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2004
CASE ANALYSIS

 In the Matter of the Application of CLARKE T. BLIZZARD and RUDOLPH ABEL 
Investment Adviser Proceeding
Investment Advisers Act of 1940 Release No. 2253, June 23, 2004

http://sec.gov/litigation/opinions/ia-2253.htm

 A Little Background

Shawmut

From its inception in 1984 until October 29, 1993, Shawmut Investment Advisers, Inc. was known as One Federal Asset Management, Inc. (both entities referred to as "Shawmut"). Shawmut withdrew its registration as an investment adviser (an "RIA") at the end of 1995 because its parent corporation was acquired by Fleet Financial Group, Inc., which had its own investment adviser subsidiary. After the acquisition, the combined entity was registered with the SEC as Fleet Investment Advisers, Inc. ("Fleet"). As an RIA, Shawmut was required to file Form ADV with the SEC, and to disclose in that form certain of its practices to clients and prospective clients. 

FORM ADV
Uniform Application for Investment Adviser Registration

Part 1A

asks a number of questions about applicant,  business practices, the persons who own and control, and the persons who provide investment advice. All advisers registering with the SEC or any of the state securities authorities must complete Part 1A.

  • Schedule A asks for information about  direct owners and executive officers.

  • Schedule B asks for information about  indirect owners.

  • Schedule C is used by paper filers to update the information required by Schedules A and B.

  • Schedule D asks for additional information for certain items in Part 1A.

  • Disclosure Reporting Pages (or “DRPs”) ask for details about disciplinary events involving applicant and affiliated persons.

 

Part 1B

asks additional questions required by state securities authorities. Part 1B contains three DRPs. If applying for registration or an SEC-only applicant,  Part 1B is not necessary. 

 

Part II

The current brochure, which must be amended, delivered to prospective clients, and annually offered to current clients. 

 

Abel

Rudolph Abel was employed at Shawmut from 1985 to September 16, 1994.  While serving as Shawmut's president from January 1992 to October 1993, he signed four amendments to Shawmut's ADV. While serving as Shawmut's chief investment officer from January 1992 until September 16, 1994, he was responsible for guiding Shawmut's overall investment policy; supervising its investment professionals, including the trading and research staffs; and ensuring compliance with SEC rules and regulations. Among the employees who reported directly to Abel was Maureen O'Malley, Division Compliance Officer for Shawmut, who coordinated the filing of Shawmut's ADV. Abel conferred frequently with other senior management at Shawmut, seeking to keep them informed of relevant issues within his areas of responsibility.

Blizzard

Clarke T. Blizzard began working in the investment advisory industry in 1980 and joined Shawmut on April 29, 1993, and left Shawmut's successor, Fleet Investment Advisers, Inc. ("Fleet") on May 7, 1996. At Shawmut, Blizzard held the title of Senior Vice President, then Managing Director. His responsibilities lay solely in the sales and marketing areas. Blizzard was not involved in reviewing research submitted by brokers to guide Shawmut's investment decisions, nor was he involved in preparing or reviewing Shawmut's ADV or in otherwise monitoring compliance issues. 

Soft Dollars

As an investment adviser, Shawmut managed the portfolios of its clients by making investment decisions, which were then executed by various broker-dealers. Shawmut usually chose the broker-dealers who were to execute the transactions, unless a client had provided a direction letter telling Shawmut where to direct commissions for its accounts. Shawmut, as an investment adviser, was required to obtain best execution when it arranged trades for its clients. 

Soft Dollars are "arrangements under which products or services other than execution of securities transactions ('soft dollar services') are obtained by an adviser from or through a broker in exchange for the direction by the adviser of client brokerage transactions to the broker." Disclosure by Investment Advisers Regarding Soft Dollar Practices, Exchange Act Rel. No. 35375 (Feb. 21, 1995), 58 SEC Docket 2279, 2279.  
Also See Kidder, Peabody & Co., 43 S.E.C. 911, 915-16 (1968); see also Interpretive Release Concerning the Scope of Section 28(e) of the Securities Exchange Act and Related Matters, Exchange Act Rel. No. 23170 (Apr. 23, 1986), 35 SEC Docket 905, 910 ("1986 Release"); Inspection Report on the Soft Dollar Practices of Broker-Dealers, Investment Advisers and Mutual Funds (Sept. 22, 1998) ("1998 Soft Dollar Report").

The 1998 Soft Dollar Report discussing conditions under which research produced by third parties and provided to advisers by broker-dealers may fall within safe harbor provided by Exchange Act Section 28(e), 15 U.S.C. § 78bb(e), which protects advisers from claims that they breached their fiduciary duties by causing clients to pay more than the lowest available commission rates in exchange for research and execution if certain conditions are met); 1986 Release, 35 SEC Docket at 908 (same). 

Read the 1998 Soft Dollar Report at this link.

In accordance with the soft dollar rules, when a broker-dealer provided research to Shawmut, Shawmut was permitted to pay more than the lowest price available, using "soft dollars" whereby brokerage firms are paid for their research, as well as executions, through commission dollars rather than through direct cash payments. The research paid for in soft dollars may be proprietary to the broker, or it may originate with a third-party vendor that the broker compensates. Shawmut's written trading policy required it to direct client securities transactions to brokerage firms that provided competitive execution, with preference given to firms that provided research assistance of benefit to all of Shawmut's clients. The policy did not include client referrals received from a brokerage firm as a factor that should be considered when directing trades to brokers. 

Between May 1993 and May 1996, Shawmut executed trades with numerous broker-dealers. Acting through a Commission Allocation Committee ("CAC"), which Abel chaired as chief investment officer, Shawmut set a "budget" for allocating brokerage commissions to certain broker-dealers.  The amount allocated to each of these research brokers was intended to be commensurate with the value of the research provided. 

Written procedures effective while Abel served as chief investment officer specified that the CAC was to include the chief investment officer, Director of Research, Heads of Institutional and Personal Portfolio Management, Manager of Trading, Head Equity Trader, and certain senior portfolio managers, all of whom reported to Abel. There were no provisions for sales or marketing personnel to be involved in the commission allocation process. Shawmut's director of research coordinated the compilation of the research broker list for CAC review, with input from research analysts and portfolio managers. As chief investment officer and CAC chairman, Abel had ultimate responsibility for Shawmut's brokerage commission allocation and for approving research brokers who were to receive ongoing payments through the commission allocation budget. 

The Allocation Budget 

  • designated target commission amounts for Shawmut's traders to use in selecting broker-dealers to execute transactions in client accounts, 

  • provided for commission payments on an ongoing basis in order to provide an incentive for brokerage firms to submit research to Shawmut throughout the year, and

  •  included "chits," which were one-time payments for good ideas, and funds used to purchase specific research services. 

 A Blizzard of Inquiries About Directed Trades

Shortly after Blizzard began work at Shawmut, he began to make inquiries about having trades directed to brokers who had previously helped him obtain client referrals ("referral brokers"). Blizzard first attempted to persuade Shawmut's Manager of Trading, James Bixler, and Shawmut's Head Equity Trader, Daniel Willey, to direct trades to such brokers. Bixler and Willey told Blizzard that trades could be directed only to brokers who provided research to, and were approved by, Shawmut. Blizzard also discussed with Abel his desire to have referral brokers receive commission allocations. Abel told Blizzard that Shawmut had an "open door" policy with regard to the inclusion of brokers on the research allocation list, and that consistent withwritten policy, Shawmut would do business on the basis of net realized price plus research or trading capability, but added that, if brokers "could provide referrals, all the better." Blizzard also asked David Rajala, Shawmut's Director of Research, about adding brokers to the research department's list of approved brokers. Like Bixler, Willey, and Abel, Rajala told Blizzard that brokers could not get on the list unless they provided research. 

Accordingly, Blizzard arranged for certain referral brokers to submit research to Shawmut, but the research was not viewed favorably enough by Shawmut's portfolio managers and analysts to result in the inclusion of the providers on the research brokers list through the usual evaluation process. Nonetheless, by the end of 1993, Abel had approved the direction of brokerage commissions to three referral brokers, all of whom were introduced by Blizzard. By July 1994, commissions were being directed to eight such referral brokers, all at Blizzard's request. 

Key Facts

  • CIO ABel, Trading Mgr. Bixler, Head Equity Trader Wiley, and Director of Research Rajala all told Blizzard that brokers could not get on the brokerge commissions allocation list unless they provided research --- mere referral of business wasn't enough.

  • Although Blizzard's referral brokers submitted research not viewed favorably in-house, Shawmut put the providers on the allocation list.

 

 

In a memorandum dated July 21, 1994, Willey asked Abel to "give written approval to the trading desk to continue to direct trades" to the referral brokers introduced by Blizzard, pending the approval of research brokers at the next CAC meeting. The memorandum noted that the referral brokers had not been "formally approved" by either Abel, as chief investment officer, or Rajala, as Director of Research. Abel approved Willey's request. At the September 15, 1994 CAC meeting, the day before Abel left Shawmut, these eight referral brokers, plus an additional referral broker introduced by Blizzard, were added to the "research broker" list. One additional referral broker was added to the "research broker" list, at Blizzard's instigation, in 1995. 

The Controversy Grows

Although Bixler knew that some institutions included marketing considerations in brokerage allocation decisions, he was troubled by the prospect of Shawmut's engaging in such a practice because it could be characterized as "buying business" and was "not consistent with [Shawmut's] historic way of doing business and was not a good direction to go." He was also concerned that Shawmut's equity commission revenues would not cover allocations provided for in the existing commission budget, and that adding additional brokers would strain the budget yet further. Additionally, Bixler and Rajala were concerned that the practice could violate the Code of Ethics for Chartered Financial Analysts. Bixler, Willey, Rajala and Abel discussed these concerns. 

The adequacy of the research that Blizzard's referral brokers submitted was also a focus of concern and discussion at Shawmut. Bixler felt that Shawmut needed to make sure the referral brokers were providing bona fide research, since Shawmut paid brokers "a reasonable price, not necessarily the lowest possible price," on the ground that the research brokers were providing added value. Rajala was openly critical of the research submitted by the referral brokers, regarding it as inferior to the research Shawmut obtained from brokers who had been put on the commission allocation list through the usual vetting procedures. Abel, Bixler, Willey, and Rajala met several times in June 1994 to discuss their concerns. The possible disclosure of the allocation of commissions to brokers based in part on marketing considerations was also discussed by Bixler, Abel, and Rajala. In mid-1994, Rajala stated at a CAC meeting that, if commissions were being directed to brokers for new business, that practice should be disclosed in Shawmut's ADV. Bixler also raised the question whether the allocation of commissions to brokers based in part on marketing considerations should be disclosed. 

Despite these concerns, it did not appear that Abel, Bixler, Willey, Rajala, or Blizzard sought or received advice from counsel as to whether the practice of directing commissions to brokers based in part on marketing considerations had to be disclosed. Perry Macrohan, an attorney whose responsibilities during the relevant period included giving legal advice to people who reported to Michael Rothmeier, president and chief executive officer of Shawmut from November 1993 to December 1995, was contacted by Bixler, who asked a hypothetical question about paying commissions to brokers who referred business to Shawmut. There is no evidence that Bixler or anyone else asked Macrohan about disclosure of such a practice. 

Growing Unease

  1. Are we buying business?

  2. Is this the direction we want to go in?

  3. Do we have enough commissions to cover the allocations?

  4. Is this ethical?

  5. Is this bona fide research?

  6. Should we disclose the commissions-for-business practice on the Form ADV?

Part II, Item 12 of Form ADV

The Firm Brochure requires that when an investment adviser or any related person has "authority to determine without obtaining specific client consent" the broker or dealer to be used, it must describe "the factors considered in selecting brokers and determining the reasonableness of their compensation." Moreover, if "the value of products, research, and services given to the [adviser] or a related person is a factor," the adviser must describe the products, research and services. 

The instructions for completing Form ADV provide that advisers must amend Form ADV promptly if information provided in Part II becomes materially inaccurate. 

In its ADV, Shawmut stated that it selected brokers to execute its clients' securities transactions based on "the contribution made to its investment product by the research offered by brokers . . . whose execution is acceptable." There was no mention of client referrals as a factor considered in selecting brokers.

 Part II, Item 13 of Form ADV 

Requires investment advisers to disclose whether they have any arrangements to compensate any person, directly or indirectly, for client referrals, and if so, to describe those arrangements. 

Shawmut disclosed that it paid bonus compensation to employees who referred new business, but said nothing about selecting brokers on the basis of referrals. 

The SEC Takes Action: Willfully Aided and Abetted

On September 9, 1999, the SEC filed an Order Instituting Proceedings ("OIP") charging Abel and Blizzard, among others, with having willfully aided and abetted and caused Shawmut's "failure to disclose that it used brokerage commissions generated from its clients' transactions to compensate brokers for client referrals, in violation of Sections 206(1) and (2) of the[Investment] Advisers Act [of 1940]." The OIP charged that "from mid-1993 through December 1995, [Shawmut] represented to clients in its disclosure document, Form ADV, that it selected brokers to execute its clients' transactions on the basis of research the brokers provided," but that those representations were false because Shawmut directed certain client transactions to brokers "on the basis of their ability to refer clients to [Shawmut], and not on research provided by the brokers." 

An administrative law judge found that Blizzard willfully aided and abetted and caused violations of Section 206(1) and 206(2) of the Investment Advisers Act of 1940 by his employer, Shawmut, but that charges that Rudolph Abel aided and abetted violations of those provisions were unproven because no primary violations by Shawmut were established during the period that Abel was employed at Shawmut. The law judge ordered Blizzard 

  • to cease and desist from committing or causing any violations or future violations of Section 206 of the Advisers Act; 

  • to disgorge SECs in the amount of $548,233, plus pre-judgment interest; 

  • to pay a civil money penalty of $100,000; and 

  • to be suspended for 90 days from association with an investment adviser. 

The Division of Enforcement asks on appeal for the SEC to find that Abel aided and abetted and caused violations by Shawmut, and that Blizzard aided and abetted and caused additional violations, to impose sanctions against Abel, and to increase the sanctions imposed on Blizzard. 

Blizzard asks the SEC to find that Shawmut did not violate Section 206 of the Advisers Act or, in the alternative, that Blizzard did not aid and abet or cause those violations. Abel opposes the Division's petition. 

Better to Fight, Settle. or Default?

Five additional respondents were also charged with violations in the OIP. 

  • Donald C. Berry and Michael Rothmeier, were associated with Shawmut. Christopher P. Roach and Craig Janutol, were associated with East West Institutional Services ("East West"), a registered broker-dealer that did business with Shawmut and that was also named as a respondent. 

  • On April 13, 2000, as to Rothmeier, Berry, and Janutol settled. See Michael J. Rothmeier, Advisers Act Rel. No. 1867 (Apr. 13, 2000), 72 SEC Docket 557 (Rothmeier); Michael J. Rothmeier, Advisers Act Rel. No. 1866 (Apr. 13, 2000), 72 SEC Docket 550 (Berry); Michael J. Rothmeier, Advisers Act Rel. No. 1865 (Apr. 13, 2000), 72 SEC Docket 544 (Janutol). 

  •  

  • On February 28, 2002,Roach and East West, both defaulted. See Christopher P. Roach, Exchange Act Rel. No. 45486 (Feb. 28, 2002), 77 SEC Docket 33. 

The SEC Reviews on Appeal

What does the SEC have to find to in order to find that Abel and Blizzard were aiders and abettors of the violations alleged?

For starters, the SEC must find a primary violation by Shawmut --- otherwise no individual could have aided and abetted any misconduct. The OIP charged that the primary violation committed by Shawmut was a violation of Advisers Act Sections 206(1) and 206(2) by failing to disclose in its ADV the use of client commissions to compensate certain broker-dealers for actual and potential client referrals. Sections 206(1) and (2) prohibit investment advisers from employing any device, scheme, or artifice to defraud clients or prospective clients, or from engaging in any transaction, practice, or course of business that defrauds clients or prospective clients.  However, and a bit oddly, Shawmut was not charged as a respondent in this proceeding. In addition to finding a primary violation, aiding and abetting liability requires a showing of substantial assistance by the aider and abettor to the primary violation and general awareness, or reckless disregard,  (often referred to as a "scienter" requriement) on the part of the aider and abettor of the wrongdoing and of his or her role in furthering it. See Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000); Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991); Abraham & Sons Capital, Inc., Exchange Act Rel. No. 44624 (July 31, 2001), 75 SEC Docket 1481, 1492 & n.24. A finding that a respondent willfully aided and abetted violations of the securities laws necessarily makes that respondent a "cause" of those violations. Abraham & Sons, 75 SEC Docket at 1492 & n.25; Sharon M. Graham, 53 S.E.C. 1072, 1085 n.35 (1998), aff'd, 222 F.3d 994 (D.C. Cir. 2000). The willfulness requirement is satisfied if a respondent intends to do the acts that constitute the violation. Feeley & Willcox Asset Management Corp.,Securities Act Rel. No. 8249 (July 10, 2003), 80 SEC Docket 2075, 2091-92, appeal pending, No. 03-41113 (2d Cir.); Wonsover v. SEC, 205 F.3d 408, 414 (D.C. Cir. 2000). In yet another quirk in this case, scienter is an element of a Section 206(1) violation, but need not be found to establish a Section 206(2) violation. Reckless behavior satisfies the scienter requirement.  See, e.g., Howard v. Everex Systems, Inc., 228 F.3d 1057, 1063 (9th Cir. 2000); Newton v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 135 F.3d 266, 272-73 (3d Cir. 1998). 

ELEMENTS OF AIDING and ABETTING

  1. Primary Violation
  2. Substantial Assistance by aider/abettor to the primary violation
  3. General awareness or reckless disregard by aider/abettor of wrongdoing (scienter) 

Section 206
Prohibited Transactions by Investment Advisers

It shall be unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly

  1. to employ any device, scheme, or artifice to defraud any client or prospective client; (Ed: scienter showing required)
  2. to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client (Ed: scienter showing  not required). . .

Did Shawmut have to disclose to its customers that it paid commissions in consideration for referrals?

Let's analyze this in pieces because it's a bit complicated.  One interesting point to keep in mind is that since the OIP did not charge that Shawmut violated the securities laws by using referrals as a factor in allocating commissions, or by paying commissions too high to be justified by the value of the research received.  As such, those issues are not addressed by the SEC.

First, Section 206 imposes on investment advisers a fiduciary duty to exercise the utmost good faith in dealing with their clients, and to disclose all material facts and conflicts of interest to their clients. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 191-92, 194, 196; Fundamental Portfolio Advisers, Inc., Securities Act Rel. No. 8251 (July 15, 2003), 80 SEC Docket 2234, 2258; Arleen W. Hughes, 27 S.E.C. 629, 634-38 (1948). 

Second, an investment adviser's arrangement to direct brokerage in exchange for benefits to the adviser creates a conflict of interest that is material and must be disclosed. 

Although Shawmut disclosed that it considered research provided by brokers in selecting brokers to execute client transactions, it did not disclose that its selection of brokers was also influenced by the fact that brokers had referred business to Shawmut or the likelihood that they would. The referral of business was a benefit to Shawmut, not its clients, and Shawmut referred its clients' brokerage business in exchange for this benefit. That arrangement created a conflict of interest that had to be disclosed under Section 206. The SEC and the ALJ parted company on this ultimate conclusion as it related to the facts of the case.  The ALJ found that Shawmut and the respondents "did not have fair notice that it was necessary to affirmatively disclose that commission brokerage was directed to brokers in part because they provided client referrals in addition to best execution and research." The SEC found to the contrary, and held that the inherent conflict of interest posed by using client funds to pay for referrals of business falls well within that rule. Moreover, the SEC found that Form ADV explicitly requires, in Part II Items 12 and 13, that investment advisers provide information about factors used to select brokers and arrangements by which the advisers provide compensation for client referrals. Accordingly, the Form itself put Shawmut on notice that disclosure of its consideration of referrals in allocating brokerage was required to be disclosed. 

See 1986 Release, 35 SEC Docket at 909 ("when an adviser receives research as a result of allocating brokerage on behalf of clients' accounts, the Commission has long maintained that an adviser must disclose soft dollar arrangements to clients"; adviser has duty to disclose to clients all material information that is intended to expose or eliminate all potential or actual conflicts of interest that might incline adviser to render advice that is not disinterested);
 see also IMS/CPAs & Assocs., Securities Act Rel. No. 8031 (Nov. 5, 2001), 76 SEC Docket 669, 683 (noting that "economic conflicts of interest . . . are material facts that must be disclosed" by investment advisers and citing additional authority), petition denied sub nom. Vernazza v. SEC, 327 F.3d 851 (9th Cir.), opinion amended, 335 F.3d 1096 (9th Cir. 2003); Kingsley, Jennison, McNulty & Morse, Inc., 51 S.E.C. 904, 907 (1993) ("[T]he adviser may not use its client's assets for its own benefit without prior consent, even if it costs the client nothing extra."). 

But how do you prove that Shawmut --- not a human being --- had scienter for purposes of Section 206(1)?

A company's scienter may be imputed from that of the individuals who control it. SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1096-97 nn. 16-18 (2d Cir. 1992) (imputing individuals' scienter to corporations they controlled); Kirk A. Knapp, 50 S.E.C. 858, 860 n.7 (1992) (attributing scienter of owner of firm to firm). As President and later Chief Investment Officer, Abel was one of Shawmut's senior officials and his responsibilities included compliance with SEC rules and regulations. Securities professionals are required to be knowledgeable about, and to comply with, requirements to which they are subject. Abraham & Sons, 75 SEC Docket at 1494.  Abel and other senior officials at Shawmut knew that Shawmut was directing brokerage based in part on client referrals. Abel and other senior officials also knew that this was a new practice for Shawmut, and therefore could not reasonably have believed it had been disclosed by Shawmut previously. The plain language of Form ADV stated that, when an investment adviser or any related person has "authority to determine, without obtaining client consent," the broker or dealer to be used and where "the value of products, research, and services given to the [adviser] or a related person is a factor in making that determination, the research, products, and services in question" must be disclosed. 

The plain language of Form ADV also required that investment advisers provide information about factors used to select brokers and arrangements by which the advisers provide compensation for client referrals. The ADV instructions specified that amendment was required if information in Part II became materially inaccurate. Under these circumstances Abel and other members of senior management at Shawmut were reckless in not ensuring that the consideration of client referrals in allocating brokerage commissions was disclosed in Shawmut's ADV. The omission of that disclosure constitutes "'an extreme departure from the standards of ordinary care, . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it'" and establishes recklessness. Steadman v. SEC, 967 F.2d at 641-42 (quoting definition of recklessness from Sunstrand Corp. v. Sun Chemical Corp., 553 F.2d 1033, 1035 (7th Cir.) (citation omitted), cert. denied, 434 U.S. 875 (1977)). 

Consequently, the SEC found that the state of mind of Abel and other senior officials at Shawmut constituted scienter necessary to find a primary violation of Section 206(1) by Shawmut. 

Did the SEC sustain the ALJ's finding of a primary violation of Sections 206(1) and (2) only with respect to the directing of commissions to a referral broker who handled a union local's accounts, but not for the direction of commissions to other referral brokers? 

No.  The SEC said that the ALJ's distinction between disclosures necessary when brokerage is directed solely on the basis of referrals (as she determined in the case of the union accounts), and disclosures necessary when brokerage is directed on the basis of best execution, research, and referrals is incorrect. Disclosure in the ADV is required when referrals are a factor in directing client business, regardless what other factors may also be involved. Moreover, the record did not support the ALJ's finding that the broker for the local's accounts "provided no service except to guarantee that Shawmut would obtain and retain [the local's] accounts." The local's broker, like the other referral brokers, provided research to Shawmut, as Blizzard had been told it must. 

Since the SEC found a primary violation of at least Section 206(1), did they then find that Abel rendered substantial assistance to Shawmut's failure to disclose the directed brokerage arrangement in its From ADV? 

Abel argued to the SEC that he cannot be liable as an aider and abettor of any disclosure violations by Shawmut because he was not aware that his behavior was part of an activity that was improper.  The SEC rejected his position because it had determined that his conduct contributed to Shawmut's recklessness in failing to disclose the consideration of client referrals in allocating brokerage. 

The SEC noted that Abel briefed management on issues within his areas of responsibility, and that he knew Shawmut management, and some compliance personnel, were aware that referrals were being taken into consideration in the allocation of brokerage commissions.  Further, the SEC believed it would have been desirable for Abel to have followed up more aggressively to see that senior management or compliance ensured that the necessary disclosures were made, and, if a longer period of conduct were considered, we might analyze his liability differently. 

Nonetheless, and a bit shockingly given all that came before, under all the circumstances of this case, the SEC did not find that Abel's failure to do more than he did during the brief, one-week period between September 9 and September 16, 1994, constitutes awareness that his behavior was part of an activity that was improper. 

What's Really Going On Here

Under 28 U.S.C. 2642, any government action for the enforcement of "any civil fine, penalty, or forfeiture, pecuniary or otherwise." must be commenced within five years from the date when the claim first accrued. Not only was the SEC aware that Abel's one-week of on-board conduct during the alleged primary violation may have been insufficient to find him an aider and abettor, but the SEC is also aware that bad facts make bad law --- this is not the case to test Section 2642.  The SEC previously lost one round in Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996),  which applied this limitations period to certain SEC proceedings.  Or, as the SEC delicately puts it " however, we are mindful of the potential applicability of the Section 2462 statute of limitations. " 

Note that the OIP was filed September 9, 1999, and Abel left Shawmut on September 16, 1994.  Not much activity would fall within the five-year statute of limitation. Remember, it was at the September 15, 1994, CAC meeting, the day before Abel left Shawmut, that the eight referral brokers, plus an additional referral broker introduced by Blizzard, were added to the "research broker" list) ns.

Since the SEC found a primary violation of at least Section 206(1), did they then find that Abel rendered substantial assistance to Shawmut's failure to disclose the directed brokerage arrangement in its From ADV? 

Blizzard was charged with aiding and abetting Shawmut's failure to disclose in its ADV the use of client commissions to compensate broker-dealers for client referrals. However, his position at Shawmut was that of a salesperson (with no compliance oversight duties), and he was not involved in preparing or reviewing Shawmut's ADV --- or responsible for delivering Form ADV to clients or explaining its contents. Additionally, he disclosed to Abel and many others at Shawmut all necessary information concerning his desire that Shawmut consider client referrals in directing brokerage commissions.  His efforts were characterized by an openness in seeking to have trades sent to brokers who helped him with referrals. Given the level of discussion at Shawmut regarding the proposed practice and the concerns expressed about the research provided by the brokers recommended by Blizzard, there can be no doubt that Blizzard adequately informed Shawmut senior management that he was proposing that commissions be directed to his introduced brokers  largely on the basis of client referrals. Moreover, Blizzard was present at the CAC meeting when Rajala raised the issue of the possible need for ADV disclosure of the direction of commissions to brokers based on referrals. Thus, Blizzard had reason to believe that the question of disclosure was being handled appropriately.  \

The SEC held that Blizzard did not substantially assist in the conduct that constituted the primary violation charged and dismissed the ALJ's findings that he aided and abetted that violation. 

Decision

The SEC Ordered the dismissal of the proceedings instituted September 9, 1999 against Clarke T. Blizzard and Rudolph Abel. 



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