The U.S. Court of Appeals for the District of Columbia strongly rejected a decision by the Securities and Exchange Commission, calling its decision affirming a National Association of Securities Dealers (NASD) restitution award “whimsical”, “incomprehensible” and “entirely unacceptable.”
The case arose from a disciplinary action brought by the NASD against a registered general securities representative. Four of the petitioner’s clients invested in a speculative start-up that later collapsed, resulting in a total loss of the clients’ investments. Petitioner failed to review any of the offering documents and later conceded that deficiencies in the documents rendered the investment “unsuitable” because the offering documents failed to set forth basic information regarding the proposed debt investments, including but not limited to the interest rate and the maturity date.
The NASD charged that petitioner, among other things, violated an NASD conduct rule by recommending the investment without having a reasonable basis for his decision. The NASD initially imposed fines and concurrent suspensions, but declined to impose restitution. On appeal to the NASD’s National Adjudicatory Council, the penalty was increased to consecutive suspensions and restitution was ordered. The SEC, reviewing the final NASD determination, affirmed on all counts.
The D.C. Circuit analyzed the level of causation required to impose restitution under General Principle No. 5 of the Financial Industry Regulatory Authority Sanction Guidelines, which provides that restitution may be ordered where an investor suffered a quantifiable loss “as a result of” a member’s misconduct. The court reviewed the SEC’s written opinion and found no guidance on or analysis of the nature of the causation requirement under Principle No. 5 (e.g., whether “but for” cause is sufficient or whether some variation of “proximate cause” or “loss causation” is required). The issue was critical because petitioner’s violation—failure to review facially deficient offering documents—may not have caused the loss of the client’s investment in a highly speculative start-up venture.
Because the SEC’s approach to the causation issue “clearly fail[ed] for want of reasoned decision making,” the court looked to see whether controlling precedent provided guidance. Finding none in the case of sophisticated investors willingly seeking to invest in highly speculative ventures, the court vacated the restitution order and held that the SEC abused its discretion. (Siegel v. SEC, No. 08-1379, 2010 WL 87610 (D.C.Cir. Jan. 12, 2010))