Thursday, February 18, 2010
Court Upholds Securities Trader Ban for Recklessness
By KENNETH OFGANG, Staff Writer
A member of the securities industry may be disciplined for misrepresentation in the sale of securities based on statements made in reckless disregard of the truth, the Ninth U.S. Circuit Court of Appeals ruled yesterday.
In an opinion by Judge Raymond Fisher, the court rejected claims by two San Diego-area salespersons that they innocently relied on representations by a broker/dealer as to the soundness of the investments they were selling.
The panel said the Securities and Exchange Commission applied the correct standard for scienter, and that substantial evidence supported its ruling that Alvin and Donna Gebhart were reckless in failing to independently investigate the broker/dealer’s claims.
Alvin Gebhart was banned from the securities industry for life, and his wife suspended for a year and fined $15,000, for falsely representing that promissory notes issued by MHP Conversions LLC had been approved by the compliance officer for a major investment firm and were backed by significant equity.
The Gebharts ran the Rancho Bernardo office of Mutual Service Corp. According to testimony, they were approached in 1996 by Jack Archer—who Alvin Gebhart knew from the time they both worked at Mutual of New York—about selling MHP notes. Archer had earlier explained to Alvin Gebhart that MHP was raising funds for a company called Community Service Group that purchased mobile home parks for conversion to resident ownership.
The Gebharts later claimed that they agreed to sell the notes, which they did from 1996 to 2000, because Archer assured them that the MONY compliance officer had approved them and that the parks “had a lot of equity in them” and were “45 to 55 percent leveraged.”
They also said they understood the company “wouldn’t have done a conversion on a park that [didn’t have] good cash flow.”
The Gebharts sold nearly $2.4 million in notes to 45 clients, and earned about $105,000 in commissions. The investors eventually recovered about 84 percent of their investments, by pursuing various remedies, after CSG and MHP collapsed and MSC terminated the Gebharts’ employment.
The National Association of Securities Dealers, now the Financial Industry Regulatory Authority, instituted a disciplinary proceeding, resulting in a decision by the NASD National Adjudicatory Council that the Gebharts had violated Sec. 10b of the Securities and Exchange Act and SEC Rule 10b-5 by selling securities through false representations.
The SEC upheld the decision. The Ninth Circuit initially reversed, holding in an unpublished memorandum in 2007 that the SEC may have applied an incorrect standard by failing to carefully consider the claim that the Gebharts acted in good faith.
On remand, the commission again determined that the couple acted with scienter and the Gebharts again sought review.
Fisher, writing for the Ninth Circuit, said the commission applied the correct standard on scienter. The Ninth Circuit and other circuits that have considered the question, the judge wrote, have held that a seller of securities commits fraud by making statements that the person knows to be false, or that are made in reckless disregard of whether they are true or false.
It was objectively unreasonable for the Gebharts to sell the notes without reviewing financial statements, talking to company officers or at least determining who they were and how they were being compensated, or verifying that the investment was being secured with recorded trust deeds, Fisher wrote.
Beyond that, the judge added, there was substantial evidence supporting the SEC’s rejection of the Gebharts’ claim of good faith reliance on Archer’s representations, even though the Gebharts themselves had invested in the notes.
Even if the Gebharts believed that the investment was sound and that the program had been approved by major investment firms, Fisher wrote, it was reckless for them to represent “that the MHP notes were a good investment, that they were secured by recorded trust deeds and that in the event of a problem investors would be able to get their investments back because the parks were not heavily leveraged,” when the only basis for the statements was Archer’s uncorroborated account.
Senior Judge Michael Daly Hawkins and Judge Harry Pregerson joined in the opinion.
The case is Gebhart v. Securities and Exchange Commission, 08-74943.
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