Brook under Article IV,...