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News December 6, 2004 Issue

SEC Abused its Discretion in Sanctioning Adviser, Says Court

Thereís a lot to like in the opinion of Monetta Financial Services v. SEC, handed down by the Seventh Circuit U.S. Court of Appeals last week.

The conduct at issue: Monettaís allocation, during an eight-month period in 1993, of IPOs to clients. Some of those clients also happened to serve as directors on the boards of the firmís mutual funds. The SEC did not allege that the IPOs were allocated in a way that favored the director-clients. Instead, the SEC alleged that the advisory firm committed fraud by failing to disclose to its fundsí other directors that the director-clients were receiving IPOs.

Over the years, the case wound its way up through the SEC. After Monetta declined to settle the case, an ALJ issued a decision imposing sanctions. Monetta appealed, and the Commission dismissed all charges except a Section 206(2) charge. Despite the fact that it dismissed the majority of the charges, the Commission did not reduce the amount of sanctions imposed.

The court upheld the fraud charge, but held that the SECís sanctions were excessive. The Commissionís opinion "does not reflect that the SEC meaningfully considered" factors such as the egregiousness of the actions and the isolated nature of the violation when imposing the sanctions, said the court. It noted that the Commission, "without explanation," imposed the same sanctions as the ALJ, despite the fact that the Commission dismissed many of the charges. "Taken together, these factors suggest that the Commission abused its discretion in sanctioning" Monetta, said the court. It remanded the issue of sanctions back to the Commission for reconsideration.

And, in good news for those concerned about personal liability, the court vacated the SECís aiding and abetting charges against Monettaís president and founder, Robert Bacarella. The court noted that the SEC did not provide any evidence suggesting that Bacarella was aware that the other directors should be provided with disclosure about the IPOs. The court said it would be difficult to show that Bacarella was reckless, since no rule expressly required the disclosure. Moreover, it noted, Bacarella wasnít accused of overlooking inequitable allocations.