By Rodney F. Tonkovic, J.D.
A Ninth Circuit panel affirmed that three municipal bond "flippers" acted as unregistered brokers. The SEC brought an enforcement action against former associates RMR Asset Management, charging them in a scheme to flip municipal bonds to broker-dealers at a markup. Relying on the statutory text, the panel concluded that the appellants were trading "for the account of others" and were thus subject to the registration requirements. The panel went on to affirm that one of the appellants used false zip codes to appear as a retail investor and confirmed that the penalties and injunctions imposed were within the district court's discretion (SEC v. Murphy, October 4, 2022, Lee, K.).
Flipping scheme. Appellants Sean and Jocelyn Murphy and Richard Gounaud held FINRA securities licenses and had many years of industry experience. In the late 2000s, the appellants associated with RMR Asset Management, owned by Ralph Riccardi, to trade securities. According to the complaint, from 2009 to 2017, RMR associates purchased new issue municipal bonds, often by posing as retail investors to gain priority in bond allocations, and then "flipped" the bonds to broker-dealers for a fee.
During that time, RMR's associates executed over 50,000 trades. The firm's business model, the SEC explained, exploited a unique feature of municipal underwriting in which retail investors are given highest priority. Operating as unregistered brokers, the associates solicited orders for new issue bonds from broker-dealers and filled the orders with bonds the associated obtained from underwriters by posing as retail investors. To create the appearance that they were retail investors, the associates used fictitious business names, falsely linked their orders to ZIP codes within the issuer's jurisdiction, and split orders among dozens of accounts. In exchange, the broker-dealer customers paid a fixed, pre-arranged commission.
The SEC's action. In August 2018, the Commission sued RMR and Riccardi, the appellants, and nine other traders. While bond flipping itself is not illegal, the complaint alleged that RMR engaged in a long-running scheme to circumvent municipal bond order priority by "operating as unregistered brokers" to appear as retail investors. Separately, Jocelyn Murphy was charged with fraud for providing false zip codes in connection with the purchase and sale of the municipal bonds.
All of the RMR trader-defendants besides the Murphys and Gounaud settled, and the SEC then moved for summary judgment. The district court held that the Murphys and Gounaud were "brokers" under Exchange Act Section 15(a) because they bought the securities at Riccardi's direction and received transaction-based compensation. In addition, Jocelyn Murphy was found to have violated the antifraud provisions by knowingly providing fraudulent zip codes. The court then imposed civil penalties against each defendant, with Jocelyn Murphy receiving the full requested penalty of $1,761,920.
"Brokers." On appeal, the Murphys and Gounaud argued that they were not brokers. The panel began with the statutory text, which defines a "broker" as anyone trading securities "for the account of others." The appellants maintained that they did not trade for others because they shared profits and losses with Riccardi, had discretion over which trades to make, and were "principals," and not agents, because they traded in partnership with Riccardi. The panel disagreed, finding that the appellants were Riccardi's "agents," and when they placed Riccardi's capital at risk by trading securities as his agent, they were trading for the account of others and were brokers subject to the registration requirements. The panel noted several factors supporting this decision, such as the fact that the appellants received transaction-based compensation, participated at key points in the transactions, and actively solicited investors.
In a brief concurrence, two of the judges wrote to recommend jettisoning the use of multi-factor tests, such as the one used by the district court in this case. The majority opinion itself noted that factors are "simply a judicial effort to provide meaning to the statutory text." The concurrence posited that multifactor tests provide little guidance and lead to unpredictable outcomes, especially if the factors are non-exclusive. "We should avert our gaze from the temptations of a non-exclusive multifactor test when, as here, the statute provides enough guidance," the concurrence said.
Fraud. The panel went on to find that Jocelyn Murphy made material misrepresentations by providing false zip codes. Murphy admitted doing so, but claimed the misrepresentations were not material, while the SEC explained that bond issuers rely on zip codes to determine retail order priority. In any event, the panel said, the SEC does not need to prove reliance, and it was enough that the misrepresentations would be significant if communicated to investors and made in connection with the purchase of securities.
Sanctions affirmed. Finally, the court affirmed the civil penalties and injunctions levied against the appellants. First, the record supported that Jocelyn Murphy committed 21 violations based on her providing underwriters with false zip codes. In addition, her violations were serious and caused systemic harm. The panel also affirmed the five-year injunctions imposed on the Murphys, noting that they were still involved in the securities industry and failed to appreciate the wrongfulness of their conduct.
The case is No. 21-55178.