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09/20/88 Stuart-James Company, Inc. v. Securities & Exchange

September 20, 1988





On Petition for Review of an Order of the Securities and Exchange Commission.


Mikva, and D. H. Ginsburg, Circuit Judges and Jackson,* District Judge. Opinion for the Court filed by Circuit Judge Mikva.


The Stuart-James Company is a securities broker-dealer. Marc N. Geman is its executive vice-president. They petition for review of an order of the Securities and Exchange Commission ("Commission" or "SEC") affirming a decision of the National Association of Securities Dealers censuring them and imposing a $500 fine for violating the Commission's net capital rule. Stuart-James is a member of NASD. Petitioners challenge the Commission's interpretation of the term "unrealized profit" in the net capital rule, and propose a different interpretation of the phrase according to which their actions would have been in conformity with the rule's net capital requirements. In addition, they contend that the Commission violated provisions of the Administrative Procedure Act by failing to publish its interpretation of the rule. Because we believe that the Commission's interpretation of "unrealized profit" is a reasonable one and that it acted within its discretion in affirming the NASD order, we deny the petition for review. I. BACKGROUND

A. Origin of the Case

Petitioner Stuart-James entered into an underwriting agreement with U.S. Electronics Group on November 1, 1984. Stuart-James undertook a firm-commitment underwriting of $1.74 million of the $2 million securities offering. As is done in firm-commitment offerings, Stuart-James purchased the securities in advance from USEG and then undertook to resell them to individual customers. According to the underwriting agreement, Stuart-James would purchase the securities at a 10% discount from the public offering price. This 10% discount, or "concession," would constitute Stuart-James's compensation for its role in the transaction.

The NASD requires its members to submit underwriting plans to it for advance review. In September, Stuart-James had initially submitted a plan whereby it would underwrite all $2 million of the USEG offering, but the NASD rejected the plan as submitted because it found that Stuart-James would not have had enough capital to support an offering of that size. In late October, Stuart-James submitted a new plan according to which it would underwrite only $1.74 million of the offering, and the NASD approved the plan. The offering became effective on November 1.

On November 13, the NASD reviewed Stuart-James's October financial report and changed its view. It found that Stuart-James's net capital at the time it entered into the USEG agreement was not in fact sufficient to undertake the underwriting while conforming to the net capital rule. The NASD informed Stuart-James of its analysis and asked Geman, the executive vice-president, to submit a new net capital computation. Working with the information submitted by Stuart-James, the NASD calculated that Stuart-James had a net capital deficiency of $81,685.

The following April, the NASD District Business Conduct Committee filed a complaint against Stuart-James and Geman, charging them with conducting a securities business without maintaining sufficient net capital as required by Rule 15c-3. It found that the company had violated the rule, but dismissed the complaint because it held that mitigating circumstances existed. On review, the NASD Board of Governors affirmed the DBCC's finding that Stuart-James had violated the net capital rule, but reversed the decision to dismiss the complaint. The Board imposed sanctions in the form of an official censure and a $500 fine. The SEC reviewed the Board's findings and upheld both the censure and the imposition of sanctions.

B. The "Unrealized Profits" Dispute

The disagreement between the Commission and Stuart-James stems in large part from their differing interpretations of the net capital rule. The Securities and Exchange Act of 1934 authorizes the SEC to impose minimum financial responsibility requirements on brokers. It requires brokers to operate within

such rules and regulations as the Commission shall prescribe as necessary or appropriate in the public interest or for the protection of investors to provide safeguards with respect to the financial responsibility and related practices of brokers and dealers. . . . Such rules and regulations shall require the maintenance of reserves with respect to customers' deposits or credit balances, and no later than September 1, 1975, establish minimum financial responsibility requirements for all brokers and dealers.

15 U.S.C. ยง 780(c)(3) (1982). Pursuant to Rule 15c-3, the SEC has promulgated various regulations imposing minimum capital requirements upon brokers. The net capital rule was designed to engender investor confidence in brokers by requiring them to maintain a specific percentage of liquid assets in relation to indebtedness. 17 C.F.R. 240.15c3-1(a) (1987). See Touche Ross & Co. v. Redington, 442 U.S. 560, 570, 61 L. Ed. 2d 82, 99 S. Ct. 2479 (1979) (net capital rule is "the principal regulatory tool by which the Commission and the Exchange monitor the ...

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