[00:00:02] Speaker 04:
Case number 16 at 1453, Robert of ED and L.

[00:00:57] Speaker 05:
Good morning.

[00:00:58] Speaker 05:
May I please support?

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The majority of our briefs in this case dealt with the Commission's primary finding, which was that Mr. Robert and Mr. Jones, who are here today,

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acted negligently in crafting the disclosure that appears in their form ADV and elsewhere over a considerable time period.

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The time period is 2005 until 2013.

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And I'd like to focus on that today in specifically two parts of the finding.

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The first being the commission's finding that negligence existed despite the absence in the record as to the applicable standard of care over that time period imposed on an investment advisor

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when crafting and using disclosure language with their advisory clients.

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And second, the Commission's finding that

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they failed to act reasonably under the circumstances.

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And this being negligence, these are rather common legal issues.

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But before turning to those two things, a very brief perspective on the history of this case is important to assessing the negligence claim.

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This was initially filed as both cilantro-based and negligence-based charges.

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And that's important because the trial strategy of the Securities and Exchange Commission from the onset

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was to prove that the conduct, the underlying conduct by my clients was so egregious that it met the standard of scienter, or at least recklessness, and that thereby they would clear the bar for negligence without further thought.

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The problem was that those claims were dismissed.

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The administrative law judge found not only that there was no seantor, but that even if they had shown seantor, that we had presented evidence that rebutted that finding.

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So on appeal, and the commission have held that on appeal.

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So on appeal, the record that they were left with was one of negligence.

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And the problem was that the record... Let me be clear.

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You said the commission affirmed.

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What did they affirm?

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Commission affirmed the finding that there was no scienter.

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So left with negligence.

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I thought the commission said it was a de novo review.

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It is a de novo review.

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So left with only the negligence charge.

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The Commission found that the petitioners acted negligently essentially because the disclosure was inadequate, because it was.

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Absent from the record is an articulation

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of what the standard as to disclosure was at the various time periods.

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There are two time periods here.

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There is the initial time period until 2011 when Form 80 was revised, and then there is a period afterwards with the revised form.

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The disclosure in terms of what the commission asked for in that form doesn't change much, but the major differences in 2011, the new revised form 80B comes with a couple pages of general instructions.

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And that's important because that form is the only place one can look for what needs to be disclosed on form ADV or elsewhere to a firm's clients.

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Beyond that, the Commission has intentionally given discretion to the investment advisor to present disclosures in a manner that their clients will understand.

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So let me ask you, your client agrees

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that the finality agreement was material, as the commission defines that word, namely something that their clients would have wanted to know about because of the potential for a conflict of interest.

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Not the agreement itself, meaning the contract, but the arrangement.

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The fact that they were receiving compensation.

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I'll call it arrangement.

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Arrangement.

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The fact of receipt of compensation from a non-client in connection with investment advisory advice.

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And that is what initially questioned.

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And your clients acknowledged that was material.

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We have acknowledged that as material.

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Yes.

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And they knew about the arrangement.

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They knew about the arrangement.

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And what didn't they understand about the question?

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It's not a misunderstanding of the question.

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So the question is, are you receiving any money that your clients might want to know about that might affect your judgment in the advice you're giving to your clients?

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Correct.

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The question is... And so your clients acknowledged that the arrangement was material.

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Yes, and they disclosed it.

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The issue is not whether or not it was disclosed.

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In response to question 13, which initially... So your point is that the Commission had to say, even though your clients knew the arrangement was material, that unless the Commission said in its form, disclose all material financial arrangements,

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Your clients were under no obligation, even as fiduciaries, to disclose?

[00:06:19] Speaker 05:
No, Your Honor, that's not our position at all.

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Okay, what is it?

[00:06:23] Speaker 05:
Yes, we were required to disclose this arrangement.

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I know, but your position, I think, is that they didn't have to mention the arrangement.

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No, our position is we didn't have to describe it in the manner that the Securities and Exchange Commission

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Now, or at least when they file these charges... Well, here's what I'm trying to understand.

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Fidelity couldn't find it either, and told your client that.

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It didn't find the disclosure.

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There is an email where Fidelity says, we want you to make this disclosure, we don't find it in your form ADB.

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But that, in response to that,

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That came out of Fidelity's own issues with defending its own disclosure.

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They communicated it to us, and the testimony at trial was that while we disagreed that it wasn't in there, our clients were willing to do whatever it took to put in whatever detail that anyone thought was advisable, whether it was their broker dealer, the compliance consultants that they had hired.

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Well, that's not exactly true, is it, on this record, at least in terms of substantial evidence?

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I'm not sure I understand your question.

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Well, Fidelity gave them a paragraph.

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They didn't put that in exactly.

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They didn't put that in.

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Fidelity gave them boilerplate language and specifically said, here's something you could use, but you remember, your obligation under the rules, the parameters that are applicable to you, is in your discretion, based on who your clients are, based on what your business is, and based on what you think they will understand, you use whatever words you think, here's what we came up with.

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So my question is, this is a kickback.

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Why isn't that obviously something that has to be disclosed to clients?

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Again, our position is it is disclosed.

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It was disclosed.

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The receipt of compensation, there's compensation directly from investment advice, right?

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The client pays directly to us.

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And this is compensation coming from somewhere else because of the investment advice.

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It is disclosed.

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It is disclosed on form 80V in response to question 13.

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By saying we may?

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Receive.

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We may receive selling compensation on certain securities transactions.

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Yes.

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How does a client, how can a client make any judgment based on we might on some unspecified transactions?

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How are they alerted?

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Certainly if you had a conflict as an attorney, that wouldn't be a sufficient or adequate disclosure.

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So how, so that your client could make

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So why didn't they have to, why weren't they specific up front?

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Why didn't they just lay it out and say, fidelity is paying compensation to us because we use their platform, but only if we choose certain non-fidelity investments.

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Whatever was needed, why wouldn't they do that?

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In the first instance, instead of 13 years later, 10 years later.

[00:09:27] Speaker 05:
Well, and in hindsight and seeing where we've ended up today, that would have certainly have been... Not hindsight.

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Why wouldn't you?

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As a lawyer, you'd know what to do right up front.

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I don't understand why they wouldn't up front have given the specifics.

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It seems like...

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was kind of pulling teeth to get them to add a word here and there over the course of 10 years.

[00:09:45] Speaker 05:
No.

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In fact, with respect, it was the opposite.

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I think that the record clearly shows that they were willing to do anything possible to get the disclosure right.

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Then why are they so cryptic and obscure?

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It's not cryptic.

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It's description of the conflict as it

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appeared to them.

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If you adopt the commission's point of view, the inherent conflict had to be described down to the detail of which investment is selected over another.

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A road that ends potentially nowhere in terms of how much detail you have to give when making investment decisions on a portfolio basis, where it's comprised of individual funds within and you move based on each individual one.

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So, taking a step back, when this arrangement came about, back in 2005, they disclosed it in the way that the conflict presented itself to them.

[00:10:40] Speaker 03:
It came in 2004, and they didn't do any disclosure until 2005.

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When the compensation started.

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I think if you look at the record... The compensation starts after investment decisions are made.

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You have to make the investment decisions first, and then the compensation comes.

[00:10:56] Speaker 05:
No, I mean the first payment from Fidelity comes after the 2005 ADD disclosure, despite the agreement being executed in 2004.

[00:11:11] Speaker 03:
So let's look at that on page JA711.

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Do I have the right page?

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JA711, is that your 2005 one?

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Yes.

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If you could point to me where they alerted clients that

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they had an incentive.

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They may not have acted on it.

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I'm sorry, can you admit that?

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Sorry, where were they alerted that they had an incentive to buy non-fidelity, to go into non-fidelity investments?

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Again, that is a level of detail.

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A level of detail is just to let them know what the conflict is.

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Is that a level of detail or is that the conflict?

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That is a level of detail.

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The conflict, if you look at question 13, does the applicant or related person have an arrangement where it receives cash or economic benefit, including commission from a non-client?

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The receipt of compensation from a non-client, the receipt of outside compensation is the conflict.

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That is what they are responding to in this question.

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Now, I understand what the SEC says later on that they were obligated to make these other more deeper disclosures or more detail as to the

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other conflicts that this brings about, but the inherent conflict, what they're responding to and asked to respond to in Form ADV is the receipt of compensation.

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Potential conflict.

[00:12:25] Speaker 04:
Potential conflict, yes.

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So I give you my money and I'd like to know, are you getting any financial rewards from

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recommending one type of investment as another.

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And that is what this disclosure says.

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I want to know that up front before you've received a dollar.

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You already have the arrangement.

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I have the arrangement, but... You think that you didn't have to do anything until you actually received that first check through that third party.

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No, that's just simply what the factual record is here.

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I know that there's the timing has been, they made a big issue of the timing in their brief, but that just is how the timing worked.

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By the time any money under this contract is paid, the disclosure had been made.

[00:13:12] Speaker 01:
The instruction requires a level of detail.

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It's not just check a box, yes.

[00:13:21] Speaker 01:
It says, generally describe the arrangement

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explain the conflict of interest and describe how you address them.

[00:13:30] Speaker 05:
I believe that's the general instructions for ADV.

[00:13:33] Speaker 01:
Right.

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That would seem to require some level of detail of just describing the conflict.

[00:13:39] Speaker 05:
Yes, I agree with that.

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But two things.

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First, those instructions did not exist until 2011.

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Second, again, it does say describe, but remember, the way, Form ADV is intentionally designed to give the advisor the discretion.

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In fact, at trial they called an SEC witness to talk about how the form works in practice, and she said it would be impossible to give guidance on how to do it because it can only be made on the facts and circumstances presented to the advisor with the knowledge of their business and their clients.

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And that is what they did with this disclosure.

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You want to save the rest for rebuttal?

[00:14:29] Speaker 05:
No, I'll continue.

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Okay, so turning from the standard of side to the standard of care to reasonableness.

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The second part of this is that the

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Commission essentially concludes that because of the words we chose in the ultimate disclosure, it was unreasonable because we didn't use what they said we should have done.

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Our failure to disclose these details that they've identified is unreasonable.

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And in doing so, they have ignored

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a tremendous amount of evidence to the contrary that shows how reasonable we were through this process.

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For example, that from the very beginning, we hired a compliance consultant, experts in the industry, to help us draft and craft these disclosures.

[00:15:14] Speaker 03:
The evidence in the record showed a specific disclosure of the details of the agreement with Fidelity to either of these compliance consultants and those compliance consultants' approval of your form.

[00:15:29] Speaker 05:
What the record shows was that while, and granted while the compliance consultant had no independent memory of seeing the agreement, what he testified was that he was well trained as a former SEC examiner to look for conflicts, that he was well trained that conflicts come from compensation.

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and that he was trained to, quote, follow the money.

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So while he could not remember one way or another being handed a copy of the agreement, that this would have been his normal business practice, and this would have been something... If it was given to him by the clients.

[00:16:01] Speaker 03:
Yes, but he also... Did the information, did he say that even if the client doesn't give me the information, I do some affirmative investigation of my own?

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What he said was that in assisting the clients in

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or Medivh in determining conflicts, that it was his practice to follow the money, to search for... What does that mean, follow the money?

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Does that mean when the client is the client... My assumption is these folks are hired by somebody, so they take the information they're given, and then they analyze in light, okay, you've told me what the potential issues are.

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and here's your forms and I will look at those.

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Is that how the process works?

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It could be that way.

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Is that how the process works?

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The process could work in a number of different ways.

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How does the process work here?

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What evidence in the record shows how the process worked here?

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The record here shows that, and unfortunately a lot of it has been lost due to the passage of time from the memory of the compliance consultant who

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met with the petitioners, but the record shows that this would have been a receipt of compensation.

[00:17:10] Speaker 03:
So you had your clients.

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Did your clients testify and say, yes, we specifically gave a copy of this fidelity agreement to Renaissance, explained to them what was going on, showed them our disclosure,

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and they approved it.

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Did your clients testify to that?

[00:17:29] Speaker 05:
Aside from the part about handing the agreement, discussing the arrangement, yes.

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But we don't know how they discussed the arrangement.

[00:17:35] Speaker 05:
We don't know how they discussed the arrangement.

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But there's no memory issue there.

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They could tell us how they discussed the arrangement with Fidelity, but they didn't put evidence in the record saying, we told Fidelity every single detail of this.

[00:17:47] Speaker 05:
Not every single detail, but the receipt of the compensation.

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And that is something that would have been easy to see for anyone looking at the money because this appears on their commission statements, fidelity 12B1 payments.

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There isn't a tremendous amount of money coming into the firm from different sources.

[00:18:05] Speaker 05:
So if you have your investment advisory fees coming in directly and then this money coming into the broker dealer, that's two sources.

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Anything further?

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I believe I'm out of time.

[00:18:27] Speaker 04:
Yes, we'll give you a couple of minutes in our bottle.

[00:18:51] Speaker 02:
May it please the Court, Daniel Matrow, for the Securities and Exchange Commission.

[00:18:56] Speaker 02:
When an investment advisor has a personal financial interest in the investments it recommends that strikes at the heart of the relationship of trust between the advisor and his clients,

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And the advisor has a fiduciary duty to disclose the potential conflict so that the investors can make an informed decision about whether to entrust their money with the advisor.

[00:19:16] Speaker 02:
Substantial evidence supports the commission's determination that the petitioners breach that duty here by failing to disclose the fidelity agreement.

[00:19:24] Speaker 02:
Petitioners don't dispute that they knew about the agreement and had a duty to disclose it.

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Instead, they argue that the commission failed to establish any applicable standard of care.

[00:19:35] Speaker 02:
But the relevant standard is set forth in Capital Gains and its progeny.

[00:19:39] Speaker 02:
Petitioners had as fiduciaries an affirmative duty to fully and fairly disclose the arrangement and the conflict of interest that it created.

[00:19:47] Speaker 01:
This is a question about extent of disclosure, whether it would have sufficiently informed the investors.

[00:19:58] Speaker 02:
I think at least up until December.

[00:20:01] Speaker 01:
At least as time goes on.

[00:20:03] Speaker 01:
At least up until December 2000.

[00:20:08] Speaker 01:
What if anything should we make of the fact that if you look at

[00:20:16] Speaker 01:
If you look at the number of clients and the amount of business that this company is involved in, it seems like these are high-net-worth individuals.

[00:20:28] Speaker 01:
They're probably sophisticated investors.

[00:20:31] Speaker 01:
Is that something we should look at in assessing whether the disclosure was sufficient?

[00:20:37] Speaker 02:
But the fact of an affirmative duty and the standard – the need to exercise reasonable care doesn't depend on the sophistication of the investor?

[00:20:47] Speaker 01:
No, but a sophisticated investor might be able to look at the 2011 disclosure and have alarm bells go off.

[00:20:58] Speaker 02:
But – so it may be – I mean, it may be that if you're dealing with a complex conflict of interest and there's a question about whether a sufficient amount of detail was used, then

[00:21:15] Speaker 02:
Perhaps among other circumstances, whether it was reasonable to disclose the conflict in a certain way, the level of sophistication of the investors might play in there.

[00:21:27] Speaker 02:
But here, we're talking about six, seven years, at least, where there was no disclosure at all of the agreement.

[00:21:34] Speaker 04:
No, but take the question as it was given.

[00:21:36] Speaker 04:
Sophisticated investors and the disclosure says, we may receive money.

[00:21:47] Speaker 04:
All right.

[00:21:48] Speaker 04:
Is that a red flag to the investor?

[00:21:50] Speaker 04:
He says, what's that all about?

[00:21:54] Speaker 02:
Well, not when what they say they may receive does not describe this arrangement at all.

[00:22:01] Speaker 02:
All they said they may receive is selling compensation in connection with facilitating securities transactions through Triad, their broker dealer, in their capacity as registered representatives of the broker dealer.

[00:22:15] Speaker 04:
But that doesn't do it.

[00:22:16] Speaker 04:
See, what I'm trying to understand is the notion that there have been requirements

[00:22:24] Speaker 04:
But the question is the adequacy of the disclosure.

[00:22:30] Speaker 04:
And if what Judge Katches was referring to was some level of detail, but how much?

[00:22:39] Speaker 04:
And did they have to actually say we have this arrangement?

[00:22:44] Speaker 04:
Or is it enough to say to the clients, you know, we may have some arrangements where we get kickbacks.

[00:22:53] Speaker 02:
I think when you actually have the arrangements and you're actually receiving payments continuously, you can't just say, we may be receiving payments.

[00:23:02] Speaker 04:
So it's the may.

[00:23:03] Speaker 02:
But in this case, I don't think the may is dispositive.

[00:23:06] Speaker 02:
That's an extra problem, the fact that they used may.

[00:23:09] Speaker 04:
What I'm trying to understand, though, is, and these are sophisticated people, sophisticated industry, all that kind of thing.

[00:23:16] Speaker 04:
But the point that is focused on is

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They were making disclosures, but they were not adequate.

[00:23:27] Speaker 04:
And so where do you find out, if you're the petitioners operating a business, what's adequate?

[00:23:36] Speaker 04:
Or do you think it's just QED?

[00:23:40] Speaker 02:
Well, so their capital gain says you have to fully and fairly disclose the conflict of interest.

[00:23:45] Speaker 02:
Here, the conflict of interest was straightforward.

[00:23:47] Speaker 02:
They had an incentive to recommend certain mutual funds over other funds, and they also had an incentive to stay with Fidelity as their custodian over other potential custodians.

[00:24:00] Speaker 02:
And they didn't – up until December 2011, they didn't disclose those payments or that arrangement at all.

[00:24:09] Speaker 02:
And so the commission reasonably concluded that that's just not good enough as a fiduciary.

[00:24:15] Speaker 02:
Those are obviously inadequate disclosures, and you don't need specific guidance as a fiduciary responsible to your clients to know that you actually have to say something that allows your client to discern the relevant conflict.

[00:24:30] Speaker 02:
And nothing in the disclosures of December 2011 would have enabled the client to discern that they were actually – the petitioners were actually getting paid in their advisory business to recommend certain funds and not others.

[00:24:44] Speaker 02:
And then you get to December 2011, and you have the fact that they said only that they may receive it, but they didn't describe, they didn't identify exactly which funds triggered payment.

[00:25:00] Speaker 03:
Well, they had to say may, because

[00:25:03] Speaker 03:
It wasn't clear to them which they didn't know which stocks would result in a payment and which investments would result in a payment and which ones would not.

[00:25:14] Speaker 03:
They said they didn't know and the commission accepted that and so they had to say may.

[00:25:19] Speaker 02:
But they knew they had this arrangement.

[00:25:22] Speaker 02:
They knew they were continuously receiving payments for a whole host of

[00:25:27] Speaker 02:
mutual funds, and there was no evidence of any real likelihood.

[00:25:33] Speaker 03:
From their mindset, it's like an accident.

[00:25:34] Speaker 03:
We don't know what triggers it or doesn't.

[00:25:36] Speaker 03:
We're not paying attention to it.

[00:25:38] Speaker 03:
No center finding.

[00:25:40] Speaker 03:
So they had to say May, didn't they, to be accurate?

[00:25:45] Speaker 02:
I think that would sort of create an incentive for them to remain ignorant about what it was.

[00:25:52] Speaker 03:
Whether or not there's no finding, the commission accepts that they did not have

[00:25:57] Speaker 03:
any kind of bad mindset here at all.

[00:26:01] Speaker 03:
I thought it had accepted, maybe if I misread the decision, that they didn't have.

[00:26:05] Speaker 02:
You're right.

[00:26:06] Speaker 02:
So May, in the December 2011 disclosure, the use of the word May is not the primary component element.

[00:26:14] Speaker 03:
It's asking whether it's a problem at all.

[00:26:17] Speaker 02:
It was the representation that they were not receiving any economic benefit from a non-client.

[00:26:23] Speaker 02:
for investment advisory services, which was not true.

[00:26:28] Speaker 02:
And it was the fact that they did not, they did not state what it was that was triggering, what kinds of funds were triggering the payments.

[00:26:40] Speaker 02:
And so an investor looking at that disclosure wouldn't be able to know, okay, it's the, okay, it's non-fidelity NTF funds.

[00:26:50] Speaker 02:
that are triggering this payment requirement.

[00:26:53] Speaker 03:
I take it your position is that first, sorry, since JA 786, that first line on December 2011, we do not receive an economic benefit from a non-client for providing investment advice or other advisory services to our clients.

[00:27:09] Speaker 03:
So that was just flatly wrong.

[00:27:11] Speaker 02:
Yeah, that's the Commission's finding is that's not true and they were, the fact is they were

[00:27:18] Speaker 04:
And somehow that remains on the latest report.

[00:27:20] Speaker 02:
Yeah.

[00:27:22] Speaker 02:
And so the commission's finding of a lack of exercise of reasonable care is predicated on the fact that the disclosures were obviously inadequate for a long period of time.

[00:27:35] Speaker 02:
They simply didn't disclose the arrangement.

[00:27:38] Speaker 02:
And even when Fidelity flagged that to them and said, look,

[00:27:41] Speaker 02:
When we looked at these disclosures, the arrangement is not here, they continued to leave out some key details to help their clients figure out what it was, what was the nature of the conflict of interest.

[00:27:56] Speaker 03:
You can just help me with one other thing though, but do you consider the April 2014 disclosure to be adequate?

[00:28:02] Speaker 02:
The commission didn't make an explicit finding on the adequacy of that, but it said that it was at least up until April 2014 the disclosures were inadequate, and that was the only basis for... It has that same opening sentence.

[00:28:15] Speaker 02:
It has the same opening sentence.

[00:28:17] Speaker 02:
The commission didn't base its liability finding or its sanctions on April 2014.

[00:28:24] Speaker 03:
It didn't make an explicit... It's kind of weird if the problem is the sentence.

[00:28:29] Speaker 02:
Yeah, I mean, I think it was... Sorry.

[00:28:34] Speaker 02:
I think the Commission was considering the fact that it was finally in April 2014 where they described the specific conflict, what kinds of funds were triggering the payments, which are non-fidelity NTF funds.

[00:28:49] Speaker 02:
And they also described the other conflict, which was that they had an incentive to choose fidelity as their custodian.

[00:28:56] Speaker 03:
Does a cease and desist order allow them to continue repeating that first sentence?

[00:29:06] Speaker 02:
They would be advised, whether the cease and desist order or not existed, they would be advised not to have anything in their disclosures that were misstatements.

[00:29:17] Speaker 03:
Does the cease and desist – I'm just trying to understand what's going on here.

[00:29:22] Speaker 03:
Because it sounds like you're relying on that sentence until we get to April 2014, and then it's like, it's OK.

[00:29:29] Speaker 03:
So.

[00:29:30] Speaker 02:
Well, so the civil penalties are based on the complete failure to disclose up until December 2.

[00:29:35] Speaker 03:
No, but I'm talking about there is a cease and desist order as well.

[00:29:38] Speaker 02:
And there is a cease and desist order.

[00:29:40] Speaker 03:
It's the jump to command.

[00:29:42] Speaker 03:
And so to the extent they've perpetuated that language under the cease and desist order, is that violating the cease and desist order or not?

[00:29:50] Speaker 02:
I haven't looked at their current disclosures potentially.

[00:29:56] Speaker 02:
Potentially it could, but I don't want to make any representations one way or the other.

[00:30:01] Speaker 02:
I haven't seen how they've continued to update their disclosures.

[00:30:07] Speaker 01:
Could I ask you about the Section 207 count that we're done with?

[00:30:16] Speaker 01:
There's not a whole lot of reasoning in the commission's order.

[00:30:21] Speaker 01:
And to the extent there is any reasoning, it seems to be that they're on the hook because they willfully filed the forms.

[00:30:31] Speaker 01:
But what the statute requires in this case is that they willfully omitted material facts, correct?

[00:30:40] Speaker 01:
You agree with that much?

[00:30:41] Speaker 02:
Yes, that's right.

[00:30:42] Speaker 01:
So at a minimum, doesn't

[00:30:45] Speaker 01:
don't we have to vacate the finding of liability on the 207 count?

[00:30:52] Speaker 02:
No, I think the Commission's finding of willfulness is supported, willfulness in this context and the securities context.

[00:30:59] Speaker 01:
It's flatly inconsistent with the Commission's findings that, right, it's the same conduct underlying both counts, which is the adequacy of the disclosure on that form.

[00:31:15] Speaker 01:
And in one count, liability is triggered because it's given to the investors.

[00:31:21] Speaker 01:
And in the other count, liability is triggered because it's given to the commission.

[00:31:27] Speaker 01:
And the commission says, we find nothing worse than negligence.

[00:31:33] Speaker 01:
We don't find c-enter.

[00:31:35] Speaker 01:
So how could there possibly be a liability for willfully

[00:31:40] Speaker 01:
omitting material facts.

[00:31:42] Speaker 02:
I think, Your Honor, because in this context, this court and other courts have said that willfulness doesn't look to the state of mind, doesn't depend on the state of mind of the perpetrator.

[00:31:54] Speaker 02:
To act willfully means to intentionally commit the act that constitutes the violation.

[00:31:59] Speaker 01:
Which is failing to disclose a material fact.

[00:32:04] Speaker 02:
Which is preparing a

[00:32:08] Speaker 02:
form ADV, which does not contain a material fact.

[00:32:13] Speaker 02:
And there's ample evidence that they participated in, that they were responsible for drafting ADV.

[00:32:22] Speaker 01:
Sure, sure, but your own findings are that, with regard to mens rea, that they did nothing worse than act negligently.

[00:32:33] Speaker 01:
They didn't make the omission willfully, nor did they make it recklessly.

[00:32:39] Speaker 03:
or intentionally.

[00:32:40] Speaker 02:
And I guess I would just go back to once over and other cases, which make clear that all that matters, it doesn't matter whether you knowingly do it, whether you have science or when you're committing the act that constitutes the violation.

[00:32:56] Speaker 02:
What matters is that you are aware of what you're doing.

[00:33:00] Speaker 01:
You need either science or at a minimum recklessness.

[00:33:05] Speaker 02:
I don't think Wants Over stands for that.

[00:33:08] Speaker 02:
In other cases, interpreting Wants Over or applying willfulness.

[00:33:11] Speaker 01:
So willfulness means negligence.

[00:33:15] Speaker 01:
And that has to be your position, because that's all the commission found here.

[00:33:19] Speaker 02:
Willfulness means that you

[00:33:23] Speaker 02:
that you intentionally committed the act that constitutes the violation.

[00:33:29] Speaker 01:
And the act is failing to disclose.

[00:33:33] Speaker 02:
And they were aware of the language they participated in drafting of the specific disclosures here.

[00:33:42] Speaker 02:
And that is sufficient, just like the 11th Circuit said in ZPR investment management.

[00:33:48] Speaker 02:
It interpreted 203e, willfulness in 203e, the exact same way.

[00:33:54] Speaker 02:
It didn't find a science or based or recklessness or science or based violation or a failure misstatement.

[00:34:04] Speaker 02:
But it said that because the advisor was

[00:34:07] Speaker 02:
involved in creating those advertisements knew what they said, that was enough to trigger willfulness under Section 203E.

[00:34:16] Speaker 02:
And other courts, the courts cited in Wants Over and other courts have made clear that it's not, it is not a science-based consideration.

[00:34:26] Speaker 03:
And there's a reason- Well, they seem, I guess as I had read it, they were saying, look, it's not the super high level of science that you have to know it violates the law to do it, but you have to know

[00:34:36] Speaker 03:
you're doing the wrongful act.

[00:34:39] Speaker 03:
And as you keep saying that they intentionally committed the act, which constitutes a violation.

[00:34:44] Speaker 03:
And so doesn't that mean they would have to intend to not disclose the conflict?

[00:34:52] Speaker 02:
I don't think so.

[00:34:52] Speaker 02:
They have to know they were doing the act of submitting the form ADV and submitting these disclosures.

[00:34:59] Speaker 03:
But they didn't have to know.

[00:35:00] Speaker 03:
Well, they don't even have to be negligent.

[00:35:01] Speaker 03:
They don't even have to be negligent.

[00:35:03] Speaker 02:
They just have to know they're mailing in a form.

[00:35:04] Speaker 02:
Yeah, they don't have to know that the disclosures are omitting a material fact.

[00:35:08] Speaker 02:
That's what Monsover and other cases say.

[00:35:10] Speaker 02:
They don't need to know that.

[00:35:12] Speaker 01:
They just need to know the statute says they have to not willfully.

[00:35:16] Speaker 01:
It doesn't say willfully file the form.

[00:35:19] Speaker 01:
It says willfully omit the material fact.

[00:35:23] Speaker 01:
Whatever is the relevant level of scienter, it attaches to the concealment, not the filing of the form.

[00:35:38] Speaker 02:
I think to willfully admit something in the securities context is to draft a disclosure that does not contain the material fact that you have to – that you have to disclose.

[00:35:50] Speaker 03:
And I think it makes sense that –

[00:35:56] Speaker 03:
obviously omitting in that typing the actual conflict, just types it up, will that person have willfully, and then mails it to the commission, will that person have willfully violated it because they submitted this form knowing they submitted a form and the form didn't include a material disclosure?

[00:36:16] Speaker 02:
I mean, I think that

[00:36:19] Speaker 03:
I would have hoped it would have been an easy no.

[00:36:22] Speaker 02:
Yeah, I mean that's a no because, you know.

[00:36:24] Speaker 03:
Because she didn't know, she didn't intend to submit.

[00:36:29] Speaker 02:
She was not responsible for submitting, for drafting the language in those forms.

[00:36:35] Speaker 02:
She may have been asked to type it out and submit it, but she was not responsible for choosing the language, which petitioners here, you know,

[00:36:47] Speaker 02:
testified about how they chose this language.

[00:36:50] Speaker 03:
So they have someone in their office who's responsible for filing these forms with the SEC, and some – you have a bad actor.

[00:37:01] Speaker 03:
The bad actor doesn't tell the person who's in charge of filing forms with the SEC about the bad acts.

[00:37:07] Speaker 03:
And so the person who's responsible for filing the forms

[00:37:10] Speaker 03:
does them and necessarily omits the material fact of what this bad actor is doing, is that person's responsibility to do it?

[00:37:19] Speaker 03:
Is that person A, whose responsibility it is to do it, liable?

[00:37:24] Speaker 02:
Is person A in your scenario, is that the advisor?

[00:37:26] Speaker 03:
Person A is my job to file these forms.

[00:37:29] Speaker 03:
That's my job.

[00:37:30] Speaker 03:
I am the commission form filer.

[00:37:32] Speaker 03:
That's my job.

[00:37:33] Speaker 03:
I'm responsible for them.

[00:37:34] Speaker 03:
I type them up.

[00:37:35] Speaker 03:
I prove freedom.

[00:37:36] Speaker 03:
I make sure they have all the requirements of the form that the commission requires.

[00:37:41] Speaker 03:
I check all that, make sure all the requirements are there.

[00:37:44] Speaker 03:
But I don't know that in fact there's a bad actor over here doing some very bad things.

[00:37:49] Speaker 03:
And so I'm not aware that when I said not getting money, that actor B over here has taken bribes.

[00:37:56] Speaker 03:
Did that person violate the statute?

[00:37:59] Speaker 03:
I think actor A, person A, whose job is to file the forms.

[00:38:02] Speaker 03:
I think that's a different case because that person... It is a different case, but is that person willfully violating, are they committing a violation of B7?

[00:38:11] Speaker 02:
I think probably not, because unlike here, you can't show that that person chose that language, was aware of the facts and chose that language.

[00:38:26] Speaker 03:
I chose that language.

[00:38:26] Speaker 03:
It was my job to choose the language.

[00:38:28] Speaker 02:
And was aware of the underlying facts and had the duty.

[00:38:33] Speaker 03:
Aware of.

[00:38:34] Speaker 03:
So you have to be aware that something's being violated.

[00:38:37] Speaker 02:
No, you don't have to be aware that anything is violated.

[00:38:40] Speaker 02:
But you have to be, in this case, the petitioners were aware that they had the disclosure, aware of the requirement to disclose, and aware of the language that they chose and the facts underlying the language that they chose.

[00:38:56] Speaker 02:
And so they were not asked to do anything by someone else who was maybe hiding facts.

[00:39:02] Speaker 04:
So go back to Judge Katz's point or question, if you will.

[00:39:07] Speaker 04:
He says the same conduct is underlying the violations of both sections.

[00:39:15] Speaker 04:
So in the first 2062 violation, it's that although they had a fiduciary duty, although they knew that this arrangement and fidelity is something their clients would want to know because of potential conflict of interest, they were negligent

[00:39:39] Speaker 04:
in not disclosing it.

[00:39:43] Speaker 04:
They didn't have any intent to harm, but they were negligent.

[00:39:49] Speaker 04:
So then we come to 207, and the commission says, essentially, and back to my point about they acknowledged this arrangement was material.

[00:40:05] Speaker 04:
The forum asked them to fill it out or to disclose it.

[00:40:11] Speaker 04:
They knew about it.

[00:40:14] Speaker 04:
They were responsible for the content.

[00:40:20] Speaker 04:
They reviewed each of the forms before filing.

[00:40:24] Speaker 04:
And Robare had authority over their content, and Jones signed each of them.

[00:40:33] Speaker 04:
So that's not your secretary or your administrator.

[00:40:36] Speaker 04:
That's the fiduciary.

[00:40:38] Speaker 02:
Yeah, exactly.

[00:40:40] Speaker 04:
But what's your response to Judge, I guess I know what it is, but to Judge Katz's point that you can't be negligent as to non-disclosures to your client and also be willful

[00:40:59] Speaker 04:
in failing to disclose something to the Commission?

[00:41:04] Speaker 02:
I guess my answer is that these are two different provisions serving two different purposes, and the purpose of Section 207 is to ensure that the Commission is getting accurate information in reports, forms that are critical to its enforcement and administration of the Act, and

[00:41:24] Speaker 02:
Congress used the word willful to make sure that the – to limit the provision to only those who are actually aware of and doing the act and not – this was not inadvertent.

[00:41:42] Speaker 02:
They weren't – it wasn't by accident.

[00:41:46] Speaker 02:
This was – these were the fiduciaries themselves who knew the underlying facts.

[00:41:51] Speaker 02:
prepared the disclosures and intentionally chose the language in the disclosures, and that the commission needs those people to provide accurate information so that it can enforce the act.

[00:42:05] Speaker 02:
And throughout the securities laws and other contexts, committed the – So on your theory

[00:42:12] Speaker 01:
It is easier to establish liability under a provision that by its terms has a willfulness requirement than it is to establish liability under a different provision for which the Supreme Court has said negligence is enough.

[00:42:34] Speaker 01:
That's very strange.

[00:42:36] Speaker 02:
But I think that follows from the courts that have interpreted willfully.

[00:42:40] Speaker 02:
I mean, the commission has to find willfulness in order to impose certain sanctions, and it often gets past that willfulness barrier to impose sanctions on conduct that is at least in part negligent.

[00:42:56] Speaker 02:
So under section

[00:42:59] Speaker 02:
203e, for example, you need to have willful conduct in order to impose a bar and other sorts of remedies.

[00:43:11] Speaker 02:
And courts have long understood that you don't need to show science or some sort of intent or knowing

[00:43:20] Speaker 02:
conduct to get past that.

[00:43:23] Speaker 01:
Once over says you need to know the defendant needs to know what he is doing, right?

[00:43:30] Speaker 01:
That's the canonical formulation of willfulness.

[00:43:34] Speaker 01:
And what he is doing in the 207 context is failing to disclose a material fact.

[00:43:44] Speaker 01:
Now, if you had put these defendants, if you had asked these defendants at the time, are you omitting a material fact from this disclosure?

[00:44:03] Speaker 01:
Under your own assessment of this record they would have truthfully said no because they were mistakenly they mistakenly and Negligently believed that the disclosures were good enough, but there was nothing worse than that I think that's the same thing your honor as asking whether they knew that the conduct was wrong and that's what's not required under willfulness if they knew they were

[00:44:26] Speaker 02:
failing to disclose a material fact, they would know that they were not complying with the law.

[00:44:34] Speaker 02:
But that's not all they need to know.

[00:44:35] Speaker 01:
I didn't say anything about complying with the law.

[00:44:38] Speaker 01:
They wouldn't have to know the first thing about 207.

[00:44:44] Speaker 01:
They would have to know that they're not disclosing something.

[00:44:48] Speaker 02:
But I guess I see those as functionally equivalent.

[00:44:53] Speaker 02:
If they knew they were omitting a material fact, that would...

[00:45:00] Speaker 02:
That's essentially requiring that they know that something was wrong about their conduct.

[00:45:06] Speaker 02:
And they knew, they specifically chose the language, they testified that they worked with their compliance consultants to choose this specific language.

[00:45:14] Speaker 04:
And I think that's all that willfulness requires.

[00:45:16] Speaker 04:
Just to be clear that whatever intent is needed, once they have acknowledged that the arrangement is material, that's

[00:45:30] Speaker 04:
all the, quote, intent that's necessary to show willfulness in terms of what they put on the form.

[00:45:40] Speaker 04:
In other words, back to their point, they thought they testified.

[00:45:46] Speaker 04:
They believed they had disclosed it.

[00:45:49] Speaker 04:
So I understand the commission's point, basically.

[00:45:52] Speaker 04:
It doesn't matter what they believed.

[00:45:54] Speaker 04:
They knew the arrangement of material to their investors.

[00:46:00] Speaker 04:
They didn't disclose it.

[00:46:04] Speaker 04:
But there was no intent to harm their investors.

[00:46:09] Speaker 04:
It was what it was.

[00:46:14] Speaker 04:
It's not sloppiness, they say, because they've got all these consultants.

[00:46:18] Speaker 04:
That's a question to say.

[00:46:19] Speaker 04:
And the commission found the client's petitioners never testified that they

[00:46:27] Speaker 04:
receive the necessary assurances that they needed.

[00:46:32] Speaker 04:
So then we get to 207, and it's just if you know about the arrangement and you don't mention it, that's all the willfulness that's needed.

[00:46:47] Speaker 02:
Yeah, 207 is there to make sure that the commission is getting all material facts in these forms and not...

[00:46:56] Speaker 04:
what I understand Judge Katz's implications of this question.

[00:47:01] Speaker 04:
So Congress and the Commission have decided it's more important that the Commission get the information than the client.

[00:47:10] Speaker 04:
Because we're relying on the fiduciary duty as to the client.

[00:47:15] Speaker 04:
And of course, if the Commission finds out about this and starts an investigation or does some type of enforcement action,

[00:47:25] Speaker 04:
that will protect the client.

[00:47:27] Speaker 04:
So it really is more important that the Commission get this information.

[00:47:33] Speaker 04:
So it is a strict liability in that sense.

[00:47:36] Speaker 02:
Again, I think they're serving different functions.

[00:47:39] Speaker 02:
207 applies to all material facts, all statements and omissions of material fact.

[00:47:44] Speaker 02:
206 here involves, we're talking about conflicts of interest, and there's an affirmative duty in every case as an investment advisor to disclose material facts to your clients.

[00:48:03] Speaker 02:
So it's not,

[00:48:07] Speaker 02:
You know, the requirement is still there in both cases.

[00:48:13] Speaker 02:
As an investment advisor, you have to provide the material facts to your clients and to the commission.

[00:48:18] Speaker 02:
And if you willfully fail to do so... What work is willfully doing?

[00:48:25] Speaker 02:
I think it's ensuring that the

[00:48:31] Speaker 01:
That there's no liability if you file through sleepwalking.

[00:48:38] Speaker 02:
Or if certain information or facts crept into a report without someone knowing, or if someone was not responsible for the disclosures and was only tangentially

[00:48:54] Speaker 02:
involved, they need to be the ones who willfully omitted the fact, and I think that means they needed to be involved – intimately involved in providing the disclosure to the commission, and not everybody is going to be here.

[00:49:10] Speaker 02:
It was petitioners themselves.

[00:49:14] Speaker 02:
the commission was able to show how the record shows how involved they were in that process and they didn't need to know the facts that they were omitting material facts because that's essentially saying they needed to know that they were doing something wrong.

[00:49:33] Speaker 01:
But the statute only applies, oh no, I'm sorry, I'm looking at

[00:49:44] Speaker 01:
I'm looking at 203, but liability wouldn't attach unless there were personal involvement, right?

[00:49:53] Speaker 02:
Under?

[00:49:54] Speaker 01:
Under 207.

[00:49:57] Speaker 02:
Under 207?

[00:49:58] Speaker 02:
Yeah.

[00:50:00] Speaker 01:
Yeah.

[00:50:02] Speaker 01:
So to say, well, the work that Willfully is doing is cutting off liability from people who aren't, it's not a great answer.

[00:50:15] Speaker 01:
I'm just saying the only circle of people who can be liable are people who are involved in making the disclosure.

[00:50:29] Speaker 01:
If they're not involved in making the disclosure, they're not covered by 207 anyway.

[00:50:39] Speaker 01:
Yeah.

[00:50:40] Speaker 02:
So then what remains unclear what work willfully – the word willfully – What this court said in Wansover and what other courts have said in other contexts in the securities laws is it's ensuring that the individual intentionally

[00:50:59] Speaker 02:
committed the act, and that may be a pretty broad standard, but in the securities context it makes sense.

[00:51:07] Speaker 02:
It makes sense in the 207 context because of the importance of getting accurate information to the Commission, and it makes sense in the 203 context because there are other checks on

[00:51:19] Speaker 02:
once you pass that, the willfulness threshold, then you take into account the severity of the conduct, whether it's negligence or scionter.

[00:51:29] Speaker 02:
There are other opportunities to take that into account, but if you basically import a scionter standard into willfulness, I think that will have a serious impact in other contexts that would be inconsistent with the way the commission, with the way courts and certainly the commission for a long period of time

[00:51:49] Speaker 02:
have interpreted willfulness.

[00:51:54] Speaker 04:
Anything further?

[00:51:56] Speaker 02:
I'm happy to answer any additional questions on the sanctions.

[00:52:00] Speaker 02:
We believe the commission reasonably considered the relevant factors.

[00:52:05] Speaker 02:
And otherwise, we would ask the court to deny the petition for review.

[00:52:12] Speaker 04:
And as far as your last comment on 207,

[00:52:16] Speaker 04:
all the citations to support that are in your brief.

[00:52:20] Speaker 02:
Yeah, we discussed.

[00:52:22] Speaker 04:
Well, I mean, both that the Commission has long understood this and that in other contexts, Commission forms have been

[00:52:30] Speaker 04:
understood in this manner, and courts have.

[00:52:33] Speaker 04:
I know you mentioned the 11th Circuit case, but.

[00:52:36] Speaker 02:
Well, so we certainly cite Wansover, and Wansover itself describes the long history of the interpretation of lawfulness, and you can find it there in the commission order in the case, cites other orders, I believe, where there's further discussion.

[00:52:51] Speaker 02:
One other point I forgot to make.

[00:52:52] Speaker 04:
I just want to be clear.

[00:52:54] Speaker 04:
Your view is that Wansover is dispositive.

[00:52:57] Speaker 04:
And I think what you're hearing from some of the questions is,

[00:53:01] Speaker 04:
I don't know how to say it but maybe.

[00:53:05] Speaker 04:
some questions about that.

[00:53:08] Speaker 02:
And I guess, and I would point the court to ZPR investment, 861 F-3, 1239, which interpret.

[00:53:15] Speaker 02:
That's the 11th Circuit.

[00:53:17] Speaker 02:
That's the 11th Circuit, interpret 203E in this way.

[00:53:20] Speaker 02:
There's another district court opinion that cites a bunch of cases, appellate level cases.

[00:53:26] Speaker 02:
Which district?

[00:53:27] Speaker 02:
KW Brown and Company, I think it's the Southern District of Florida, 555 F-SUP 2D, 12th, 2nd.

[00:53:35] Speaker 02:
Pardon?

[00:53:36] Speaker 04:
That's in your brief?

[00:53:38] Speaker 02:
I don't think we cited this district court opinion in the brief.

[00:53:41] Speaker 04:
So what is the citation?

[00:53:43] Speaker 02:
555 F sub second 1275.

[00:53:48] Speaker 02:
And it's interpreting 207 in the manner that we do, the commission did here.

[00:53:52] Speaker 02:
And it's citing, I believe it cites once over and other federal appellate cases for the proposition.

[00:54:01] Speaker 04:
And did you come over any cases interpreting 213?

[00:54:05] Speaker 04:
at talking about the lawfulness and penalties.

[00:54:09] Speaker 02:
213 of the Advisors Act.

[00:54:14] Speaker 02:
Not off the top of my head, Your Honor.

[00:54:15] Speaker 02:
If I could just make one last point to Judge Katzis.

[00:54:19] Speaker 02:
I think you asked opposing counsel whether there was a requirement to describe the arrangement in dating back already in 2004.

[00:54:29] Speaker 02:
And I just wanted to point out that, yes, they were required to describe the arrangement in the 2004 form A to B.

[00:54:35] Speaker 02:
Thank you, Your Honors.

[00:54:37] Speaker 02:
Thank you.

[00:54:38] Speaker 04:
Council for petitions?

[00:54:47] Speaker 05:
Very briefly, in response to two things that came up when Council was speaking, is that he mentioned several times, used the phrase, obviously inadequate.

[00:54:54] Speaker 05:
The disclosures were obviously inadequate, and I'm sure you saw that apply.

[00:54:57] Speaker 05:
That comes over and over again in their brief.

[00:55:00] Speaker 05:
But the phrasing of these disclosures where you're talking about whether or not the words that were used were sufficient in a facts and circumstances analysis where you defer discretion on how to do something to the advisor just doesn't comport with the standard today.

[00:55:18] Speaker 05:
that they're obviously inadequate, right?

[00:55:20] Speaker 05:
You have something that isn't inherently determinative on a variety of factors compared to the position today that it obviously didn't meet whatever standard that that was.

[00:55:33] Speaker 05:
And the other point I would like to make in response is to remember that in the absence

[00:55:38] Speaker 05:
of the articulated standard by the government as to how this should have been made.

[00:55:42] Speaker 05:
At the time they were drafting these disclosures, what words or phrases should they have picked and how would they know that at the time?

[00:55:49] Speaker 05:
Remember, we did put in evidence in the record.

[00:55:51] Speaker 05:
We had an expert witness that talked about the industry standard at the time, how the industry reacted

[00:55:56] Speaker 05:
to the questions, how the industry grappled with these issues.

[00:55:59] Speaker 05:
And that is something that can be taken into consideration when determining what the standard is.

[00:56:05] Speaker 05:
In addition, we had the testimony of Triad, which was their broker-dealer.

[00:56:09] Speaker 05:
And there's no dispute.

[00:56:10] Speaker 05:
We spoke about the compliance consultants.

[00:56:12] Speaker 05:
But there's no dispute as to whether or not Triad was aware of this agreement, because for the majority of the time period, they were a party to it.

[00:56:19] Speaker 05:
And there's no question that they were reviewing the forms ADV

[00:56:22] Speaker 05:
And we've quoted the testimony from the compliance consultant in our brief.

[00:56:27] Speaker 05:
And that's important because when you're talking about the how of it and whether or not the way that they did it, even if different than another way it could have been done, is inadequate.

[00:56:38] Speaker 05:
And the absence of parameters by which to judge that, I think it's obviously inadequate.

[00:56:45] Speaker 05:
It's just an oversimplification of real life, what these individuals are trying to do.

[00:56:51] Speaker 05:
Thank you.