WTFC v. SEC

Petitioners who have violated Section 5(a) and 5(c) of the Securities Act of 1933 cannot claim the brokers’ exemption under Section 4(4) of the Act when they fail to meet their duty of reasonable inquiry.

World Trade Financial Corporation, Jason Adams, Rodney Michel, and Frank Brickell (collectively, “Petitioners”) petitioned for review of an order by the Securities and Exchange Commission (“SEC”) that upheld fines by Financial Industry Regulatory Authority (“FINRA”) for violations of sections 5(a) and 5(c) of the Securities Act of 1933, which require filing a registration statement in the sale, or offer of, a security. Petitioners sold over 2.3 million shares of stock to the public for iStorage’s stock promoters. There were multiple red flags in the transactions. The Ninth Circuit reviewed the findings of fact for substantial evidence and conclusions of law de novo. Petitioners argued that the brokers’ exemption applied, urging the panel to find that “the exemption [did] not require reasonable inquiry.” The panel concluded that it was clear that after FINRA made its prima facie case of Section 5 violations, Petitions carried the burden to show the exemption applied. Further, the panel agreed with the Commission and D.C. Circuit that “a broker must conduct a ‘reasonable inquiry’ to claim the Section 4(4) exemption for trades that violate Section 5.” The panel found that Petitioners’ duty of reasonable inquiry was not met because they had not established “an industry standard of reliance on third-parties;” even if such a practice existed, it still would not absolve Petitioners of liability; and reliance on third parties is at a broker’s own peril, which will not absolve them of liability. The panel concluded that “substantial evidence support[ed] the Commission’s finding….” Thus, “Petitioners did not meet their duty of inquiry necessary to claim the Section 4(4) brokers’ exemption,” and the panel deferred “to the Commission’s discretionary determination as to the appropriate fines and sanctions...” DENIED.