Securities and Exchange Commission
Washington, D.C.

Securities Exchange Act of 1934
Rel. No. 47572 / March 26, 2003

Admin. Proc. File No. 3-9440-EAJA

OPINION OF THE COMMISSION

EQUAL ACCESS TO JUSTICE ACT PROCEEDING

Applicant, who had prevailed in Commission administrative proceeding, sought an award of attorneys' fees and expenses under the Equal Access to Justice Act. Held, the application is denied because the Division's position in the underlying action was substantially justified.

APPEARANCES:

Bruce Sanders, of Law Office of Bruce Sanders, for Robert L. McCook.

Theresa J. Verges, for the Division of Enforcement.

Appeal filed: June 11, 2002
Last brief received: September 17, 2002

I.

The Division of Enforcement appeals from the decision of an administrative law judge awarding Robert L. McCook attorneys' fees and costs in the amount of $15,127.75 under the Equal Access to Justice Act ("EAJA"). ^{1} McCook, a registered representative associated with Crestar Securities Corporation ("Crestar"), abroker-dealer, was charged with aiding and abetting net capital and books and records violations. ²

The Commission action underlying McCook's EAJA claim charged that three registered representatives and traders at First Montauk Securities Corporation ("FM") engaged in a scheme to "park" complex mortgage-backed derivative securities with other dealers in order to move the securities off FM's books, and that the traders used this scheme to manipulate the price of the derivative securities. As a result of the scheme, the Division alleged, FM failed to maintain accurate books and records and incurred net capital deficiencies. McCook was charged with having participated in some of the transactions that were part of the alleged scheme.

The law judge dismissed the charges against McCook. The law judge found that FM committed net capital and books and records violations. The law judge found, however, that the evidence did not establish that McCook knew that his conduct was part of an overall activity that was improper, or that McCook knowingly or substantially assisted the conduct that constituted the violations. The law judge's decision became final, and McCook timely filed the EAJA claim that is now before us. ³

The EAJA provides that a respondent who has prevailed against the government in an adversary proceeding may recover the fees and expenses that were incurred unless "the position of the agency was substantially justified." ⁴ The Division contends on review that its position in the underlying case against McCook met that standard. Our findings are based on an independent review of the record.

II.

The facts underlying the net capital and books and records violations are not in dispute. Between April 1993 and February 1994, McCook participated in at least twelve complex transactions on behalf of Crestar. In these transactions, the prices at which collateralized mortgage obligations ("CMOs") were bought and sold were dictated by Joel L. Hurst, David E. Lynch, and Larry E. Muller, who were registered representatives associated with the Houston office of FM ("the FM representatives"). ⁵ FM,as a matter of policy, did not ordinarily allow its representatives to hold a position in a security without a committed buyer. ⁶ Thus, the FM representatives were directed to engage only in riskless principal transactions, where the purchase and sale of a CMO occurred contemporaneously. ⁷

In the twelve transactions at issue, FM sold government securities subject to an agreement that FM would repurchase the securities at an established future time at a price set by FM when the transaction was arranged. Rather than selling the securities to Crestar and repurchasing them from Crestar, however, the arrangement called for the securities to pass through a third party dealer, either Simmons First National Bank ("Simmons") or Trading Desk of Memphis, Inc. ("TDI").

McCook arranged each series of trades with the FM representatives and representatives at Simmons or TDI. McCook also made the trades on Crestar's behalf. He agreed to purchase the securities without researching any aspect of the CMOs, including their market price. In at least one instance, McCook agreed to a transaction without knowing what security wasinvolved, at what price, or in what quantity. McCook selected the third parties who were inserted into the repurchase arrangement discussed above and proposed to the FM representatives that the third parties be included in the transactions. ⁸ On one occasion, McCook acquiesced in FM's request that he delay writing an order ticket for a trade for more than a week despite Crestar's policy that tickets should be written at the time the trade was arranged.

As a result of information submitted to FM's main office by the FM representatives, the order tickets depicted each transaction as two separate trades, even though both trades were agreed upon in the same conversation. The scheme caused FM to maintain books and records that were inaccurate in that they did not reflect as liabilities the commitments to repurchase the securities. Moreover, improperly recording the transactions on FM's books and records affected FM's net capital computations, resulting in undisclosed net capital deficiencies. The scheme also caused FM to file inaccurate Financial and Operational Combined Uniform Single ("FOCUS") Reports. ⁹ Finally, the scheme caused FM to fail to disclose to the Commission that FM was in net capital violation repeatedly between April 1993 and November 1993.

III.

Finding that a respondent aided and abetted violations of the federal securities laws requires (1) a securities law violation committed by another party, (2) general awareness or knowledge by the aider and abettor that his or her actions are part of an overall course of conduct that is improper, and (3) substantial assistance by the aider and abettor in the conduct that constitutes the violation. ¹⁰

The existence of securities violations by FM is not at issue. As the law judge found, FM's submission of inaccurate FOCUS reports, net capital deficiencies, failure to disclose those deficiencies, and failure to maintain accurate books and records violated several sections of the Exchange Act and multiple rules thereunder. Thus, the question at this juncture is whether the Division's position as to the other two elements of aiding and abetting was substantially justified.
An agency position can be substantially justified even if the trier of fact finds the evidence insufficient to prove the violations alleged. To satisfy the standard, the agency position need only be justified to a degree that could satisfy a reasonable person, i.e., it must have a reasonable basis in law and fact. ¹¹ Because the EAJA analysis involves a standard different from that applied in the underlying action, the conclusions reached in the initial proceeding are not dispositive. Instead, "an 'independent evaluation must be conducted through an EAJA perspective.'" ¹²

The law judge, while acknowledging her obligation to conduct an independent evaluation, based her conclusion that the Division's position was not substantially justified on the findings she made against it in her initial decision. She found that McCook had no knowledge that his role was part of an overall activity that was improper because "[the] evidence presented at trial was consistent with McCook's characterization of the transactions as usual business conduct." She noted that the Division's two expert witnesses identified "several business motives to account for many features" of the transactions. She observed that the books and records and net capital violations resulted from actions by the FM representatives and concludedthat McCook was "too far removed from the perpetrators" to be aware of the violations. The law judge found that no evidence at trial contradicted McCook's testimony that each trade was approved by Crestar management, and that he entered accurate trade dates except when instructed to do otherwise by Crestar management. She interpreted this "management approval" as evincing McCook's ignorance of FM's violative conduct. Finally, the law judge found that a Simmons representative's inquiry to McCook, "You know, they aren't going to come back and put us in jail for this five years down the road, are they?" and McCook's response, "Ha, ha. No promises here," were not, as the Division argued, evidence that McCook was on notice that the conduct was wrong, but were simply "a joke."

The law judge also found that the Division's position regarding McCook's assistance in the violative conduct was not substantially justified. She noted that the Division viewed McCook's insertion of a third party into the transactions and his delayed writing of order tickets as conduct that assisted the violations. She faulted the Division, however, for not having called McCook's supervisors at Crestar to rebut his testimony that he obtained supervisory approval of both the use of third-party conduits and the delayed tickets.

We find the law judge's analysis to be at odds with the requirements of the EAJA. The law judge's task in the EAJA analysis was not to weigh the strength of McCook's case, but rather to assess the case presented by the Division. The Division introduced considerable evidence that McCook was involved in improper activity, much of which was discounted or disregarded by the law judge. For example, the law judge highlighted expert testimony to the effect that there were "several business motives to account for many features" of the transactions at issue, but she did not acknowledge the experts' clearly stated conclusions that the transactions, viewed as a whole, did not conform to any recognizable type of legitimate securities transaction. One expert stated plainly, "These transactions are not transactions that fall into the ordinary course of business." The other expert rejected the suggestion that the transactions could be "innocent repurchase or [roll] transactions that just got poorly documented," stating: "There is not a chance that this is an innocent mistake, a pattern of innocent mistakes." We find it hard to understand how the law judge could view the experts' testimony as supporting McCook's position rather than the Division's.

The experts' testimony also supported the Division's position that McCook knew that his actions were part of, andcontributed to, an overall course of conduct that was improper. One expert testified that there was never a legitimate business reason to delay writing a trade ticket, that postponing the written paperwork associated with an oral agreement would ordinarily lead to a trader's termination from his or her firm, and that it was "not possible" that McCook could have engaged in the transactions in the mistaken belief that they were legal and legitimate. The other expert testified that he knew of no sensible business reason to insert a third party into the transactions in question and that, "There's no such thing [as delaying writing a trade ticket]. . . . [Doing] that is a clear violation of how you are supposed to be operating as a trader. . . . I think it's a very extreme transgression."

The law judge credited McCook's testimony that his supervisors at Crestar approved of the delayed tickets and the use of third parties. Although supervisory approval would not necessarily exonerate McCook from liability had he been charged with a primary violation, under some circumstances it could affect our assessment of his knowledge that the conduct in which he was involved was improper. ¹³ At this stage, however, we are not assessing liability, but merely evaluating the strength of the Division's case. The forceful testimony of the experts as to the obvious impropriety of McCook's actions goes far to justify the Division's position.

The law judge found it "unreasonable" for the Division to regard McCook's conversation about going to jail as evidence of knowledge, finding instead that it was a joke. The remarks, on their face, suggest guilty knowledge. If interpreted as the Division urges, the remarks support the position that McCook knew the transactions were improper.

Finally, the Division elicited from McCook admissions that the transactions were at least unusual, if not improper. McCook acknowledged that these were the only trades he had done at Crestar that he would characterize as repurchase transactions; that he would not ordinarily agree to buy a security without knowing what it was, how much it would cost, and what quantity he was buying; and that he had never been asked to delay writing a trade ticket at Crestar except in connection with these transactions. McCook also acknowledged having previously testified that inserting a third party into the transaction was away to conceal the transaction, and he admitted that there would be no reason to conceal a legitimate repurchase transaction by delaying tickets or inserting a third party into the transaction. McCook also admitted that he expected that his agreement to delay writing one order ticket for more than a week would lead FM to similarly misdate its order ticket, and additionally would result in a confirmation bearing the incorrect date to be generated and sent to FM.

The Division's evidence, viewed in its entirety, provided substantial justification for the Division's position that McCook was aware that his conduct was part of an overall activity that was improper. We therefore find the Division's position as to this issue to have been substantially justified for purposes of the EAJA.

We also find that the Division's position regarding McCook's substantial assistance to FM's violations was substantially justified. McCook arranged these transactions with FM. McCook admitted that he agreed to delay an order ticket for more than a week, and that he followed through on that agreement. McCook also admitted that he involved Simmons and TDI as third parties in the transactions in question. McCook dealt directly with the Simmons, TDI, and FM representatives. Regardless of any involvement his supervisors at Crestar may have had in approving these arrangements, the deals could not have been done without McCook. Indeed, as the Division observes, "the factual record . . . placed McCook at the center of an elaborate . . . scheme orchestrated by the [FM] representatives."

After a careful analysis of the evidence submitted by the Division, we are satisfied that there was a reasonable basis in law and fact for bringing proceedings against McCook. We accordingly deny his claim under the EAJA for attorneys' fees and costs. ¹⁴

An appropriate order will issue. ¹⁵

By the Commission ((Chairman DONALDSON and Commissioners GLASSMAN, GOLDSCHMID, ATKINS and CAMPOS).

Jonathan G. Katz
Secretary

Securities and Exchange Commission
Washington, D.C.

Securities Exchange Act of 1934
Rel. No. 47572 / March 26, 2003

Admin. Proc. File No. 3-9440-EAJA

ORDER DENYING APPLICATION UNDER THE EQUAL ACCESS TO JUSTICE ACT

On the basis of the Commission's opinion issued this day it is

ORDERED that the application of Robert L. McCook for an award of attorneys' fees and costs under the Equal Access to Justice Act be, and it hereby is, denied.

By the Commission.

Jonathan G. Katz
Secretary

Endnotes

¹ 5 U.S.C. § 504. The law judge awarded McCook $14,988.75 in attorneys' fees and $139.00 in expenses.

² Specifically, McCook was charged with aiding and abetting violations of Sections 15(c) and 17(a) of the Securities Exchange Act of 1934 and Rules 15c3-1, 17a-3, 17a-5, and 17a-11 thereunder. Among other things, Section 15(c) of the Exchange Act, 15 U.S.C. § 78o(c), makes it illegal for a broker or dealer to effect any transaction in a security in contravention of the Commission's rules with respect to financial responsibility. Exchange Act Section 17(a), 15 U.S.C. § 78q(a), requires every registered broker or dealer to keep certain records and file certain reports. Exchange Act Rule 15c3-1, 17 C.F.R. § 240.15c3-1, specifies the net capital requirements for brokers and dealers. Exchange Act Rule 17a-3, 17 C.F.R. § 240.17a-3, requires brokers and dealers to create and maintain certain records, including brokerage orders and memoranda of the firm's trading activity. As relevant here, Exchange Act Rule 17a-5, 17 C.F.R. § 240.17a-5, requires broker-dealers to file Financial and Operational Combined Uniform Single ("FOCUS") Reports within specified time periods. Exchange Act Rule 17a-11, 17 C.F.R. §§ 240.17a-11, provides in relevant part that every broker or dealer whose net capital falls below the required minimum must give notice of such deficiency that same day to the Commission. The rule also provides that a broker or dealer that fails to make or keep current the books and records required by Rule 17a-3 must give notice to the Commission of this fact on the same day. Further, the broker or dealer must transmit a report to the Commission within 48 hours of the notice saying what it has done or is doing to correct the situation.

³ Although we are authorized to review an initial decision on our own initiative, see 17 C.F.R. § 201.411(c), our usual practice is not to do so, and we did not do so here. That we did not order review should not be construed as an endorsement of the law judge's analysis of McCook's position.

⁴ 5 U.S.C. § 504(a)(1).

⁵ Hurst, Lynch, and Muller were originally respondents in the administrative proceeding brought against McCook, as was Kent T. Black. The allegations pertaining to Black are unrelated to the violations with which McCook was charged. The Commission accepted an offer of settlement from Black on July 16, 1998. See Kent T. Black, Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order, Exchange Act Rel. No. 40218, 67 SEC Docket 1677 (July 16, 1998). The Commission accepted offers of settlement fromMuller and Hurst on March 12, 1999. See Larry E. Muller, Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order, Securities Act Rel. No. 7655, Exchange Act Rel. No. 41166, 69 SEC Docket 1022 (Mar. 12, 1999); Joel L. Hurst, Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order, Securities Act Rel. No. 7654, Exchange Act Rel. No. 41165, 69 SEC Docket 1018 (Mar. 12, 1999). An Order Making Findings and Imposing Sanctions By Default was entered against Lynch on November 14, 2001. See Kent T. Black, Order Making Findings and Imposing Sanctions By Default against David Lynch, Securities Act Rel. No. 8033, Exchange Act Rel. No. 45052, 76 SEC Docket 819 (Nov. 14, 2001), aff'd sub nom. David E. Lynch, Exchange Act Rel. No. 46439 (Aug. 30, 2002), 78 SEC Docket 1269 (increasing civil money penalty).

⁶ There were two reasons for the policy restriction on holding securities in inventory. First, FM wanted to avoid incurring the market risk associated with holding the positions. Second, the more funds it had tied up in inventory, the higher FM's net capital requirement.

⁷ See Strategic Resource Management, Inc., 52 S.E.C. 542, 544 n.8 (1995) (defining "riskless principal transaction").

⁸ McCook testified that a supervisor told him to include a third party in the trades, but did not tell him why he should do this or whom he should choose.

⁹ As noted above, filing FOCUS Reports is required by Exchange Act Rule 17a-5.

¹⁰ See, e.g., Howard R. Perles, Exchange Act Rel. No. 45691 (April 4, 2002), 77 SEC Docket 896, 904 ; Sharon M. Graham, 53 S.E.C. 1072, 1080-81 (1998), aff'd, 222 F.3d 994, 1000 (D.C. Cir. 2000).

It was not necessary for the Division to establish that McCook knew that the improper conduct he assisted violated the securities laws. "'Knowledge means awareness of the underlying facts, not the labels that the law places on those facts.'" Nicholas P. Howard, Exchange Act Rel. No. 47357 (February 12, 2003), __ SEC Docket __, __ (quoting SEC v. Falstaff Brewing Corp., 629 F.2d 62, 77 (D.C. Cir. 1980)).

¹¹ Rita C. Villa, Exchange Act Rel. No. 42502 (March 8, 2000), 71 SEC Docket 2438, 2443.

¹² Id. (quoting FEC v. Rose, 806 F.2d 1081, 1087 (D.C. Cir. 1986)).

¹³ But see, e.g., Adrian C. Havill, 53 S.E.C. 1060, 1068 & n.18 (1998) (finding aiding and abetting liability despite asserted reliance on supervisor's advice).

¹⁴ In view of our determination, we need not reach the parties' contentions with respect to the amount of the award made by the law judge.

¹⁵ We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion.

http://www.sec.gov/litigation/opinions/34-47572.htm