Years ago, I handled the defense of a FINRA Enforcement case that still galls me. The client sent a series of emails, over many months, about a particular security to customers who already owned the stock. The point of the emails was largely to provide updates, and, from time-to-time, to suggest that the customers consider adding to their existing positions. FINRA maintained that the emails violated the Advertising Rule, because each and every email had to contain a detailed description of the potential risks associated with the security. In response, I argued that that would be pointless, as the customers already knew those risks, having been explained in prior communications, both oral and written, so to judge the adequacy of the disclosures in any one particular email, it was necessary to view that email in the context of the entire stream of emails.
I lost. FINRA concluded that context was irrelevant, that every email had to contain the full-blown risk disclosure, no matter how many times that same disclosure had already been made. This is just a nonsensical result, and, to prove that, FINRA, to my knowledge, has never, ever applied that standard again.
That was a long time ago. But, in December, the First Circuit issued a decision overturning an SEC matter that, at long last, justifies my old argument that context is, in fact, important.
In Flannery v. SEC, the First Circuit vacated an Order that the SEC had issued against John Flannery and James Hopkins, two former employees of State Street Global Advisors, finding that they had made certain material misrepresentations and omissions about a State Street bond fund. Notably, the SEC’s Order – a 3-2 decision – happened because the Division of Enforcement managed to lose its case against Messrs. Flannery and Hopkins in front of the ALJ. And we all know how much the SEC hates to lose, so the Division of Enforcement appealed its loss to the Commission.
Anyway, contrary to the ALJ, who actually heard the evidence, the SEC concluded that Mr. Hopkins was liable because a single slide in a PowerPoint presentation that he made to investors was misleading. Specifically, the SEC was unhappy that the slide used the word “typical” to describe the fund’s portfolio, rather than its actual portfolio at the time. The First Circuit disagreed with this narrow approach, and concluded that the SEC’s evidence of materiality was “marginal,” and that it could not support a finding of scienter, even based on recklessness.
Why? Because “[c]ontext makes a difference.” The single slide in question was only one “of at least twenty.” Also, the Court was impressed by Mr. Hopkins’ expert witness, who testified that a “pre-prepared document,” such as the PowerPoint presentation, is “not intended to present a complete picture of” the investment, but, rather, to “serve as a starting point’” for investors. After seeing the presentation, “a typical investor” would then perform his or her own due diligence. Here, the investors were all made aware that additional, more specific, information was available upon request, and that information about the fund’s actual (not merely “typical”) portfolio was available through fact sheets and annual audited financial statements.
The Court was careful to point out in a footnote that it was not “suggest[ing] that the mere availability of accurate information negates an inaccurate statement.” But, “when a slide is labeled ‘typical,’ and where a reasonable investor would not rely on one slide but instead would conduct due diligence when making an investment decision, the availability of actual and accurate information is relevant.”
As for Mr. Flannery, the SEC found that he made misrepresentations in two letters. In reversing that finding, the Court concluded that one of the two letters was not misleading. Because of that finding, the Court never even bothered to consider whether the second letter was misleading. Even if it was, according to the SEC’s own finding in an earlier case that the Court cited with approval, a single misleading letter could not support a finding of a violation of Section 17(a)(3) of the Securities Act: “an isolated misstatement unaccompanied by other conduct does not give rise to liability under” 17(a)(3).
There are several important takeaways from Flannery, but, to me, the most important is that when your client is accused of having violated Section 17(a) as a result of a making a single, allegedly misleading statement, the context in which that statement was made, i.e., the “total mix” of available information to the investors, can dictate whether the SEC has a case or not.
 Please forgive the long gap between posts, as I have been a bit busy with my new son, Jailen, born in December!
 The standard of review here is very interesting, in and of itself. It is well accepted that the SEC’s findings “control if supported by substantial evidence,” and its orders and conclusions are not “arbitrary, capricious, an abuse of discretion, or otherwise not in accordance with law.” Cody v SEC, 693 F.3d 251, 257 (1st Cir. 2012). But, when the Commission and the ALJ “reach different conclusions,” a different standard applies. In that circumstance, as was the case in Flannery, the court’s review is “less deferential” to the Commission, as it will put more weight on the findings made by the ALJ, “who . . . observed the witnesses and lived with the case.”