Edward John McCarthy v. Securities and Exchange Commission
Docket: 03-40977
Court: Court of Appeals for the Second Circuit; April 26, 2005; Federal Appellate Court
Congress enacted the Securities Exchange Act of 1934 to ensure investor confidence in the integrity of floor traders on the New York Stock Exchange (NYSE), who possess advantages over the investing public. This case involves Edward John McCarthy, a floor broker convicted of violating the Act and related regulations. The court denied McCarthy's petition challenging his conviction but granted his petition regarding a two-year suspension upheld by the Securities and Exchange Commission (SEC), citing a lack of meaningful justification from the SEC for this penalty. McCarthy argued that the SEC's findings lacked substantial evidence and violated his due process rights, alongside contending that the suspension was excessively punitive. While the court found McCarthy's evidentiary and due process claims procedurally barred, it remanded the suspension issue back to the SEC for further consideration. The background involves the "Oakford scandal," where the Oakford Corporation conspired with NYSE floor traders, leading to criminal liability for several involved parties, with McCarthy's role being relatively minor.
McCarthy, an independent broker, began executing trades for Oakford in June 1995, billing them 70% of the net profits from these trades. However, Oakford reduced payments due to undisclosed clearing fees. After McCarthy inquired about the reduced payments, he was instructed to bill based on total net profits, but payments remained close to 70%. McCarthy executed unauthorized trades on four occasions, indicating he acted with discretion over the Oakford account. He also engaged in beneficial practices for Oakford, such as "crossing trades" and "trading ahead."
Additionally, McCarthy failed to maintain adequate trading records, including time-stamping order tickets, and on multiple occasions, he time-stamped tickets after trades were executed, raising concerns about the timing of orders. His records also lacked critical information required by federal securities law and NYSE rules. On June 30, 2000, the Stock Exchange's Division of Enforcement charged McCarthy with violations of various statutes and regulations, including having an impermissible interest in the Oakford account, engaging in discretionary trading without consent, crossing trades, trading ahead, and failing to meet record-keeping requirements.
A Stock Exchange Hearing Panel found Edward John McCarthy not guilty of most charges against him on September 10, 2001, except for failing to maintain proper records. The Panel determined that the Enforcement Division did not meet its burden of proof regarding allegations of discretionary trading and trading in an account where McCarthy had an interest. The Panel characterized McCarthy as an inexperienced broker who did not recognize that his compensation was linked to client profits. At the time of the alleged violations in 1995-96, members generally understood that receiving higher payments from clients based on more profitable trades was permissible under Rule 11a-1(a) unless there was a clear agreement or ownership interest in the account. The Hearing Panel found insufficient evidence for discretionary trading and concluded that McCarthy's issues stemmed more from a lack of experience than intent to violate rules, resulting in a censure and a $7,500 fine.
Upon appeal by the Enforcement Division, the Stock Exchange Board reversed the not-guilty findings and remanded the case for a new penalty determination. On remand, the Hearing Panel reaffirmed its view of McCarthy's inexperience and regulatory confusion at the time, retaining the censure but increasing the fine to $75,000. The Enforcement Division appealed again, leading the Board to uphold the censure and fine while imposing an additional two-year suspension from NYSE membership and employment on the floor, without offering a specific rationale for the suspension beyond referencing Exchange precedent and case specifics.
Petitioner appealed to the SEC, which upheld the Hearing Panel and Board's findings of guilt on all charges against him and affirmed the imposed penalties, as stated in In re Edward John McCarthy, Exchange Act Release No. 48,554. The SEC determined that McCarthy shared in the economic risk of trades with Oakford, contradicting his claim that he merely calculated profits for a customer without any agreement for profit-sharing. The Commission concluded he had an ownership interest in the Oakford account, which was impermissible under Rule 11a-1(a). Additionally, the SEC found that McCarthy engaged in discretionary trading by executing trades against Oakford's instructions and before time-stamping orders, thus violating the Securities Exchange Act due to his conflicting interests and improper trading practices. Although McCarthy admitted to record-keeping violations, he contested the findings related to other charges.
The SEC upheld the sanctions imposed by the Stock Exchange Board, including censure, a fine, and a two-year suspension, emphasizing the need for floor brokers to maintain high standards of honesty and integrity. The Commission noted that McCarthy’s actions undermined the principles of trust essential to the exchange auction market, prioritizing his interests over his customers' over the course of nearly a year. The SEC deemed further consideration of mitigating factors unnecessary given the seriousness of the misconduct.
In his appeal, McCarthy challenged the SEC's refusal to overturn the Board's summary reversals and remand for a reasoned opinion, claimed due process violations from the application of a 1998 interpretation of a rule to his actions from 1995 and 1996, contested the finding of an impermissible interest in the account, and argued that the sanctions were excessive. However, he failed to contest the SEC's determination of his discretionary trading in his opening brief, only addressing it in his reply brief.
Appellate counsel is required to include all significant arguments in the opening brief; failure to do so results in waiver of those arguments. Arguments introduced only in a reply brief, even if previously mentioned at the trial level, are not considered by the appellate court. Compliance with Federal Rule of Appellate Procedure 28(a)(9) is necessary for orderly appeal processing. In this case, the petitioner’s claim that his challenge to his trading conviction was included within broader due process arguments is incorrect; the opening brief only addressed his interest in the Oakford account. An implicit challenge to the discretionary trading conviction does not fulfill the requirement for explicit argumentation. Discretionary trading constitutes a separate violation, meaning the merits of the due process claims need not be addressed since the Commission's decision stands unchallenged on this independent ground.
While appellate courts may overlook procedural lapses to prevent manifest injustice, no such injustice exists here because the petitioner’s due process and evidentiary claims, stemming from the discretionary trading issue, lack merit. The court indicates it will not evaluate alleged errors in the Board's summary reversals as long as the Commission conducted a comprehensive review and arrived at an independent decision. The Commission's thorough evaluation of the record and reasoned decision affirming the Board’s ruling precludes the need to assess the Board's justification for its decision, as the due process afforded during the Commission's review rectified any potential shortcomings.
Petitioner’s due process rights regarding the application of the impermissible interest standard from NYSE Information Memo 98-34 were not considered, as the conduct in question occurred before regulatory definitions were precise. McCarthy testified that he understood it was a violation of Rule 11a-1(a) to link his compensation to net profits during 1995 and 1996. The Commission found substantial evidence contradicting McCarthy's claim of having no expectations about compensation from Oakford, noting he consistently billed for 70% of the account's net profits, indicating he knew or should have known his actions were prohibited.
The Commission had sufficient evidence to establish McCarthy's impermissible interest in the Oakford account, as his testimony suggesting ignorance was deemed implausible. McCarthy failed to challenge his discretionary trading conviction properly, leaving his substantive claims procedurally barred and without merit.
Regarding sanctions, McCarthy did not contest the censure and fine but challenged the two-year suspension from Stock Exchange membership upheld by the Commission. Appeals courts review SEC sanctions for abuse of discretion, only overturning them if they are unjustified either legally or factually. The review is case-specific, and sanctions must be proportionate to the violation, supported by a meaningful statement of findings. If a sanction is found excessive or ineffective, the court may reduce or eliminate it, as evidenced in previous cases where penalties were adjusted based on the specifics of the transgressions and mitigating factors.
Expulsion or suspension from trading serves to protect investors rather than penalize brokers, as established in case law including Wright v. Securities Exchange Commission. Such actions are deemed remedial, aimed at safeguarding the public from potential harm. The SEC's decisions should reflect considerations of public protection and deterrence, as indicated in cases like Steadman v. SEC. However, in the case of McCarthy, the SEC failed to demonstrate how his removal from the Stock Exchange would serve protective interests or provide a deterrence rationale. The SEC found that McCarthy's violations were serious, indicating he prioritized his interests over his customers' in multiple improper trades over a year. Critically, the justification for upholding McCarthy's suspension was overly generalized, mirroring justifications in unrelated cases without addressing the specific circumstances of McCarthy's actions, suggesting a lack of individualized consideration by the Commission.
The two-year suspension of McCarthy could be upheld if deemed punitive, but the Commission overlooked key factors regarding his minor role in the Oakford scheme, the limited duration of his violations ending in 1996, and his subsequent law-abiding trading for the past nine years. The SEC confirmed that aside from his past involvement, McCarthy has complied with trading regulations. The Commission failed to demonstrate that suspending a trader with an established record of compliance serves to protect the trading public or is justified in light of current regulations, which have clarified previous ambiguities. The characteristics of McCarthy's offense, including its seriousness and impact, suggest that the suspension may be excessive and punitive, jeopardizing his brokerage practice without serving remedial purposes. The Commission's reliance on generic language from other cases lacks engagement with the unique circumstances of McCarthy's situation, rendering their decision arbitrary and constituting an abuse of discretion.
The Commission is not required to perform a "ritualistic incantation" when addressing remedial effects but must provide an explanation regarding the nature of the violation and mitigating factors in each case. While the SEC's findings have been accepted in prior cases, each case requires individual consideration of its specific facts, violations, and circumstances. If evidence suggests a sanction is excessive, the Commission must offer a more detailed justification for the imposed sanction. In this instance, the court finds that the SEC failed to adequately support its decision to uphold McCarthy's two-year suspension, lacking necessary findings and justification. Consequently, the court vacates this decision as an abuse of discretion and remands the case for the SEC to reconsider in light of the presented mitigating factors. The court's ruling does not imply that a trader is entitled to a reversal of a suspension if no further violations occur during an appeal stay. The court denies the appellant's remaining arguments but grants the petition concerning the suspension, which is vacated and remanded for further proceedings. All other challenges to the sanctions are denied.
