Securities & Exchange Comm'n

• Decision Date: 30 October 2000
• Docket Number: No. 99-1733,99-1733
• Parties: (4th Cir. 2001) SECURITIES & EXCHANGE COMMISSION, Plaintiff-Appellee, v. CHARLES ZANDFORD, Defendant-Appellant. . Argued:
• Court: U.S. Court of Appeals — Fourth Circuit

Page 559

238 F.3d 559 (4th Cir. 2001)

SECURITIES & EXCHANGE COMMISSION, Plaintiff-Appellee, v. CHARLES ZANDFORD, Defendant-Appellant.

No. 99-1733.

UNITED STATES COURT OF APPEALS, FOR THE FOURTH CIRCUIT.

Argued: October 30, 2000.

Decided: January 26, 2001.

Appeal from the United States District Court for the District of Maryland, at Greenbelt.

Andre M. Davis, District Judge. (CA-95-2826-AMD)

[Copyrighted Material Omitted] COUNSEL: ARGUED: Erin J. Roth, Student Counsel, Appellate Litigation Program, GEORGETOWN UNIVERSITY LAW CENTER, Washington, D.C., for Appellant. Melinda Hardy, Assistant General Counsel, SECURITIES AND EXCHANGE COMMISSION, Washington, D.C., for Appellee. ON BRIEF: Steven H. Goldblatt, Director, Lisa M. Porcari, Supervising Attorney, Robert L. Jacobson, Student Counsel, Appellate Litigation Program, GEORGETOWN UNIVERSITY LAW CENTER, Washington, D.C., for Appellant. David M. Becker, General Counsel, Meyer Eisenberg, Deputy General Counsel, Richard M. Humes, Associate General Counsel, Philip J. Holmes, AttorneyFellow, SECURITIES AND EXCHANGE COMMISSION, Washington, D.C., for Appellee.

Before WILKINSON, Chief Judge, and MICHAEL and TRAXLER, Circuit Judges.

Reversed and remanded by published opinion. Chief Judge Wilkinson wrote the opinion, in which Judge Michael and Judge Traxler joined.

OPINION

WILKINSON, Chief Judge:

Defendant Charles Zandford was convicted of thirteen counts of wire fraud for stealing from two of his investment clients. The Securities and Exchange Commission subsequently filed this civil action against Zandford under S 17(a) of the Securities Act of 1933, S 10(b) of the Securities Exchange Act of 1934, and the SEC's Rule 10b-5. The district court granted the SEC's motion for summary judgment. Zandford now appeals. We hold that the federal securities laws do not reach every claim for the theft or conversion of a security from a brokerage account. Because Zandford's fraudulent actions were not sufficiently connected with a securities transaction, we reverse the judgment of the district court and remand with directions to dismiss the case.

I.

Between 1987 and 1991, Charles Zandford worked as a securities broker. In 1987, Zandford persuaded William Wood to open a joint investment account for himself and his daughter, Diane Wood Okstulski. Wood was an elderly man who was in poor health. His daughter was mentally retarded and suffered from a multiple personality disorder. Zandford promised to "conservatively invest" the Woods' money. In total, the Woods entrusted Zandford with $419,255. By September 1990, all of it was lost.

In April 1995, a federal grand jury indicted Zandford on thirteen counts of wire fraud in violation of 18 U.S.C. S 1343. The indictment alleged that Zandford engaged in a scheme to defraud the Woods. The first count maintained that Zandford sold the Woods' shares of a mutual fund in order to use the proceeds for his own benefit. The remaining counts related to twelve separate checks from the Woods' account that Zandford made payable to himself. Zandford generated money in the Woods' account by selling their securities. A jury convicted Zandford on all counts. Zandford was sentenced to 52 months imprisonment and was ordered to pay $10,800 in restitution. This court subsequently affirmed Zandford's conviction. See United States v. Zandford, 110 F.3d 62 (4th Cir. 1997) (Table).

In September 1995, the Securities and Exchange Commission filed this civil action against Zandford under Section 17(a) of the Securities Act of 1933, 15 U.S.C. S 77q(a), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. S 78j(b), and Rule 10b-5 promulgated thereunder, 17 C.F.R. S 240.10b-5. The SEC's complaint alleged that Zandford violated these laws by selling the securities in the Woods' account, by misappropriating $343,000 in proceeds, and by using the money for his own personal needs. The SEC sought to enjoin Zandford from further violating the federal securities laws and to recover Zandford's ill-gotten gains.

In April 1998, the SEC moved for partial summary judgment on its misappropriation claim. Zandford subsequently moved for permission to conduct limited discovery on the issue of whether his fraud was "in connection with" a securities transaction. On March 2, 1999, the district court denied Zandford's motion and granted the SEC's motion for summary judgment. The court determined that Zandford's criminal conviction for wire fraud established all facts necessary to satisfy the elements of the SEC's securities fraud claim. Therefore, the court held that the doctrine of collateral estoppel prevented Zandford from arguing that he was not civilly liable under the federal securities laws. The court enjoined Zandford from committing future violations of the securities laws. It also ordered Zandford to disgorge $343,000. Zandford now appeals.¹

II.

The district court determined that Zandford's criminal conviction for wire fraud established all facts necessary to satisfy the elements of the SEC's securities fraud claim. That court erred in holding that the doctrine of collateral estoppel prevented Zandford from contesting his civil liability under the federal securities laws.

A criminal conviction can prevent a party from relitigating issues in a subsequent civil proceeding. See Emich Motors Corp. v. General Motors Corp., 340 U.S. 558, 568 (1951). For collateral estoppel to apply, the SEC must establish that: (1) the issue sought to be precluded is identical to one previously litigated; (2) the issue must have been actually determined in the prior proceeding; (3) determination of the issue must have been a necessary part of the proceeding; (4) the prior judgement must be final and valid; and (5) the party against whom estoppel is asserted must have had a full and fair opportunity to litigate the issue in the previous forum. See Sedlack v. Braswell Servs. Group, Inc., 134 F.3d 219, 224 (4th Cir. 1998).

At the very least, the SEC's invocation of collateral estoppel fails to satisfy the "identity of issues" requirement. To establish that Zandford violated sections 17(a) and 10(b), the SEC must prove, inter alia, that Zandford committed fraud "in the offer or sale" of securities, or "in connection with the purchase or sale" of securities. See 15 U.S.C. S 77q(a); 15 U.S.C. S 78j(b); 17 C.F.R.S 240.10b-5. By contrast, under the wire fraud statute, the government only need prove that (1) Zandford engaged in a scheme to defraud, and (2) that he used interstate wire communications in executing his scheme. See 18 U.S.C. S 1343; United States v. ReBrook, 58 F.3d 961, 966 (4th Cir. 1995). Thus, to find Zandford guilty of wire fraud it was wholly unnecessary to determine whether his fraud was sufficiently connected to a securities transaction. Since Zandford was never charged with a criminal violation of S 10(b), he did not have the opportunity to argue at trial or on appeal that, as a legal matter, his fraud was not sufficiently connected to a securities transaction. The SEC concedes as much when it argues both that the criminal trial established the fact that Zandford sold securities as part of a scheme to misappropriate proceeds, and that the district court properly made a legal conclusion in this case that such a scheme satisfies the "in connection with" requirement. It is this legal conclusion which we will now review.

III.

A.

The Securities Act of 1933 was designed "to provide full and fair disclosure of the character of securities sold . . . and to prevent frauds in the sale thereof, and for other purposes." Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 728 (1975). Likewise, "the fundamental purpose of the Securities Exchange Act of 1934 [was] to implement a `philosophy of full disclosure,' by providing participants in stock transactions with the information they need to make their investment decisions." Hunt v. Robinson, 852 F.2d 786, 787 (4th Cir. 1988) (quoting Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 47778 (1977)) (citation omitted).

The federal securities laws do not cover all types of fraud. Rather, both the Securities Act and the Exchange Act require that the defendant's fraud be connected sufficiently to a securities transaction. To state a claim under S 17(a) of the Securities Act, the SEC must show that Zandford's fraud, misstatement, or omission occurred "in the offer or sale of any securities." 15 U.S.C. S 77q(a).² Likewise, to state a claim under S 10(b) of the Exchange Act and Rule 10b-5, the SEC must show, inter alia, that Zandford misrepresented or failed to state material facts "in connection with" the purchase or sale of a security. See 15 U.S.C. S 78j(b); 17 C.F.R. S 240.10b-5.³

The precise contours of the in connection with requirement are not self-evident. It seems unavoidable "that the standard be fleshed out by a cautious case-by-case approach." See Chemical Bank v. Arthur Andersen & Co., 726 F.2d 930, 942-43 (2d Cir. 1984) (quoting Smallwood v. Pearl Brewing Co., 489 F.2d 579, 595 (5th Cir. 1974)). While the in connection with requirement must be flexible, it is not so elastic as to cover incidents which bear no relationship to market integrity or investor understanding. In particular, it is clear that ordinary state law fraud or conversion claims do not invariably violate the federal securities laws. "Congress, in enacting the securities laws, did not intend to provide a federal remedy for all common law fraud." Rivanna Trawlers Unlimited v. Thompson Trawlers, Inc., 840 F.2d 236, 241 (4th Cir. 1988) (citing Marine Bank v. Weaver, 455 U.S. 551, 556 (1982)). Indeed, the goal of S 10(b) would not be served by expanding its scope to include "claims amounting to breach of contract or common law fraud which have long been the staples of state law." Hunt, 852 F.2d at 787-88. With these principles in mind, we turn to the merits of Zandford's appeal.

B.

The precise issue before us is whether Zandford's alleged fraud is...