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Malouf v. Securities and Exchange Commission

United States Court of Appeals, Tenth Circuit

August 13, 2019

DENNIS J. MALOUF, Petitioner,
v.
SECURITIES AND EXCHANGE COMMISSION, Respondent.

          Petition for Review from an Order of the Securities & Exchange Commission (SEC No. 3-15918)

          Kenneth F. Berg, Ulmer & Berne LLP, Chicago, Illinois (Alan M. Wolper and Heidi E. VonderHeide with him on the briefs), for Petitioner.

          Daniel Aguilar, Attorney, Appellate Staff, Civil Division, United States Department of Justice, Washington, D.C. and Lisa Helvin, Senior Counsel, Securities and Exchange Commission, Washington, D.C. (Chad A. Readler, Acting Assistant Attorney General, Mark R. Freeman, Attorney, and Joshua A. Salzman, Attorney, Appellate Staff, Civil Division, United States Department of Justice, Washington, D.C.; Michael A. Conley, Solicitor, and Dominick V. Freda, Assistant General Counsel, Securities and Exchange Commission, Washington, D.C., with them on the briefs), for Respondent.

          Before BRISCOE, HARTZ, and BACHARACH, Circuit Judges.

          BACHARACH, CIRCUIT JUDGE.

         Mr. Dennis Malouf occupied key roles at two firms. One of the firms (UASNM, Inc.) offered investment advice; the other firm (a branch of Raymond James Financial Services) served as a broker-dealer. Raymond James viewed those dual roles as a conflict, so Mr. Malouf sold the Raymond James branch. But the structure of the sale perpetuated the conflict. Because Mr. Malouf did not disclose perpetuation of the conflict, administrative officials sought sanctions against him for violating the federal securities laws.

         An administrative law judge found that Mr. Malouf had violated the Securities Exchange Act of 1934, the Securities Act of 1933, the Investment Advisers Act of 1940, Rule 10b-5, and Rule 206(4)-1. Given these findings, the judge imposed sanctions. The SEC affirmed these findings and imposed additional sanctions, including disgorgement of profits.

         Mr. Malouf appeals the SEC's decision, and we affirm.

         Background

         I. Mr. Malouf sells the Raymond James branch and uses that branch to execute trades for UASNM's clients.

         In 2007, Raymond James became concerned about the conflict of interest between (1) Mr. Malouf's role at its branch office and (2) his role at UASNM. These concerns led Raymond James to ask Mr. Malouf to choose between the two roles. Mr. Malouf opted to remain at UASNM and sold his Raymond James branch to Mr. Maurice Lamonde for roughly $1.1 million, to be paid in installments based on the Raymond James branch's collection of securities-related fees.[1]

         To facilitate the installment payments, Mr. Malouf routed bond trades on behalf of his UASNM clients through the Raymond James branch. This way, Mr. Lamonde would receive enough in commissions to allow him to pay what he owed Mr. Malouf.[2]

         While Mr. Malouf was routing bond trades to the Raymond James branch, he regularly failed to seek competing bids for the trades. Mr. Malouf conceded that he should have sought competing bids: UASNM's compliance procedures required firm personnel to solicit bids from three different broker-dealers before placing a trade, and Mr. Malouf admitted that he probably could have received better prices for his clients through competing bids.

         II. UASNM makes misstatements concerning Mr. Malouf's conflict of interest, and he does not correct these misstatements.

         Mr. Malouf bore responsibility for preparing UASNM's forms to be filed with the SEC (referred to as "Forms ADV")[3] and ensuring the accuracy of the UASNM website. But UASNM delegated compliance with these responsibilities to a chief compliance officer and hired an outside consultant to review UASNM's compliance procedures and Forms ADV.

         Mr. Malouf later acknowledged that his financial arrangement with Mr. Lamonde had created a conflict of interest that should have been disclosed. But Mr. Malouf did not disclose that arrangement to UASNM's chief compliance officer or the outside consultant. Because these individuals did not know the details of the Malouf-Lamonde arrangement, UASNM not only failed to disclose Mr. Malouf's conflict of interest but also boasted that (1) UASNM's employees were not receiving any commissions or fees from the Raymond James branch and (2) UASNM was providing impartial advice untainted by any conflicts of interest.

         While UASNM was boasting of its impartiality, Mr. Malouf was participating in deciding what UASNM would disclose. He acknowledged that he had reviewed some of the Forms ADV for what to disclose and had at least some familiarity with the contents of the website. But he took no steps to remedy UASNM's misstatements or to disclose his own conflict of interest.

         III. UASNM discloses Mr. Malouf's conflict of interest.

         In June 2010, UASNM's outside consultant learned that Mr. Malouf had been receiving ongoing payments from Mr. Lamonde. With this information, the consultant told Mr. Malouf and UASNM that the payments had created a conflict of interest that needed to be disclosed. UASNM disclosed the conflict roughly nine months later.

         IV. The SEC finds that Mr. Malouf violated the federal securities laws.

         The SEC then brought an enforcement proceeding against Mr. Malouf. Based on the evidence introduced in that proceeding, an administrative law judge found that Mr. Malouf had (1) aided and abetted UASNM's violations of the federal securities laws and (2) committed violations of his own. In the administrative appeal, the SEC agreed, finding that Mr. Malouf had violated

• § 10(b) of the Securities Exchange Act of 1934 and Rules 10b-5(a) and (c),
• §§ 17(a)(1) and 17(a)(3) of the Securities Act of 1933, and
• §§ 206(1) and 206(2) of the Investment Advisers Act of 1940.

         The SEC also found that Mr. Malouf had aided and abetted UASNM's violations of §§ 206(4) and 207 of the Investment Advisers Act and Rule 206(4)-1(a)(5).

The SEC imposed four sanctions on Mr. Malouf:
1. a lifetime bar from the securities industry,
2. an order to cease and desist violations of federal securities laws,
3. an order to disgorge $562, 001.26 plus prejudgment interest, and
4. an order to pay a $75, 000 civil penalty.
On appeal, Mr. Malouf makes four arguments:
1. The appointment of his administrative law judge violated the Constitution's Appointments Clause.
2. The SEC misinterpreted the securities laws.
3. The SEC's findings lack substantial evidence.
4. The sanctions should be vacated.

         Standard of Review

         When considering these appellate arguments, we credit the SEC's factual findings if they are supported by substantial evidence. Geman v. SEC, 334 F.3d 1183, 1188 (10th Cir. 2003). Substantial evidence is "such relevant evidence as a reasonable mind might accept as adequate to support a conclusion." C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1433 (10th Cir. 1988) (quoting Consol. Edison Co. of New York v. NLRB, 305 U.S. 197, 229 (1938)).

         Discussion

         I. Mr. Malouf forfeited his challenge under the Appointments Clause.

         Mr. Malouf contends that the administrative law judge was not validly appointed under the Constitution's Appointments Clause. But Mr. Malouf forfeited this contention by failing to present it in the SEC proceedings.[4] Given the forfeiture, we decline to reach the merits of this challenge.

         A. Exhaustion of administrative remedies is mandatory under the pertinent statutes.

         The Constitution's Appointments Clause authorizes Congress to delegate the appointment of "inferior officers" to the President, courts, and department heads. U.S. Const. art. II § 2, cl. 2. Mr. Malouf contends that his administrative law judge was an "inferior officer" who had not been appointed by the President, a court, or a department head. See Lucia v. SEC, 138 S.Ct. 2044 (2018). For this contention, the threshold issue involves exhaustion of administrative remedies.

         The underlying securities laws expressly require administrative exhaustion. See 15 U.S.C. §§ 77i(a) (Securities Act), 78y(c) (Securities Exchange Act), 80b-13(a) (Investment Advisers Act).[5] Given the statutory requirement, courts lack discretion to excuse the failure to exhaust administrative remedies. Ross v. Blake, 136 S.Ct. 1850, 1856-57 (2016). Failure to comply with a mandatory exhaustion requirement prevents judicial review of the issue. United States v. L.A. Tucker Truck Lines, Inc., 344 U.S. 33, 37 (1952).

         B. Mr. Malouf lacks reasonable grounds to excuse his failure to exhaust.

         Mr. Malouf concedes that his administrative filings did not address the Appointments Clause. We thus must decide whether Mr. Malouf satisfies an exception to the exhaustion requirement.

         The Securities Act does not contain an express exception to the exhaustion requirement, so we cannot excuse a failure to satisfy the Securities Act's exhaustion requirement. 15 U.S.C. § 77i(a); see Ross, 136 S.Ct. at 1856-57. But the other two securities statutes (the Securities Exchange Act and Investment Advisers Act) provide an exception, allowing the claimant to avoid the exhaustion requirement upon a showing of reasonable grounds. 15 U.S.C. §§ 78y(c)(1), 80b-13(a).

         Mr. Malouf argues that he had two reasonable grounds to skip the exhaustion requirement:

1. It would have been futile to raise this challenge in the SEC proceedings.
2. The law changed after the SEC had ruled.[6]

          We reject both arguments.

         1. Raising the challenge would not have been futile.

         Mr. Malouf argues that exhausting this challenge would have been futile because the SEC would undoubtedly have denied relief. We reject this argument.

         The failure to pursue administrative remedies may be excused when exhaustion would have been futile. Gilmore v. Weatherford, 694 F.3d 1160, 1169 (10th Cir. 2012). But the futility exception is available only when the administrative process would have been "clearly useless." Id. (quoting McGraw v. Prudential Ins. Co. of Am., 137 F.3d 1253, 1264 (10th Cir. 1998)).

         Mr. Malouf has not shown that exhaustion of this challenge would have been clearly useless. Indeed, when he filed his brief in the SEC (on September 2, 2015), the SEC had not yet addressed the applicability of the Appointments Clause to administrative law judges.[7]

         Despite the absence of any prior SEC decisions on the issue, Mr. Malouf insists that the SEC would have rejected this challenge. He points out that attorneys for the SEC had previously argued that its administrative law judges were not inferior officers subject to the Appointments Clause. But the prior arguments by SEC attorneys do not mean that exhaustion would have been futile. See Gilmore v. Weatherford, 694 F.3d 1160, 1169 (10th Cir. 2012) (rejecting an argument that the agency's position had been "predetermined" based on the agency's position in three earlier cases); C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1439 (10th Cir. 1988) ("[A]lthough petitioners contend that raising [the] argument below would have been futile given the SEC's past response, that alone is not a sufficient ground for presuming futility.").

         Mr. Malouf points out that after he began his administrative appeal, the SEC frequently rejected challenges under the Appointments Clause. But these decisions do not mean that the SEC necessarily would have rejected a challenge by Mr. Malouf. See Gilmore, 694 F.3d at 1169 ("Requiring exhaustion of [claims asserted against agency precedent or an agency's litigation position] allows agencies to take into account the specific facts of each matter, and to change course if appropriate." (internal citation omitted)). Had Mr. Malouf exhausted available administrative remedies, the SEC might have changed its position on the Appointments Clause issue; and "if it did not, the [SEC] would at least be put on notice of the accumulating risk of wholesale reversals being incurred by its persistence." United States v. L.A. Tucker Truck Lines, Inc., 344 U.S. 33, 37 (1952).

         Because Mr. Malouf has not shown that presentation of this challenge to the SEC would have been clearly useless, we do not regard exhaustion as futile.

         2. No intervening change of law took place.

         We also reject Mr. Malouf's reliance on an intervening change in the law.

         For the sake of argument, we can assume that an intervening change in the law might constitute a reasonable ground to excuse the failure to exhaust. But the law did not change.

         Mr. Malouf bases his argument largely on Bandimere v. SEC, 844 F.3d 1168 (10th Cir. 2016), and Lucia v. SEC, 138 S.Ct. 2044 (2018).[8] In these cases, our court and the Supreme Court held that SEC administrative law judges are inferior officers subject to the Appointments Clause. See Bandimere, 844 F.3d at 1170; Lucia, 138 S.Ct. at 2049. The Courts decided these cases after the SEC had ruled in Mr. Malouf's case, preventing him from relying on either opinion during his administrative appeal. But neither Bandimere nor Lucia changed the law: In both cases, the Courts merely applied the Supreme Court's 1991 opinion in Freytag v. Commissioner of Internal Revenue, 501 U.S. 868 (1991).

         In Freytag, the Supreme Court held that special trial judges for the Tax Court were inferior officers subject to the Appointments Clause. 501 U.S. at 881. The Supreme Court's decision hinged on the extensive powers granted to special trial judges, which were significant enough to characterize these judges as inferior officers. See id. at 881-82 (noting that special trial judges "take testimony, conduct trials, rule on the admissibility of evidence, and have the power to enforce compliance with discovery orders"). SEC administrative law judges are "near-carbon copies" of the Tax Court's special trial judges. Lucia, 138 S.Ct. at 2052. So in Bandimere and Lucia, our court and the Supreme Court regarded Freytag as dispositive on the status of the SEC's administrative law judges. Bandimere, 844 F.3d at 1174 ("In our view, Freytag controls the result of this case."); Lucia, 138 S.Ct. at 2052 (concluding that Freytag's analysis "necessarily decides this case").

         In the SEC proceedings, Mr. Malouf could have invoked Freytag, just as the petitioners in Bandimere and Lucia had done. See Island Creek Coal Co. v. Wilkerson, 910 F.3d 254, 257 (6th Cir. 2018) (stating that no precedent would have prevented a party from bringing an Appointments Clause challenge before Lucia, which itself "noted that existing case law 'sa[id] everything necessary to decide this case'" (quoting Lucia v. SEC, 138 S.Ct. 2044, 2053 (2018))).[9] Thus, Mr. Malouf cannot avoid the exhaustion requirement based on an intervening change in the law. See Saffle v. Parks, 494 U.S. 484, 488 (1993) (stating that a rule is not new if the court "would have felt compelled by existing precedent" to conclude that the rule being urged "was required by the Constitution").

         Mr. Malouf failed to administratively exhaust his challenge under the Appointments Clause. We thus conclude that Mr. Malouf forfeited this challenge.[10]

         II. The SEC reasonably found that Mr. Malouf had violated Rule 10b-5 [11] and § 17(a) of the Securities Act of 1933.

         The SEC found that Mr. Malouf had failed to correct material misstatements, violating

. Rule 10b-5(a) and (c) and
. the Securities Act of 1933 § 17(a)(1) and (3).

         For purposes of this appeal, Mr. Malouf does not deny that he failed to correct UASNM's misstatements. But he argues that a failure to correct UASNM's misstatements does not constitute a separate violation of the securities laws. We disagree.

         A. Rule 10b-5(a) and (c) and § 17(a)(1) and (3) of the Securities Act of 1933 encompass the failure to correct UASNM's false or misleading statements.

         The relevant provisions ban two broad categories of conduct. The first category involves the making of a materially untrue or misleading statement. The second category involves employment of a fraudulent or deceptive scheme. Addressing the second category, the SEC found that Mr. Malouf had failed to correct UASNM's false or ...


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