hopkins v. securities & exchange comm, 1st cir. (2015)

7/26/2019 Hopkins v. Securities & Exchange Comm, 1st Cir. (2015)

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United States Court of AppealsFor the First Circuit

No. 15- 1080

J OHN P. FLANNERY,

Pet i t i oner ,

v.

SECURI TI ES & EXCHANGE COMMI SSI ON,

Respondent .

No. 15- 1117

J AMES D. HOPKI NS,

Pet i t i oner ,

v.

SECURI TI ES & EXCHANGE COMMI SSI ON,

Respondent .

PETI TI ONS FOR REVI EW OF AN ORDER OF THE SECURI TI ES AND EXCHANGE COMMI SSI ON

Bef ore

Lynch, St ahl , and Kayat t a,

Ci r cui t J udges.

Mar k W. Pear l st ei n, wi t h whom Laur a McLane, Fredr i c D.Fi r est one, Davi d H. Chen, and McDermot t Wi l l & Emery LLP were onbr i ef , f or pet i t i oner J ohn P. Fl anner y.

J ohn F. Syl vi a, wi t h whom Andr ew N. Nat hanson, J ess i ca C.Sergi , and Mi nt z Levi n Cohn Fer r i s Gl ovsky & Popeo PC were on



br i ef , f or pet i t i oner J ames D. Hopki ns.Li sa K. Hel vi n, Seni or Counsel , wi t h whom Mi chael A. Conl ey,

Deput y Gener al Counsel , J ohn W. Aver y, Deput y Sol i ci t or , andBenj ami n L. Schi f f r i n, Seni or Li t i gat i on Counsel , Secur i t i es andExchange Commi ssi on, wer e on br i ef , f or r espondent .

J onat han G. Cedarbaum, Chr i st opher Davi es, Dani el Agui l ar , J ohn Byr nes, Wi l mer Cut l er Pi cker i ng Hal e and Dor r LLP, Kat eComer f ord Todd, St even P. Lehotsky, and U. S. Chamber Li t i gat i onCent er , I nc. , on br i ef f or t he Chamber of Commer ce of t he Uni t edSt at es of Amer i ca, ami cus cur i ae i n suppor t of pet i t i oner s.

December 8, 2015



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LYNCH, Circuit Judge. I n 2010, t he Uni t ed St at es

Secur i t i es and Exchange Commi ssi on ( "SEC" or "Commi ssi on" ) i ssued

an Or der I nst i t ut i ng Pr oceedi ngs agai nst t wo f or mer empl oyees of

St ate St r eet Bank and Trust Company ( "St ate St r eet " ) : ( 1) J ames D.

Hopki ns, a f ormer vi ce pr esi dent and head of Nor t h Amer i can Product

Engi neer i ng, and ( 2) J ohn P. Fl anner y, a f or mer chi ef i nvest ment

of f i cer ( "CI O") . The Commi ssi on al l eged t hat dur i ng t he 2007

subpr i me mor t gage cr i si s, Hopki ns and Fl anner y "engaged i n a cour se

of busi ness and made mat er i al mi sr epr esent at i ons and omi ss i ons

t hat mi sl ed i nvest or s" about t wo subst ant i al l y i dent i cal St at e

St r eet –managed f unds col l ect i vel y known as t he Li mi t ed Dur at i on

Bond Fund ( "LDBF") . Hopki ns and Fl anner y were charged wi t h

vi ol at i ng Sect i on 17( a) of t he Secur i t i es Act of 1933 ( 15 U. S. C.

§ 77q( a) ) , Sect i on 10( b) of t he Secur i t i es Exchange Act of 1934

( 15 U. S. C. § 78j ( b) ) , and Exchange Act Rul e 10b- 5 ( 17 C. F. R.

§ 240. 10b- 5) . Af t er an el even- day hear i ng, i nvol vi ng ni net een

wi t nesses and about f i ve hundr ed exhi bi t s, t he SEC' s Chi ef

Admi ni st r at i ve Law J udge ( "ALJ " ) di smi ssed t he pr oceedi ng, f i ndi ng

t hat nei t her Hopki ns nor Fl anner y was r esponsi bl e f or , or had

ul t i mat e aut hor i t y over , t he document s at i ssue and t hat t hese

document s di d not cont ai n mat er i al l y f al se or mi sl eadi ng

st at ement s or omi ssi ons.

The SEC Di vi si on of Enf or cement ( "Di vi si on") appeal ed

t he ALJ ' s deci si on t o t he Commi ssi on. I n 2014, t he Commi ssi on, i n



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a 3- 2 deci si on, r ever sed t he ALJ wi t h r egar d t o a sl i de t hat

Hopki ns used at a May 10, 2007, pr esentat i on t o a gr oup of

i nvest ors, and t wo l et t er s, dated August 2 and August 14, 2007,

t hat Fl anner y wr ot e or had seen bef or e t hey wer e sent t o i nvest or s.

See I n r e J ohn P. Fl anner y & J ames D. Hopki ns, Secur i t i es Act

Rel ease No. 9689, Exchange Act Rel ease No. 73, 840, I nvest ment

Company Act Rel ease No. 31, 374, 2014 WL 7145625 ( Dec. 15, 2014) .

The Commi ssi on f ound Hopki ns l i abl e under Secur i t i es Act Sect i on

17( a) ( 1) ( "Sect i on 17( a) ( 1) " ) , Secur i t i es Exchange Act Sect i on

10( b) ( "Sect i on 10( b) " ) , and Exchange Act Rul e 10b- 5 ( "Rul e 10b-

5") ; i t f ound Fl anner y l i abl e under Secur i t i es Act Sect i on 17( a) ( 3)

( "Sect i on 17( a) ( 3) " ) . The Commi ssi on i mposed cease- and- desi st

orders on Hopki ns and Fl annery, suspended Hopki ns and Fl annery

f r om associ at i on wi t h any i nvest ment advi ser or company f or one

year , i mposed a $65, 000 ci vi l monetary penal t y on Hopki ns, and

i mposed a $6, 500 ci vi l monetary penal t y on Fl annery. These

pet i t i ons f or r evi ew f ol l owed.

We concl ude t hat t he Commi ssi on' s f i ndi ngs are not

support ed by subst ant i al evi dence. Wi t h r egard t o Hopki ns, we

f i nd t hat t he Di vi si on' s mat er i al i t y showi ng was mar gi nal , and

t hat t her e was not subst ant i al evi dence suppor t i ng sci ent er i n t he

f or m of r eckl essness. Wi t h r egar d t o Fl anner y, we concl ude t hat

at l east t he August 2 l et t er was not mi sl eadi ng, and t her ef or e, as

we expl ai n, we need not r each t he i ssue of whether t he August 14



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l et t er was mi sl eadi ng. We gr ant t he pet i t i ons f or r evi ew and

vacate t he Commi ssi on' s or der .

I .

We t ake t he under l yi ng f act s f r om t he r ecor d bef or e t he

Commi ssi on. See Ri zek v. SEC, 215 F. 3d 157, 159 ( 1st Ci r . 2000) .

St at e St r eet Gl obal Advi sor s ( "SSgA") i s t he i nvest ment

management arm of St ate St r eet Corporat i on. 1 I t advi ses and

manages St at e St r eet –af f i l i at ed r egi st er ed mut ual f unds and

unr egi st er ed col l ect i ve t r ust f unds. 2 On Mar ch 1, 2002, SSgA

cr eated t he LDBF, a combi nat i on of t wo unr egi st er ed f i xed- i ncome

f unds t hat wer e i nvest ed i n var i ous f i xed- i ncome pr oduct s. The

LDBF was of f er ed and sol d onl y t o i nst i t ut i onal i nvest or s.

I nvest ment s i n t he LDBF came f r omt hr ee sour ces: f i r st , ot her St at e

St r eet f unds i nvest ed di r ect l y i n t he LDBF; second, cl i ent s of

i nt er nal advi sor y gr oups i nvest ed i n t he LDBF based on SSgA' s

r ecommendat i on t o t hose gr oups; and t hi r d, i ndependent

i nst i t ut i onal i nvest or s i nvest ed di r ectl y i n t he LDBF.

The LDBF was heavi l y i nvest ed i n asset - backed secur i t i es

( "ABS") , whi ch i ncl uded r esi dent i al mor t gage- backed secur i t i es

( "RMBS") . Unt i l 2007, t he LDBF had out per f ormed i t s benchmark

1 St at e St r eet i s a whol l y owned subsi di ar y of St at e St r eetCor por at i on. St at e St r eet Cor por at i on i s a publ i cl y t r adedcor por at i on.

2 St at e St r eet and SSgA were used i nt erchangeabl y dur i ngt he pr oceedi ng.



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i ndex. I n J anuar y and Febr uar y 2007, i t under per f or med i t s

benchmar k i ndex because of i t s i nvest ment i n cer t ai n l ower - r at ed

secur i t i es. Apr i l and May 2007, however , wer e t wo of t he best

mont hs i n t he LDBF' s hi st or y. Then, begi nni ng i n J une 2007, dur i ng

t he subpr i me mor t gage cr i si s, t he LDBF exper i enced subst ant i al

under per f or mance. The Di vi si on' s char ges agai nst Hopki ns and

Fl annery i nvol ve communi cat i ons about t he LDBF t hat Hopki ns and

Fl anner y ei t her made or wer e i nvol ved wi t h i n 2007.

A. Vi ce Pr esi dent Hopki ns

Hopki ns wor ked at St at e St r eet f r om 1998 unt i l 2010,

when he was of f er ed r et i r ement as a resul t of t he SEC pr oceedi ng.

Fr om 2006 t o 2007, he was a vi ce pr esi dent and head of Nor t h

Amer i can Product Engi neer i ng. Dur i ng t hat t i me, Hopki ns was t he

seni or pr oduct engi neer r esponsi bl e f or f i xed- i ncome f unds,

i ncl udi ng t he LDBF. He served as a l i ai son bet ween t he por t f ol i o

manager s and t he cl i ent - f aci ng peopl e, whi ch i ncl uded sal espeopl e

and consul t ant r el at i ons peopl e. Hopki ns was one of sever al peopl e

t hat woul d make pr esent at i ons to pot ent i al cl i ent s. He was al so

r esponsi bl e f or cor r ect i ng i naccur aci es i n LDBF "f act sheet s, "

t wo- page quart er l y document s made avai l abl e t o cl i ent s and

pr ospect i ve cl i ent s t hat showed t he LDBF' s st r ategy and

perf ormance numbers. Apar t f r om t he SEC char ges, Hopki ns worked

i n t he secur i t i es i ndust r y f or t hi r t y- f i ve year s wi t h an

unbl emi shed r ecord.



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SSgA used a st andar d PowerPoi nt present at i on when

pr esent i ng i nf ormat i on about t he LDBF. I n 2006 and 2007, t hi s

pr esent at i on i ncl uded a sl i de t i t l ed "Typi cal Por t f ol i o Exposur es

and Char act er i st i cs - - Li mi t ed Dur at i on Bond St r at egy" ( "Typi cal

Por t f ol i o Sl i de") . We descr i be t he sl i de:

Under t he sl i de t i t l e, i t r ead:

Exposur e t o non- corr el ated f i xed i ncomeasset cl asses

Hi gh qual i t y

No i nt er est r at e r i sk

Bel ow, i t had a box cont ai ni ng t he f ol l owi ng t abl e:

Limited Duration

Bond Fund

Aver age qual i t y AAModi f i ed adj ust ed dur at i on 0. 09 year s Yi el d over One Mont h LI BOR 50 bpsAver age l i f e 2. 5 year s

I t t hen had a headi ng "Br eakdown by market val ue" and contai ned

t wo bar gr aphs. The gr aph on t he l ef t was t i t l ed "By sect or " and

cont ai ned t he f ol l owi ng i nf or mat i on:

ABS: 55%

CMBS: 25%

MBS: 10%

Agency: 5%

Cor por at es: 0%

Cash: 5%

The graph on t he r i ght was t i t l ed "By qual i t y" and cont ai ned t he

f ol l owi ng i nf or mat i on:

AAA: 45%

AA: 40%



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A: 10%

BBB: 5% I mpor t ant l y, t he Typi cal Por t f ol i o Sl i de por t r ayed

per cent ages f or bot h sect or al l ocat i ons and qual i t y of

i nvest ment s. I t i s t he sect or al l ocat i ons ( goi ng t o

di ver si f i cat i on) whi ch di st ur b t he SEC. The t ypi cal sect or

al l ocat i on gr aph showed t hat t he LDBF was 55% i nvest ed i n ABS, 25%

i nvest ed i n commer ci al mort gage- backed secur i t i es ( "CMBS") , and

10% i nvest ed i n mor t gage- backed secur i t i es ( "MBS") . I n 2006 and

2007, t he LDBF' s act ual i nvest ment i n ABS r eached 80% t o near l y

100%. One exper t t est i f i ed t hat al ong wi t h "Condi t i onal Val ue at

Ri sk, " credi t r at i ngs ar e used t o det er mi ne t he r i sk of a por t f ol i o

l i ke t he LDBF.

Hopki ns di d not updat e t he Typi cal Por t f ol i o Sl i de' s

sect or breakdown f r omat l east December 2006 t hrough t he summer of

2007. He woul d, however , br i ng not es on t he act ual i nvest ment s

when he made pr esent at i ons, but he di d not necessar i l y di scuss t he

i nf or mat i on i n hi s not es i f i t di d not come up i n a quest i on.

Hopki ns used t he Typi cal Por t f ol i o Sl i de at sever al pr esent at i ons.

He di d not r ecal l ever bei ng asked a quest i on about t he LDBF' s

act ual por t f ol i o composi t i on, i ncl udi ng at t he speci f i c

pr esent at i on next descr i bed.

On May 10, 2007, Hopki ns made a present at i on t o t he

Nat i onal J ewi sh Medi cal and Resear ch Cent er ( "NJ C" ) , whi ch was a



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cl i ent of Yanni Par t ner s, an i nst i t ut i onal i nvest ment consul t i ng

f i r m. Davi d Hammer st ei n, Yanni Par t ner s' chi ef st r at egi st , who

was at t he meet i ng, t est i f i ed t hat Hopki ns pr esent ed t he Typi cal

Por t f ol i o Sl i de. Accor di ng t o Hammer st ei n, Hopki ns used t he sl i de

t o demonst r at e t hat t he LDBF was of ver y hi gh qual i t y and

di ver si f i ed. I t i s t r ue t he Typi cal Por t f ol i o Sl i de l abel ed t he

LDBF as "hi gh qual i t y. "

The Di vi si on al l eged t hat Hopki ns vi ol at ed Sect i on

17( a) , Sect i on 10( b) , and Rul e 10b- 5 i n sever al ways, i ncl udi ng by

bei ng r esponsi bl e f or and usi ng f act sheet s t hat cont ai ned f al se

and mi sl eadi ng i nf or mat i on; by mi sl eadi ng i nvest or s wi t h t he

Typi cal Por t f ol i o Sl i de; by f ai l i ng t o updat e a sl i de t hat st at ed

t he LDBF had r educed i t s exposur e t o t he i ndex of l ower - r ated

secur i t i es t hat had cont r i but ed t o t he J anuar y and Febr uar y 2007

under per f ormance; and by maki ng or act i ng negl i gent l y i n

connect i on wi t h mat er i al l y mi sl eadi ng st at ement s i n t wo di f f er ent

l et t er s. The ALJ f ound t hat Hopki ns was not r esponsi bl e f or t he

document s at i ssue and t hat he di d not make any mat er i al

mi sr epr esent at i ons or omi ssi ons.

Af t er t he Di vi si on appeal ed t he ALJ ' s deci si on

di smi ssi ng t he pr oceedi ng, t he Commi ssi on f ound t hat t he Typi cal

Por t f ol i o Sl i de i ncl uded mat er i al mi sr epr esent at i ons t hat Hopki ns

knew were mi sl eadi ng and t hat he "made" t he mi sr epr esent at i ons i n

t he sl i de, at l east wi t h r egar d t o t he May 10, 2007, pr esent at i on



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t o t he NJ C. The Commi ssi on hel d Hopki ns l i abl e f or t hi s

pr esent at i on under Sect i on 17( a) ( 1) , Sect i on 10( b) , and Rul e 10b-

5. See 15 U. S. C. § 77q( a) ( 1) ; 15 U. S. C. § 78j ( b) ; 17 C. F. R.

§ 240. 10b- 5.

B. CI O Fl anner y

Fl anner y j oi ned SSgA i n 1996 as a pr oduct engi neer . I n

2005, he became SSgA' s Fi xed I ncome CI O f or t he Amer i cas. As CI O,

Fl anner y had gener al super vi sory over si ght f or SSgA' s oper at i ons.

However , he was not i nvol ved i n the LDBF' s i nvest ment deci si ons or

i t s dai l y management . Fl anner y wor ked at SSgA unt i l hi s posi t i on

was el i mi nated i n 2007. Bef ore j oi ni ng SSgA, Fl anner y had worked

i n t he f i xed- i ncome ar ea f or about si xt een year s, f i r st i n bond

sal es, t hen i n managi ng f i xed- i ncome i nvest ment s. He had an

unbl emi shed r ecor d i n t he i ndust r y and a reput at i on f or bei ng ver y

honest and havi ng a gr eat deal of i nt egr i t y.

I n May 2006, Fl anner y expressed t hat he was concer ned

about mort gage r i sk i n the real est ate market and request ed SSgA' s

f i xed- i ncome t eam t o pr ovi de hi m wi t h an anal ysi s on t he subj ect .

Af t er t he LDBF began underper f ormi ng i n J une 2007, Fl annery

r equest ed on J une 25, 2007, t hat member s of SSgA' s management t eam

and a member of i t s r i sk t eamr e- exami ne t he subpr i me market . That

day, t he head of Gl obal St r uct ur ed Pr oj ect s gave Fl anner y a

memor andum t hat st at ed, " [ w] e r emai n const r uct i ve on t he

f undament al s" and t hat f orecl osur es wer e l ower t han t he 10- year



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aver age except i n Cal i f or ni a and t he Rust Bel t s t at es. The

memor andum i ndi cat ed t hat "we thi nk t her e wi l l be cont i nued

weakness i n cer t ai n par t s of t he count r y . . . but we don' t bel i eve

t her e i s an i mmi nent ' mel t down' scenar i o. Subpr i me borr ower s

need l oans, l ender s are maki ng l oans, t he st r eet cont i nues t o f und

t hese l oans vi a the secur i t i zat i on mar ket , and we expect t hi s t o

cont i nue goi ng f or war d. "

By t he end of J ul y 2007, as t he subpr i me cr i si s wor sened,

Fl anner y became personal l y i nvol ved wi t h managi ng t he LDBF and had

dai l y cont act wi t h t he SSgA r i sk t eam dur i ng t he summer and f al l

of 2007. He f i l l ed i n as chai r at a J ul y 25, 2007, SSgA I nvest ment

Commi t t ee meet i ng. Accor di ng t o meet i ng mi nut es, Fl annery

di scussed t wo ways t o pr ovi de l i qui di t y i f cl i ent s want ed t o l eave

t he LDBF: ( 1) by sel l i ng t he LDBF' s t op- r at ed ( AAA) bonds; or ( 2)

by sel l i ng a pr o- r at a shar e of asset s across t he por t f ol i o.

Fl anner y not ed t hat al t hough AAA- r at ed bonds wer e l i qui d, i f t he

l i qui di t y gai ned f r om t he sal es wer e si phoned of f , t hen t hey woul d

be l ef t wi t h a l ower qual i t y por t f ol i o. Af t er di scussi on among

t he meet i ng' s part i ci pant s, t he I nvest ment Commi t t ee deci ded on an

appr oach i ncorporat i ng both opt i ons, wher e t hey woul d i ncr ease

l i qui di t y i n t he f und and sel l a pr o- r at a shar e of asset s t o cover

any wi t hdr awal s f r omt he f und. The commi t t ee al so agr eed t o r educe

t he LDBF' s exposur e t o AA- r at ed asset s. I n t he t wo days f ol l owi ng

t he J ul y 25 meet i ng, t he port f ol i o management t eamsol d about $1. 6



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bi l l i on i n AAA- r at ed bonds and $200 mi l l i on i n AA- r at ed bonds,

whi ch pai d f or i nvest or r edempt i ons and repur chase commi t ment s.

These t r ansact i ons caused t he LDBF' s por t f ol i o composi t i on t o

change f r om appr oxi mat el y 48% i nvest ment i n AAA- r at ed secur i t i es

t o l ess t han 5%, and f r om 46% i nvest ment i n AA- r at ed secur i t i es t o

mor e t han 80%.

1. August 2, 2007, Let t er ( Not Fr om Fl anner y)

On August 2, 2007, Rel at i onshi p Management sent a l et t er

t o cl i ent s i n at l east t went y- t wo f i xed- i ncome f unds, si gned by

t he i ndi vi dual Rel at i onshi p Manager s and i ncl udi ng f und speci f i c

per f or mance i nf or mat i on. A dr af t of t hi s l et t er had been sent t o

t he l egal depart ment as wel l as sever al peopl e t o r evi ew. Fl anner y

had al so r ecei ved a dr af t , and he made a number of edi t s, some of

whi ch st ayed i n t he f i nal ver si on. However , Fl anner y had not been

i ncl uded on sever al e- mai l exchanges r el at ed t o edi t s on t he l et t er

pr i or to i t s di str i but i on. The f i nal ver si on of t he l et t er

i ncl uded t he f ol l owi ng par agr aph:

We bel i eve t hat what has occur r ed i n t hesubpr i me mor t gage mar ket t o dat e t hi s year hasbeen more dr i ven by l i qui di t y and l ever agei ssues than l ong t er m f undament al s.Addi t i onal l y, t he downdr af t i n val uat i ons has

had a si gni f i cant i mpact on t he r i sk pr of i l eof our por t f ol i os, pr ompt i ng us t o t ake st epst o seek t o r educe r i sk acr oss t he af f ect edpor t f ol i os. To dat e, i n t he Li mi t ed Dur at i onBond St r ategy, we have r educed a si gni f i cantpor t i on of our BBB- r at ed secur i t i es and wehave sol d a si gni f i cant amount of our AAA-r at ed cash posi t i ons. Addi t i onal l y, AAA- r at ed



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exposur e has been r educed as some tot al r et urnswaps r ol l ed of f at mont h end. Thr oughoutt hi s per i od, t he St r at egy has mai nt ai ned andcont i nues t o be AA i n aver age cr edi t qual i t yaccor di ng t o SSgA' s i nt er nal por t f ol i oanal yt i cs. The act i ons we have t aken t o dat ei n the Li mi t ed Dur at i on Bond St r at egysi mul t aneousl y r educed r i sk i n ot her SSgAact i ve f i xed i ncome and act i ve der i vat i ve-based st r at egi es.

2. August 14, 2007, Let t er ( From Fl anner y)

On August 14, 2007, Fl anner y sent a l et t er t o LDBF

i nvest or s, i n an at t empt t o expl ai n what was t aki ng pl ace i n t he

housi ng- r el at ed secur i t i es mar ket . Fl anner y was nor mal l y not

r esponsi bl e f or cl i ent communi cat i ons, and t he Chi ef Execut i ve

Of f i cer ( "CEO") of SSgA sai d i t woul d not be a good i dea, aski ng

why Fl anner y woul d want t o " r ai se [ hi s] head up. " Fl anner y

under st ood t he CEO t o be sayi ng t hat " t hi s [ was] ki nd of an ugl y

si t uat i on . . . why st and up and t ake a bul l et , " but Fl anner y wr ot e

t he l et t er because he t hought i t was " t he r i ght t hi ng t o do. "

Fl anner y sai d t hat "up t o t he l i mi t s t hat [ he] was gi ven by l egal ,

[ he] want ed t o t ake r esponsi bi l i t y f or t hi s di sast er . . . and . . .

t o t el l somet hi ng of t he ar c of t he st or y t o put i t i n cont ext . "

He sai d he "want ed t o be as j ust compl et el y st r ai ght f orward as

[ he] coul d be. " The dr af t of t he l et t er Fl anner y pr epar ed i ncl uded

t he f ol l owi ng par agr aph:

The si t uat i on i s ext r eme and di f f i cul t t omanage. Whi l e we bel i eve t hat t he subpr i memar ket s cl ear l y convey f ar gr eat er r i sk t hant hey have hi st or i cal l y[ , ] we f eel t hat f or ced



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sel l i ng i n t hi s chaot i c and i l l i qui d mar ket i sunwi se. Even i f mort gage del i nquenci es soarbeyond our expect at i ons we woul d expectsi gni f i cant l y hi gher val ues f or our subpr i mehol di ngs. Whi l e r ecent event s may haver epr i ced t he r i sk of t hese asset s f or t hef or eseeabl e f ut ur e and i t i s unl i kel y t hatt hey wi l l r et r ace t o val ues at t he t ur n of t heyear we bel i eve t hat l i qui di t y wi l l sl owl y r e-ent er t he market and t he segment wi l l r egai ni t s f oot i ng. Whi l e we wi l l cont i nue t ol i qui dat e asset s f or our cl i ent s when t heydemand i t , our advi ce i s t o hol d t he posi t i onsf or now.

The l ast sentence was t hen edi t ed t o r ead, "Whi l e we wi l l cont i nue

t o l i qui dat e asset s f or our cl i ent s when t hey demand i t , our advi ce

i s t o hol d t he posi t i ons i n ant i ci pat i on of gr eat er l i qui di t y i n

t he mont hs to come. " Deput y General Counsel Mar k Duggan r evi sed

t hat sent ence t o r ead, "Whi l e we wi l l cont i nue t o l i qui dat e asset s

f or our cl i ent s when t hey demand i t , we bel i eve t hat many j udi ci ous

i nvest or s wi l l hol d t he posi t i ons i n ant i ci pat i on of gr eat er

l i qui di t y i n t he mont hs t o come. " Fl anner y kept Duggan' s change

because Fl anner y bel i eved bot h hi s or i gi nal l anguage and the

r evi sed l anguage were accur at e. I n addi t i on t o Duggan, a number

of peopl e r evi ewed t he l et t er , i ncl udi ng t he co- heads of

Rel at i onshi p Management , SSgA' s pr esi dent and CEO, and out si de

l egal counsel .

3. SEC Proceedi ng

I n t he Di vi si on' s appeal of t he ALJ ' s deci si on, t he

Commi ssi on hel d Fl anner y l i abl e under Sect i on 17( a) ( 3) f or



- 15 -

mi sl eadi ng st atement s i n both t he August 2 and August 14 l et t er s.

Wi t h r egard t o the August 2 l et t er , t he Commi ssi on f ound t he

st at ement t hat SSgA r educed i t s r i sk i n par t by sel l i ng "a

si gni f i cant amount " of i t s "AAA- r at ed cash posi t i ons" was

"mi sl eadi ng because LDBF' s sal e of t he AAA- r at ed secur i t i es di d

not r educe r i sk i n t he f und. Rat her , t he sal e ul t i mat el y i ncreased

bot h t he f und' s credi t r i sk and i t s l i qui di t y r i sk because t he

secur i t i es t hat r emai ned i n t he f und had a l ower cr edi t r at i ng and

wer e l ess l i qui d t han t hose t hat wer e sol d. " The Commi ssi on f ound

t hat "even i f [ Fl anner y] di d suggest mi nor edi t s t o t he l et t er

t hat wer e never i ncor por at ed, and even i f ot her s wer e ' heavi l y

i nvol ved' i n i t s dr af t i ng . . . t hose f acts . . . do not excuse

hi s deci si on t o appr ove mi sl eadi ng l anguage. "

Wi t h regard t o t he August 14 l et t er , t he Commi ssi on f ound

t he "many j udi ci ous i nvest ors" l anguage Duggan i nser t ed was

mi sl eadi ng "because i t suggest ed t hat SSgA vi ewed hol di ng ont o t he

LDBF i nvest ment as a ' j udi ci ous' deci si on when, i n f act , of f i ci al s

at SSgA had t aken a cont r ary vi ew, r edeemi ng SSgA' s own shares i n

LDBF and advi si ng SSgA advi sory gr oup cl i ent s t o r edeem t hei r

i nt er est s, as wel l . " The Commi ssi on f ound t hat t he

mi sr epr esent at i ons i n bot h l et t er s wer e mat er i al and t hat Fl anner y

acted negl i gent l y i n both cases. The SEC went on t o hol d, as a

mat t er of l aw, t hat t wo mi sst at ement s wer e suf f i ci ent t o f i nd a

vi ol at i on of Sect i on 17( a) ( 3) ' s pr ohi bi t i on on "engag[ i ng] i n any



- 16 -

. . . cour se of busi ness whi ch oper at es or woul d oper ate as a f r aud

or decei t upon t he pur chaser . " We need not r each t hat i ssue of

l aw.

I I .

"The SEC' s f act ual f i ndi ngs cont r ol i f suppor t ed by

subst ant i al evi dence, . . . and i t s order s and concl usi ons must

not be ' ar bi t r ar y, capr i ci ous, an abuse of di scret i on, or ot her wi se

not i n accor dance wi t h l aw. ' " Cody v. SEC, 693 F. 3d 251, 257 ( 1st

Ci r . 2012) ( ci t at i ons omi t t ed) ( quot i ng 5 U. S. C. § 706( 2) ( A)

( 2006) ) . "Subst ant i al evi dence i s ' such r el evant evi dence as a

r easonabl e mi nd mi ght accept as adequate t o support a concl usi on. ' "

Penobscot Ai r Ser vs. , Lt d. v. FAA, 164 F. 3d 713, 718 ( 1st Ci r .

1999) ( quot i ng Uni ver sal Camera Corp. v. NLRB, 340 U. S. 474, 477

( 1951) ) . We consi der t he whol e r ecor d, and " [ t ] he subst ant i al i t y

of evi dence must t ake i nt o account what ever i n t he r ecor d f ai r l y

det r act s f r om i t s wei ght . " Uni ver sal Camer a, 340 U. S. at 488.

When t he Commi ss i on and t he ALJ " r each di f f erent

concl usi ons, . . . t he [ ALJ ] ' s f i ndi ngs and wr i t t en deci si on ar e

si mpl y par t of t he r ecor d t hat t he r evi ewi ng cour t must consi der

i n det er mi ni ng whet her t he [ SEC] ' s deci si on i s suppor t ed by

subst ant i al evi dence. " NLRB v. I nt ' l Bhd. of Teamst er s, Local

251, 691 F. 3d 49, 55 ( 1st Ci r . 2012) ( ci t i ng Uni ver sal Camer a, 340

U. S. at 493) . Because "evi dence support i ng a concl usi on may be

l ess subst ant i al when an i mpart i al , exper i enced exami ner who has



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obser ved the wi t nesses and l i ved wi t h t he case has dr awn

concl usi ons di f f er ent f r om t he [ Commi ssi on] ' s t han when [ t he ALJ ]

has r eached t he same concl usi on, " i d. at 55 ( quot i ng Uni ver sal

Camera, 340 U. S. at 496) , "wher e the [ Commi ss i on] has r eached a

concl usi on opposi t e of t hat of t he ALJ , our r evi ew i s sl i ght l y

l ess def er ent i al t han i t woul d be ot her wi se, " i d. ( quot i ng Haas

El ec. , I nc. v. NLRB, 299 F. 3d 23, 28–29 ( 1st Ci r . 2002) ) .

A. Hopki ns

Li abi l i t y under Sect i on 17( a) ( 1) , Sect i on 10( b) , and

Rul e 10b- 5 r equi r es mat er i al i t y and sci ent er . See SEC v. Fi cken,

546 F. 3d 45, 47 ( 1st Ci r . 2008) ; see al so Mat r i xx I ni t i at i ves,

I nc. v. Si r acusano, 131 S. Ct . 1309, 1318 ( 2011) . "[ T] o f ul f i l l

t he mat er i al i t y r equi r ement ' t her e must be a subst ant i al

l i kel i hood t hat t he di scl osur e of t he omi t t ed f act woul d have been

vi ewed by the r easonabl e i nvest or as havi ng si gni f i cant l y al t er ed

t he "t ot al mi x" of i nf or mat i on made avai l abl e. ' " Basi c I nc. v.

Levi nson, 485 U. S. 224, 231–32 ( 1988) ( quot i ng TSC I ndus. , I nc. v.

Nor t hway, I nc. , 426 U. S. 438, 449 ( 1976) ) . "Sci ent er i s an

i nt ent i on ' t o decei ve, mani pul at e, or def r aud. ' " Fi cken, 546 F. 3d

at 47 ( quot i ng Er nst & Er nst v. Hochf el der , 425 U. S. 185, 194 n. 12

( 1976) ) ; see al so Aaron v. SEC, 446 U. S. 680, 686 n. 5 ( 1980) .

Hopki ns concedes t hat sci ent er can be est abl i shed by pr ovi ng "a

hi gh degr ee of r eckl essness, " but deni es t hat he was r eckl ess.

Compar e Fi cken, 546 F. 3d at 47 ( "I n t hi s ci r cui t , pr ovi ng sci ent er



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r equi r es ' a showi ng of ei t her consci ous i nt ent t o def r aud or "a

hi gh degr ee of r eckl essness. " ' " ( quot i ng ACA Fi n. Guar . Cor p. v.

Advest , I nc. , 512 F. 3d 46, 58 ( 1st Ci r . 2008) ) ) , wi t h Mat r i xx

I ni t i at i ves, 131 S. Ct . at 1323 ( "We have not deci ded whet her

r eckl essness suf f i ces to f ul f i l l t he sci ent er r equi r ement . ") .

Quest i ons of mat er i al i t y and sci ent er ar e connect ed.

Ci t y of Dear bor n Hei ght s Act 345 Pol i ce & Fi r e Ret . Sys. v. Wat er s

Cor p. , 632 F. 3d 751, 757 ( 1st Ci r . 2011) . "I f i t i s quest i onabl e

whet her a f act i s mat er i al or i t s mat er i al i t y i s mar gi nal , t hat

t ends t o undercut t he argument t hat def endant s act ed wi t h t he

r equi si t e i nt ent or ext r eme r eckl essness i n not di scl osi ng t he

f act . " I d.

Her e, assumi ng t he Typi cal Por t f ol i o Sl i de was

mi sl eadi ng, 3 evi dence suppor t i ng t he Commi ssi on' s f i ndi ng of

mat er i al i t y was margi nal . The Commi ssi on' s opi ni on st at es t hat

3 Whi l e t he act ual i nvest ment i n ABS exceeded t hat whi chwas on t he sl i de, t he sl i de was cl ear l y l abel ed "Typi cal Por t f ol i oExposur es and Char act er i st i cs - - Li mi t ed Dur at i on Bond St r at egy"and di d not pur port t o show t he actual exposur es t o each sect or atany gi ven t i me. The Commi ssi on cont ends t hat t he al l ocat i on t hesl i de repr esent ed was st i l l not t ypi cal dur i ng t he 2006–2007 t i meper i od. I n r esponse t o t he ALJ ' s quest i on of whet her t he sect orbr eakdown "was, i n f act , what exi st ed at t hat t i me, " Hopki nsr esponded, "I t hi nk i t pr obabl y was - - i n t er ms of t he sect orbr eakdown on t hi s page, i t was not . . . what was t ypi cal . " Weassume t hi s was an admi ssi on t hat t he sl i de was mi sl eadi ng as t oi t s " t ypi cal i t y. "

We al so assume t hat t he Commi ssi on di d not err i n i t sf i ndi ng t hat Hopki ns i n f act pr esent ed t he Typi cal Por t f ol i o Sl i dei n hi s present at i on t o t he NJ C on May 10, 2007.



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" r easonabl e i nvest or s woul d have vi ewed di scl osur e of t he f act

t hat , dur i ng the rel evant per i od, LDBF' s exposur e t o ABS was

subst ant i al l y hi gher t han was st at ed i n t he sl i de as havi ng

si gni f i cant l y al t er ed t he t ot al mi x of i nf or mat i on avai l abl e t o

t hem. " Yet t he Commi ssi on i dent i f i es onl y one wi t ness ot her t han

Hopki ns r el evant t o t hi s concl usi on. Hammer st ei n, Yanni Par t ner s'

chi ef str at egi st , 4 t est i f i ed t hat at t he May 10 meet i ng, Hopki ns

spoke f or about t hi r t y mi nut es, 5 pr esent ed t he Typi cal Por t f ol i o

Sl i de, and sai d t hat t he f und was of ver y hi gh qual i t y.

Hammer st ei n sai d that t he i nf or mat i on on the Typi cal Por t f ol i o

Sl i de was i mpor t ant t o hi m because "[ i ] t l ed t o the i mpr essi on

t hat t he f und was wel l di ver si f i ed, and t her ef or e t hat St at e St r eet

t ook st eps t o r educe t he r i sks or cont r ol t he r i sks. " Hammer st ei n

t est i f i ed t hat when he l at er l ear ned t hat t he LDBF' s ABS exposur e

act ual l y appr oached 100 per cent , he was surpr i sed i n l i ght of t he

May 10 meet i ng. Thi s l ed Yanni Par t ner s t o advi se i t s cl i ent s t o

l i qui dat e t hei r posi t i ons i n t he LDBF. Hammer st ei n sai d t hey came

t o t hi s concl usi on because t hey "f el t t hat St at e St r eet di d not

adequat el y i nf or m[ t hem] of t he r i sks i n t he por t f ol i o, and [ t hey]

4 Hammer st ei n hi msel f was not actual l y an i nvest or . Hewas t he chi ef st r at egi st at Yanni Par t ner s, whi ch i s an i nvest mentconsul t i ng f i r m t hat wor ks wi t h i nvest or s. The Commi ssi on poi nt st o no act ual i nvest or s t o suppor t a f i ndi ng of mat er i al i t y.

5 Amanda Wi l l i ams, who co- pr esent ed wi t h Hopki ns, wr ot e i na not e the day af t er t he meet i ng t hat t hey had onl y about f i f t eenmi nut es f or t hei r pr esent at i on.



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ci t ed t he exampl e of t he pr esent at i on t hat St ate St r eet made t o

Nat i onal J ewi sh on May 10 when St at e St r eet st at ed t hat . . . t he

t ypi cal al l ocat i on was 55 per cent t o the ABS sect or , but as

r ecent l y as March 31 of 2007, t he act ual ABS al l ocat i on was 100

per cent . " The Di vi si on pr esent ed a l et t er Yanni Par t ner s sent t o

ever y cl i ent i nvest ed i n t he LDBF, si gned by t he f i el d consul t ant

r esponsi bl e f or t he speci f i c cl i ent , r ecommendi ng t hat t hey

l i qui dat e t hei r hol di ngs and ci t i ng t he May 10 meet i ng wher e " [ t ] he

LD Bond Fund Por t f ol i o Manager . . . di d not di scl ose t he act ual

sect or exposur e at t he t i me, i nst ead pr esent i ng ' t ypi cal '

por t f ol i o character i st i cs . . . . "

On t he ot her hand, t he sl i de was cl ear l y l abel ed

"Typi cal . " As f ar as Hammerst ei n was aware, t hr ough May 2007,

Yanni Par t ners never asked SSgA f or a breakdown of t he LDBF' s

actual i nvest ment by sect or nor was he aware of any r equest f r om

Yanni Par t ners f or t he LDBF' s audi t ed f i nanci al st at ements.

Fur t her , t he Commi ssi on has not i dent i f i ed any evi dence i n t he

r ecor d t hat t he credi t r i sks posed by ABS, CMBS, or MBS were

mat er i al l y di f f er ent f r om each ot her , 6 ar gui ng i nst ead t hat t he

6 We al so not e t hat t he LDBF' s composi t i on i n t er ms ofcredi t qual i t y of hol di ngs r emai ned r el at i vel y const ant , and, i fanyt hi ng, i mpr oved. The Typi cal Por t f ol i o Sl i de r epr esent ed t hat85% of t he LDBF' s i nvest ment was i n AAA- and AA- r at ed bonds ( 45%and 40% r espect i vel y) , whi l e t he Mar ch 31, 2007, f act sheetdi scl osed t hat 94. 46% of i t s i nvest ment was i n AAA- and AA- r at edbonds ( 62. 2% and 32. 26% r espect i vel y) .



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per cent of i nvest ment i n ABS and di ver si f i cat i on as such ar e

i mpor t ant t o i nvest or s.

Cont ext makes a di f f er ence. Accor di ng t o a r epor t

Hammerst ei n aut hored t he day af t er t he meet i ng, t he meet i ng' s

pur pose was t o expl ai n why t he LDBF had underper f ormed i n the f i r st

quar t er of 2007 and t o di scuss i t s i nvest ment i n a speci f i c i ndex

t hat had cont r i but ed t o t he under per f ormance. The Typi cal

Por t f ol i o Sl i de was one sl i de of a pr esent at i on of at l east t went y.

Per haps unsur pr i si ngl y, t he sl i de was not ment i oned i n

Hammer st ei n' s r eport .

Hopki ns present ed exper t t est i mony f r om J ohn W. Peavy

I I I ( "Peavy") t hat "[ p] r e- pr epar ed document s such as . . .

pr esent at i ons . . . ar e not i nt ended t o pr esent a compl et e pi ct ur e

of t he f und, " but r at her ser ve as "st ar t i ng poi nt s, " af t er whi ch

due di l i gence i s per f or med. Peavy expl ai ned t hat " a t ypi cal

i nvest or i n an unr egi st er ed f und woul d under st and t hat i t coul d

speci f i cal l y request addi t i onal i nf or mat i on r egar di ng t he f und. " 7

And not onl y wer e cl i ent s gi ven speci f i c i nf or mat i on upon r equest ,

i nf or mat i on about t he LDBF' s act ual per cent of sect or i nvest ment

was avai l abl e t hr ough t he f act sheet s and annual audi t ed f i nanci al

7 Peavy al so opi ned t hat "i n t he hundr eds of . . . meet i ngsand pr esent at i ons [ he has] at t ended, [ he di d] not r ecal l a si ngl ei nst ance i n whi ch t he di scussi on was based sol el y on t he cont entof mater i al pr epared bef orehand or a r ote r eadi ng of a Power Poi ntpr esent at i on sl i de deck. "



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st at ement s. 8 The Mar ch 31, 2007, f act sheet , avai l abl e si x weeks

pr i or t o the May 10, 2007, pr esent at i on, i ncl uded t hat t he LDBF

was 100% i nvest ed i n ABS. The J une 30, 2007, f act sheet i ncl uded

t hat t he LDBF was 81. 3%i nvest ed i n ABS. These f act s wei gh agai nst

any concl usi on t hat t he Typi cal Por t f ol i o Sl i de had "si gni f i cant l y

al t er ed t he ' t ot al mi x' of i nf or mat i on made avai l abl e. " Basi c,

485 U. S. at 232 ( quot i ng TSC I ndus. , I nc. , 426 U. S. at 449)

( i nt er nal quot at i on mar k omi t t ed) .

Thi s t hi n mat er i al i t y showi ng cannot suppor t a f i ndi ng

of sci ent er her e. 9 See Gef f on v. Mi cr i on Corp. , 249 F. 3d 29, 35

( 1st Ci r . 2001) . Hopki ns t est i f i ed t hat i n hi s exper i ence,

8 I nf ormat i on was al so pr ovi ded on SSgA' s websi t e t hr ought he passwor d pr ot ect ed "Cl i ent ' s Cor ner " and "Consul t ant ' s Cor ner "sect i ons. However , t he i nf or mat i on avai l abl e on t hese par t s oft he websi t e var i ed by f und and cl i ent . Hopki ns pr esent ed evi dence

t hat dur i ng 2007, t he Cl i ent ' s Cor ner sect i on was l ogged i nt o28, 969 t i mes by 465 uni que user s. Hopki ns al so pr esent ed evi dencet hat Hammerst ei n was copi ed on an e- mai l about t he Cl i ent ' s Cornersect i on of t he websi t e, but Hammer st ei n had no recol l ect i on ofseei ng t he e- mai l .

We do not suggest t hat t he mer e avai l abi l i t y of accur at ei nf or mat i on negat es an i naccur at e st at ement . Rat her , when a sl i dei s l abel ed " t ypi cal , " and wher e a r easonabl e i nvest or woul d notr el y on one sl i de but i nst ead woul d conduct due di l i gence whenmaki ng an i nvest ment deci si on, t he avai l abi l i t y of act ual andaccur at e i nf or mat i on i s r el evant .

9 Our determi nat i on i s based on how a r easonabl e i nvest orwoul d r eact . Gi ven our concl usi on t hat t he Commi ssi on abused i t sdi scret i on i n hol di ng Hopki ns l i abl e under Sect i on 17( a) ( 1) ,Sect i on 10( b) , and Rul e 10b- 5, we need not deci de whet her t he l evelof sophi st i cat i on of t he LDBF i nvest ors woul d have made anymi sr epr esent at i on i mmat er i al . Cf . SEC v. Happ, 392 F. 3d 12, 21–23 ( 1st Ci r . 2004) .



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i nvest or s di d not f ocus on sect or br eakdown when maki ng t hei r

i nvest ment deci si ons and t hat LDBF i nvest ors di d not f ocus on how

much of t he LDBF i nvest ment was i n ABS versus MBS. 10 I n f act ,

Hopki ns di d not r ecal l ever di scussi ng t he Typi cal Por t f ol i o Sl i de

or bei ng asked a quest i on about t he act ual sect or br eakdown when

pr esent i ng t he sl i de. 11 He di d not updat e t he Typi cal Por t f ol i o

Sl i de' s sector br eakdowns because he di d not t hi nk t he t ypi cal

sect or br eakdowns wer e i mport ant t o i nvest or s. To t he extent t hat

an i nvest or woul d want t o know t he act ual sect or br eakdowns,

Hopki ns woul d br i ng not es wi t h " t he accur at e i nf ormat i on" so t hat

he coul d answer any quest i ons t hat arose. We cannot say t hat t hese

handwr i t t en not es pr ovi de subst ant i al evi dence of r eckl essness,

much l ess i nt ent i onal i t y t o mi sl ead - - par t i cul ar l y i n l i ght of

Hopki ns' s bel i ef t hat t hi s i nf or mat i on was not i mpor t ant t o

i nvest or s. Cf . Ci t y of Dear bor n Hei ght s, 632 F. 3d at 757 ( " [ T] he

quest i on of whet her Def endant s r eckl essl y f ai l ed t o di scl ose [ a

f act ] i s . . . i nt i matel y bound up wi t h whet her Def endant s ei t her

act ual l y knew or r eckl essl y i gnor ed t hat t he [ f act ] was mat er i al

10 Hopki ns was not al one i n hi s bel i ef . Lawr ence J .Car l son, t he co- head of Rel at i onshi p Management at SSgA i n 2007,t est i f i ed t hat at l east pr i or t o t he summer of 2007, he di d notr ecal l cl i ent s ever aski ng f or a sect or br eakdown of t he LDBF, andexper t wi t ness Peavy t est i f i ed t hat i t was common f or cl i ent s " nott o ask f or hol di ngs. "

11 Out si de of t he pr esent at i ons, pr i or t o t he May 10meet i ng, t her e wer e at l east occasi onal i nqui r i es about t he LDBF' shol di ngs, t o whi ch Hopki ns pr ovi ded answer s.



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and never t hel ess f ai l ed t o di scl ose i t . " ( al t er at i ons i n or i gi nal )

( quot i ng Ci t y of Phi l a. v. Fl emi ng Cos. , 264 F. 3d 1245, 1265 ( 10t h

Ci r . 2001) ) ) . Gi ven t he evi dence wei ghi ng agai nst t he mat er i al i t y

of t he por t i on of t he sl i de t o whi ch t he SEC obj ect s, we cannot

say t her e i s subst ant i al evi dence t hat Hopki ns' s pr esent at i on of

a sl i de cont ai ni ng sect or br eakdowns l abel ed " t ypi cal , " wi t h not es

of t he act ual sect or br eakdown r eady at hand, const i t ut es " a hi ghl y

unr easonabl e [act i on] , i nvol vi ng not mer el y si mpl e, or even

i nexcusabl e[ ] negl i gence, but an ext r eme depar t ur e f r om t he

st andar ds of or di nar y car e . . . t hat i s ei t her known t o [ Hopki ns]

or i s so obvi ous [ Hopki ns] must have been awar e of i t . " Fi cken,

546 F. 3d at 47–48 ( second al t er at i on i n or i gi nal ) ( quot i ng SEC v.

Fi f e, 311 F. 3d 1, 9–10 ( 1st Ci r . 2002) ) . We concl ude t hat t he

Commi ssi on abused i t s di scr et i on i n hol di ng Hopki ns l i abl e under

Sect i on 17( a) ( 1) , Sect i on 10( b) , and Rul e 10b- 5.

B. Fl anner y

Sect i on 17( a) ( 3) deems i t unl awf ul " f or any per son i n

t he of f er or sal e of any secur i t i es . . . t o engage i n any

t r ansact i on, pr act i ce, or cour se of busi ness whi ch oper at es or

woul d oper ate as a f r aud or decei t upon t he pur chaser . " 15 U. S. C.

§ 77q( a) ( 3) . "[ N] egl i gence i s suf f i ci ent t o establ i sh l i abi l i t y

under . . . § 17( a) ( 3) . " Fi cken, 546 F. 3d at 47.

The Commi ssi on concl uded " t hat t he August 2 and August

14 l et t er s wer e mat er i al l y mi sl eadi ng, par t i cul ar l y when t hei r



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cumul at i ve ef f ect i s t aken i nt o account . " I t f ound t hat "[ w] hen

consi der ed t oget her - - and as par t of a l ar ger ef f or t t o convi nce

i nvest or s t o r emai n i n t he poor l y per f or mi ng LDBF - - t he l et t er s

mi sl eadi ngl y downpl ayed LDBF' s r i sk and encour aged i nvest ors t o

hol d ont o thei r shar es, even t hough SSgA' s own f unds and i nt er nal

advi sor y gr oup cl i ent s wer e f l eei ng t he f und. " We di sagr ee. At

t he ver y l east , t he August 2 l et t er was not mi sl eadi ng - - even

when consi der ed wi t h the August 14 l et t er - - and so t her e was not

subst ant i al evi dence t o suppor t t he Commi ssi on' s f i ndi ng that

Fl anner y was " l i abl e f or havi ng engaged i n a ' cour se of busi ness'

t hat oper at ed as a f r aud on LDBF i nvest or s. " 12

The Commi ssi on' s pr i mar y r eason f or f i ndi ng t he August

2 l et t er mi sl eadi ng was i t s vi ew t hat t he "LDBF' s sal e of t he AAA-

r at ed secur i t i es di d not r educe r i sk i n t he f und. Rat her , t he

sal e ul t i mat el y i ncreased bot h t he f und' s cr edi t r i sk and i t s

l i qui di t y r i sk because t he secur i t i es t hat r emai ned i n t he f und

had a l ower cr edi t r at i ng and wer e l ess l i qui d t han t hose t hat

wer e sol d. " At t he out set , we not e t hat nei t her of t he

Commi ssi on' s asser t i ons - - t hat t he sal e i ncr eased t he f und' s

credi t r i sk and i ncreased i t s l i qui di t y r i sk - - ar e suppor t ed by

subst ant i al evi dence.

12 I n l i ght of t hi s concl usi on, we do not reach Fl anner y' sar gument t hat t he Commi ssi on' s i nt er pr et at i on of Sect i on 17( a) ( 3)as appl yi ng t o mi sst at ement s i s i ncor r ect .



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Fi r st , al t hough credi t r at i ng al one does not necessar i l y

measur e a por t f ol i o' s r i sk, t he Commi ssi on does not di sput e t he

t r ut h of t he l et t er ' s st at ement t hat t he LDBF mai nt ai ned an aver age

AA- cr edi t qual i t y. Second, exper t t est i mony pr esent ed at t he

pr oceedi ng expl ai ned t hat t he J ul y 26 AAA- r ated bond sal e reduced

r i sk because t hese bonds "ent ai l ed cr edi t and mar ket r i sk t hat

wer e subst ant i al l y gr eat er t han t hose of cash posi t i ons. I n

addi t i on, a port i on of t he sal e pr oceeds was used t o pay down

[ r epur chase agr eement ] l oans and r educe t he por t f ol i o l ever age. "

Fur t her , t est i mony t hr oughout t he pr oceedi ng i ndi cat ed t hat t he

LDBF' s bond sal es i n J ul y and August r educed r i sk by decr easi ng

exposur e to the subpr i me resi dent i al mar ket , by reduci ng l ever age,

and by i ncr easi ng l i qui di t y, par t of whi ch was used t o r epay l oans.

To be sure, t he Commi ssi on mai nt ai ned t hat t he bond

sal e' s pot ent i al l y benef i ci al ef f ect s on t he f und' s l i qui di t y r i sk

were i mmedi at el y undermi ned by t he "massi ve out f l ows of t he sal e

pr oceeds . . . t o ear l y r edeemer s. " But t hi s r easoni ng f al t er s

f or t wo r easons. Fi r st , t he Commi ssi on acknowl edged t hat bet ween

$175 and $195 mi l l i on of t he cash pr oceeds r emai ned i n the LDBF as

of t he t i me t he l et t er was sent ; i t of f er ed no r eason, however ,

why t hi s l evel of cash hol di ngs pr ovi ded an i nsuf f i ci ent l i qui di t y

cushi on. Second and more f undament al l y, even i f t he Commi ssi on

was cor r ect t hat t he l i qui di t y r i sk i n t he LDBF was hi gher

f ol l owi ng t he sal e t han i t was pr i or t o t he sal e, i t does not



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f ol l ow t hat t he sal e f ai l ed t o r educe r i sk. Rat her , t o t r eat as

mi sl eadi ng t he st at ement i n t he August 2 l et t er t hat St at e St r eet

had " r educed r i sk, " t he Commi ssi on woul d need to demonst r at e t hat

t he l i qui di t y ri sk i n t he LDBF f ol l owi ng t he sal e was hi gher t han

i t woul d have been i n t he count er f act ual wor l d i n whi ch t he

f i nanci al cri si s had cont i nued t o r oi l - - and i n whi ch l ar ge

number s of i nvest ors l i kel y woul d have sought r edempt i on - - and

t he LDBF had not sol d i t s AAA hol di ngs. But t he Commi ssi on has

not done t hi s.

I ndependent l y, t he Commi ssi on has mi sr ead t he l et t er .

The August 2 l et t er di d not cl ai mt o have r educed r i sk i n t he LDBF.

The l et t er st at es t hat " t he downdr af t i n val uat i ons has had a

si gni f i cant i mpact on t he r i sk pr of i l e of our por t f ol i os, pr ompt i ng

us t o take st eps t o seek t o reduce r i sk acr oss t he af f ect ed

por t f ol i os" ( emphasi s added) . I ndeed, at oral ar gument , t he

Commi ssi on acknowl edged t hat t her e was no par t i cul ar sent ence i n

t he l et t er t hat was i naccur at e. I t cont ends t hat t he st at ement ,

" [ t ] he act i ons we have t aken to dat e i n t he [ LDBF] si mul t aneousl y

r educed r i sk i n ot her SSgA act i ve f i xed i ncome and act i ve

der i vat i ve- based st r at egi es, " mi sl ed i nvest or s i nt o t hi nki ng SSgA

r educed t he LDBF' s r i sk pr of i l e. Thi s ar gument i gnor es t he wor d

"ot her . " The l et t er was sent t o cl i ent s i n at l east t went y- one

ot her f unds, and, i f anyt hi ng, speaks t o havi ng r educed r i sk i n

f unds ot her t han t he LDBF.



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Even beyond t hat , t her e i s not subst ant i al evi dence t hat

SSgA di d not "seek t o reduce r i sk across t he af f ect ed por t f ol i os. "

As one exper t t est i f i ed, t her e ar e di f f er ent t ypes of r i sk

associ at ed wi t h a f und l i ke t he LDBF, i ncl udi ng mar ket r i sk,

l i qui di t y r i sk, and credi t or def aul t r i sk. The LDBF was f aci ng

a l i qui di t y pr obl em, and at t he J ul y 25 meet i ng, Mi chael Wands,

t he Di r ect or of Act i ve Nor t h Amer i can Fi xed I ncome, expl ai ned t hat

"[ i ] t ' s har d t o pr edi ct i f t he mar ket wi l l hol d on or i f t her e

wi l l be a l arge number of wi t hdr awal s by cl i ent s. We need t o have

l i qui di t y shoul d t he cl i ent s deci de t o wi t hdr aw. " Fl anner y not ed

t hat " i f [ t hey di dn' t ] r ai se l i qui di t y [ t hey] f ace[ d] a gr eat er

unknown. " Rober t Pi cket t , t he LDBF' s l ead por t f ol i o manager , not ed

t hat sel l i ng onl y AAA- r at ed bonds woul d af f ect t he LDBF' s r i sk

pr of i l e. Af t er di scussi on of bot h of t hese concer ns, t he

I nvest ment Commi t t ee ul t i mat el y deci ded t o i ncr ease l i qui di t y,

sel l a pr o- r at a shar e t o war r ant wi t hdr awal s, and r educe AA

exposur e. And t hat i s what i t di d. On J ul y 26 and 27, 2007,

LDBF' s por t f ol i o management t eam sol d appr oxi mat el y $1. 6 bi l l i on

i n AAA- r ated bonds and about $200 mi l l i on i n AA- r ated bonds;

bet ween appr oxi matel y J ul y 31 and August 24, 2007, i t sol d about

$1. 2 bi l l i on of AA- r at ed bonds; and on August 7 and 8, 2007, i t

sol d about $100 mi l l i on of A- r at ed bonds. The August 2 l et t er

does not t r y to hi de t he sal e of t he AAA- r at ed bonds; i t candi dl y

acknowl edges i t . At t he pr oceedi ng, Fl anner y t est i f i ed t hat



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sel l i ng AAA- r at ed bonds i t sel f r educes r i sk, and her e, i n

combi nat i on wi t h t he pr o- r at a sal e, was i nt ended t o mai nt ai n a

consi st ent r i sk pr of i l e f or t he LDBF. Pi cket t t est i f i ed t hat t he

goal of t he pr o- r at a sal e was t o t r eat al l shar ehol der s - - bot h

t hose who exi t ed t he f und and t hose who remai ned - - as equal l y as

possi bl e and mai nt ai n t he r i sk- char act er i st i cs of t he por t f ol i o t o

t he ext ent possi bl e. These act i ons ar e not i nconsi st ent wi t h

t r yi ng t o r educe t he r i sk pr of i l e across t he por t f ol i os.

Fi nal l y, we not e t hat t he Commi ssi on has f ai l ed t o

i dent i f y a si ngl e wi t ness t hat suppor t s a f i ndi ng of mat er i al i t y.

Cf . SEC v. Phan, 500 F. 3d 895, 910 ( 9t h Ci r . 2007) ( "The SEC, whi ch

bot h bear s t he bur den of pr oof and i s t he par t y movi ng f or summary

j udgment , submi t t ed no evi dence t o t he di st r i ct cour t

demonst r at i ng t he mater i al i t y of t he mi sst atement about t he

payment t er ms. " ) . We do not t hi nk t he l et t er was mi sl eadi ng, and

we f i nd no subst ant i al evi dence suppor t i ng a concl usi on ot her wi se.

We need not r each t he August 14 l et t er . 13 I n i t s opi ni on,

t he Commi ssi on st ated that whi l e Sect i on 17( a) ( 1) and Rul e 10b-

5( a) & ( c) "woul d pr oscr i be even a si ngl e act of maki ng or dr af t i ng

a mat er i al mi sst at ement t o i nvest or s, Sect i on 17( a) ( 3) i s not

13 We al so do not r each t he def ense of whether t he l astsent ence of t he r el evant par agr aph was no more t han a non-act i onabl e "opi ni on, " pr ot ect ed under Omni car e, I nc. v. Labor er sDi st . Counci l Const r . I ndus. Pensi on Fund, 135 S. Ct . 1318, 1327( 2015) .



suscept i bl e t o a si mi l ar r eadi ng. Of cour se, one who r epeat edl y

makes or dr af t s such mi sst at ement s over a per i od of t i me may wel l

have engaged i n a f r audul ent ' pr act i ce' or ' cour se of busi ness, '

but not ever y i sol at ed act wi l l qual i f y. " See al so I n r e Ant hony

Fi el ds, CPA, Secur i t i es Act Rel ease No. 9727, Exchange Act Rel ease

No. 74, 344, I nvest ment Company Act Rel ease No. 31, 461, 2015 WL

728005, at *10 ( Feb. 20, 2015) ( " [ A] n i sol ated mi sst atement

unaccompani ed by ot her conduct does not gi ve r i se t o l i abi l i t y

under [ Sect i on 17( a) ( 3) ] . " ) . Even wer e we t o assume t hat t he

August 14 l et t er was mi sl eadi ng, i n l i ght of t he SEC' s

i nt er pr et at i on of Sect i on 17( a) ( 3) and our concl usi on about t he

August 2 l et t er , we f i nd t her e i s not subst ant i al evi dence t o

support t he Commi ssi on' s f i ndi ng t hat Fl anner y engaged i n a

f r audul ent "pract i ce" or "cour se of busi ness. "

I I I .

For t he r easons above, we gr ant t he pet i t i ons f or r evi ew

and vacat e t he Commi ssi on' s or der .

hopkins v. securities & exchange comm, 1st cir. (2015)

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