SECURITIES AND EXCHANGE COMMISSION v. DONALD J. FOWLER
Docket No. 20-1081-cv
UNITED STATES COURT OF APPEALS FOR THE SECOND CIRCUIT
Decided: July 22, 2021
August Term, 2020
LOHIER and NARDINI, Circuit Judges, and CRONAN, Judge.
(Argued: June 3, 2021 Decided: July 22, 2021)
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff-Appellee,
v.
DONALD J. FOWLER,
Defendant-Appellant.*
Before: LOHIER and NARDINI, Circuit Judges, and CRONAN, Judge.**
In this enforcement lawsuit filed by the Securities and Exchange Commission (SEC), Donald Fowler appeals from a judgment of the United States District Court for the Southern District of New York (Woods, J.) entered after a jury found that he recommended an unsuitable trading strategy and made unauthorized trades in customer accounts. The District Court ordered disgorgement and the payment of civil penalties, among other sanctions. On appeal, Fowler argues that the applicable statute of limitations,
JOHN DELLAPORTAS, Beth Claire Khinchuck, Emmet, Marvin & Martin, LLP, New York, NY, for Defendant-Appellant Donald J. Fowler
RACHEL M. MCKENZIE, Senior Counsel, Dominick V. Freda, Assistant General Counsel, Michael A. Conley, Solicitor, Robert B. Stebbins, General Counsel, Securities and Exchange Commission, Washington, DC, for Plaintiff-Appellee Securities and Exchange Commission
The principal questions presented on appeal are (1) whether
BACKGROUND
I
Donald Fowler, a financial broker, challenges a February 28, 2020 judgment of the United States District Court for the Southern District of New York (Woods, J.) entered after a jury trial. The jury found that Fowler lied to his investors, recommended a high frequency trading strategy that was not suitable for any customer, and made a series of unauthorized trades in customer accounts, in violation of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 promulgated under Section 10(b) of the Exchange Act, and Sections 17(a)(1), 17(a)(2), and 17(a)(3) of the Securities Act of 1933. After trial, the District Court ordered Fowler to disgorge $132,076.40, with prejudgment interest, and to pay civil penalties in the amount of $1,950,000 based largely on the number of defrauded customers who were the focus at trial. It also permanently enjoined Fowler from further violations of the securities laws.
II
Fowler was a registered representative (a broker) for J.D. Nicholas & Associates, Inc. from January 2007 to November 2014. By 2011 Fowler and another J.D. Nicholas broker, Gregory Dean, began pursuing an “event-driven” investment strategy on behalf of several J.D. Nicholas customers.2 The event-driven strategy was uncomplicated. Fowler reviewed the financial news and found “events” that he believed the stock price of particular companies had yet to fully absorb. He then traded based on his assessment of whether those events would lower or increase the price of a stock. The frequency of Fowler‘s trades in customer accounts and the average turnover rate of customer accounts—that is, the number of times that assets in the account were replaced—was very high. While J.D. Nicholas considered a turnover rate of just four times per year to be high for an account with conservative objectives, Fowler‘s customer accounts examined at trial experienced a turnover rate of 116 times per year.
Fowler‘s excessive trading in these accounts came with significant costs. Customers were charged $65 (later $49.95) per trade. Fowler, meanwhile, had the discretion to charge an extra 3.5 percent fee on any purchase or sale. Fowler received portions of both of those fees as compensation. To make matters worse, Fowler also recommended margin trading to several of his customers, permitting him to borrow money (for which his customers were on the hook) to buy even more stock and thereby increase his commissions.
Thirteen customers were the focus of Fowler‘s trial. Combined, they lost $467,627 as a result of Fowler‘s trading. Customers, including those who were not the focus of trial, eventually complained about Fowler to the Financial Industry Regulatory Authority (FINRA), a self-regulatory organization that oversees brokers. In particular, they pointed to violations of FINRA‘s customer suitability requirements and to Fowler‘s unauthorized trading in their accounts. These complaints prompted J.D. Nicholas to put Fowler on special supervision in 2012, but he nevertheless continued to use the same investment strategy that had landed him in trouble with his customers.
The SEC‘s investigation of Fowler‘s trading activity began in 2014. In 2016 the SEC and Fowler executed two agreements that tolled the five-year statute of limitations for the SEC to file an action against Fowler for one year, from March 1, 2016 to February 28, 2017. It is not clear why the parties entered into the tolling agreement when they did, although the District Court surmised that the SEC needed more time to investigate what it discovered were “unsuitable investment strategies implemented by . . . Dean and Fowler in their customers’ accounts.” Sp. App‘x 68. In any event, the SEC filed this action on January 9, 2017, well before the tolling agreement was set to lapse. By the time the complaint was filed, J.D. Nicholas had gone out of business.
The SEC‘s amended complaint alleged that Fowler knowingly recommended to customers a “high-cost, in-and-out trading strategy without having a reasonable basis for believing that this strategy was suitable for anyone.” App‘x 24. The amended complaint also alleged that Fowler “knew or recklessly disregarded that the strategy . . . was bound to lose money,” App‘x 17, but made “little or no mention of fees and costs” that he knew would erase any gains, App‘x 21. Finally, it alleged that Fowler made trades without customer authorization and engaged in churning with respect to at least three customer accounts. In all, the allegations targeted a series of trades implemented by Fowler (and Dean) in twenty-seven accounts at J.D. Nicholas. For reasons not apparent in the record, the SEC eventually dropped the churning cause of action and proceeded with six causes of action under Section 10(b) of the Exchange Act, Rule 10b-5, and Sections 17(a)(1), (2), and (3) of the Securities Act.
III
Before trial, the District Court resolved the parties’ motions in limine. Fowler wanted to adduce evidence of customer sophistication to counter what he described as the SEC‘s “quantitative suitability [i.e. churning] claim masked as a reasonable
The District Court decided that the SEC could properly bring a suitability claim arising from Fowler‘s excessive trading in customer accounts and that the sophistication of his customers was irrelevant. The customers’ background or diligence, the court said, did not justify the brokers’ affirmative misrepresentations or failure to disclose adverse financial information. See Hanly v. SEC, 415 F.2d 589, 595 (2d Cir. 1969). As noted, Dean settled with the SEC on the eve of trial and Fowler proceeded to trial alone. The SEC‘s case in chief focused on thirteen of Fowler‘s customers. The jury heard testimony from four of those customers, as well as from an expert and from Fowler himself. The SEC also introduced a summary chart based on Fowler‘s phone records to show that Fowler made the majority of trades in the customer accounts without notifying the clients in advance.
The jury rendered a verdict against Fowler on all six causes of action, finding that Fowler had run afoul of the relevant securities laws by recommending an unsuitable investment strategy, making unauthorized trades, and making false and misleading statements to his clients. After the jury‘s verdict, the District Court ordered Fowler to disgorge $132,076.40 and pay a civil penalty in the amount of $1,950,000. It also permanently enjoined him from future violations of the securities laws.
DISCUSSION
I
On appeal, Fowler makes a number of arguments, the most serious of which is that the relevant five-year statute of limitations for SEC enforcement actions,
The SEC alleged that Fowler‘s fraudulent scheme began in 2011, meaning that the statute of limitations would ordinarily have expired in 2016. To buy more time, the SEC and Fowler entered into two agreements that together tolled the statute of limitations for a year, from March 1, 2016 through February 28, 2017. The SEC ultimately sued on January 9, 2017, well within the tolled statute of limitations period.5
Fowler maintains that the statute of limitations is jurisdictional and not subject to tolling, so that the limitations period clearly lapsed by 2016 and the SEC could not have sued him thereafter for any of the misconduct alleged in this case. His position runs headlong into the Supreme Court‘s decision in Henderson ex rel. Henderson v. Shinseki, 562 U.S. 428 (2011). There the Court held that “[f]iling deadlines . . .
The statutory history of
II
Next, Fowler argues that the SEC improperly brought and pursued a suitability claim rather than a churning claim arising from his excessive trading in his customers’ accounts. As we previously noted, the SEC claimed that Fowler had violated his reasonable-basis suitability obligation under FINRA‘s rules. Fowler‘s conduct contravened this suitability obligation, the SEC alleged, because he “knew or recklessly disregarded that the strategy [he] knowingly recommended—a high-cost strategy of excessive in-and-out trading—was bound to lose money and was not suitable for [his] customers.” App‘x 17.
Fowler insists that the SEC‘s suit should have been limited to a churning claim rather than a reasonable-basis suitability claim. Of course, this argument assumes that churning claims and suitability claims arise from mutually exclusive events. They do not. The various securities law provisions do not cover “different, mutually exclusive, spheres of conduct. . . . [The Supreme] Court and the [SEC] have long recognized considerable overlap among the subsections of . . . Rule [10b-5] and related provisions of the securities laws.” Lorenzo v. SEC, 139 S. Ct. 1094, 1102 (2019). So brokers may, in the same course of conduct, make unsuitable trading recommendations to their customers while at the same time actively churning customer accounts just to generate fees and commissions. In other words, churning claims and suitability claims can arise from the same general set of facts.
The SEC had an adequate basis to pursue its suitability claim under the circumstances
For these reasons, we find no error in the District Court‘s decision to allow the SEC to proceed to trial with its reasonable-basis suitability claim.
In his final challenge to the jury verdict, Fowler suggests that the SEC failed to prove that he controlled the customer accounts. There is no doubt that a churning claim requires a plaintiff to prove that the defendant exercised actual or de facto control over the churned accounts. See Newburger, Loeb & Co. v. Gross, 563 F.2d 1057, 1069-70 (2d Cir. 1977). Even the SEC, which has the burden of proof on this issue, appears to agree. See Calabro, Exchange Act Release No. 9798, 2015 WL 3439152, at *1 (May 29, 2015). But what is before us is a suitability claim, not a churning claim. And a suitability claim is different: it fundamentally rests on the broker‘s recommendation to a potential or actual customer rather than on any actual trading activity. The SEC was therefore not required to show that Fowler controlled any account in order to prove its suitability claim. See Brown v. E.F. Hutton Grp., Inc., 991 F.2d 1020, 1031 (2d Cir. 1993). The District Court‘s ruling to that effect was correct.
III
Fowler challenges the verdict against him for unauthorized trading because not every victim of his scheme testified at trial to his lack of authorization. Only some of his customers testified that they had not authorized certain trades Fowler made on their behalf. In addition to customer testimony, however, the SEC relied on records of phone calls between Fowler and the thirteen customers who were the focus of the trial. Those records were summarized in a chart. Fowler had earlier stipulated that he communicated with his customers exclusively by phone, and there was no genuine dispute that the chart accurately reflected Fowler‘s phone records. The chart was admitted pursuant to Federal Rule of Evidence 1006 over Fowler‘s objection, but Fowler does not contest its admission on appeal. It showed that Fowler had failed to communicate with his customers before making a majority of the trades in their accounts. The jury ultimately found that Fowler had made unauthorized trades in twelve of the thirteen accounts. On appeal, Fowler contends that the SEC was required to elicit testimony from each customer regarding their accounts and any unauthorized trades at issue.6 We conclude that the SEC was not required to elicit testimony from every affected customer in order to prove its suitability claim.
As an initial matter, the summary chart itself, which was admitted under Rule 1006 and as such constituted substantive evidence, powerfully demonstrated the extent
IV
After the jury‘s verdict, the District Court imposed (along with a disgorgement award and a permanent injunction) a penalty of $150,000 for each of the thirteen customers who were the focus at trial, totaling $1,950,000. Fowler complains that these penalties exceed the maximum permitted by the statute and in any event are excessive under the Fifth and Eighth Amendments. The SEC responds that Fowler forfeited these arguments by failing to raise them before the District Court. But “we . . . exercise discretion to address an issue not raised properly before the district court” where, as here, “the issue is purely legal and there is no need for additional fact-finding.” Davis v. Shah, 821 F.3d 231, 246 (2d Cir. 2016) (quotation marks omitted).
A
We first address Fowler‘s argument that the civil penalties in this case run afoul of the penalty sections of the Securities Act, which provide for three tiers of civil penalties. See
The term “violation” is not defined by the statutory scheme. In the course of determining the appropriate unit of violation, the District Court observed that “Fowler selected his victims for this conduct individually.” Sp. App‘x 86. As a result, it concluded that “treating his treatment of each of his defrauded customers as a separate violation best effectuates the purposes of the statute.” Id. This conclusion is entirely plausible. In SEC v. Pentagon Capital Management PLC, 725 F.3d 279, 288 n.7 (2d Cir. 2013), for example,
The difference between the two statutory caps in
Adopting a slightly different tack, Fowler points to the SEC‘s allegations that he engaged in a single fraudulent scheme rather than multiple schemes. He protests that he likewise should have been penalized for a single violation rather than multiple violations. We reject the idea that the penalty imposed by a district court must track the SEC‘s litigation approach. And in this case, the District Court did not “believe that penalties should be assessed as if this was a single scheme” because Fowler “selected his victims for this conduct individually” and “each set of trades within a given defrauded customer‘s account could be considered to be part of a single scheme to defraud that individual.” Sp. App‘x 86-87. Indeed, Fowler has acknowledged that the number of violations at issue should be determined “based on the Verdict,” Appellant‘s Br. 32, and the jury found Fowler liable on a customer-basis. And Fowler has not disputed that the course of conduct in which he engaged involved multiple violations of the securities laws. Moreover, his argument before the District Court was only that “a single-violation penalty . . . is more appropriate,” thus leaving discretionary room for the District Court‘s conclusion that a multiple-violation penalty was also appropriate. App‘x 169-71.
Finally, Fowler urges us to focus on a district court‘s authority to impose a third-tier penalty “for each . . . violation” only if the “violation directly or indirectly resulted
Fowler‘s reading would foreclose a Tier III penalty whenever there is a single victim regardless of the type or level of harm. The interpretation also contradicts the basic principle that “unless the context indicates otherwise . . . words importing the plural include the singular.”
Fowler also asks us to consider that the monetary penalty that the SEC can impose in SEC administrative proceedings under the Investment Company Act,
In sum, we are not persuaded that the District Court was barred from treating each defrauded customer as a separate unit of violation in imposing civil penalties. We see no need to set a maximum number of violations that would be appropriate on these facts. We conclude only that the District Court did not abuse its wide discretion in finding at least thirteen violations here.
B
Fowler‘s constitutional argument fares no better than his statutory challenge. Analogizing to punitive damages, he submits that his civil penalty is so grossly disproportionate to the amount he was ordered to disgorge (fifteen times) that it violated his rights under the Fifth and Eighth Amendments. See, e.g., Pac. Mut. Life Ins. Co. v. Haslip, 499 U.S. 1, 23-24 (1991) (noting that a punitive damage award more than quadruple the compensatory damage award was “close to the [constitutional] line“).
We have not previously held that the civil penalty for a securities fraud offense needs to be proportional to the disgorgement amount. Instead, several factors determine an appropriate civil penalty award: “(1) the egregiousness of the defendant‘s conduct; (2) the degree of the defendant‘s scienter; (3) whether the defendant‘s conduct created substantial losses or the risk of substantial losses to other persons; (4) whether the defendant‘s conduct was isolated or recurrent; and (5) whether the penalty should be reduced due to the defendant‘s demonstrated current and future financial condition.” SEC v. Rajaratnam, 918 F.3d 36, 44 (2d Cir. 2019).
Fowler has never said that he is unable to pay the civil penalty. The District Court nevertheless considered various
V
Fowler also asks us to vacate the District Court‘s disgorgement award and remand to allow it to recalculate the amount of disgorgement in light of Liu v. SEC, 140 S. Ct. 1936 (2020), which held in relevant part that “courts must deduct legitimate expenses before ordering disgorgement under § 78u(d)(5).” 140 S. Ct. at 1950. Consistent with Liu, the District Court deducted the portion of Fowler‘s commissions that were transferred to J.D. Nicholas and Dean in the ordinary course. But Fowler failed then and fails now to identify any other legitimate business expenses that the District Court should have deducted in light of Liu.
In general, “[t]he amount of disgorgement ordered need only be a reasonable approximation of profits causally connected to the violation.” SEC v. Razmilovic, 738 F.3d 14, 31 (2d Cir. 2013) (quotation marks omitted). If the disgorgement amount is generally reasonable, “any risk of uncertainty” about the amount “fall[s] on the wrongdoer whose illegal conduct created that uncertainty.” Id. (quotation marks omitted). Fowler failed to identify any additional “legitimate” business expenses that, consistent with Liu, should have been deducted from an otherwise reasonable disgorgement amount. Yet it was his burden to do so. We therefore decline to remand to the District Court on this issue.
Relatedly, the parties agree that the District Court miscalculated the disgorgement award by ordering Fowler to disgorge more postage fees—that is, the $65 and then $49.95 per trade fee, of which Fowler was to receive a portion—than he actually received. The District Court found that Fowler received $27,498 in postage fees, and ordered him to disgorge that amount (along with his commissions) because it thought that Fowler received 50 percent of the postage fees charged to the thirteen customers, when in fact he received only $3,005 in postage fees. We need not remand to correct this agreed error. See SEC v. Palmisano, 135 F.3d 860, 863-64 (2d Cir. 1998). Instead, we modify the disgorgement award to $107,591.40, plus prejudgment interest in the amount of $25,891.17.
CONCLUSION
For the foregoing reasons, the judgment of the District Court is AFFIRMED and the disgorgement award is MODIFIED consistent with this opinion.
LOHIER
Circuit Judge