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In Securities & Exchange Commission v. Goble,
2012 WL 1918819 (11th Cir. May 29, 2012), the United States
Court of Appeals for the Eleventh Circuit held that the
recording of a sham transaction in the corporate books did not
constitute "securities fraud" in violation of Section 10(b) of the Securities Exchange Act of
1934 ("Exchange Act"), 15 U.S.C. § 78j(b), and Securities &
Exchange Commission ("SEC") Rule 10b-5, 17 C.F.R. § 240.10b-5, because
"a misrepresentation that would only influence an
individual's choice of broker-dealers cannot form the basis for
§ 10(b) securities fraud liability." In so holding, the
Eleventh Circuit declined "the SEC's invitation to expand
[the] definition of materiality" to capture the
misrepresentation.
Richard Goble founded and controlled North American Clearing,
Inc. ("North American"), a clearing broker for about
forty small brokerage firms which cleared transactions for more
than 10,000 customer accounts valued at more than $500 million.
During late 2007 and early 2008, North American faced declining
revenues, and allegedly struggled to meet its operating expenses
and make required contributions to its cash reserve account as
required by SEC regulations. Finally, in May 2008, Goble directed
the CFO of North American to record a sham transaction —
a $5 million money market purchase — to make it appear
that North American could withdraw $3.4 million from its cash
reserve account. Financial Industry Regulatory Authority, Inc.
examiners discovered a discrepancy created by the sham money market
purchase and demanded an explanation. An SEC enforcement action
followed, charging that North American violated the Customer Protection Rule under Section 15(c)(3)
of the Exchange Act, 15 U.S.C. § 78o(c)(3), codified in SEC
Rule 15c3-3, 17 C.F.R. § 240.15c3-3, and the Exchange
Act's books and records requirements under Section
17(a) of the Exchange Act, 15 U.S.C. § 78q(a), codified in SEC
Rule 17a-3, 17 C.F.R. § 240.17a-3. The SEC also charged Goble
with violating Rule 10b-5 (in addition to aiding and abetting the
firm's alleged securities law violations).
The SEC settled with North American, but not Goble personally.
After trial, the United States District Court for the Middle
District of Florida held that Goble's actions concerning
the sham money market transaction violated Section 10(b) and Rule
10b-5 (in addition to aiding and abetting the firm's
violations). The district court enjoined Goble from future
violations of the securities laws and permanently restrained him
from seeking a securities license or engaging in the securities
business.
On appeal, the Eleventh Circuit reversed the district
court's judgment on the Section 10(b) count, upheld the
judgment on the aiding and abetting count and remanded for
reconsideration of the injunctive relief and the bar.
The Eleventh Circuit "easily dispatched" the SEC's
allegation that Goble's recording of a sham transaction was a
"material misrepresentation" under the Exchange Act. The
Court held that the materiality test focuses on whether a
reasonable person would attach "importance" to the fact
misrepresented in determining a "course of action." The
Eleventh Circuited noted that it understood this "course of
action" to mean an "investment decision — not
an individual's choice of broker-dealers." Thus, "a
misrepresentation that would only influence an individual's
choice of broker-dealers cannot form the basis for a §10(b)
securities fraud liability." The Eleventh Circuit also held
that even if Goble had made a "material
misrepresentation," that misrepresentation was not made
"in connection with the purchase or sale of securities,"
even though it assumed, without deciding, that the money market
fund was a security. The Eleventh Circuit also noted that even
though the United States Supreme Court has instructed that
Section 10(b) be construed "flexibly to effectuate its
remedial purposes" (SEC v. Zandford , 535 U.S. 813, 819, (2002)),
Goble did not engage in an actual "purchase" of a
security for purposes of Section 10(b). Since the only
"purchase" was a sham transaction, it was neither a
"purchase" nor "the type of fraudulent behavior
which was meant to be forbidden by the statute and the
rule."
This decision reflects than an investor's choice of
broker-dealer is not "material" because it does not
relate to an "investment decision." In so holding, the
Eleventh Circuit constricted the reach of Section 10(b) of the
Exchange Act and tightened the standards for issuing an injunction,
precluding "obey the law" orders which have long been a
staple of SEC enforcement.
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