United States Court of Appeals
For the First Circuit
No. 99-2114
AL RIZEK,
Petitioner,
v.
SECURITIES AND EXCHANGE COMMISSION,
Respondent.
ON PETITION FOR REVIEW OF AN ORDER OF
THE SECURITIES AND EXCHANGE COMMISSION
Before
Lynch and Lipez, Circuit Judges,
and Keeton, District Judge.*
José R. Riguera, with whom John R. Squitero and Katz, Barron,
Squitero & Faust, P.A. were on brief, for petitioner.
Catherine A. Broderick, Counsel to the Assistant General Counsel,
with whom Mark Pennington, Assistant General Counsel, and Meyer
Eisenberg, Deputy General Counsel, were on brief, for respondent.
June 16, 2000
*Of the District of Massachusetts, sitting by designation.
LYNCH, Circuit Judge. Al Rizek was a vice president
of PaineWebber Incorporated of Puerto Rico. Over a ten-month
period in 1993 he churned the accounts of five customers,
causing losses of approximately $195,000 on accounts with
average balances that totaled about $700,000. This violated
Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.
78j, and Rule 10b-5, 17 C.F.R. § 240.10b-5. Although his
customers indicated that they had conservative investment
objectives, Rizek pursued the extremely risky strategy of
trading U.S. Treasury bonds in an attempt to take advantage of
short-term fluctuations in the market. He magnified the risk by
trading the accounts on margin.
In 1999, the Securities and Exchange Commission ordered
that Rizek be permanently barred from the securities industry,
cease and desist from violations, pay a civil penalty of
$100,000, and disgorge over $120,000. In doing so, the SEC
departed from the recommendations of its own Administrative Law
Judge, who would have imposed a disgorgement of over $275,000,
but only a two-year suspension. See generally In re Al Rizek,
Exchange Act Release No. 41,725, 70 S.E.C. Docket 705 (Aug. 11,
1999), available in 1999 WL 600427.
Rizek, by petition for review of the SEC order,
challenges the permanent bar order and the civil penalty; he
does not challenge the findings that he excessively traded the
accounts. The essence of his argument is that the SEC was wrong
in finding he had the degree of scienter required for such a
-2-
sanction: while his investment strategy may have been wrong, he
had a good faith belief in it, he meant no harm, and he is
remorseful. From this he argues that a permanent bar from the
industry where he has supported himself and his family for
fifteen years is arbitrary and capricious, and so should be
reversed. He also urges that this court adopt a rule that when
the Commission imposes a permanent bar, the most drastic
sanction available, it must show that a less drastic remedy
would not suffice to protect the public.
We decline that invitation and affirm the Commission
order.
I.
There is very little dispute about the underlying
facts, which we take from the record before the Commission. The
parties disagree, however, as to the conclusions that may be
drawn from those facts.
The five customers in question -- Eddie Figueroa, Jorge
Donato, José Acevedo, Hector Torres Nadal, and Herminio R.
Cintron -- opened their accounts with Rizek in 1990 and 1991.
Only Donato and Cintron had some prior experience investing in
securities. Acevedo and Torres had purchased CDs or similar
investment products, while Figueroa had previously kept his
money in a savings account.
Four of the customers' new account forms listed
"speculation" last among possible investment objectives, while
Rizek's record of Torres's account does not mention speculation
-3-
at all. Donato told Rizek that he was primarily interested in
long-term bonds and the "safety of [his] investment." Acevedo
testified that he was looking for a long-term investment; he was
not willing to speculate or risk any of his principal. Cintron
was planning for his retirement and his children's education; he
testified that he was looking for "something that was safe";
Torres was also saving for retirement and described himself as
"very cautious" and interested in "something that was protected
and secure." Figueroa testified that he was willing to take
"any type of risk," but that Rizek had counseled him that "given
the small amount of money that [he] had, the most convenient
thing was to put most of the savings into some safe investments
and devote a small amount to moderate type of risk."
Torres and Cintron testified that Rizek never asked
them later if they wanted to change their investment objectives
to indicate a willingness to speculate. Acevedo, Donato, and
Figueroa testified that they could not recall if Rizek had ever
asked them about changing their objectives.
In early 1993, Rizek recommended a strategy of short-
term trading of zero-coupon bonds to certain of his customers,
including the five whose accounts are at issue here. Zero-
coupon bonds are U.S. government instruments that accumulate
interest until maturity, rather than paying interest
periodically. The value of a zero-coupon bond is very sensitive
to changes in interest rates. Rizek recommended that his
customers purchase the bonds on margin, which significantly
-4-
increased the face value amounts of the trades, thus magnifying
the potential gains and losses. Purchasing on margin meant that
the customers had to make monthly margin interest payments to
PaineWebber; it also placed them at risk of being forced to sell
at a loss to meet a margin call.
The SEC Division of Enforcement's expert witness
testified that there was no economic logic to Rizek's trading
strategy of swapping zero-coupon bonds, because bond prices move
in parallel with each other. The expert stated that only a
"very sophisticated, experienced investor" could have understood
Rizek's strategy and its risks. On the other hand, Rizek's
expert witness testified that trading zero-coupon bonds was an
"accepted trading strategy," but conceded that Rizek's customers
would have had to be able to tolerate "aggressive risk" for the
strategy to have been appropriate for them.
Figueroa, Torres, and Cintron testified that they
always followed Rizek's investment recommendations, while Donato
said that he followed them "ninety-nine percent" of the time.
Acevedo testified that he could not remember refusing any of
Rizek's recommendations during the relevant period.
During the fifteen-month period from January 1993 to
March 1994, the five accounts had average monthly balances of
approximately $50,000; $85,000; $86,000; $165,000; and $312,000.
During this time, Rizek carried out approximately $24 million in
transactions on the accounts, generating tens of thousands of
dollars in commissions and margin interest fees. For example,
-5-
Rizek effected $1.6 million in transactions on the account with
the $50,000 average balance, incurring average annual
commissions of about $16,000 and interest fees of over $5,000.
On the largest account, Rizek carried out $9.3 million in
transactions, which generated average annual commissions of more
than $82,000 and interest fees of over $30,000. All told,
Rizek's strategy led to losses of approximately $195,000 on the
five accounts, which had average monthly balances totaling about
$700,000.
II.
A sanctions order of the Commission must be upheld
unless the order is a "gross abuse of discretion." A.J. White
& Co. v. SEC, 556 F.2d 619, 624 (1st Cir.) (internal quotation
marks omitted), cert. denied, 434 U.S. 969 (1977); see also
Lawrence v. SEC, 398 F.2d 276, 280 (1st Cir. 1968).
Congress has charged the Commission with protecting the
investing public. See, e.g., 15 U.S.C. § 78j(b) (referring to
"rules and regulations . . . the Commission may prescribe . . .
for the protection of investors"); see also Pierce v. SEC, 239
F.2d 160, 163 (9th Cir. 1956) ("The Commission is given the duty
to protect the public. What will protect the public must
involve, of necessity, an exercise of discretionary
determination."). And so the question of the appropriate remedy
is "peculiarly a matter for administrative competence." Butz v.
Glover Livestock Comm'n Co., 411 U.S. 182, 185 (1973) (quoting
American Power & Light Co. v. SEC, 329 U.S. 90, 112 (1946))
-6-
(internal quotation marks omitted); see also Phelps Dodge Corp.
v. NLRB, 313 U.S. 177, 194 (1941) ("[T]he relation of remedy to
policy is peculiarly a matter for administrative competence . .
. ."). As a result, the Commission's sanctions must be affirmed
unless "unwarranted in law or . . . without justification in
fact." American Power & Light, 329 U.S. at 112-13.
Rizek contends that his conduct was at most negligent
and naive. He says that the violations involved only five of
his 400 customers; that his strategy relied on predictions from
Paine Webber’s chief economist; and that he stopped investing in
zero-coupon bonds when his customers began to lose money. He
also points to the fact that he has given assurances against
future violations. Rizek claims that the bar is improperly
punitive in nature and not meant to protect the investing
public.
Rizek argues that this court should follow Steadman v.
SEC, 603 F.2d 1126 (5th Cir. 1979), aff’d on other grounds, 450
U.S. 91 (1981). Rizek claims Steadman held that a court should
not affirm a permanent bar, the most drastic sanction available,
unless the SEC has shown that no lesser remedy will suffice to
protect the public interest. See id. at 1140.
We think Rizek’s argument confuses two concepts. We
understand Steadman to articulate no more than the well-
established rule that agencies must sufficiently articulate the
grounds of their decisions so that appellate courts are able to
perform their function of judicial review meaningfully. The
-7-
Supreme Court made this point about the need for adequate SEC
findings in SEC v. Chenery Corp., 318 U.S. 80, 94 (1943)
("[T]he orderly functioning of the process of review requires
that the grounds upon which the administrative agency acted be
clearly disclosed and adequately sustained."); see also Beck v.
SEC, 413 F.2d 832, 834 (6th Cir. 1969). This court has made the
point in various contexts involving judicial review of
administrative actions, and at times has remanded to the agency
when it has not provided such an explanation. See, e.g., City
of Boston v. U.S. Dep't of Hous. and Urban Dev., 898 F.2d 828,
835 (1st Cir. 1990); Jasinskas v. Bethlehem Steel Corp., 735
F.2d 1, 5 (1st Cir. 1984).
To say that the Commission must adequately set forth
its grounds is far different from saying that the agency’s
discretion as to remedy is curtailed by judge-made rules, such
as a rule that a permanent bar may be imposed only if the agency
has explained to the satisfaction of a court why no lesser
remedy will do. If that is what Steadman intended, then we
respectfully disagree. As the Butz Court said in reversing a
court of appeals that had overturned an administrative agency’s
choice of sanctions, "[w]e search in vain for that requirement
in the statute." Butz, 411 U.S. at 186. Section 15(b)(6)(A) of
the Securities Exchange Act authorizes the Commission to issue
a permanent bar if it finds that such a bar "is in the public
interest." 15 U.S.C. § 78o(b)(6)(A). Considerable deference
-8-
should be given the Commission’s ultimate judgment about what
will best protect the public.1
We also note that the term "permanent bar" is more than
a bit of a misnomer. It does not literally mean that the
sanctioned person may never reenter the securities industry. In
fact, there are two routes back in. First, Rizek may later
apply to the SEC for consent to associate with an entity that is
not a member of a self-regulatory organization such as the
National Association of Securities Dealers (NASD). See SEC Rule
of Practice 193, 17 C.F.R. § 201.193(a). Second, Rizek may find
a NASD member firm willing to employ him, and that firm may
apply to NASD to have Rizek become associated with it. See By-
Laws of The National Association of Securities Dealers, Inc.,
art. III, § 3(d). NASD's approval of any such application is
subject to whatever further action the Commission may take. See
id., art. III, § 3(f).2 This is a remarkably porous definition
of a permanent bar.
The Commission said it was imposing a permanent bar on
Rizek because of the egregiousness of his violation; because
1 That is not to say there is no room for a court to find
that a particular sanction is an abuse of discretion. See,
e.g., Hateley v. SEC, 8 F.3d 653, 655-57 (9th Cir. 1993)
(reducing a disgorgement order which was approximately ten times
the amount of the petitioner’s unjust enrichment).
2 If the Commission wishes to order review of a NASD
determination, it must do so within 40 days of receiving notice
of the determination. See 17 C.F.R. § 201.421.
-9-
there was little basis to credit his claim of remorse (he was
remorseful about the losses, but not about using the strategy
which caused the losses); and because Rizek, who was at the time
president of his own investment company,3 posed a substantial
threat to public investors.
The activity was egregious. These five clients were
unsophisticated in the world of investing and trusted Rizek to
handle their savings conservatively. In some instances these
were their life savings, their funds for retirement, or their
funds for educating their children. On average balances in the
five accounts totaling $700,000, Rizek engaged in over $24
million in transactions over a ten month period. The
transaction costs equaled roughly 40% of the account balances;
one customer lost about 50% of his account. While his customers
lost $195,000, Rizek received about $125,000 in commissions.
There is no doubt that Rizek churned the accounts.
Churning is commonly said to have three elements: (1) control of
the customer’s account by the broker, either explicit or de
facto; (2) excessive trading in light of the customer’s
investment objectives; and (3) scienter -- the required state of
mind for liability under Section 10(b) and Rule 10b-5. See
Tiernan v. Blyth, Eastman, Dillon & Co., 719 F.2d 1, 2 (1st Cir.
3 Rizek argues that his own firm is now defunct and so
he cannot be a threat to others. The point, rather, is one of
protecting the investing public, and the Commission has
concluded that it would protect the public by precluding Rizek
from further association with the industry.
-10-
1983); see also, e.g., Craighead v. E.F. Hutton & Co., 899 F.2d
485, 489 (6th Cir. 1990); Laird v. Integrated Resources, Inc.,
897 F.2d 826, 838 (5th Cir. 1990); Hotmar v. Lowell H. Listrom
& Co., 808 F.2d 1384, 1385 (10th Cir. 1987). Rizek focuses on
the third element.
The Supreme Court has said that scienter is "a mental
state embracing intent to deceive, manipulate, or defraud."
Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12 (1976).
This circuit has accepted as meeting the requirement of scienter
a form of recklessness that is not merely ordinary negligence,
but is more like a lesser form of intent. See Greebel v. FTP
Software, 194 F.3d 185, 199 (1st Cir. 1999). We have defined
reckless conduct as "a highly unreasonable omission, involving
not merely simple, or even inexcusable, negligence, but an
extreme departure from the standards of ordinary care, and which
presents a danger of misleading buyers or sellers that is either
known to the defendant or so obvious the actor must have been
aware of it." Id. at 198 (quoting Sundstrand Corp. v. Sun Chem.
Corp., 553 F.2d 1033, 1045 (7th Cir. 1977)).
Rizek argues that while the Commission may have been
entitled to find that he had the degree of scienter needed to
establish a churning violation, a greater degree of scienter is
needed to justify the sanctions imposed. There is no statutory
basis to distinguish between the scienter needed to establish a
violation for which a sanction may be imposed administratively
and the scienter needed to warrant a particular penalty. At
-11-
most, Rizek's argument goes to the Commission’s exercise of its
discretion. And the Commission found that even if Rizek had a
good faith belief in the efficacy of his strategy, "he had no
justification for recommending it to unsophisticated customers
who were incapable of making an independent judgment, when he
knew that the extremely high risk was directly contrary to the
customers’ conservative investment objectives." In re Al Rizek,
Exchange Act Release No. 41,725, 70 S.E.C. Docket 705 (Aug. 11,
1999), available in 1999 WL 600427 at *6. That finding is
adequate support for the remedy.
In any event, this case involves churning plus. The
Commission also found that "Rizek was well aware that he had
acted improperly in recommending his strategy, and tried to
conceal his conduct from his firm." Id. Rizek both misled his
firm's management and attempted to mislead the Commission.
Paine Webber management had become concerned about Rizek’s
trading strategy and questioned him about it at four meetings.
Rizek responded by giving the firm a list of clients whose
strategies, he said, had changed so that "speculation" was now
a high ranking objective. In addition, at the hearings before
the ALJ, Rizek testified that he had called all of the customers
in November 1993 and all of them agreed to the reordering of
their investment objectives. But the facts were to the
contrary: none of the customers testified that Rizek had sought
or received their permission to change their investment
objectives. There was ample evidence to support the
-12-
Commission’s conclusion that Rizek acted willfully and
recklessly.
Under these circumstances, there is simply no viable
argument that the permanent bar was an abuse of discretion, or
that it was punitive and not meant to protect the investing
public. See, e.g., Sheldon v. SEC, 45 F.3d 1515, 1519 (11th
Cir. 1995) (affirming permanent bar); Sartain v. SEC, 601 F.2d
1366, 1376 (9th Cir. 1979) (same); O’Leary v. SEC, 424 F.2d 908,
912 (D.C. Cir. 1970) (same); Fink v. SEC, 417 F.2d 1058, 1060
(2d Cir. 1969) (same).
III.
Rizek also challenges the imposition of a $100,000
civil penalty. Under Section 21B(b) of the Act, there is a
three-tiered system for assessing civil penalties, ranging from
a first tier penalty of $5,000 to a third tier penalty of
$100,000. See 15 U.S.C. § 78u-2(b). The requirements for
imposition of the third tier penalty are set forth at 15 U.S.C.
§ 78u-2(b)(3):
(3) Third tier
Notwithstanding paragraphs (1) and (2), the maximum amount
of penalty for each such act or omission shall be $100,000
for a natural person or $500,000 for any other person if --
(A) the act or omission described in subsection (a)
of this section involved fraud, deceit, manipulation,
or deliberate or reckless disregard of a regulatory
requirement; and
(B) such act or omission directly or indirectly
resulted in substantial losses or created a
significant risk of substantial losses to other
persons or resulted in substantial pecuniary gain to
the person who committed the act or omission.
-13-
In turn, the statute sets forth six factors which the
Commission may consider in assessing monetary penalties:
(1) whether the act or omission for which such penalty is
assessed involved fraud, deceit, manipulation, or
deliberate or reckless disregard of a regulatory
requirement;
(2) the harm to other persons resulting either directly or
indirectly from such act or omission;
(3) the extent to which any person was unjustly enriched,
taking into account any restitution made to persons
injured by such behavior;
(4) whether such person previously has been found by the
Commission, another appropriate regulatory agency, or
a self-regulatory organization to have violated the
Federal securities laws, State securities laws, or the
rules of a self-regulatory organization, has been
enjoined by a court of competent jurisdiction from
violations of such laws or rules, or has been
convicted by a court of competent jurisdiction of
violations of such laws or of any felony or
misdemeanor described in section 78o(b)(4)(B) of this
title;
(5) the need to deter such person and other persons from
committing such acts or omissions; and
(6) such other matters as justice may require.
Id. § 78u-2(c). To the extent Rizek argues he is unable to pay
the penalty, we note that he did not raise the argument before
the Commission, and so it is waived. See 15 U.S.C. § 78y(c)(1).
For the same reasons there was no abuse of discretion in the
permanent bar order, there was no abuse of discretion in the
imposition of the civil penalty.
We affirm the Commission's order.
-14-