## Facts

- State Street offered a Limited Duration Bond Fund (LDBF) and related funds to institutional investors, marketing LDBF as a conservative “enhanced cash” product.
- By mid-2007, LDBF was heavily invested in, or exposed to, subprime residential mortgage-backed securities and other subprime-linked investments.
- During the 2007 subprime crisis, State Street communicated with current and prospective investors through letters, presentations, and other materials discussing LDBF’s strategy, holdings, and risk.
- The SEC alleged that certain communications materially misstated or omitted the extent of subprime exposure and related risks, inducing institutions to buy or hold and later incur substantial losses.
- John P. Flannery (a senior SSgA officer) and James D. Hopkins (a portfolio manager/product specialist) participated in aspects of the communication process regarding the funds.
- The SEC instituted administrative cease-and-desist proceedings in 2010 alleging violations of antifraud provisions; an ALJ found violations and imposed sanctions in 2013.
- Both respondents appealed, and the Commission reviewed the record de novo, issuing its final decision in December 2014.

## Issues

1. Whether Flannery and Hopkins committed primary violations of Exchange Act § 10(b) and Rule 10b-5, and Securities Act § 17(a), through material misstatements, omissions, or a deceptive course of conduct concerning subprime exposure.
2. Whether the evidence established “scheme” liability under Rule 10b-5(a) and (c) based on respondents’ roles in preparing or influencing fund communications.
3. Whether any challenged statements were attributable to either respondent for misstatement liability under Rule 10b-5(b) and related provisions.
4. Whether the Division proved scienter (intent or recklessness) for the § 10(b)/Rule 10b-5 claims.
5. Whether sanctions (cease-and-desist relief, industry bars, and penalties) were warranted.

## Decision

- The Commission declined to impose antifraud liability on Flannery and Hopkins on the principal charges.
- The Commission reversed or set aside key portions of the ALJ’s adverse antifraud findings and dismissed the proceeding against both respondents on those substantive antifraud claims.
- The Commission found the Division did not meet its burden to show either respondent engaged in independently deceptive conduct sufficient for Rule 10b-5(a) or (c) scheme liability.
- The Commission concluded the evidence did not establish actionable, attributable material misstatements or omissions by these individuals under Rule 10b-5(b) and related provisions.
- The Commission determined the Division failed to prove scienter as to either respondent.
- Because the antifraud violations were not proven, the Commission did not sustain requested sanctions premised on those violations.

## Legal Principles

- Rule 10b-5(a) and (c) require proof of deceptive conduct constituting a fraudulent scheme; participation in a broader drafting or review process, without independently deceptive acts, is insufficient for primary scheme liability.
- Misstatement liability under Rule 10b-5(b) requires that the allegedly false or misleading statement be attributable to the charged individual, not merely associated with an institution’s diffuse communications process.
- Materiality depends on whether a reasonable investor would view the misstated or omitted information as significantly altering the total mix of information; the Division bears the burden of proof in administrative antifraud claims.
- Scienter for § 10(b)/Rule 10b-5 requires intent to deceive or recklessness; the Commission will not infer scienter from shared responsibility or organizational involvement absent persuasive record evidence tied to the specific statements or conduct charged.
- Sanctions in SEC administrative proceedings require an underlying violation; when antifraud violations are not established, cease-and-desist relief, bars, and penalties predicated on those violations cannot be imposed.

## Conclusion

The Commission dismissed the core antifraud claims against Flannery and Hopkins, holding that the Division failed to prove primary scheme liability, attributable material misstatements or omissions, or scienter in connection with investor communications about LDBF’s subprime exposure during the 2007 crisis, and therefore declined to impose antifraud-based sanctions.


In re Flannery, Exchange Act Release No. 73,752, 2014 WL 7145625 (S.E.C. Dec. 15, 2014)