A three-judge panel from the U.S. Court of Appeals for the Ninth Circuit recently upheld a the U.S. District Court for the Central District of California’s order granting summary judgment in favor of the Securities and Exchange Commission (“SEC”) and levying $10 million in penalties against Brookstreet Securities Corp.’s former CEO, Stanley Brooks. The penalties were for his role in hiring and directing brokers who systematically misled investors over the course of several years. The Ninth Circuit’s upholding this significant penalty is a reminder to the investing public, and to potential whistleblowers, that the SEC may take action against officers of brokerage firms that sell inappropriate investments to private investors without adequate disclosure if those officers fail to stop the practice. Katz, Marshall & Banks partner David Marshall remarked that “Brokers and others who work for firms selling retail securities should keep this in mind when deciding whether to submit information about these types of practices to the SEC.”
According to the Ninth Circuit, “[Former Brookstreet CEO Stanley] Brooks knew that Brookstreet representatives were recommending and selling CMOs to retail customers beginning in 2004, and yet Brookstreet did not establish suitability standards for CMO clients until 2007, three years later.” CMOs –collateralized mortgage obligations – are particularly risky investment vehicle. As the Ninth Circuit explained, the National Association of Securities Dealers (“NASD”) had informed Brooks and others in 2005 of “a broker’s responsibility to educate clients about the risks of CMOs and made clear that certain CMOs were suitable only for sophisticated investors with a high risk profile.” Despite this warning, Brooks allowed his brokers to sell CMOs to Brookstreet clients without suitability standards until 2007. As explained in Law360, his actions prompted the SEC to file suit in 2009. The district court granted the summary judgment in favor of the SEC on its fraud charges in 2012, and levied $10 million in penalties against Mr. Brooks, both of which the Ninth Circuit upheld last week.