By Rodney F. Tonkovic, J.D.
A petition for certiorari asks the Supreme Court to address how civil penalties are calculated in SEC enforcement cases. While Congress has not changed the baseline statutory penalty caps since 1990, the magnitude of SEC penalties has reached "eye popping" levels impossible to square with these caps. In addition to extracting mega-dollar settlements from targets desperate to avoid litigation, the SEC also slices violations into multiple components, as it did in the petitioner's case, which can "geometrically" inflate total penalties. The petition asserts that the district court's multiplying of the statutory cap for failing to register as a broker by the number of months not registered creates a circuit split. The petition also challenges the test the Ninth Circuit used concerning who must register as a broker (Murphy v. SEC, June 23, 2023).
Flipping scheme. Petitioners Sean and Jocelyn Murphy and Richard Gounaud were sued by the SEC in 2018. According to the Commission, the three participated in a scheme to "flip" municipal bonds by posing as retail investors to gain priority in bond allocations and then flip the bonds to broker-dealers for a fee. While bond flipping is not illegal, the complaint alleged that the petitioners operated as unregistered brokers.
The district court held that the Murphys and Gounaud were "brokers" under Exchange Act Section 15(a) because they bought the securities at their employer'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.
On appeal, the Murphys and Gounaud argued that they were not brokers, but a Ninth Circuit panel disagreed. The panel said that when the petitioners placed their employer's capital at risk by trading securities as his agent, they were trading for the account of others and were thus brokers subject to the registration requirements. The panel also affirmed the civil penalties and injunctions levied against the appellants. In particular, the panel noted that the record supported that Jocelyn Murphy committed 21 violations based on her providing underwriters with false zip codes.
Violations sliced thin. At issue is the fact that Congress has never delineated how to calculate the number of violations in a given case. In the case of Jocelyn Murphy, the district court multiplied the penalty for each of the 21 instances in which she included false zip codes in communications with securities brokers. Sean Murphy and Gounaud received penalties multiplied by the number of months that they were unregistered as securities brokers.
The petition argues that the "arbitrary and inconsistent" counting of violations exceeds the statutory caps set by Congress. The Ninth Circuit's decision conflicts with a 2012 D.C. Circuit case, Rapoport v. SEC, in which that court rejected a requested penalty multiplied by the five years during which the violation persisted. The petition concedes that some courts have multiplied statutory caps by, for example, the number of trades made or by the number of victims, while others have rejected similar requests. The only prediction that can be made, the petition suggests, is that outcomes are unpredictable and depend on the "ingenuity of SEC prosecutors and the willingness (or unwillingness) of federal courts to go along."
These penalties greatly exceed the statutory caps set by Congress. Here, the petition says that if Congress wanted penalties based on units of time, it would have explicitly said so, as it has done elsewhere. The most natural reading of "each violation," the petition argues, is as a single course of conduct. The penalties are also excessive under the Eighth Amendment because the fines levied against the petitioners were grossly disproportionate to the gravity of their alleged offenses. This was demonstrated by the lower fines imposed against petitioners' settling co-defendants for materially similar offenses, the petition says.
Registration. The petition also takes issue with what it calls the Ninth Circuit's expansion of who must register as a broker-dealer. Up until this case, the Ninth Circuit, along with other federal courts, has used a multi-factor test based on a "totality of the circumstances" approach. Under this test, the petitioners argue that they would not have been found to be brokers, but the Ninth Circuit now found them to be because they at times took direction and financing from, and shared profits and losses with, another person. This conflicts with the common understanding of "broker" and greatly expands the universe of those required to register, the petitioners say, adding that such an expansion should only occur through legislation, or, at a bare minimum, SEC rulemaking.
Read the Docket. This case, and others before the Court, may be referenced in the latest version of the Supreme Court Docket, a regular feature of Securities Regulation Daily. Issued opinions, granted petitions, pending petitions, and denied petitions are listed separately, along with a summary of the questions presented and the current status of each appeal.
The petition is No. 12-1241.