Vancook v. Sec.

• Decision Date: 08 August 2011
• Docket Number: Docket No. 10–0031–ag.
• Citation: 653 F.3d 130
• Parties: John Joseph VANCOOK, Petitioner,v.SECURITIES AND EXCHANGE COMMISSION, Respondent.
• Court: U.S. Court of Appeals — Second Circuit

653 F.3d 130

John Joseph VANCOOK, Petitioner,

v.SECURITIES AND EXCHANGE COMMISSION, Respondent.

Docket No. 10–0031–ag.

United States Court of Appeals, Second Circuit.

Argued: May 26, 2011.Decided: Aug. 8, 2011.

Michael J. Sullivan, Coughlin Duffy LLP, Morristown, NJ (Mark K. Silver, Coughlin Duffy LLP, Morristown, NJ; Lewis D. Lowenfels, Tolins & Lowenfels, New York, NY, on the brief), for Petitioner.

Susan S. McDonald, Senior Litigation Counsel (David M. Becker, General Counsel; Mark D. Cahn, Deputy General Counsel; Jacob H. Stillman, Solicitor, on the brief), Securities and Exchange Commission, Washington, DC, for Respondent.Before: POOLER, SACK, and LYNCH, Circuit Judges.GERARD E. LYNCH, Circuit Judge:

Petitioner John Joseph VanCook, a former stockbroker, seeks review of an order of the Securities and Exchange Commission (“SEC” or “Commission”), which found that he willfully violated the antifraud provisions of the Securities Exchange Act of 1934 (“Exchange Act”), see 15 U.S.C. § 78j(b), 17 C.F.R. § 240.10b–5, by orchestrating a scheme that allowed certain customers to engage in late trading of mutual funds, and that he aided and abetted and caused the failure of his firm to keep accurate books and records, in violation of the Exchange Act's recordkeeping requirements, see 15 U.S.C. § 78q(a)(1), 17 C.F.R. 240.17a–3(a)(6). The SEC barred VanCook from working in the securities industry, issued a cease-and-desist order against him, ordered him to disgorge his unjust enrichment of $533,234.01 plus interest, and imposed a civil penalty of $100,000.

VanCook petitions this Court to vacate the SEC's order. He argues that, although he helped select customers engage in late trading, he did not violate the Exchange Act's antifraud provisions, because he never made misrepresentations to any victims and because late trading is not in itself fraudulent or deceptive conduct. He further argues that he could not have aided and abetted his employer's recordkeeping violations because he was never aware of the illegality or wrongfulness of his employer's recordkeeping practices, and because compliance was not his job. Finally, VanCook argues that the SEC's disgorgement and penalty order was unfair and disproportionate. Because we conclude that VanCook's conduct clearly violated the Exchange Act's antifraud and recordkeeping provisions, and because the penalties imposed by the SEC were not unreasonable, we deny VanCook's petition and affirm the SEC's order.

BACKGROUND

I. Facts

The following facts are derived from the findings of the Administrative Law Judge (“ALJ”) and the SEC, which are supported by substantial evidence and which we therefore must accept for purposes of this review. See 15 U.S.C. § 80b–13(a); Valicenti Advisory Servs., Inc. v. SEC, 198 F.3d 62, 64–65 (2d Cir.1999). Where VanCook's testimony, which the ALJ reasonably found lacking in credibility, differs from that of the witnesses found believable, the divergence is indicated in footnotes.

VanCook has worked in the securities industry since 1995, and since 2000 has provided brokerage services to hedge funds that trade mutual funds. In 2001, he joined Louisiana-based Pritchard Capital Partners, LLC (“Pritchard Capital” or “the firm”) in order to launch and manage the firm's New York office and to attract new, mutual-fund-trading hedge-fund customers to the firm. When the New York office opened in March 2001, Pritchard Capital also hired Elizabeth McMahon to assist VanCook in taking and executing customers' orders. At that time, VanCook and McMahon were the office's only employees; McMahon reported to VanCook, and they worked closely together. VanCook eventually purchased a 20 percent interest in the firm, becoming a co-owner with Thomas Pritchard.

Pritchard Capital was an introducing broker—that is, “a firm that has the initial contact with the public customer” but does not itself “handle[ ] the mechanics of order entry, confirmation, clearance of trades, calculation of margin, [or] similar activities.” Katz v. Fin. Clearing & Servs. Corp., 794 F.Supp. 88, 90 (S.D.N.Y.1992). For the latter functions, Pritchard Capital contracted with a clearing broker. When VanCook joined the firm, its clearing broker was Bear Stearns. Bear Stearns required the firm to fax its orders for mutual-fund trades by 4:00 p.m. every trading day in order for fund shares to be credited with that day's net asset value (“NAV”).¹ NAVs change daily depending on market events. Late trading enables the trader to profit from market events, such as earning announcements, that occur after 4:00 p.m. and consequently are not reflected in that day's NAV. See Amendments to Rules Governing Pricing of Mut. Fund Shares, Investment Company Act Release No. 26,288, 81 SEC Docket 2553, 2003 WL 22926831, at *2 (Dec. 11, 2003) (“A late trader can exploit events occurring after 4:00 p.m., such as earnings announcements, by buying on good news (and thus obtaining fund shares too cheaply) or selling on bad news (and thus selling at a higher price than the shares are worth).”). That is, the late trader who enters orders after 4:00 p.m., but nevertheless manages to secure that day's NAV, is able to buy, exchange, or redeem his fund shares at a NAV that was calculated before the release of any after-market information. This practice of late trading violates the forward pricing rule of SEC Rule 22c–1. See 17 C.F.R. 270.22c–1.

Mutual funds generally are required to calculate their NAVs daily by 4:00 p.m. Eastern Standard Time, when the closing bell rings on the major U.S. stock exchanges. See 17 C.F.R. 270.22c–1(b)(1); SEC v. Pentagon Capital Mgmt. PLC, 612 F.Supp.2d 241, 247 (S.D.N.Y.2009). Most mutual funds disclose their NAV calculation times in their prospectuses. The mutual funds traded by Pritchard Capital disclosed in their prospectuses that they calculated their NAVs “at” or “as of” the close of regular trading on the New York Stock Exchange (“NYSE”), which is 4:00 p.m. According to McMahon's testimony, Bear Stearns's 4:00 p.m. deadline for receiving orders was a “hard and fast rule.”

Late in 2001, VanCook convinced Pritchard Capital to change its clearing broker to Banc of America Securities (“BOA”), which did not have a 4:00 p.m. deadline. Instead, BOA used a computer system, the Mutual Fund Routing System (“MFRS”), that allowed its customers, including Pritchard Capital, to enter orders up to an hour and a half after the NYSE closing bell—that is, up to 5:30 p.m.—while still receiving that day's NAV. The MFRS's instruction manual, a copy of which BOA provided to Pritchard Capital, specified that

[a]ll orders should be received and time stamped by the close of the NYSE 4 PM EST. The MFRS system allows orders that have been entered prior to 4 PM EST to be review[ed] until 5:15 PM EST.²

This feature of the MFRS was designed to allow brokers to “review” timely orders and make corrections after 4:00—not to enter new orders after 4:00 p.m.

Nevertheless, VanCook soon began exploiting this MFRS loophole on behalf of three of the firm's hedge-fund customers: Simpson Capital Management (“Simpson”), Goodwin Trading Corporation (“Goodwin”), and Millennium Capital Management (“Millennium”). In accordance with VanCook's instructions, these three customers would e-mail or fax VanCook daily lists of proposed orders, or “possible trade sheets,” by 4:00 p.m. VanCook or McMahon would immediately timestamp these tentative instructions, but would wait to submit any orders to BOA until after they had received final instructions as to which trades the customers wanted to be executed. This procedure enabled the three favored customers to decide, after the funds' NAVs were calculated at the close of market, whether to go ahead with the “possible” trades, depending on whether the trades turned out to be favorable. VanCook would not record the time that a late-trading customer submitted its final instructions; instead, he would enter the order into MFRS and print a screenshot of his computer monitor, which reflected the time the order had been entered into MFRS but not the time that Pritchard Capital had received that customer's final instruction. Thus, regardless of whether the firm received final order instructions prior to 4:00 p.m. or afterward, the order appeared to have been received by 4:00.

VanCook has stipulated that he regularly allowed Simpson and Goodwin to finalize trades after 4:00 p.m., that he and McMahon “took some of those calls, took the final trading orders,” and that “one or the other of them or [another Pritchard Capital employee] would enter them into” MFRS after 4:00 p.m. in order to secure that trading day's NAV. Between November 2001 and July 2003, VanCook—or Pritchard Capital employees acting at his behest—executed nearly five thousand late-trading orders for these clients: 3,085 for Simpson, 1,828 for Goodwin, and 23 for Millennium.

VanCook's exploitation of the MFRS loophole yielded significant profits for himself, his firm, and these three late-trading clients. His compensation increased dramatically each year; he was paid $180,000 in 2001, $600,000 in 2002, and $800,000 in 2003. And although not all of his pay was connected to late trading, VanCook admits that the Simpson orders, in particular, “accounted for a substantial portion of [his] commissions.” In addition, VanCook's late-trading scheme attracted business and convinced existing customers to stay with the firm. Goodwin's chief, for example, testified that VanCook's late-trading scheme was one reason he selected Pritchard Capital as his company's introducing broker, and that Goodwin finalized “probably over ninety percent” of its proposed trade sheets after 4:00 p.m.

Millennium, by contrast, did not originally hire Pritchard Capital for the purpose of engaging in late trading. At first, Millennium always submitted its finalized proposed sheets to VanCook by 3:30 p.m. in accordance with general industry practice....