Flannery v. Securities & Exchange Commission
810 F.3d 1
1st Cir.2015Background
- In 2010 the SEC charged two former State Street/SSgA employees—James D. Hopkins (VP, head of North American Product Engineering) and John P. Flannery (Fixed Income CIO)—with making materially misleading statements about the Limited Duration Bond Fund (LDBF) during the 2007 subprime crisis.
- The SEC alleged misstatements/omissions in: a PowerPoint “Typical Portfolio” slide Hopkins used (May 10, 2007) and two investor letters (Aug. 2 and Aug. 14, 2007) that Flannery edited or sent.
- After an ALJ dismissed the case (finding no responsibility/authority over the documents and no material misstatements), the SEC reversed in a 3–2 decision, finding Hopkins liable under Securities Act §17(a)(1), Exchange Act §10(b) and Rule 10b-5, and finding Flannery liable under §17(a)(3); it imposed suspensions and modest civil penalties.
- The challenged facts: the Typical Portfolio Slide showed ~55% ABS when the fund’s actual ABS exposure was much higher in 2007; SSgA sold large amounts of AAA and AA bonds in late July 2007 and sent explanatory letters to clients in August 2007.
- The First Circuit reviewed for substantial evidence and deference to the ALJ, considered availability of accurate disclosures (fact sheets, audited statements, client portals), and assessed materiality and scienter for Hopkins and negligence/"course of business" under §17(a)(3) for Flannery.
- The court concluded the SEC’s findings lacked substantial evidence, vacated the Commission’s order, and granted the petitions for review.
Issues
| Issue | Plaintiff's Argument (SEC) | Defendant's Argument | Held |
|---|---|---|---|
| Whether Hopkins’ Typical Portfolio slide was material | Slide misrepresented ABS exposure (55% vs near 100%) and would alter the "total mix" for reasonable investors | Slide labeled "Typical," accurate full disclosures were available (fact sheets, audited statements), and investors would request further information | Materiality showing was marginal; not enough evidence to support SEC finding of materiality |
| Whether Hopkins acted with scienter (recklessness/intent) | Hopkins knew slide was misleading or was highly reckless in presenting it without updating | Hopkins reasonably believed sector breakdowns were not material, brought accurate notes to meetings, and had no history of misleading conduct | No substantial evidence of scienter; extreme recklessness not shown; SEC liability under §17(a)(1)/§10(b)/Rule 10b-5 not supported |
| Whether Aug. 2 letter (Flannery) was misleading | Letter claimed actions had "reduced risk" and said AAA sales reduced exposure—misleading because sales increased credit/liquidity risk | Letter qualified statements ("seek to reduce"; referred to "other" funds); sales and pro-rata actions intended to increase liquidity and reduce certain risks; record supports risk-reduction rationale | Aug. 2 letter was not shown to be misleading; no substantial evidence of material misstatement |
| Whether Flannery engaged in a "course of business" fraud under §17(a)(3) (cumulative effect incl. Aug. 14 letter) | Cumulative letters downplayed risk and encouraged investors to stay while insiders/redemptions showed contrary conduct | Even if Aug. 14 contained debatable language, Aug. 2 was not misleading; isolated or limited edits do not establish a course of fraudulent business practice | Because Aug. 2 was not misleading, record fails to support finding that Flannery engaged in a fraudulent "course of business" under §17(a)(3); SEC order vacated |
Key Cases Cited
- Rizek v. SEC, 215 F.3d 157 (1st Cir. 2000) (court takes underlying facts from the administrative record)
- Cody v. SEC, 693 F.3d 251 (1st Cir. 2012) (substantial-evidence standard for SEC factual findings)
- Universal Camera Corp. v. NLRB, 340 U.S. 474 (U.S. 1951) (consider whole record and ALJ findings when reviewing agency decisions)
- Penobscot Air Servs., Ltd. v. FAA, 164 F.3d 713 (1st Cir. 1999) (definition of substantial evidence)
- Basic Inc. v. Levinson, 485 U.S. 224 (U.S. 1988) (materiality as substantial likelihood of altering the total mix)
- TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (U.S. 1976) (materiality standard under securities laws)
- Matrixx Initiatives, Inc. v. Siracusano, 563 U.S. 27 (U.S. 2011) (materiality and scienter principles in securities fraud)
- Ernst & Ernst v. Hochfelder, 425 U.S. 185 (U.S. 1976) (scienter requirement for certain securities claims)
- Aaron v. SEC, 446 U.S. 680 (U.S. 1980) (scienter and liability under securities laws)
- City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters Corp., 632 F.3d 751 (6th Cir. 2011) (link between materiality and scienter)
- Geffon v. Micrion Corp., 249 F.3d 29 (1st Cir. 2001) (insufficient materiality undercuts scienter)
- SEC v. Phan, 500 F.3d 895 (9th Cir. 2007) (SEC bears burden to prove materiality)
- SEC v. Ficken, 546 F.3d 45 (1st Cir. 2008) (negligence sufficient for §17(a)(3); scienter standards for §10(b))
- SEC v. Fife, 311 F.3d 1 (1st Cir. 2002) (extreme departure standard for scienter)
- Omnicare, Inc. v. Laborers Dist. Council Constr. Indus. Pension Fund, 575 U.S. 175 (U.S. 2015) (opinion statements and liabilities under securities law)