## Facts

- A registered broker-dealer and FINRA member, through its principals and chief compliance officer, sold more than two million shares of iStorage stock during 2004–2005.
- The firm had written supervisory procedures requiring inquiry into the issuer and terms before selling unregistered stock, but in practice largely relied on whether certificates bore restrictive legends and on a clearing firm’s processing.
- The iStorage transactions presented multiple warning signs, including unusual volume, issuer-related concerns, and the absence of restrictive legends despite circumstances suggesting restrictions or distribution activity.
- The registered representative made no meaningful inquiry into the origin or registration status of the shares before selling them.
- FINRA found violations of Securities Act §§ 5(a) and 5(c) (sales of unregistered securities) and NASD Conduct Rules 2110 and 3010 (supervision), and imposed fines and other sanctions; the SEC sustained FINRA’s action, and the petitioners sought judicial review.

## Issues

1. Whether substantial evidence supported the SEC’s findings that petitioners participated in the distribution of unregistered securities in violation of Securities Act §§ 5(a) and 5(c).
2. Whether petitioners qualified for the Securities Act § 4(4) broker transaction exemption, including whether they satisfied a duty of reasonable inquiry given transaction “red flags,” and whether the SEC misallocated the burden regarding the exemption.
3. Whether the SEC properly sustained findings of supervisory violations under NASD Conduct Rules 2110 and 3010 and acted within its discretion in affirming FINRA sanctions.

## Decision

- The Ninth Circuit denied the petition for review and affirmed the SEC’s order sustaining FINRA’s disciplinary action.
- The court held substantial evidence supported the SEC’s finding of §§ 5(a) and 5(c) violations.
- The court held petitioners failed to conduct the reasonable inquiry required to invoke the § 4(4) broker exemption, particularly in light of multiple suspicious circumstances.
- The court upheld the supervisory violation findings and deferred to the SEC’s affirmance of sanctions as within FINRA guidelines and supported by the record.

## Legal Principles

- Sales or offers to sell securities without an effective registration statement violate Securities Act §§ 5(a) and 5(c) unless an exemption applies.
- A broker claiming the Securities Act § 4(4) exemption must prove it and must conduct a reasonable inquiry into the legality of the transaction when circumstances suggest an unregistered distribution.
- Red flags (e.g., unusual volume, issuer concerns, atypical certificate features, or missing restrictive legends in suspicious contexts) require heightened inquiry; reliance solely on the absence of a restrictive legend or on third-party clearance is insufficient.
- Broker-dealers and responsible principals must implement and enforce effective supervisory systems for transactions involving potentially unregistered securities; written policies not followed in practice can support supervision violations.
- On judicial review, SEC factual findings are upheld if supported by substantial evidence, and sanctions are generally sustained absent arbitrariness or abuse of discretion, particularly when consistent with FINRA guidelines.

## Conclusion

The Ninth Circuit upheld the SEC’s decision sustaining FINRA sanctions because the record supported findings that the broker-dealer and associated persons sold unregistered securities, failed to conduct reasonable inquiry required for the § 4(4) exemption amid clear red flags, and failed reasonably to supervise in violation of applicable NASD rules.


World Trade Fin. Corp. v. SEC, 739 F.3d 1243 (9th Cir. 2014)