306 F.3d 1293 (2002)

[1294] [1295] Louis R. Cohen, Washington, DC (Charles E. Davidow, Paul A. Engelmayer, Wilmer, Cutler & Pickering, Washington, DC; Dennis J. Block, Jonathan D. Polkes, Cadwalader, Wickersham & Taft, New York, NY; John L. Warden, Kenneth M. Raisler, Sullivan & Cromwell, New York, NY; Bernard J. Rothbaum, Jr., Hartzog Conger Cason & Neville, Oklahoma City, OK, on the brief), for Appellants.

Myron Kirschbaum, New York, NY (Paul J. Curran, Daniel L. Reisner, Andrew K. Solow, Kaye Scholer LLP, New York, NY, on the brief), for Appellee.

Matthew D. Slater, Washington, DC (Giovanni P. Prezioso, Onnig H. Dombalagian, Petia Vretenarova, Cleary, Gottlieb, Steen & Hamilton, Washington, DC, on the brief), for The Bond Market Association, the Futures Industry Association, and the Foreign Exchange Committee, as amici curiae appearing on behalf of Appellant.

Richard A. Rosen, New York, NY (Lara Shalov, Paul, Weiss, Rifkind, Wharton & Garrison, New York, NY, on the brief), for the Securities Industry Association, as amicus curiae appearing on behalf of Appellant.

Daniel J. Roth, Executive Vice President and General Counsel, National Futures Association, Chicago, IL, for National Futures Association, as amicus curiae appearing on behalf of Appellant.

David C. Vladeck, Washington, DC (Alan B. Morrison, Public Citizen Litigation Group, Washington, DC, on the brief), for Public Citizen, as amicus curiae appearing on behalf of Appellee.

Before: JACOBS, F.I. PARKER, SOTOMAYOR, Circuit Judges.

JACOBS, Circuit Judge.

In a period of less than five months in 1994-95, plaintiff Henryk de Kwiatkowski ("Kwiatkowski") made and lost hundreds [1296] of millions of dollars betting on the U.S. dollar by trading in currency futures. Kwiatkowski traded on a governmental scale: At one point, his positions accounted for 30 percent of the total open interest in certain currencies on the Chicago Mercantile Exchange. After netting over $200 million in the first trading weeks, Kwiatkowski's fortunes turned; between late December 1994 and mid-January 1995, Kwiatkowski suffered single-day losses of $112 million, $98 million, and $70 million. He continued losing money through the winter. Having lost tens of millions over the preceding several days, Kwiatkowski liquidated all his positions starting on Sunday, March 5 and finishing the next day. In all, Kwiatkowski had suffered net losses of $215 million.

In June 1996, Kwiatkowski sued the brokerage firm (and related entities) that had executed his trade orders, Bear, Stearns & Co., Inc., Bear, Stearns Securities Corporation, and Bear Stearns Forex Inc. (collectively, "Bear Stearns" or "Bear"), as well as his individual broker, Albert Sabini ("Sabini"), alleging (inter alia) common law negligence and breach of fiduciary duty. At trial, Kwiatkowski contended that Bear and Sabini failed adequately to warn him of risks, failed to keep him apprised of certain market forecasts, and gave him negligent advice concerning the timing of his trades.

In May 2000, a jury in the United States District Court for the Southern District of New York (Marrero, J.) found Bear negligent and awarded Kwiatkowski $111.5 million in damages. The jury found for Bear on the breach of fiduciary duty claim. Sabini prevailed on both claims.

Bear made timely motions for judgment under Fed.R.Civ.P. 50, arguing principally that Kwiatkowski's account was a "nondiscretionary" trading account (i.e., one where all trades require the client's authorization), and that as to such accounts (as a matter of law) a broker has none of the advisory duties that Bear was found to have breached.

In an opinion dated December 29, 2000, the district court denied Bear's motion for judgment. Kwiatkowski v. Bear Stearns & Co., Inc., 126 F.Supp.2d 672 (S.D.N.Y. 2000). The court ruled that the unique facts and circumstances of the parties' relationship permitted the jury reasonably to find that Bear undertook to provide Kwiatkowski with services beyond those that are usual for nondiscretionary accounts, and that there was evidence sufficient to find that Bear provided those services negligently. The district court added $53 million to the jury's damages award for prejudgment interest dating back to March 6, 1995, bringing Kwiatkowski's total recovery to $164.5 million.

On appeal, Bear argues principally: [1] that as a matter of law, because Kwiatkowski was a nondiscretionary customer, Bear had no ongoing duty to provide him with information and advice; [2] that Bear did not undertake to provide ongoing advice and account-monitoring services; and [3] that Bear was not negligent in performing any of the services it did provide.

We reverse.

Background

The facts of this case are recounted in scrupulous detail in the district court's opinion denying Bear's Rule 50(b) motion. Kwiatkowski, 126 F.Supp.2d at 678-83. On appeal, we review the evidence (as the district court did) in the light most favorable to Kwiatkowski, resolving ambiguities in his favor. See Galdieri-Ambrosini v. Nat'l Realty & Dev. Corp., 136 F.3d 276, 289 (2d Cir.1998) ("Judgment as a matter of law may not properly be granted under Rule 50 unless the evidence, viewed in the light most favorable to the opposing party, [1297] is insufficient to permit a reasonable juror to find in her favor.").

A. Facts

For the most part, the operative facts are undisputed. Kwiatkowski first opened an account at Bear Stearns in 1988, when his broker, Albert Sabini, relocated there from the defunct E.F. Hutton firm. The account was handled by Bear's "Private Client Services Group," which provides large private investors with enhanced services, including access if requested to the firm's executives and financial experts. As a member of this group, Sabini was in regular contact with Kwiatkowski, often communicating several times a day. Sabini provided his client with news and market reports, and sometimes sent him Bear Stearns documents containing market forecasts and investment recommendations.

At first, Kwiatkowski's account at Bear was limited to securities trading. His currency trading was conducted through Bank Leu, a bank in the Bahamas, where Kwiatkowski maintained his principal residence. In January 1991, Kwiatkowski opened a futures account at Bear by transferring from Bank Leu a position consisting of 4000 Swiss franc short contracts traded on the Chicago Mercantile Exchange ("CME"). Kwiatkowski effected the transfer because he thought Bear would be better able to service the account, Sabini having "extolled the capacity of Bear Stearns to provide him the full services and resources he needed for large-scale foreign currency trading." Kwiatkowski, 126 F.Supp.2d at 679. The Private Client Services Group provided its clients with access to Bear's financial experts and executives, id. at 678, and advertised "a level of service and investment timing comparable to that which [Bear] offer[ed its] largest institutional clients." Id. at 702.

Kwiatkowski's futures account at Bear was at all times "nondiscretionary," meaning that Bear executed only those trades that Kwiatkowski directed.^[1] When the account was opened in January 1991, Kwiatkowski signed a number of documents and risk-disclosure statements (some of which were mandated by federal regulations). These reflect in relevant part that:

• Kwiatkowski declared his net worth to be in excess of $100 million, with liquid assets of $80 million;

• He was warned that "commodity futures trading is highly risky" and a "highly speculative activity," that futures "are purchased on small margins and ... are subject to sharp price movements," and that he should "carefully consider whether such [futures] trading is suitable for [him]";

• He was warned that because, under some market conditions, he "may find it difficult or impossible to liquidate a position" — meaning that he "may sustain a total loss" of his posted collateral — he should "constantly review [his] exposure ... and attempt to place at risk only an amount which [he knew he could] afford to lose";

• He was warned that if he chose to trade on margin, he could lose more than what he posted as collateral;

[1298] • He gave Bear a security interest in all his accounts at the firm, authorized Bear to transfer funds from his other account to his futures account if necessary to avoid margin calls, and authorized Bear to protect itself by liquidating his futures account if Kwiatkowski failed to meet margin requirements.

126 F.Supp.2d at 679.

Kwiatkowski's trading strategy reflected his belief in the long-term strength of the U.S. dollar. As he testified at trial, he had believed "the dollar should appreciate" over time, though he conceded that he always understood that the dollar would experience "ups and downs" in the near term. Tr. 472-74.

Kwiatkowski had been an experienced currency trader before he opened his Bear Stearns futures account. As an entrepreneur and founder of Kwiatkowski Aircraft — which leases and sells airplanes internationally — he developed a background in trading to hedge the risks associated with his company's foreign currency transactions. Kwiatkowski also had experience betting on the dollar in hopes of earning speculative profit. In 1990, shortly before transferring his Bank Leu position to Bear Stearns, Kwiatkowski lost nearly $70 million in that account when the dollar declined against the German mark and Swiss franc.

Before Kwiatkowski did his first currency transaction at Bear in September 1992, he met with Bear's then-Chief Economist, Lawrence Kudlow, who expressed the view that the dollar was undervalued worldwide and therefore was a good investment opportunity. In the weeks following this meeting, Kwiatkowski executed several trades betting on the rise of the dollar, ultimately acquiring 16,000 open contracts on the CME. He closed his position in January 1993, having made $219 million in profits in about four months. At trial, Kwiatkowski testified that he consulted Bear prior to liquidating: "We discussed it and they thought the advisement was a change of feelings about it." Tr. at 483. The record is vague as to who at Bear said what, but (construing ambiguities in Kwiatkowski's favor) a fair reading is that Kwiatkowski was encouraged by someone at Bear to liquidate his position.

Kwiatkowski's futures account was dormant between January 1993 and October 1994. Kwiatkowski testified that in an October 1994 phone call, Sabini told him that "this is the time to buy the dollar," and that "this time the dollar will do what [Kwiatkowski] always believed it would do." Tr. 490. Kwiatkowski began aggressively short-selling the Swiss franc, the British pound, the Japanese yen, and the German mark. Within a month, Kwiatkowski amassed 65,000 contracts on the franc, pound, yen, and mark in equal proportions — a position with a notional value of $6.5 billion.^[2] All of the transactions were executed on the CME. At one point, Kwiatkowski's position amounted to 30 percent of the CME's total open interest in some of the currencies. According to David Schoenthal, the head of Bear Stearns Forex, Kwiatkowski's position was more than six times larger than any other position Schoenthal had ever seen in 27 years on the CME.^[3] Tr. 1111-12.

In mid-November 1994, after Kwiatkowski had acquired the bulk of his position [1299] (approximately 58,000 contracts), Sabini sent him a copy of a report by Wayne Angell, then-Chief Economist at Bear, entitled "Dollar Investment Opportunity," expressing the view that the dollar was still undervalued. According to Kwiatkowski, the report influenced him to "roll over" his entire 65,000-contract position past the December date on which the contracts came due.

Like many speculative investors, Kwiatkowski traded on margin, meaning he put up only a fraction of the $6.5 billion notional value, as specified by the brokerage firm. As the dollar fluctuated, Kwiatkowski's position was "marked-to-market," meaning that his profits were added to his margin and his losses were deducted. As he earned profits, his margin increased, meaning he could opt (as he did) to have profits paid out to him daily; when losses reduced his margin, Kwiatkowski was compelled to meet the margin requirement by depositing more money or by liquidating contracts. Thus, while Kwiatkowski put up only a small percentage of the notional value (well under ten percent, which is apparently not unusual), his personal profits and losses reflected the full $6.5 billion position, and magnified vastly the slightest blip in the dollar's value.

As Kwiatkowski acquired his colossal position in the volatile futures market, Bear took precautions. In November 1994, the firm's Executive Committee and senior managers assumed oversight of Kwiatkowski's account. Bear also required Kwiatkowski to increase his posted margin collateral to $300 million in cash and liquid securities.

In late November or early December, Schoenthal told Bear's Executive Committee that Kwiatkowski's position was too conspicuous on the CME to allow a quick liquidation, and (with Sabini) recommended to Kwiatkowski that he move his position to the over-the-counter ("OTC") market, the unregulated international commodities market whose traders generally consist of governments and large financial institutions. Schoenthal told Kwiatkowski that he could trade with less visibility on the larger and more liquid OTC market, and more easily liquidate without impacting the market. According to Kwiatkowski, Schoenthal told him that, when and if Kwiatkowski needed to liquidate, Schoenthal could get him out of the OTC market "on a dime." Tr. 502. Kwiatkowski accepted Schoenthal's recommendation in part: when it came time to roll over his contracts in early December, Kwiatkowski moved half of them to the OTC market.

By late January 1995, Kwiatkowski's account had booked breathtaking gains and losses. As of December 21, 1994 — less than two months after he resumed currency speculation at Bear — Kwiatkowski had made profits of $228 million. When the dollar fell a week later, Kwiatkowski lost $112 million in a single day (December 28). When the dollar fell again, on January 9, 1995, Kwiatkowski lost another $98 million. Ten days later, on January 19, he lost $70 million more. After absorbing these hits, Kwiatkowski was still ahead $34 million on his trades since October 28, 1994.

As the dollar fell, Kwiatkowski consulted with Bear at least three times. After the December 28 shock, Kwiatkowski told Schoenthal and Sabini he was concerned about the dollar and was thinking of closing his position. They advised him that it would be unwise to liquidate during the holiday season, when the markets experience decreased liquidity and prices often fall.^[4] The dollar rebounded on December [1300] 29, and Kwiatkowski recouped $50 million of the previous day's losses.

After the January 9 decline, Kwiatkowski spoke with Sabini and Wayne Angell, Bear's Chief Economist. According to Kwiatkowski, Angell thought that the dollar remained undervalued and would bounce back. Kwiatkowski decided to stand firm. In late January, he spoke with Schoenthal about the U.S. Government policy of strengthening the Japanese yen, and afterward Kwiatkowski liquidated half of his yen contracts.

The dollar remained volatile through the winter, due in large part (it was thought) to geopolitical currents. Two salesmen in Bear's futures department, William Byers and Charles Taylor, who wrote a monthly report called Global Futures Market Strategies, announced in their February 1995 issue that they were downgrading the dollar's outlook to "negative," principally because of the Mexican economic crisis, certain steps taken by the Federal Reserve Board, and an anticipated increase in German interest rates. The report cited the German mark and the Swiss franc as especially likely to strengthen — two of the currencies in which Kwiatkowski held short positions. Kwiatkowski testified that he never received a copy of this report.^[5]

As of February 17, Kwiatkowski was down $37 million since October 1994. In mid-February, rather than deposit more cash, Kwiatkowski instructed Bear to meet future margin calls by liquidating his contracts. As the dollar declined, Bear gradually liquidated Kwiatkowski's position (obtaining his approval of each trade). By the close of business on Thursday, March 2, 1995, Kwiatkowski's total position had been reduced to 40,800 contracts in the Swiss franc and the German mark. He had suffered net losses of $138 million in slightly over four months.

Over the next three days, the dollar fell sharply against both the franc and the mark, and Kwiatkowski's remaining contracts were liquidated at a further loss of $116 million.

On the morning of Friday, March 3, Bear tried to reach Kwiatkowski for authorization to liquidate 18,000 of his contracts in order to meet a margin call. Kwiatkowski was unavailable, so (as the account agreement allowed) Bear effected the liquidation unilaterally and secured Kwiatkowski's approval later that day. At that time, Kwiatkowski expressed interest in liquidating his position altogether. Schoenthal and Sabini advised Kwiatkowski that because market liquidity generally lessens on Friday afternoons, it would be prudent to hold on and take the chance that the dollar would strengthen.^[6] According to Kwiatkowski, he relied on this advice [1301] in deciding to hold on to the balance of his contracts.

When the overseas markets opened on Sunday (New York time), the dollar fell. Schoenthal was in his office to monitor Kwiatkowski's account and was in touch with Kwiatkowski throughout the day, obtaining Kwiatkowski's authorization for necessary liquidating trades. By the early hours of Monday, the liquidation was complete. In order to cover his losses, Kwiatkowski was forced to liquidate his securities account and pay an additional $2.7 million in cash. 126 F.Supp.2d at 682.

In all, Kwiatkowski suffered a net loss of $215 million in his currency trading from October 1994 through Monday, March 6, 1995. At trial, Kwiatkowski's expert witness testified that Kwiatkowski could have saved $53 million by liquidating on Friday, March 3. The same expert surmised that $116.5 million would have been saved if Kwiatkowski had liquidated on Wednesday and Thursday, March 1 and 2.

B. Proceedings in the District Court

Of the various federal, state, and common law claims in the complaint, all but the claims for negligence and breach of fiduciary duty were dismissed in August 1997 by Judge Koeltl (who had initially been assigned to the case). By the consent of the parties, Kwiatkowski filed a Second Amended Complaint in October 1998, which re-pleaded the original claims on somewhat different theories. The amended pleading alleged that Bear had failed to give adequate warning about trading risks and adequate advice regarding liquidation of Kwiatkowski's position. Bear again moved for summary judgment on all claims, arguing that under New York law, the duties it owed to a nondiscretionary customer such as Kwiatkowski were limited to the faithful execution of the client's instructions, and did not entail ongoing advice. In November 1999, the district court granted the motion in part, but refused to dismiss the breach of fiduciary duty and negligence claims, citing issues of fact as to whether Bear had undertaken advisory duties notwithstanding that Kwiatkowski's account was at least nominally of the nondiscretionary kind. Kwiatkowski v. Bear, Stearns & Co., Inc., 96 Civ. 4798, 1999 WL 1277245, at *11-*16 (S.D.N.Y. Nov.29, 1999).

The case was reassigned to Judge Marrero, who conducted a jury trial in May 2000. At trial, Kwiatkowski contended that Bear had breached its duties in three ways: [1] Bear failed adequately to advise him about unique risks inherent in his giant currency speculation; [2] Bear failed to provide him with market information and forecasts, generated by Bear personnel, that were more pessimistic about the dollar than views Kwiatkowski was hearing from others at Bear; and [3] Bear should have advised Kwiatkowski well before March 1995 to consider liquidating his position, and specifically should have advised him on Friday, March 3 to liquidate immediately rather than hold on through the weekend.

At the close of evidence, Bear moved for judgment under Fed.R.Civ.P. 50, arguing that it had owed Kwiatkowski no duty to give advice. Bear's motion was denied. As to negligence, the district court instructed the jury (inter alia) that the defendants owed Kwiatkowski "a duty to use the same degree of skill and care that other brokers would reasonably use under the same circumstances." Tr. 2283.

The jury found Bear liable on the negligence claim, and awarded Kwiatkowski $111.5 million in damages. It found for Bear on the breach of fiduciary duty claim, and for Sabini on both claims (verdicts from which no appeals have been taken). Bear renewed its motion for judgment as a matter of law on the negligence claim under [1302] Rule 50(b), and moved in the alternative for a new trial pursuant to Fed. R.Civ.P. 59.

The district court denied both motions, ruling (inter alia) that the evidence supported the finding of an "entrustment of affairs" to Bear that included "substantial advisory functions," and that the services that Bear provided "embodied the full magnitude of `handling' Kwiatkowski's accounts, with all the considerable implications that such responsibility entailed." Kwiatkowski, 126 F.Supp.2d at 701, 708.

Discussion

We must decide whether the facts of this case support the legal conclusion that Bear Stearns as broker owed its nondiscretionary customer, Kwiatkowski, a duty of reasonable care that entailed the rendering of market advice and the issuance of risk warnings on an ongoing basis. If so, we must decide whether a reasonable juror could find that Bear breached that duty.

I

It is uncontested that a broker ordinarily has no duty to monitor a nondiscretionary account, or to give advice to such a customer on an ongoing basis. The broker's duties ordinarily end after each transaction is done, and thus do not include a duty to offer unsolicited information, advice, or warnings concerning the customer's investments. A nondiscretionary customer by definition keeps control over the account and has full responsibility for trading decisions. On a transaction-by-transaction basis, the broker owes duties of diligence and competence in executing the client's trade orders, and is obliged to give honest and complete information when recommending a purchase or sale. The client may enjoy the broker's advice and recommendations with respect to a given trade, but has no legal claim on the broker's ongoing attention. See, e.g., Press v. Chem. Inv. Servs. Corp., 166 F.3d 529, 536 (2d Cir.1999) (broker's fiduciary duty is limited to the "narrow task of consummating the transaction requested"); Independent Order of Foresters v. Donald, Lufkin & Jenrette, Inc., 157 F.3d 933, 940-41 (2d Cir.1998) (in a nondiscretionary account, "the broker's duties are quite limited," including the duty to obtain client's authorization before making trades and to execute requested trades); Schenck v. Bear, Stearns & Co., 484 F.Supp. 937, 947 (S.D.N.Y.1979) (noting that the "scope of affairs entrusted to a broker is generally limited to the completion of a transaction"); Robinson v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 337 F.Supp. 107, 111 (N.D.Ala.1971) ("The relationship of agent and principal only existed between [broker and nondiscretionary customer] when an order to buy or sell was placed, and terminated when the transaction was complete."); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F.Supp. 951, 952-54 (E.D.Mich.1978) (same; drawing distinction between discretionary and nondiscretionary accounts); accord Paine, Webber, Jackson & Curtis, Inc. v. Adams, 718 P.2d 508, 516-17 (Colo.1986) (observing same distinction, and holding that existence of broad fiduciary duty depends on whether broker has "practical control" of customer's account). As the district court observed, these cases generally are cast in terms of a fiduciary duty, and reflect that a broker owes no such duty to give ongoing advice to the holder of a nondiscretionary account.

The giving of advice triggers no ongoing duty to do so. See, e.g., Caravan Mobile Home Sales, Inc. v. Lehman Bros. Kuhn Loeb, Inc., 769 F.2d 561, 567 (9th Cir.1985) (securities broker had no duty to provide customer with information about stock after purchase was complete); Leib, 461 F.Supp. at 953 (broker has no duty to keep nondiscretionary customer abreast of [1303] "financial information which may affect his customer's portfolio or to inform his customer of developments which could influence his investments"); Robinson, 337 F.Supp. at 112 ("[T]he broker has no duty to relay news of political, economic, weather or price changes to his principal, absent an express contract to furnish such information."); Puckett v. Rufenacht, Bromagen & Hertz, Inc., 587 So.2d 273, 280 (Miss.1991) ("If a broker were under a duty to inform all of its customers of every fact which might bear upon any security held by the customer, the broker simply could not physically perform such a duty."); Walston & Co. v. Miller, 100 Ariz. 48, 410 P.2d 658, 661 (1966) ("[A]ny continuing duty to furnish all price information and information of all facts likely to affect the market price would be so burdensome as to be unreasonable.").

From these principles, Bear argues that: it had no ongoing duty to give Kwiatkowski financial advice about his dollar speculation; its sole obligation was to "execute [Kwiatkowski's] transactions at the best prices reasonably available and ... offer honest and complete information when recommending [a] purchase or sale"; and it had no "open-ended duty of reasonable behavior, or to provide such investment advice as a trier of fact decides would have been prudent." As Bear points out, Kwiatkowski makes no claim that any of his instructions were improperly carried out, or that he was given dishonest or incomplete information about any trade. Thus, when the district court instructed the jury to evaluate Bear's overall conduct according to whatever a "reasonable broker" would have done under the circumstances, Bear argues, it allowed the jury to enforce advisory obligations that do not exist.

This argument, addressed to the features of nondiscretionary accounts, misses the point. The theory of the case is that this was no ordinary account (an observation that is true enough as far as it goes). Kwiatkowski contends that in the course of dealing, Bear voluntarily undertook additional duties to furnish information and advice, on which he came to rely (as Bear surely knew); that his trading losses were caused or enlarged by Bear's failures to perform those duties; and that Bear's liability arises from generally applicable tort rules requiring professionals to exercise due care in performing whatever services they undertake to provide, as measured against the standard observed by reasonable and prudent members of the profession.

II

The district court acknowledged the general principles limiting a broker's duties to a nondiscretionary customer: it agreed that "[i]n the ordinary situation, the broker's professional obligation to the customer with respect to any particular investment ends upon the completion of the authorized transaction." Kwiatkowski, 126 F.Supp.2d at 691. Moreover, "[a]s regards a nondiscretionary account, the customer retains management and control over investment transactions, determining what purchases and sales to make. For the purposes of assessing the broker's role and ascribing attendant legal duties, each transaction is considered separately." Id. at 690 (internal citations omitted). But the court rejected what it called the "mechanical" argument that the nondiscretionary label disposed of Kwiatkowski's claim. Id. at 691-92 (noting that if "a mere recitation of bare legal maxims were all there was to this matter, the action would present only an easy, garden-variety dispute"). The court observed that the cases that articulate the general rules also allude to "special circumstances" that may "exempt the particular action from the scope of the general standard." Id. at 692.

[1304] The court characterized Bear's position as a "per se defense" that a broker's duties to a nondiscretionary customer "not only exclude any obligation to offer advice, but may not even embrace a duty of ordinary, reasonable care." Id. at 690. Reviewing principles of contract, negligence, and agency law, as well as case law concerning the broker/client relationship, see id. at 690-701, the district court concluded that, on the contrary, "a legal foundation exists which supports application of the duty of care to the broker/customer relationship between Kwiatkowski and Bear Stearns." Id. at 700.

The court contrasted the general duty of due care with the duties that arise from the parties' intentional relationship, which the court agreed are limited and narrowly defined:

[T]he duty of due care arises not by agreements or imposition of the parties governing their relations, but by operation of law. The duty emerges out of a totality of given circumstances and holds the defendant in an action to a standard of conduct designed to protect persons located within a reasonable zone of foreseeability who were injured by a defendant's careless behavior.

Id. at 694. The court explained that "contractual commitments cannot serve to excuse carelessness or shield a defendant from liability for injury that a breach of the duty of due care may engender." Id. Just as "exceptional conditions" may create fiduciary duties without the parties' "express intent," and notwithstanding a contractual disclaimer, id. at 695, the court reasoned that "extraordinary events" may "support imposition of a duty of reasonable care arising from aspects of the same conduct on the part of the broker," id. at 696. Such an extraordinary situation may arise from the "assumption, by promise or partial performance, of certain responsibilities under certain conditions." Id. at 698 (citing the example of good samaritan liability) (collecting cases).

The district court further ruled that the breach of the duty of care could "be evidenced by Bear Stearns's failure to provide particular information essential to the affairs entrusted and which under all the circumstances a reasonable broker exercising ordinary care would have supplied to the client." Id. at 700-01. The court indicated that a duty of care arose by virtue of the broker-client relationship itself, but also specifically considered that a duty of reasonable care arises when the parties depart from the usual rules of a nondiscretionary account, such as where the broker undertakes performance of additional functions. Consistent with this view, the jury was charged both that Bear had a general duty to behave as a reasonable broker^[7] and that the jury should decide what functions Bear undertook and (thereby) had a duty to perform with reasonable care.^[8]

Accordingly, the court ruled that the jury's verdict was sustainable on any one of several findings supportable by the record and the charge:

• Bear assumed substantial advisory functions that made it the "handler" of Kwiatkowski's account, id. at 708, [1305] and that amounted to special circumstances sufficient to impose an ongoing duty of reasonable care.^[9]Id. at 701.

• Even absent special circumstances, Bear breached the standard of care applicable to the ordinary broker/client relationship by the following: Bear's execution of Kwiatkowski's large trades in the fall of 1994 without conducting new risk and suitability analyses, id. at 711;^[10] possible noncompliance with internal Bear procedures concerning notification to the client of increased risk, id. at 713-14, 717; the initial placement of Kwiatkowski's position on the CME rather than the OTC market, id. at 712-13; giving overly optimistic advice (specifically, Schoenthal's statement that he could get Kwiatkowski out of the OTC market "on a dime," and Angell's opinion that the dollar was undervalued) in conjunction with the failure to furnish other, negative dollar forecasts, id. at 714-16; and the handling of the liquidation in March 1995.^[11]

• Even if Bear had no standing obligation (under ordinary or special circumstances) to provide Kwiatkowski with assistance, Bear nonetheless undertook to do so in connection with the March liquidation, and did so in a manner that was imprudent and that actually worsened Kwiatkowski's situation.^[12]

III

No doubt, a duty of reasonable care applies to the broker's performance of its obligations to customers with nondiscretionary accounts. See, e.g., Conway v. Icahn & Co., Inc., 16 F.3d 504, 510 (2d Cir.1994); Vucinich v. Paine, Webber, Jackson & Curtis, Inc., 803 F.2d 454, 460-61 (9th Cir.1986); Scott v. Dime Sav. Bank of New York, F.S.B., 886 F.Supp. 1073, 1080-81 (S.D.N.Y.1995); Fustok v. Conti-commodity Servs., Inc., 618 F.Supp. 1082, 1085-86 (S.D.N.Y.1985); Cauble v. Mabon Nugent & Co., 594 F.Supp. 985, 992 [1306] (S.D.N.Y.1984); Merrill Lynch, Pierce, Fenner & Smith, Inc. v. Cheng, 697 F.Supp. 1224, 1227 (D.D.C.1988).

The claim of negligence in this case, however, presupposes an ongoing duty of reasonable care (i.e., that the broker has obligations between transactions). But in establishing a nondiscretionary account, the parties ordinarily agree and understand that the broker has narrowly defined duties that begin and end with each transaction. We are aware of no authority for the view that, in the ordinary case, a broker may be held to an open-ended duty of reasonable care, to a nondiscretionary client, that would encompass anything more than limited transaction-by-transaction duties. Thus, in the ordinary nondiscretionary account, the broker's failure to offer information and advice between transactions cannot constitute negligence.

All of the cases relied on by Kwiatkowski in which brokers have been found liable for their nondiscretionary customers' trading losses involve one or more of the following: unauthorized measures concerning the customer's account (i.e., the account became discretionary-in-fact because the broker effectively assumed control of it); failure to give information material to a particular transaction; violation of a federal or industry rule concerning risk disclosure upon the opening of the account; or advice that was unsound, reckless, ill-formed, or otherwise defective when given. See, e.g., Conway, 16 F.3d at 510 (broker liable where he liquidated part of nondiscretionary account in order to satisfy margin call without obtaining client's authorization, where client never received notification that margin requirement had changed); Vucinich, 803 F.2d at 459-61 (vacating directed verdict for broker where evidence showed broker may have violated Securities Exchange Act by failing to disclose material facts relating to risk to his unsophisticated client, disregarded client's clearly-stated wish to avoid speculative trades, and may effectively have exercised control over the account); Lehman Bros. Commercial Corp. v. Minmetals Int'l Non-Ferrous Metals Trading Co., No. 94 Civ. 8301, 2000 WL 1702039, at *26-*28 (S.D.N.Y. Nov.13, 2000) (denying summary judgment for broker on breach of fiduciary duty claim, ruling that issues of fact existed concerning the "true nature of the relationship" between the parties); Dime Sav. Bank, 886 F.Supp. at 1080-81 (negligence verdict upheld where broker failed to evaluate client's financial situation before opening margin account, in violation of "suitability rule" of the National Association of Securities Dealers); Cheng, 697 F.Supp. at 1227 (negligence claim was adequately stated where it was based on broker's alleged failure to comply with NASD suitability rule).

Kwiatkowski does not claim any unauthorized trading, any omission of information material to a particular transaction, any violation of government or industry regulations concerning risk disclosures at the time he opened his account, or (except for Schoenthal's advice that he not liquidate on Friday, March 3, 1995) any unsound or reckless advice. Indeed (with that exception, discussed infra), Kwiatkowski is in no position to complain about any of these things. He can hardly contend that Bear negligently induced his speculations in the dollar (Kwiatkowski made early profits in excess of $200 million); or that Schoenthal was negligent in advising him to move the position to the OTC market (he claims that Bear was negligent in failing to give him that advice in the first place); or that Schoenthal was negligent in advising him after the late-December loss that the dollar would probably bounce back (Kwiatkowski made about $50 million the following day). Kwiatkowski does not allege that any of this advice was given negligently or in bad faith; he does not [1307] even allege that it was bad advice — nor could he, given the immense profits he made when he acted on it.

In sum, aside from the March liquidation, the claimed negligence is not in the advice that Bear gave, but in advice that Bear did not give. Specifically, Kwiatkowski finds a breach of duty in: [1] Bear's failure to volunteer certain advice, namely the Byers-Taylor prediction in early 1995 that the dollar was likely to fall; [2] Bear's failure to advise him, on an ongoing basis, of risks associated with his dollar speculation; and [3] Bear's negligence in connection with the March 1995 liquidation.

Kwiatkowski does not dispute that in the ordinary case, a broker's failure to offer ongoing, unsolicited advice to a nondiscretionary customer would breach no duty. Kwiatkowski's claim is viable, therefore, only if there is evidence to support his theory that Bear, notwithstanding its limited contractual duties, undertook a substantial and comprehensive advisory role giving rise to a duty on Bear's part to display the "care and skill that a reasonable broker would exercise under the circumstances."

We conclude that the district court's judgment must be reversed because there was insufficient evidence to support the finding that Bear undertook any role triggering a duty to volunteer advice and warnings between transactions, or that Bear was negligent in performing those services it did provide. Liability cannot rest on Bear's failure to give ongoing market advice that it had no duty to give, on Bear's failure to issue warnings that it had no duty to give (concerning risks about which Kwiatkowski surely knew more than anyone), or on Bear's failure to foretell the short-term gyration of the dollar.

1. Advice

Kwiatkowski points to the advice he received from Bear, both solicited and unsolicited. There is certainly ample evidence that Kwiatkowski transferred his account to Bear's Private Client Services Group in part to get (as Bear advertised) access to the firm's top financial analysts and experts. And he received it. The record also supports inferences that Bear encouraged Kwiatkowski's betting on the dollar, that he moved half his position to the OTC market on the strength of Schoenthal's advice, that twice he decided against liquidating his position at least in part because of Bear's advice that the dollar was still undervalued, and that he followed Schoenthal's advice against trying to liquidate on the afternoon of Friday, March 3, 1995.^[13]

But the giving of advice is an unexceptional feature of the broker-client relationship. W hat little case law there is on the subject makes clear that giving advice on particular occasions does not alter the character of the relationship by triggering an ongoing duty to advise in the future (or between transactions) or to monitor all data potentially relevant to a customer's investment. See, e.g., Caravan Mobile Home Sales, Inc. v. Lehman Bros. Kuhn Loeb, Inc., 769 F.2d 561, 567 (9th Cir.1995) (securities broker had no duty to provide customer with information about stock after purchase was complete); Leib v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 461 F.Supp. 951, 953 (E.D.Mich.1978) (broker has no duty to keep nondiscretionary customer abreast of "financial information which may affect his customer's portfolio or to inform his customer of developments which could influence his investments"); Robinson v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 337 F.Supp. 107, 112 [1308] (N.D.Ala.1971) ("[T]he broker has no duty to relay news of political, economic, weather or price changes to his principal, absent an express contract to furnish such information."); Puckett v. Rufenacht, Bromagen & Hertz, Inc., 587 So.2d 273, 280 (Miss.1991) (the broker could not possibly perform such a duty); Walston & Co. v. Miller, 100 Ariz. 48, 410 P.2d 658, 661 (1966) (same).

A broker may be liable in tort (as noted above) for breach of a duty owed in respect of advice given. But if a broker had a broad duty to furnish a nondiscretionary customer with all advice and information relevant to an investment, then, as the Robinson court observed, the customer could recover damages "merely by proving nontransmission of some fact which, he could testify with the wisdom of hindsight, would have affected his judgment had he learned of it." 337 F.Supp. at 113.

Thus if Bear had a duty to advise Kwiatkowski in early 1995 that the dollar might fall, it could not arise merely because Bear advised him in late 1994 that the dollar might rise. Kwiatkowski characterizes Bear's frequent giving of advice as an "undertaking" that supports a generalized duty of reasonable care to perform ongoing advisory duties not created by contract. The advisory services that Bear advertised and provided to Kwiatkowski, however, were wholly consistent with his status as a nondiscretionary customer; Kwiatkowski bargained for the expertise of the Private Client Services Group, but he simultaneously signed account agreements making clear that he was solely responsible for his own investments. It was thus obviously contemplated that Kwiatkowski would receive a lot of advice from Bear's senior economists and gurus, and that this advice would not amount to Bear's entrustment with the management of the account. It follows that Kwiatkowski cannot reasonably have believed that once he sought and Bear gave advice, Bear had become "account handler."

Any duty by Bear to offer advice therefore could arise only if the law, under the circumstances of this case, imposes on Bear some special duty as a result of the relationship between the parties — that is, if Kwiatkowski's account deviated from the usual nondiscretionary account in a way that creates a special duty beyond the ordinary duty of reasonable care that applies to a broker's actions in nondiscretionary accounts. The district court alluded to "special circumstances," in particular Kwiatkowski's outsized account, the frequency of broker contacts, and the unique risk run by a private individual speculating in currency on a scale known only to governments of large countries. Kwiatkowski, 126 F.Supp.2d at 701-05.

These circumstances made Kwiatkowski's account special, even very special; but these circumstances are not special in a way that transforms the account relationship. The transformative "special circumstances" recognized in the cases are circumstances that render the client dependent — a client who has impaired faculties, or one who has a closer than arms-length relationship with the broker, or one who is so lacking in sophistication that de facto control of the account is deemed to rest in the broker. The law thus imposes additional extra-contractual duties on brokers who can take unfair advantage of their customers' incapacity or simplicity. See, e.g., Societe Nationale D'Exploitation Industrielle Des Tabacs Et Allumettes v. Salomon Bros. Int'l Ltd., 251 A.D.2d 137, 674 N.Y.S.2d 648, 649 (App.Div.1998) (referring to the broker's "requisite high degree of dominance and reliance"); Leib, 461 F.Supp. at 954 (referring to heightened duties where "broker has usurped actual control," such as a case involving a 77-year-old widow); cf. Robinson, 337 F.Supp. at 113 (absent an express advisory [1309] contract, there is no fiduciary duty on part of broker-dealer "unless the customer is infirm or ignorant of business affairs"). See also n. 18, infra.

Kwiatkowski of course is the very opposite of the naive and vulnerable client who is protected by "special circumstances." He was a special customer chiefly by reason of his vast wealth, his trading experience, his business sophistication, and his gluttonous appetite for risk. These factors weigh strongly against — and not at all in favor of — heightened duties on the part of the broker (as suitability rules in other contexts imply^[14]). We therefore conclude that the theory of "special circumstances" does not broaden the scope of Bear's undertaking.^[15]

In short, there was no permissible basis on which a reasonable jury could find that Bear undertook to provide comprehensive "account-handling" services that would have obliged it to provide unsolicited advice to Kwiatkowski on an ongoing basis; nor was Kwiatkowski's account "special" in a way that would justify imposing extra-contractual duties on Bear absent such an undertaking.

2. Risk

When Kwiatkowski opened his account, Bear warned him of the risks of currency trading. Kwiatkowski argues that Bear should have given further specific warnings throughout the relevant period concerning "extraordinary market and liquidity risks" posed by the size of his position, especially in conjunction with market changes and the volatility of the dollar. Kwiatkowski's argument fails because he has not demonstrated that Bear was under an obligation to provide the warnings he claims were omitted, because he grossly understates the warnings Bear in fact issued and the impact such warnings would have had on any reasonable investor, and because (even if Bear failed to give warnings it was obliged to give) as a matter of law, Kwiatkowski's trading losses were not caused by any insufficiency of warnings.

Under the written terms of Kwiatkowski's currency futures account, Bear undertook to serve as "futures commission merchant" ("FCM") (for the trades placed on the CME) and as "OTC dealer" (for the trades placed on the over-the-counter market), and in no other capacity. Bear did not in this case contract to serve in an advisory capacity (at least with respect to Kwiatkowski's futures account), and thus (undisputedly) was neither an "investment adviser" as defined by the Investment Advisers Act of 1940, 15 U.S.C. § 80b-2(a)(11), nor a "commodity trading adviser" [1310] as defined by the Commodities Exchange Act, 7 U.S.C. § 1a(6).

As an FCM, Bear was subject to regulations promulgated by the Commmodity Futures Trading Commission ("CFTC") and by the National Futures Association ("NFA"), a self-regulatory organization registered with the CFTC. (Bear is an NFA member, as all FCMs must be.) At the time Kwiatkowski opened his account, Bear as FMC had certain obligations: pursuant to CFTC Rule 1.55, Bear was to provide Kwiatkowski with a detailed risk disclosure statement, see 17 C.F.R. § 1.55(a),(b); and pursuant to NFA Compliance Rule 2-30, Bear was to obtain from Kwiatkowski a variety of personal information, including his net worth, estimated annual income, and previous experience in futures trading. It is undisputed that Bear did these things.

But, as Kwiatkowski argues, there is trial evidence to show that industry standards — even Bear's own internal policies — may have demanded something more. For example, New York Stock Exchange ("NYSE") Rule 405, the "know your customer" rule, provides (inter alia) that the broker must "use due diligence to learn the essential facts relative to every customer, every order, every cash or margin account accepted or carried...." Kwiatkowski, 126 F.Supp.2d at 711 n. 40 (emphasis added). Although Rule 405 does not apply to commodities brokers, Sabini testified that in practice Bear adhered to that rule in the commodities context. Moreover, Sabini understood the rule to require the broker to undertake a new risk analysis every time a customer's investment position materially changed. Id. at 711 n. 41. Kwiatkowski argues further that the minimum requirements established by NFA Rule 2-30 understate industry practice,^[16] and he cites administrative decisions of the CFTC indicating that FCMs, in certain circumstances (depending on the nature of the broker-client relationship), may have risk-disclosure obligations that go beyond CFTC Rule 1.55.^[17] In sum, Kwiatkowski argues that Bear's negligence is evidenced by industry practice and internal Bear rules indicating that Bear should have provided more than it did in the way of risk warnings and account monitoring.

We disagree. First, the CFTC cases on which Kwiatkowski relies are exemplars of the "special circumstances" that some courts have cited to justify departure from ordinary rules — circumstances, as we noted above, that have nothing to do with Kwiatkowski.^[18]

[1311] Second, deviation from industry or internal standards for monitoring risk and suitability does not necessarily amount to the breach of a duty owed to Kwiatkowski. The general rule (as we have emphasized) is that commodities brokers do not owe nondiscretionary clients ongoing advisory or account-monitoring duties, such as the duty to warn of changes in market conditions or other information that can impact the client's investments.

As a policy matter, it makes no sense to discourage the adoption of higher standards than the law requires by treating them as predicates for liability. Courts therefore have sensibly declined to infer legal duties from internal "house rules" or industry norms that advocate greater vigilance than otherwise required by law. See, e.g., Farmland Indus. v. Frazier-Parrott Commodities, Inc., 871 F.2d 1402, 1407 (8th Cir.1989) ("[F]ailure to follow [internal policies and procedures] will not give rise to a cause of action in the absence of independent facts establishing fraud.") (citation omitted); J.E. Hoetger & Co. v. Ascencio, 572 F.Supp. 814, 822 (E.D.Mich. 1983) (observing that to allow private cause of action based on firm's violation of internal rules "would impose the greatest additional liability on those firms policing themselves rigorously ... effectively punishing the diligent and favoring the lax"); see also Puckett, 587 So.2d at 282 (collecting cases).

Kwiatkowski cites no competing authority; indeed he does not argue directly that noncompliance with internal rules or industry standards is a basis for liability. Kwiatkowski instead relies on such noncompliance as evidence of Bear's overall failure to exercise due care. The district court agreed. Kwiatkowski, 126 F.Supp.2d at 711-12.

It may be that noncompliance with internal standards could be evidence of a failure to exercise due care, assuming however a duty as to which due care must be exercised. But the assertion that Bear had an ongoing duty to exercise "due care" or "behave like a reasonable broker," breach of which could be evidenced by noncompliance with internal rules, cannot be squared with the cases holding that a broker's obligations to a nondiscretionary client arise and are satisfied transaction-by-transaction. And, as illustrated above, there is no basis in this case for a more comprehensive duty on Bear's part to monitor Kwiatkowski's account between transactions. He cites the frequent advice from senior economists at Bear. But giving advice is consistent with the limited duties owed by a broker to the holder of a nondiscretionary account. And though Kwiatkowski's account was enormous, and he could therefore elicit such advice more frequently and from the most senior persons in the firm, the service rendered by Bear was not different in kind.

Kwiatkowski can succeed therefore only if the district court was correct that some "special circumstances" justify imposing extraordinary duties on Bear. We have already explained why Kwiatkowski is the very opposite of the type of client protected by that very limited doctrine. We therefore conclude that Bear had no ongoing duty to give advice and warnings concerning his investments.

Kwiatkowski contends that Bear did "literally nothing" to advise him of the distinct risks he was facing. This claim wholly [1312] ignores Bear's advice in late 1994 that Kwiatkowski was too visible on the CME because of the size of his position, and that he should move to the OTC market generally favored by governments and banks. It is hard to conceive of a clearer signal to an experienced investor that the account is exposed and unique.^[19]

Finally, even if one could say that Bear breached a duty to advise Kwiatkowski of certain additional risks, that breach could not (as a matter of law) have caused Kwiatkowski's losses. Kwiatkowski could have been under no illusions about his situation after January 19, 1995. In the three weeks preceding that date, he had suffered single-day losses of $112 million, $98 million, and $70 million. Kwiatkowski could not have mistaken his trading account for an annuity. Yet, despite these blows, he could have walked away on January 19, 1995 with a net profit of $34 million from three months of trading. At this point, when Kwiatkowski decided to press on, there was nothing that Bear could tell him about the risks that he did not know from experience.

Kwiatkowski has two further points that merit brief consideration. First, Kwiatkowski cites the failure of the firm to mail him the February 1995 Byers-Taylor report downgrading the dollar to "negative." Assuming that Kwiatkowski would have read and been influenced by the report, and assuming further that Bear was obliged to send him that particular report, this argument misconceives the nature of the risk that Kwiatkowski faced-and welcomed. Kwiatkowski knew that the dollar would experience short-term "ups and downs," and he certainly knew that market liquidity was variable and that he could experience massive losses quickly. He made and lost millions of dollars virtually every day. Yet Kwiatkowski nevertheless built a position that exposed him to disaster at any moment by reason of developments anywhere and everywhere on earth that could not have been predicted by Bear even if it had volunteered all of its information and predictions. Kwiatkowski knew — at the very least, he should have known after December 28, 1995 (the day he lost $112 million) — that even within a long-term upswing, a severe enough down-tick could wipe him out. Accordingly, it would be pure speculation to find that the delivery of one long-term forecast would have rendered Kwiatkowski risk-averse.

Kwiatkowski also argues that he was misled concerning his ability to liquidate quickly by Schoenthal's statement that he could get out of the OTC market "on a dime." This argument cannot bear the weight Kwiatkowski puts on it. There is no dispute that Schoenthal's advice was sound: The OTC market was preferable to the CME (though, as it happened, Kwiatkowski only half-followed this advice). Nothing suggests that Kwiatkowski fared worse because of this move than he would have if he had left his contracts on the CME.^[20] He could not reasonably have believed that "on a dime" meant that billions [1313] of dollars in contracts could be folded instantaneously and without loss. The phrase is hyperbole. No one could reasonably bet millions on the idea that it meant immediate liquidity all the time, certainly not Kwiatkowski after he had been warned over the holidays that liquidation sometimes could be difficult even on the OTC market.^[21]

3. Liquidation

Kwiatkowski's remaining argument is that Bear negligently handled the liquidation of his account in March 1995. He contends first that Bear should have advised him to liquidate no later than Wednesday, March 1, in order to avoid being forced into liquidation by margin calls over the ensuing weekend. His expert testified that Kwiatkowski's risk of loss was ten times greater in March 1995 than it had been in November 1994. Kwiatkowski also claims that Bear should have advised him in the weeks leading up to the March liquidation that his positions were much too large given the volatility of the dollar. Finally, he charges negligence in Bear's advice that Friday afternoon, March 3, was a dangerous time to start liquidating. He cites expert testimony that it is well-known in the industry that Sunday in New York (when only the Asian markets are open) is a worse time to liquidate than Friday afternoon, when American markets are still open. On this basis, Kwiatkowski contends that it was "foreseeable" to Bear that as Kwiatkowski's position deteriorated over the weekend, he would encounter even more difficulty liquidating in a relatively illiquid market, and that as a result his effort to exit his massive position on Sunday had proportionately greater impact on the price of the dollar, driving it downward and further exacerbating Kwiatkowski's losses.

Kwiatkowski's expert testified that Kwiatkowski would have saved $116.5 million if the position had been liquidated on Wednesday, March 1; $53 million, if it had been liquidated on Friday, March 3. The jury's damages award ($111.5 million) roughly approximates the former figure.

Kwiatkowski's arguments concerning the liquidation depend on the premise that, at various times, Bear knew or should have known whether in the course of a day or two the dollar would go up or go down. Wholly aside from whether Bear was obliged to give advice at all, the idea that Bear should have advised Kwiatkowski in February to exit the market because of the dollar's "volatility" implies knowledge on Bear's part that the dollar's volatility would work to Kwiatkowski's disadvantage. If the dollar had gone up, Kwiatkowski would of course have profited from volatility, as he had richly done in the past.

The same applies to the March liquidation. Assuming that Bear did undertake to assist Kwiatkowski and guide him through the liquidation, there is no evidence of negligence in that process. The notion that Bear negligently failed to advise a Wednesday liquidation in order to avoid a forced weekend liquidation presupposes that Bear knew that liquidation would be forced over the weekend. But there is no evidence that Bear knew this; no one could. There is evidence that Sunday afternoon is a worse time to liquidate a large position than Friday afternoon, but there is no evidence that Bear knew better than Kwiatkowski whether he would be forced to liquidate at all. Kwiatkowski was well aware, as he testified at trial, that the dollar would experience "ups and downs" in the short term. There is no evidence that Bear knew better than Kwiatkowski [1314] whether the dollar would go up or down between Friday and Monday. Indeed, there can be no such evidence; it is the nature of markets to go up and down. Schoenthal's advice on Friday afternoon was not that Sunday would be a better time to liquidate than Friday; his advice (as Kwiatkowski himself testified) was that the market "may improve next week." Tr. 516.^[22] There is no suggestion that Schoenthal failed to exercise reasonable care in forming or expressing that view; Kwiatkowski had no reasonable basis for relying on it, if indeed he did; and the fact that Schoenthal turned out to be wrong does not imply negligence. See, e.g., Hill v. Bache Halsey Stuart Shields, Inc., 790 F.2d 817, 824-25 (10th Cir.1986) ("Regarding trading advice, brokers cannot be liable for honest opinions that turn out to be wrong. Otherwise brokers would refuse to take discretionary accounts and would refuse to advise on nondiscretionary accounts."); cf. In re Bank of New York, 35 N.Y.2d 512, 364 N.Y.S.2d 164, 169, 323 N.E.2d 700, 704 (1974) (prescience not required of trustee in investment decisions).

Conclusion

For the reasons stated, we reverse the judgment of the district court and remand for entry of judgment dismissing the complaint.

[1] One of Kwiatkowski's main contentions is that Bear assumed a far more extensive advisory role than the "nondiscretionary" label would imply. But there is no dispute that the account was (at least nominally) nondiscretionary, and that all trades were in fact done per Kwiatkowski's instructions. (Kwiatkowski apparently contended at an earlier stage of the case that Bear had traded in his account without authorization, but that allegation was withdrawn and is not before us on appeal.)

[2] Notional value refers to the dollar value of the quantity of foreign currency covered by a contract. One contract is typically worth about $100,000.

[3] The record does not indicate that Bear specifically advised Kwiatkowski to build a position of that size; it does reflect that Kwiatkowski understood Bear (via Sabini) to be "bullish" on the dollar, and chose to invest at least in part for that reason.

[4] According to Kwiatkowski, Schoenthal and Sabini advised him at the time that "between Christmas and New Years it is too short a period to liquidate, it is unwise to liquidate the position now." Tr. 509.

[5] Evidently the same publication repeated its dollar-negative forecast in March 1995, but it may not have been published before Kwiatkowski exited the market in early March, and in any event he only testified to not receiving the February report.

[6] According to the district court's opinion, Schoenthal and Sabini suggested that Kwiatkowski "postpone" further liquidation until Sunday, March 5, when the markets opened first in Australia and New Zealand, and later in Asia. 126 F.Supp.2d at 682. As far as we can see, the record reflects no recommendation on Friday to liquidate on Sunday. Kwiatkowski testified that he was advised that Friday was a bad time and that the market might improve, without being warned that the situation could worsen over the weekend. Tr. 516-17. Sabini testified that the advice was to wait to see if the dollar "might rally." Tr. 213. Kwiatkowski does not assert on appeal that anyone told him that Sunday was a better day than Friday to liquidate; his argument is that Schoenthal advised that Friday afternoon was a bad time, and that Bear knew that "if Kwiatkowski's positions had to be liquidated after the close of trading on Friday," this would be done on Sunday when only the Asian markets were open.

[7] The court instructed the jury that "[a]s brokers in this case, defendants owed plaintiff a duty to use the same degree of skill and care that other brokers would reasonably use under the same circumstances." Tr. 2283.

[8] The court instructed the jury that "[i]f you find that defendants owed plaintiff a duty of care, then you must determine whether defendants breached this duty," Tr. 2285, and that "[i]f you find ... that the defendants had a duty to perform particular services as brokers for plaintiff and failed in respect of their dealings with plaintiff to exercise the degree of care of a reasonably prudent and diligent broker under the same circumstances, you must find the defendants were negligent." Tr. 2285-86.

[9] According to the court, the jury could have found such a relationship on the basis of (inter alia) Kwiatkowski's access to elite services, id. at 702; the frequency of his contacts with Sabini, id.; the "extraordinary" size of Kwiatkowski's position, built in part on the strength of advice and encouragement from Bear, id.; the "distinct risks and vulnerabilities" Kwiatkowski faced, which prompted Bear executives to advise Kwiatkowski to move the position to the OTC market, id. at 703-04; and the fact that Kwiatkowski was advised on three separate occasions against liquidating his account, after he expressed interest in doing so, id. at 707-08.

[10] When Kwiatkowski opened his 65,000-contract position in the fall of 1994, Bear relied on the documentation and disclosure forms that were on file dating from the opening of Kwiatkowski's account in 1991. The court found an issue of fact as to whether Bear should have undertaken a new risk and suitability analysis. Id. at 711.

[11] See n. 12, infra.

[12] The court concluded that "under the exceptional conditions that prevailed here, with Kwiatkowski caught in a position fraught with financial peril, Bear Stearns undertook efforts to respond by providing some assistance," id. at 718, and that the jury could find that in that undertaking Bear failed to measure up to the standard of a "reasonably prudent broker encountering the same events," id. Witnesses at trial challenged Schoenthal's advice that Kwiatkowski should hold on to his contracts, explaining that if liquidation was necessary, Sunday would be a worse time than Friday afternoon. The court reasoned that this created a factual dispute as to "whether the choices Bear Stearns officials made under these circumstances indicated the exercise of the degree of prudence and skill expected of a broker acting under similar conditions." Id.

[13] The record also establishes that Sabini did not inform Kwiatkowski about the February 1995 Byers-Taylor report downgrading their dollar forecast to negative.

[14] See, e.g., 7 U.S.C. § 1a(12), 2 (exempting from some Commodity Exchange Act coverage certain transactions with individuals whose assets exceed $10,000,000); 17 C.F.R. § 1.55(f) (certain risk disclosures not required prior to opening commodity futures account if customer is a natural person with total assets exceeding $10,000,000); cf. NASD Manual, Rule 2310 Recommendations to Customers (Suitability) (certain securities broker due diligence requirements not applicable to customers with assets of greater than $50 million).

[15] On appeal, Kwiatkowski does not rely on any theory of "special circumstances" apart from the undertaking argument. It is also not clear to what extent the district court actually conceived of special circumstances as an independent basis, aside from the undertaking theory, for imputing to Bear an ongoing duty of reasonable care. For example, while the district court referred several times to the "extraordinary" or "exceptional" facts of this case, it elsewhere stated that the same result would obtain "whether the amount in controversy implicated hundreds of dollars or hundreds of millions." Kwiatkowski, 126 F.Supp.2d at 726. In any event, the "special circumstances" rationale is the only exception recognized to the rule on which Bear relies to claim judgment as a matter of law, and Kwiatkowski is not a candidate for that special status.

[16] The NFA has filed an amicus curiae brief arguing, on behalf of Bear, that the disclosure obligations imposed by its Rule 2-30 exist only at the time the account is opened.

[17] Kwiatkowski also points out that the CFTC has made clear that Rule 1.55 was intended merely to ensure that customers would be advised of the risks inherent in trading commodity futures, and does not necessarily relieve an FCM of obligations that may arise under state or common law. See, e.g., 63 Fed.Reg. 8566, 8568-69, 1998 WL 66438 (C.F.T.C. Feb. 20, 1998). The administrative cases cited by Kwiatkowski can be understood to reflect this principle; but they provide no support for inferring such obligations with respect to a sophisticated customer such as Kwiatkowski. See n. 18, infra.

[18] See, e.g., Gittemeier v. Smith Barney, Harris Upham & Co., Inc., R80-1255-81-182, 1983 WL 29719, at *7 (C.F.T.C. Nov. 30, 1983), ruling that the basic disclosure statement under Rule 1.55 was "not enough" where the customer was a novice and unsophisticated trader who wished to trade contracts in ten-bag U.S. silver coins futures, and the broker failed to advise him that the particular market was thin, infrequently traded, and had days when no trades occurred at all (distinguishing the standard disclosure as appropriate for the "usual or basic risks attendant to a normal commodity futures market, i.e., a thick or thriving market involving competitive prices, a reasonable level of volume and a high open interest"); see also Levitt v. Int'l Trading Group, Ltd., R81-1010-82-394, 1985 WL 55211, at *5 (C.F.T.C. July 30, 1985) (involving a broker's affirmative, negligent misrepresentation concerning whether the equity in the client's account was sufficient to meet a margin requirement); Doud v. Shearson Loeb Rhoades, Inc., R80-313-80-600, 1985 WL 55301 (C.F.T.C. Sept. 9, 1985) (involving discretionary-in-fact account where broker made all trading decisions for unsophisticated customer).

[19] The fact that Kwiatkowski only partially accepted this advice (he moved half his contracts to the OTC) also defeats any inference that he entrusted account-shepherding functions to Bear that could trigger on ongoing duty of reasonable care. See, e.g., Banca Cremi, S.A. v. Alex. Brown & Sons, Inc., 132 F.3d 1017, 1029 (4th Cir.1997) (customer's rejection of broker's advice on some occasions demonstrated that customer made independent investment decisions).

[20] Kwiatkowski also argues that negligence could be found in Bear's failure to advise him at the outset that he should place his position on the OTC market. This omission of advice, even if negligent, is equally devoid of causal significance. At the time Bear advised Kwiatkowski to move to the OTC market (thus correcting for any "error" in placing the position on the CME to begin with), Kwiatkowski had made more than $200 million in profits.

[21] See n. 4, supra.

[22] See n. 6, supra. Kwiatkowski also argues that Bear should have advised him that "the liquidity situation would certainly worsen through the weekend." In light of Kwiatkowski's sophistication and his specific awareness that the market experienced variable liquidity, we think it was not unreasonable for Bear to omit a special warning that some markets close on the weekends.

475 F.3d 392 (2007)

[393] [394] [395] Russell G. Ryan argued the cause for appellants. With him on the briefs was Bradley H. Cohen.

Mark R. Pennington, Assistant General Counsel, Securities & Exchange Commission, argued the cause for appellee. With him on the brief were Brian G. Cartwright, [396] General Counsel, and Jacob H. Stillman, Solicitor.

Before: GINSBURG, Chief Judge, and TATEL and BROWN, Circuit Judges.

Opinion for the Court filed by Circuit Judge BROWN.

BROWN, Circuit Judge.

Appellants ask us to reverse the district court's finding that appellant Washington Investment Network ("WIN") violated sections 203(f), 206(1), and 206(2) of the Investment Advisers Act of 1940 (the "Act"), 15 U.S.C. §§ 80b-3(f), 80b-6(1), and 80b-6(2), and that appellant Robert Radano aided and abetted those violations. Appellants also seek to vacate the district court's injunction and reverse the imposition of penalties. Because the district court's factual findings are not clearly erroneous, and because we find no error of law, we uphold the district court's finding of violations. We remand the case to the district court so it may craft a more narrow injunction. Appellants have forfeited their objection to the imposition of penalties.

I

This case revolves around the business dealings of Steven Bolla, Robert Radano, and their company, Washington Investment Network (WIN). WIN was, at relevant times, a registered investment advisor. Bolla was not actually a legal owner of WIN—rather, Radano and Bolla's wife were the owners—but the evidence indicates Bolla was the principal figure directing WIN's activities, and Bolla's wife played a relatively minor role. Moreover, ownership of WIN had little practical significance. WIN had no capital assets; it was essentially an empty shell Radano and Bolla used to do business under a corporate name. When money came into WIN, it was distributed to Bolla, Radano, and others with whom Bolla and Radano had fee-sharing agreements. According to the Securities and Exchange Commission ("SEC"), Bolla designated his wife as co-owner of WIN (rather than himself), because Bolla was under SEC investigation.

Radano and Bolla's business involved locating investors and referring them to Lockwood Financial Services. Lockwood is a third-party administrator serving several well-regarded money managers. Lockwood acts as the intermediary between the money managers and investors. Specifically, Lockwood offers investors a service called a "wrap" account, which allows several investors to combine their funds to meet the high minimum-investment requirements of the money managers. Lockwood administers these accounts, but to attract investors, it relies primarily on referrals from investment advisers like WIN.

According to Lockwood's business model, the investment adviser determines the individual investor's specific investment priorities and directs the investor to the Lockwood money managers best suited to the investor's objectives. The investor then enters into a direct contractual relationship with Lockwood, and Lockwood begins paying fees to the investment adviser. Fees are generally calculated as a percentage of the total assets the investor places in Lockwood's control, and they are deducted directly from the investor's investment account. Investment advisers are also obligated to remain in regular contact with the investor and to monitor the investor's account, ensuring the investor's portfolio remains consistent with his or her investment objectives. Lockwood continues paying quarterly fees to the investment adviser from the investor's account as long as the investor has assets under Lockwood management.

[397] Bolla and Radano received fees attributable to the assets each respectively had brought to Lockwood, though it appears Radano trusted Bolla to make the division. Over the course of several years, Bolla channeled $30-40 million in assets to Lockwood, and by the summer of 2000, he was receiving about $150,000 per year in fees. Radano had brought much less money to Lockwood, and his fee-sharing arrangements with third parties were not as favorable to him. Therefore, he received only about $10,000 per year in fees.

Bolla personally handled most of WIN's financial affairs. For example, though WIN was listed as the investment adviser in Lockwood's records, when Lockwood paid fees to WIN, it mailed the check to Bolla, and Bolla deposited the fees in an account under his exclusive control, opened under the name "Steve M. Bolla DBA Washington Investment Network." Bolla would then disburse funds from this personal account to pay Radano his portion of the fees, with Bolla making the fee-split determination unilaterally. Bolla used the same account to pay many of his personal obligations including his mortgage and his wife's credit card.

On March 20, 2000, Bolla entered into a settlement with the SEC in regard to the ongoing investigation, not related to WIN or Radano; he signed a consent to entry of a judgment against him. On June 19, 2000, the federal district court entered a judgment in that unrelated case, enjoining Bolla from violating certain securities laws. The next day, the SEC issued an order barring Bolla from the investment advisory business. During the months leading up to this bar order, Radano knew it was likely and did nothing to disassociate himself (and WIN) from Bolla.

When the bar order issued in June of 2000, Radano learned of it almost immediately and contacted Lockwood within a month or two to report the change in circumstances and to establish himself as the new recipient of WIN fee payments (for both his own and Bolla's clients at WIN). Radano apparently hoped to take over some (if not all) of Bolla's lucrative book of business, but because Lockwood had Bolla listed as the "rep" for all WIN accounts, it refused to accept Radano as the new WIN representative without written letters of authorization from each individual investor. Radano testified this impasse with Lockwood came as a complete surprise to him. He expected Lockwood to switch the WIN accounts to his name on the basis of a simple telephone call, and he thought little more was necessary to disassociate both himself and WIN from Bolla.

Radano got letters of authorization from his own clients, but he had a much harder time getting letters from Bolla's clients, in part because he lacked the necessary contact information. Eventually he succeeded, at least with some of Bolla's clients, and he established himself as the "rep" for WIN accounts. Because of the delay, Lockwood continued to send WIN's quarterly fee payments to Bolla for at least two quarters after the June 20, 2000 bar order. Bolla did not forward these fee payments unopened to Radano, thereby distancing himself from WIN and the investment advisory business; instead, Bolla continued to manage WIN's financial affairs, depositing the fee payments in his personal account, paying WIN's expenses, and disbursing a portion of the fees to Radano. In addition, Bolla refused to transfer control over the bank account to Radano, and he continued to give investment advice to WIN clients.

During this period, Radano continued to consult Bolla about WIN's affairs. For example, Radano sought Bolla's assistance in persuading Lockwood to transfer the WIN accounts to Radano's control. In [398] addition, when Bolla's clients continued to call Bolla seeking investment advice, Bolla contacted Radano and in some cases gave instructions as to the needs of these clients. Bolla characterized these contacts as merely a matter of handing off these calls to Radano, but Bolla also instructed Radano about the payment of certain WIN expenses, instructions Radano then followed. Most important, when Radano began receiving WIN fee payments from Lockwood, he forwarded a portion of one of the fee payments (roughly $2,700) to Bolla's wife. This payment, which Radano made eight months after the bar order, was exactly fifty percent of the investment adviser fees attributable to each of several clients during the previous quarter, many of whom were formerly Bolla's clients. Radano characterized this payment as an appropriate payment of investment adviser fees to Bolla's wife who was herself an investment advisor, but he conceded she performed only clerical duties for WIN and had not previously received fee payments for her services. Bolla did not suggest the payment was for services his wife had provided; rather, he asserted it was a reimbursement to him for accumulated expenses he had incurred over several years, including moving expenses. Bolla also said the payment was a fair settlement—a "cleaning up"—of what was owing to him: "I built a company . . . I think that WIN owed me that."

During the months after the bar order, Radano was evasive in some conversations with Bolla's clients, avoiding specific descriptions of Bolla's situation. Radano did not always make clear the SEC had barred Bolla from the investment advisory business, instead making vague comments that Bolla "was no longer with WIN," "was out of the business," or was "going to pursue more of the insurance angle." When one of these clients specifically asked about the bar order (having learned of it from an independent source), Radano downplayed the significance of the order, saying it related to a bankrupt company in California and had nothing to do with WIN.

II

The SEC brought this action against Bolla, Bolla's wife, Radano, and WIN, asserting Bolla continued to act as an investment adviser after he was barred from the investment advisory business and did so in association with WIN and Radano. Bolla and his wife settled, and the matter proceeded to a bench trial against WIN and Radano. The SEC asserted WIN violated sections 203(f), 206(1), and 206(2) of the Act by allowing Bolla to continue to associate with the firm and failing to disclose Bolla's bar, and it asserted Radano aided and abetted those violations. Section 203(f) of the Act prohibits investment advisers from associating with parties they know to have been barred from the investment advisory business. 15 U.S.C. § 80b-3(f). Sections 206(1) and 206(2) prohibit investment advisers from "defraud[ing] any client or prospective client," id. § 80b-6(1), or "engag[ing] in any . . . practice . . . which operates as a fraud or deceit," id. § 80b-6(2).

The district court made findings of fact substantially consistent with the summary of evidence related above; however, the court expressly found Radano's testimony lacked credibility, and the court even found Radano fabricated evidence in support of his claim he severed ties between WIN and Bolla's wife in July 2000. The district court sustained the SEC's charges and issued an injunction barring WIN and Radano from future violations of sections 203(f), 206(1), and 206(2) of the Act. It also imposed a penalty of $15,000 against Radano and $50,000 against WIN. SEC v. Bolla, 401 F.Supp.2d 43, 75 (D.D.C.2005).

[399] III

A

"In all actions tried upon the facts without a jury . . . [the trial court's f]indings of fact, whether based on oral or documentary evidence, shall not be set aside unless clearly erroneous, and due regard shall be given to the opportunity of the trial court to judge of the credibility of the witnesses." FED. R. CIV. P. 52(a). To satisfy this standard the district court's findings need only be plausible. Anderson v. City of Bessemer City, 470 U.S. 564, 573-74, 105 S.Ct. 1504, 84 L.Ed.2d 518 (1985). The district court's conclusions of law are subject to de novo review. United States v. Microsoft Corp., 253 F.3d 34, 50-51 (D.C.Cir.2001). We review the decision to grant an injunction for abuse of discretion. SEC v. Banner Fund Int'l, 211 F.3d 602, 616 (D.C.Cir.2000).

B

Appellants first argue WIN was not an investment adviser as that term is defined in section 202(a)(11) of the Act. As relevant here, section 202(a)(11) defines "[i]nvestment adviser" as "any person who, for compensation, engages in the business of advising others . . . as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities." 15 U.S.C. § 80b-2(a)(11). Appellants contend WIN acted primarily as a referral service for Lockwood, receiving what amounted to a finder's fee, and they minimize any role WIN played in giving investment advice. This claim, however, is refuted by the evidence, including Radano's own testimony, which shows WIN had an obligation to advise new clients regarding various investment options and a continuing obligation to monitor each client's investment account. For example, Radano testified WIN's continuing duties after a client had set up an account with Lockwood included "[e]nsuring that . . . the integrity of the account remained," "ensur[ing] that the account . . . was still consistent with risk parameters, goals and objectives," and "mak[ing] sure [the account] was on track and consistent." Radano further testified the quarterly fee payments WIN received were in exchange for these ongoing account monitoring obligations. At his deposition, which the district court also considered in making its findings, Radano specified that, if a client's account ceased to be consistent with the client's needs, "[c]hanges would be made in terms of management, in terms of allocation between stock and bond." Moreover, Radano executed WIN's March 22, 2000 application to the State of Connecticut for an "investment adviser registration." In that application, WIN stated it "reviewed [client statements] monthly for accuracy" and completed client profiles "annually to allow account objectives to adjust to any changes in client goals or risk tolerances." WIN also stated its fee was "[f]or overall portfolio management, portfolio allocation, manager selection and personalized account services." Finally, WIN described its business as follows:

Applicant offers advice to clients about other outside unaffil[i]ated investment advisors through a wrap account program. Applicant develops a detailed investment profile about each client prior to manager selection. Applicant's advice to clients consists of asset allocation and assistance in the selection of investment managers for account assets. . . . Applicant monitors all selected investment managers on an ongoing basis for investment returns, sector analysis, investment process and investment objectives.

[400] All of this evidence leaves no doubt WIN had an ongoing obligation to give investment advice and did not merely act as a referral service.

Because WIN's business entailed advising clients in choosing among different investment managers who had distinct investment styles, and because it also advised clients in regard to "asset allocation," we think WIN's activities easily fall within the Act's definition of investment adviser. As the district court found, WIN's business of selecting particular investment managers in lieu of others had the effect of channeling client funds to particular security investments. Indeed, if this were not so, then there would have been no point in making "[c]hanges . . . in terms of management" and "allocation" when an account ceased to be consistent with a client's needs. In short, we cannot say the district court's factual conclusions were "clearly erroneous," FED. R. CIV. P. 52(a), and we agree with the district court that WIN's service constituted "advising others . . . as to the advisability of investing in, purchasing, or selling securities," 15 U.S.C. § 80b-2(a)(11), making WIN an investment adviser.

C

Appellants deny WIN violated section 203(f) of the Act. As noted, that section prohibits investment advisers from associating with parties they know have been barred from the investment advisory business. Id. § 80b-3(f). Specifically, section 203(f) provides: "[I]t shall be unlawful for any investment adviser to permit [any person as to whom a bar order is in effect] to become, or remain, a person associated with him . . . if such investment adviser knew, or in the exercise of reasonable care, should have known, of such order." Id. (emphasis added). Section 202(a)(17) provides in relevant part: "The term `person associated with an investment adviser' means any partner, officer, or director of such investment adviser (or any person performing similar functions), or any person directly or indirectly controlling or controlled by such investment adviser, including any employee of such investment adviser. . . ." Id. § 80b-2(a)(17) (emphasis added).

The record makes clear, as the district court found, that Bolla continued to manage WIN's finances after the bar order. When Bolla received fee checks from Lockwood—checks that belonged to WIN—he did not forward those checks unopened to Radano; instead, he deposited the fees in his personal account, paid WIN's expenses, and disbursed a portion of the fees to Radano. He even claimed, according to Radano's testimony, that September 30, 2000 (three months after the bar order) was a "good break point"—a good time, that is, for Radano to take over the finances at WIN. In addition, Bolla refused to transfer control over WIN's bank account to Radano, and Bolla continued to receive inquiries from WIN clients and direct Radano as to the needs of these clients. Radano, for example, testified Bolla "was calling me and saying client A, B, C call[,] client so and so call. . . . He would call me and say . . . Tim[ ] Riordan . . . called; Daniel Davon needs [an] IRA distribution, call him." Bolla also specifically instructed Radano concerning the payment of WIN's obligations in accordance with certain third-party fee-sharing agreements. At trial, Radano was asked: "[Y]ou're still [on November 27, 2000] taking instructions from [Bolla] on how to subdivide fees?" To which, Radano replied: "On some level, yes, ma'am, because he's received . . . this check directly from Lockwood, so what I'm trying to do is make sure that the fees are properly processed through the system." Similarly, [401] Radano testified about a check he had received from Bolla after the bar order:

This was a check that was sent out to me so that I could send a client— . . . I don't have a direct recollection as to why [Bolla] sent it to me to send out to other people, but . . . there's a . . . deposit into the WIN. . . .

[T]hen I paid out—for whatever reason, he wanted me to pay out, or requested that I pay someone else out fees at that time.

To clarify that response, counsel asked: "[Bolla] directed you to make payments to third parties?" To which, Radano replied: "Yes."

Furthermore, the evidence easily supports the district court's finding that the $2,700 payment WIN made to Bolla's wife in February 2001 was a division of fees between Radano and Bolla for the previous quarter, and this division of fees was made at the direction of Bolla himself. This payment was exactly fifty percent of the fees attributable to several WIN clients, most of whom were Bolla's former clients, and Bolla's testimony indicated the payment was really to him, and not to his wife. If the payment were merely a reimbursement of expenses Bolla incurred before the bar order, as Bolla suggested, it would probably not constitute "associat[ion]" in violation of section 203(f), but the evidence supports the district court's finding that the payment was actually a division of fees for a quarter that post-dated the bar order. Moreover, Radano's characterization of this payment as a fee payment to Bolla's wife has no credibility at all in light of her limited duties at WIN and the fact that she had never previously received payment.

This evidence makes very clear Bolla continued to be a "person directly or indirectly controlling" WIN after the bar order, id. § 80b-2(a)(17), and therefore the district court's conclusion that Bolla remained associated with WIN is not clearly erroneous, FED. R. CIV. P. 52(a).

However, evidence showing Bolla continued his WIN-related activities after the June 20, 2000 bar order is insufficient, by itself, to warrant a judgment against WIN and Radano. If, for example, Bolla stole fee checks that properly belonged to WIN and disbursed funds from those checks in contravention of WIN's wishes and despite WIN's active efforts to prevent Bolla's actions, then WIN could not be held liable for violating section 203(f), because WIN would not in that case have "permit[ted]" Bolla to remain associated with WIN. 15 U.S.C. § 80b-3(f). WIN would then be a victim of Bolla, not an associate. Therefore, to establish a violation of section 203(f), the SEC needed to prove WIN took some affirmative step to permit Bolla to associate with WIN, or at least that it acquiesced in Bolla's ongoing management of WIN finances such that its passivity can be deemed a violation of section 203(f). The latter possibility is significant here. Appellants argue the term "permit" in section 203(f) means "authorize," which suggests an affirmative giving of permission, as when a regulatory agency issues a license allowing a private party to engage in a regulated activity. The SEC rejects this narrow reading of the word "permit," interpreting the word to mean, in effect, "acquiesce." We think the SEC's reading of the statute is correct. If Congress in adopting section 203(f) used the word "permit" to mean "authorize," the statute would be so narrow in scope as to be almost silly. It is hard to imagine an investment adviser ever actively authorizing a barred individual to take control of the firm. The much more natural reading of the statute is that it prohibits investment advisers from standing aside passively while a barred individual takes control [402] of the firm, and this is the reading we adopt. In sum, we need to consider whether WIN acquiesced in Bolla's continuing control over its finances to a degree sufficient to hold it liable under section 203(f).

As a corporation, WIN could only act through its officers, and with the exception of Bolla himself, WIN's only corporate officers were Radano and Bolla's wife. Because Bolla's wife did not act in an executive capacity at WIN (as all parties concede), the focus is on Radano's actions as managing director of WIN during the months leading up to and immediately following the bar order.

Radano testified in essence that he was blind-sided by the June 20, 2000 bar order, and he immediately took action to sever ties between WIN and Bolla, but he did not gain full control of WIN's finances for several months. Bolla, however, settled with the SEC in March 2000, and Radano knew of Bolla's problems with the SEC long before that settlement. Moreover, Radano conceded he knew in February of 2000 that Bolla was likely to be barred soon; he just did not know precisely when the bar would take effect. Radano further claims that, in his ignorance, he thought a mere telephone call to Lockwood would cause Lockwood to change the address on the WIN accounts to Radano's address, and with that change of address, the necessary transition would be complete. But even if we assume Radano was completely ignorant of WIN's contractual relationship with Lockwood, Radano could not very well expect to take over Bolla's WIN clients with neither a formal introduction to these clients nor records of their investment history or objectives, which remained in Bolla's possession. Moreover, assuming Radano could convince these clients to remain with WIN, he could not hope to take over Bolla's side of the business without knowledge of Bolla's fee-sharing arrangements with third parties. Therefore, even if we accept Radano's claim, Radano had no basis for expecting to take over control of WIN without Bolla's cooperation. Under these circumstances, Radano's casual, "wait and see" approach was simply inadequate. As soon as Radano knew the bar order was imminent, Radano, as WIN's managing director, should have actively sought Bolla's cooperation with the transition of Bolla's WIN clients to Radano's oversight, and if that cooperation was not forthcoming, Radano should have taken steps to protect WIN and its clients.

Radano's failure in this regard might be dismissed as mere managerial incompetence. It rose to the level of a violation of section 203(f) once the bar order took effect and Radano still took no steps on behalf of WIN to prevent Bolla's continuing control over WIN and its finances. Because Bolla had, prior to the bar order, held himself out as one of WIN's managing directors, WIN needed to take immediate steps to terminate its relationship with Bolla. Radano's actions as the managing director of WIN make clear WIN did not. Radano failed to notify the SEC that Bolla was insisting on continuing his role as manager of WIN's finances despite the bar order. Radano also did not bring any legal action against Bolla on behalf of WIN, and in fact, Radano did not even formally protest to Bolla in writing concerning Bolla's continuing involvement with WIN. Rather, Radano was complicit in the arrangement, treating it as part of a necessary transition, and even going so far as to make a fee payment to Bolla on behalf of WIN.

Finally, Radano did not take formal steps on behalf of WIN to inform WIN's clients of the bar order, along with an explanation of how the bar order might affect their interests and a neutral discussion [403] of the options these clients might have. Such a formal notification would likely have caused WIN's clients either (1) to terminate their relationship with WIN, or (2) to execute letters of authorization making Radano their selected representative at Lockwood. In either case, notification would have made clear WIN was not complicit in Bolla's ongoing involvement with WIN's financial affairs, and it would have satisfied WIN's fiduciary obligations to its clients. Radano testified he could not contact Bolla's WIN clients because Bolla possessed the contact information for these clients. But this assertion does not excuse Radano's failure to take immediate action, as WIN's managing director, to protect WIN's interests. If Bolla was refusing to release WIN's client files and related records, then Radano needed to initiate legal proceedings on WIN's behalf to obtain those files. By not doing so, he signaled that WIN was content to allow Bolla to continue in his traditional role as WIN's principal. Moreover, even when Bolla's former clients contacted Radano, he still did not make clear the SEC had barred Bolla from the investment advisory business. Instead, he resorted to dodgy statements that obscured the truth. WIN's failure to notify its clients indicates, as the district court found, that "Radano chose the lure of . . . potential profit from Bolla's book of clients over his obligations under Section 203(f)."

In sum, the district court found Radano took no significant actions on behalf of WIN to sever ties with Bolla during the months following the bar order. Radano knew Bolla continued to serve as the contact person for his clients, and he also knew Bolla continued to manage WIN's finances. He followed Bolla's instructions in regard to the disbursement of WIN's fees, and eight months after the bar order, he paid Bolla a portion of WIN's fees, at Bolla's behest. Finally, he failed to inform WIN's clients of the bar order. In light of the evidence, these findings are not "clearly erroneous," FED. R. CIV. P. 52(a), and they amply support the district court's conclusion that WIN permitted Bolla's continued association with the firm in violation of section 203(f).

D

Appellants also deny WIN violated section 206 of the Act. Section 206 provides in relevant part: "It shall be unlawful for any investment adviser . . . directly or indirectly—(1) to employ any device, scheme, or artifice to defraud any client or prospective client; (2) to engage in any transaction, practice, or course of business which operates as a fraud or deceit upon any client or prospective client. . . ." 15 U.S.C. § 80b-6. The district court found WIN violated both subparagraph (1) and subparagraph (2) of section 206 when Radano, as a representative of WIN, spoke to Bolla's former clients without disclosing the bar order. In the district court's view, Radano hoped to attract these clients to himself, and therefore he did not want to say anything that would cause these clients to sever their relationship with WIN. Appellants raise several objections to the district court's decision.

First, appellants argue that, with few exceptions, a failure to disclose cannot constitute a fraud in violation of section 206. Appellants base this argument on the absence from section 206 of a failure-to-disclose provision that is included in section 17(a) of the Securities Act of 1933. Id. § 77q(a). Section 17(a) of the Securities Act has two subparagraphs that are almost identical to the first two subparagraphs of section 206, but section 17(a) includes a third subparagraph that makes it unlawful "to obtain money or property by means of . . . any omission to state a [404] material fact" when omitting the fact is "misleading." Id. § 77q(a)(2) (emphasis added). Appellants argue the absence of this provision from the Investment Advisers Act suggests the Act was not intended to cover inadequate disclosure of material information, but only actual misrepresentations of fact and other affirmative frauds.

In response, the SEC argues the two statutory schemes cannot be compared. The Investment Advisers Act concerns itself with investment advisers, who, as fiduciaries, have a duty to disclose material information to clients. Because the Securities Act applies to non-fiduciaries as well as fiduciaries, it is more specific as regards the implications of failing to disclose material information.

The SEC also relies on SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963), in which the Supreme Court made clear the failure to disclose material information can, in at least some circumstances, provide the basis for a fraud finding under section 206. Capital Gains considered whether an investment adviser had a duty to disclose a practice known as "scalping." Id. at 181, 84 S.Ct. 275. Scalping occurs when an investment adviser purchases shares of a security for his own account prior to recommending the security for longterm investment and then immediately sells the shares after a rise in the market price following the recommendation. Id. The Supreme Court held section 206 requires investment advisers to disclose this practice. Id. at 181-82, 84 S.Ct. 275. Appellants argue Capital Gains is distinguishable factually, pointing out that Capital Gains (unlike the present case) involved multiple securities transactions made against a background of nondisclosure. Be that as it may, we think the better reading of section 206 is that it prohibits failures to disclose material information, not just affirmative frauds. This reading is consistent with the fiduciary status of investment advisers in relation to their clients, id. at 191-92, 194, 84 S.Ct. 275, and it is also more likely to fulfill Congress's general policy of promoting "full disclosure" in the securities industry, id. at 186, 84 S.Ct. 275.

The district court found Radano, as WIN's representative, was evasive in conversations with at least two of WIN's clients during the months following the bar order, thereby violating section 206. Radano did not disclose the bar order to these clients, choosing instead to offer vague comments about Bolla's status and then only after these clients pressed for information. When one of these clients directly confronted Radano about the bar order, he downplayed its significance. In this way, the court found "Radano affirmatively misled [these clients] regarding Mr. Bolla" and provided these clients "an inaccurate, skewed version of WIN as an investment entity." The district court's findings in this regard are supported by the clients' testimony, which the court found more credible than Radano's own testimony, and therefore these findings are not "clearly erroneous." FED. R. CIV. P. 52(a).

Moreover, we agree with the district court that WIN's evasiveness in these conversations constituted fraudulent behavior in violation of section 206. In Capital Gains, the Supreme Court noted that investment advisers, as fiduciaries, have "an affirmative duty of utmost good faith, and full and fair disclosure of all material facts, as well as an affirmative obligation to employ reasonable care to avoid misleading [their] clients." 375 U.S. at 194, 84 S.Ct. 275 (citations and internal quotation marks omitted). Certainly, in WIN's case, this duty included disclosing Bolla's bar from the investment advisory business. Bolla [405] was not an incidental player in WIN's business. His clients at WIN represented WIN's largest accounts, and his corresponding share of WIN's fees dwarfed that of Radano, who was WIN's only other active investment adviser. Moreover, he personally managed WIN's finances, and for many of WIN's clients, he was the face of WIN. When such a critical player in an investment advisory firm is barred from the business on account of misconduct, the firm has a fiduciary duty to disclose that fact to its clients, and in particular to clients who previously dealt exclusively with that individual.

Appellants assert Radano's communications with WIN's clients were not misleading, or if they were, they did not rise to the level of fraud. The SEC's evidence, appellants point out, focused primarily on conversations Radano had with only two clients. The SEC did not establish either client lost money as a result of Radano's evasiveness during these conversations, and in one of the conversations, the client already knew about the bar order. Therefore, appellants assert, Radano's failure to disclose the bar order could not constitute fraud.

To obtain an injunction under section 206 against fraudulent conduct, the SEC does not need to prove reliance on the investment adviser's misleading statements, nor does the SEC need to prove injury. Id. at 192-93, 195, 84 S.Ct. 275. Rather, if an investment adviser is likely to repeat fraudulent conduct and future injury is reasonably foreseeable, an injunction may issue as a prophylactic measure without the necessity of waiting until the injury actually occurs. Id. Hence, we reject appellants' contention that the failure of the SEC to establish injury requires reversal here.

Appellants also argue the bar order was a matter of public record and therefore disclosure of the bar order was unnecessary. Appellants rely on Kapps v. Torch Offshore, Inc., 379 F.3d 207, 216 (5th Cir.2004), in which the Fifth Circuit found the public availability of information relevant in a failure-to-disclose case. We agree the public availability of information is a relevant consideration when evaluating a party's disclosure obligations under the securities laws, but we do not think this principle requires reversal here. The existence of the bar order may have been public information, but it was not information that was so widely disseminated that an average small investor could be expected to be aware of it.

Finally, appellants deny Radano acted with the requisite "intent to deceive, manipulate, or defraud," SEC v. Steadman, 967 F.2d 636, 641 (D.C.Cir.1992) (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n. 12, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976)), when he failed to disclose the bar order to WIN's clients, and therefore argue WIN cannot be held liable for violating section 206(1). Similarly, appellants deny Radano acted with the negligence required to make out a violation of section 206(2). See id. at 643. The district court made an express finding of intent to defraud, as well as negligence, stating that Radano, in his dealings with WIN's clients, "opted to pursue the potential financial gain resulting from easy transfers of accounts over the hard acknowledgment that his business partner had been barred from further practice by the regulating agency." The court also rejected appellants' argument that Radano's quick action in informing Lockwood about the bar order established his good faith. As the court saw it, "Mr. Radano immediately notified Lockwood of Mr. Bolla's bar . . . because it was in his economic interest to separate Mr. Bolla from Lockwood as soon as possible. In contrast, . . . [406] Mr. Radano was reticent and reserved [with WIN's clients] . . . in an effort to maintain their association with WIN. . . ." In short, the district court found Radano, driven by self-interest, intentionally breached his fiduciary obligations and those of WIN, "well aware that he could potentially increase his salary fifteen-fold" by taking over Bolla's accounts.

The district court's findings are amply supported by the testimony of WIN's clients, who described their conversations with Radano and whom the court found to be more credible than Radano. We also agree with the district court that Radano's denial of any intent to be evasive in conversations with WIN's clients is highly doubtful in light of his openness and candor in situations where such candor served his personal interest—to wit, with Lockwood. The district court's findings of both intent and negligence are not "clearly erroneous." FED. R. CIV. P. 52(a).

E

The district court held Radano liable on an aider and abettor theory, while holding WIN liable as the principal violator. Radano argues the court's findings are insufficient to support aider and abettor liability, because the court made no express finding that he had "knowledge of wrongdoing." See Howard v. SEC, 376 F.3d 1136, 1142-43 (D.C.Cir.2004).

To be liable as an aider and abettor under sections 203(f), 206(1), and 206(2), the SEC must prove "knowledge of wrongdoing," id., or "a general awareness [on the part of the alleged aider and abettor] that his role was part of an overall activity that was improper," Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C.Cir.1980). With respect to WIN's violation of section 203(f), Radano admits he knew of the bar order, having learned of it almost immediately after it went into effect. Certainly, then, he knew it was improper for WIN to continue associating with Bolla, and the district court found WIN continued to associate with Bolla in several ways, including: (1) permitting Bolla to control its finances; (2) complying with Bolla's instructions regarding payment of its obligations; (3) paying Bolla a portion of its fees, at Bolla's behest; and (4) failing to inform its clients about the bar order. Moreover, in each instance, WIN acted under Radano's direction. Though the district court did not make an express finding that Radano knew the wrongfulness of WIN's actions—that is, that they constituted improper association—the court made such a finding implicitly. We think the record as a whole indicates Radano, as WIN's agent, was "general[ly] aware[ ] that his role was part of an overall activity that was improper," id., and therefore the record adequately supports the district court's holding that he aided and abetted WIN's violation of section 203(f).

With respect to WIN's violation of section 206, we think an express finding that Radano had knowledge of WIN's wrongdoing was unnecessary because this question was subsumed within the question whether WIN acted with the requisite scienter. As noted, a violation of section 206(1) requires proof of "intent to deceive, manipulate, or defraud." Steadman, 967 F.2d at 641 (quoting Hochfelder, 425 U.S. at 194 n. 12, 96 S.Ct. 1375). The district court found WIN had acted with such intent based solely on Radano's motives as WIN's managing director. In a situation like that presented here, where a small firm, acting solely through the agency of a single individual, has intentionally deceived, manipulated, or defrauded its clients, the conclusion is unavoidable that the individual in question has knowledge of the firm's wrongdoing.

[407] F

Appellants argue this case did not involve the sort of repeated violations and likelihood of future violations that warrant injunctive relief. See Steadman, 967 F.2d at 647-48. We conclude the record adequately supports the district court's finding of a reasonable likelihood of future violations, and the court therefore acted within the bounds of its discretion in entering the injunction. Significantly, we are not presented here with an isolated event or a violation that is technical in nature. Radano's willingness to enter into a business relationship with Bolla though he knew the SEC was likely to bar Bolla from the investment advisory industry, his failure to take decisive action to distance himself and WIN from Bolla once the bar order became imminent, his willingness to permit Bolla to continue his control over WIN's finances after the bar order took effect, his payment of fees to Bolla eight months after the bar order, and his lack of candor in conversations with WIN's clients (thereby putting his self-interest over that of the clients), all strongly suggest a willfulness and a continuing pattern of fiduciary violations that is likely to be repeated in the future. Therefore, we uphold the injunction. However, we find the injunction insufficiently specific.

Rule 65(d) of the Federal Rules of Civil Procedure provides: "Every order granting an injunction . . . shall be specific in terms [and] shall describe in reasonable detail, and not by reference to the complaint or other document, the act or acts sought to be restrained. . . ." The district court's injunction states simply: "Defendants WIN and Radano are enjoined from future violations of Sections 203(f), 206(1), and 206(2) of the Advisers Act." We think this injunction fails to clarify "the act or acts sought to be restrained," FED. R. CIV. P. 65(d), and it might subject defendants to contempt for activities having no resemblance to the activities that led to the injunction, thereby being overly broad in its reach. See SEC v. Savoy Indus., Inc., 665 F.2d 1310, 1318-19 (D.C.Cir.1981). We therefore remand the case to the district court to reform the injunction and to address the question of overbreadth.

G

The SEC's complaint sought penalties under section 20(d) of the Securities Act of 1933, 15 U.S.C. § 77t(d), and section 21(d)(3) of the Securities Exchange Act of 1934, id. § 78u(d)(3). Appellants argue the district court erred in awarding penalties under these provisions. In addition, Radano argues the Investment Advisers Act does not authorize penalties against an aider and abettor, but only against "the person who committed [the] violation." Id. § 80b-9(e)(1). Appellants did not raise these issues before the district court, and therefore the issues are forfeit. See, e.g., Albrecht v. Comm. on Employee Benefits of Fed. Reserve Employee Benefits Sys., 357 F.3d 62, 66 (D.C.Cir.2004).

IV

We affirm the district court's judgment finding WIN violated sections 203(f), 206(1), and 206(2) of the Investment Advisers Act of 1940 and finding Radano aided and abetted those violations. We also affirm the imposition of penalties on WIN and Radano, as set forth in the district court's judgment. We remand the case to the district court for it to amend the injunction to describe more specifically the act or acts sought to be restrained.

So ordered.

[482] Merril Hirsh argued the cause for petitioner. With him on the briefs was Jonathan A. Cohen.

Rachel M. Weintraub and Mercer E. Bullard were on the brief for amici curiae Consumer Federal of America and Fund Democracy, Inc. in support of petitioner.

Debra G. Speyer was on the brief for amicus curiae Public Investors Arbitration Bar Association in support of petitioner.

Rex A. Staples was on the brief for amicus curiae North American Securities Administrators Association, Inc. in support of petitioner.

Rada L. Potts, Senior Litigation Counsel, Securities & Exchange Commission, argued the cause for respondent. With her on the brief were Brian G. Cartwright, General Counsel, Jacob H. Stillman, Solicitor, Michael A. Conley, Special Counsel, and Jeffrey T. Tao, Senior Counsel.

Before: ROGERS, GARLAND and KAVANAUGH, Circuit Judges.

[483] Opinion for the Court filed by Circuit Judge ROGERS.

Dissenting opinion filed by Circuit Judge GARLAND.

ROGERS, Circuit Judge.

Brokers and dealers are not subject to the requirements of the Investment Advisers Act ("IAA") where their investment advice is (1) "solely incidental to the conduct of [their] business as a broker or dealer," and (2) the broker or dealer "receives no special compensation therefor." 15 U.S.C. § 80b-2(a)(11)(C) (2000). The Securities and Exchange Commission, acting pursuant to § 202(a)(11)(F) and § 211(a) of the IAA, 15 U.S.C. §§ 80b-2(a)(11)(F)^[1], 80b-11(a), promulgated a final rule exempting broker-dealers^[2] from the IAA when they receive "special compensation therefor." See "Certain Broker-Dealers Deemed Not to be Investment Advisers," 70 Fed.Reg. 20,424 (Apr. 19, 2005). The Financial Planning Association ("FPA") petitions for review of the final rule on the ground that the SEC has exceeded its authority. We agree, and we therefore grant the petition and vacate the final rule.

I.

The IAA was enacted by Congress as one title of a bill "to provide for the registration and regulation of investment companies and investment advisers." Pub.L. No. 76-768, tit. II, 54 Stat. 847 (1940). The other title was the Investment Company Act ("ICA"). Pub.L. No. 76-768, tit. I, 54 Stat. 789 (1940). These were the last in a series of congressional enactments designed to eliminate certain abuses in the securities industry that contributed to the stock market crash of 1929 and the depression of the 1930s. Congress had previously enacted the Securities Act of 1933, the Securities Exchange Act of 1934 (hereinafter "the Exchange Act"), the Public Utility Holding Company Act of 1935, and the Trust Indenture Act of 1939.

"A fundamental purpose, common to these statutes, was to substitute a philosophy of full disclosure for the philosophy of caveat emptor and thus to achieve a high standard of business ethics in the securities industry." SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 186, 84 S.Ct. 275, 11 L.Ed.2d 237 (1963). The IAA arose from a consensus between industry and the SEC "that investment advisers could not `completely perform their basic function—furnishing to clients on a personal basis competent, unbiased, and continuous advice regarding the sound management of their investments—unless all conflicts of interest between the investment counsel and the client were removed.'" Id. at 187, 84 S.Ct. 275 (citation omitted). According to the Committee Reports, "[t]he essential purpose of [the IAA] . . . [was] to protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment adviser against the stigma of the activities of these individuals by making fraudulent practices by investment [484] advisers unlawful." H.R.Rep. No. 76-2639, at 28 (1940).

"Virtually no limitations or restrictions exist with respect to the honesty and integrity of individuals who may solicit funds to be controlled, managed, and supervised. . . . Individuals assuming to act as investment advisers at present can enter profit-sharing contracts which are nothing more than `heads I win, tails you lose' arrangements. Contracts with investment advisers which are of a personal nature may be assigned and the control of funds of investors may be transferred to others without the knowledge or consent of the client."

S.Rep. No. 76-1775, at 21-22 (1940).

Under the IAA, investment advisers are required, among other things, to register and to maintain records, 15 U.S.C. § 80b-3(c) & (e); to limit the type of contracts they enter, id. § 80b-5; and not to engage in certain types of deceptive and fraudulent transactions, id. § 80b-6. Congress has amended the IAA on several occasions,^[3]see VII Louis Loss & Joel Seligman, Securities Regulation 3314-15 (3d ed.2003), but the provisions at issue in this appeal have remained, in relevant part, unchanged.

In § 202(a)(11) of the IAA, Congress broadly defined "investment adviser" as

"any person who, for compensation, engages in the business of advising others, either directly or through publications or writings, as to the value of securities or as to the advisability of investing in, purchasing, or selling securities, or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities. . . . "

15 U.S.C. § 80b-2(a)(11). Carving out six exemptions from this broad definition, Congress determined that an "investment adviser" did not include:

(A) a bank, or any bank holding company as defined in the Bank Holding Company Act of 1956 which is not an investment company, except that the term "investment adviser" includes any bank or bank holding company to the extent that such bank or bank holding company serves or acts as an investment adviser to a registered investment company, but if, in the case of a bank, such services or actions are performed through a separately identifiable department or division, the department or division, and not the bank itself, shall be deemed to be the investment adviser;

(B) any lawyer, accountant, engineer, or teacher whose performance of such services is solely incidental to the practice of his profession;

(C) any broker or dealer [1] whose performance of such services is solely incidental to the conduct of his business as a broker or dealer and [2] who receives no special compensation therefor;

(D) the publisher of any bona fide newspaper, news magazine or business or financial publication of general and regular circulation;

(E) any person whose advice, analyses, or reports relate to no securities other than securities which are direct obligations of or obligations guaranteed as to principal or interest by the United States, or securities issued or guaranteed by corporations in which the United States has a direct or indirect interest which shall have been designated by the Secretary of the Treasury, pursuant to [485] section 3(a)(12) of the Securities Exchange Act of 1934, as exempted securities for the purposes of that Act; or

(F) such other persons not within the intent of this paragraph, as the Commission may designate by rules and regulations or order.

15 U.S.C. § 80b-2(a)(11) (emphasis added). Subsections (C) and (F) are at issue in this appeal.

Before enactment of the IAA, broker-dealers and others who offered investment advice received two general forms of compensation. Some charged only traditional commissions (earning a certain amount for each securities transaction completed). Others charged a separate advice fee (often a certain percentage of the customer's assets under advisement or supervision). See 11 Fed.Reg. 10,996 (Sept. 27, 1946). The Committee Reports recognized that the statutory exemption for broker-dealers reflected this distinction; the Reports explained that the term "investment adviser" was "so defined as specifically to exclude . . . brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions)." S.Rep. No. 76-1775, at 22 [HA 164]; H.R.Rep. No. 76-2639, at 28 [HA 168].

The final rule took a different approach. After determining in 1999 that certain new forms of fee-contracting adopted by broker-dealers were "not . . . fundamentally different from traditional brokerage programs," the SEC proposed a rule very similar to the final rule, see Notice of Proposed Rulemaking, 64 Fed.Reg. 61,228 (Nov. 10, 1999) ("1999 NOPR"), stating it would act as if it had already issued the rule, id. at 61,227. In adopting the temporary rule, pursuant to subsection (F) and its general rulemaking authority under IAA § 211(a), the SEC exempted a new group of broker-dealers from the IAA. 64 Fed.Reg. 61,226 (Nov. 10, 1999). After reproposing the rule in January 2005, again pursuant to its authority under subsection (F) and § 211(a), the SEC adopted a slightly modified final rule on April 12, 2005, codified at 17 C.F.R. § 275.202(a)(11)-1. 70 Fed.Reg. 20,424, 453-54.

The final rule provides, generally, in Paragraph (a)(1), on "fee-based programs," that a broker-dealer who (1) receives special compensation will not be deemed an investment adviser if (2) any advice provided is solely incidental to brokerage services provided on a customer's account and (3) specific disclosure is made to the customer.^[4] In Paragraph (a)(2), on discount brokerage programs, a broker-dealer will not be deemed to have received special compensation merely because it charges one customer more or less for brokerage services than it charges another customer. Paragraph (b) lists three non-exclusive circumstances in which advisory services, for which special compensation is received under paragraph (a)(1), would not be performed "solely incidental to" brokerage: when (1) a separate fee or contract exists for advice; (2) a customer receives certain financial planning services; and, (3) generally, a broker-dealer has investment discretion over a client's account. Paragraph [486] (c) states a "special rule" that broker-dealers registered under the Exchange Act are investment advisers only for those accounts for which they receive compensation that subjects them to the IAA. Paragraph (d) defines the term "investment discretion," which appears in paragraphs (a)(1) and (b)(3), to have the same meaning as § 3(a)(35) of the Exchange Act, 15 U.S.C. § 78c(a)(35), except for "discretion granted by a customer on a temporary or limited basis."

The FPA petitions for review, challenging the SEC's authority to promulgate the final rule.^[5] We first address the threshold issue presented by the SEC's challenge to FPA's standing.

II.

Article III standing is a fundamental prerequisite to any exercise of the court's jurisdiction, see Lujan v. Defenders of Wildlife, 504 U.S. 555, 560, 112 S.Ct. 2130, 119 L.Ed.2d 351 (1992), and requires, at the "irreducible constitutional minimum," id., a showing that the litigant has suffered a concrete and particularized injury that is actual or imminent, traceable to the challenged act, and redressable by the court. See Allen v. Wright, 468 U.S. 737, 751, 104 S.Ct. 3315, 82 L.Ed.2d 556 (1984); Simon v. E. Ky. Welfare Rights Org., 426 U.S. 26, 37-38, 41-42, 96 S.Ct. 1917, 48 L.Ed.2d 450 (1976). A petitioner must support each element of its claim to standing "by affidavit or other evidence." Defenders of Wildlife, 504 U.S. at 561, 112 S.Ct. 2130; see Sierra Club v. EPA, 292 F.3d 895, 899 (D.C.Cir.2002). The SEC maintains that the FPA fails to show injury-in-fact because FPA's assertions of injury from the final rule's dual standard are conclusory.

The standard for representational standing is well-established:

[A]n association has standing to bring suit on behalf of its members when: (a) its members would otherwise have standing to sue in their own right; (b) the interests it seeks to protect are germane to the organization's purpose; and (c) neither the claim asserted nor the relief requested requires the participation of individual members in the lawsuit.

United Food & Commercial Workers Union Local 751 v. Brown Group, Inc., 517 U.S. 544, 553, 116 S.Ct. 1529, 134 L.Ed.2d 758 (1996) (quoting Hunt v. Wash. State Apple Adver. Comm'n, 432 U.S. 333, 343, 97 S.Ct. 2434, 53 L.Ed.2d 383 (1977)). The FPA meets this test.

The court has "repeatedly recognized that parties `suffer constitutional injury in fact when agencies . . . allow increased competition' against them." U.S. Telecom Ass'n v. FCC, 295 F.3d 1326, 1331 (D.C.Cir.2002) (citation omitted). The FPA is a non-profit organization with over 27,000 members that exists to advance the financial planning profession. See Decl. of Daniel Moisand, President of the FPA, ¶¶ 1, 2, Petitioner's Br.App. 1. The final rule creates a dual standard for the provision of investment advice. First, there are investment advisers who are covered by the IAA; many FPA members are investment advisers, and must comply with the IAA. See FPA Comment Letter of Feb. 7, 2005 n. 1. Second, there is a new group of broker-dealers who are exempted from the IAA even though their activities do not conform to the two-pronged requirements of subsection (C). The two groups compete for customers, and under the final [487] rule one of them (including FPA members) must continue to comply with the IAA, while the other one (the broker-dealers in the new, exempt category) need not.

Additionally, contrary to the SEC's view, the FPA also has prudential standing. Its members are within the IAA's zone of interest, see Clarke v. Sec. Indus. Ass'n, 479 U.S. 388, 399, 107 S.Ct. 750, 93 L.Ed.2d 757 (1987), because one of Congress's purposes in enacting the IAA was to protect the ability of "bona fide" investment advisers to compete on a level regulatory playing field with those advisers who did not fully disclose their conflicts of interest, see Capital Gains, 375 U.S. at 191, 84 S.Ct. 275 (1963).

Accordingly, we hold that the FPA has standing to bring its petition.

III.

The FPA contends that when Congress enacted the IAA, Congress identified in subsection (C) the group of broker-dealers it intended to exempt, and that subsection (F) was only intended to allow the SEC to exempt new groups from the IAA, not to expand the groups that Congress specifically addressed. The resolution of the FPA's challenge thus turns on whether the SEC is authorized under § 202(a)(11)(F) or § 211(a) to except from IAA coverage an additional group of broker-dealers beyond the broker-dealers exempted by Congress in subsection (C), 15 U.S.C. § 80b-2(a)(11)(C). Subsection (F) of § 202(a)(11) authorizes the SEC to except from the IAA "such other persons not within the intent of this paragraph, as the Commission may designate by rules and regulations or order." 15 U.S.C. § 80b-2(a)(11)(F). As such, we review the SEC's exercise of its authority pursuant to subsection (F) under the familiar two-step analysis of Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-43, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984). Under step one, the court must determine whether Congress has directly spoken to the precise question at issue. "If the intent of Congress is clear, that is the end of the matter; for the court, as well as the agency, must give effect to the unambiguously expressed intent of Congress." Id. Under step two, "if the statute is silent or ambiguous with respect to the specific issue, the question for the court is whether the agency's answer is based on a permissible construction of the statute." Id. at 843, 104 S.Ct. 2778. In reviewing an agency's interpretation of its authority under a statute it administers, the court will uphold that interpretation as long as it is a reasonable interpretation of the statute. See Village of Bergen v. FERC, 33 F.3d 1385, 1389 (D.C.Cir.1994).

Applying the "traditional tools of statutory construction," see Chevron, 467 U.S. at 843 n. 9, 104 S.Ct. 2778, the court looks to the text, structure, and the overall statutory scheme, as well as the problem Congress sought to solve. See PDK Labs. Inc. v. DEA, 362 F.3d 786, 796 (D.C.Cir. 2004); Sierra Club v. EPA, 294 F.3d 155, 161 (D.C.Cir.2002). All four elements demonstrate that the SEC has exceeded its authority in promulgating the rule under § 202(a)(11)(F) because Congress has addressed the precise issue at hand.

Section 202(a)(11) lists exemptions (A)-(E) from the broad definition of "investment adviser" for several classes of persons—including, for example, lawyers, accountants, and others whose advice is "solely incidental" to their regular business; and publishers of newsletters that circulate widely and do not give individually-tailored financial advice. Among the IAA exemptions is subsection (C)'s exemption for "any broker or dealer whose performance of such [investment advisory] services is solely incidental to the conduct of his business as a broker or dealer and [488] who receives no special compensation therefor." (Emphasis added). Beyond the listed exemptions, subsection (F) authorizes the SEC to exempt from the IAA "such other persons not within the intent of this paragraph, as the Commission may designate by rules and regulations or order." (Emphasis added).

In the final rule, the SEC purports to use its authority under subsection (F) to broaden the exemption for broker-dealers provided under subsection (C). The rule is inconsistent with the IAA, however, because it fails to meet either of the two requirements for an exemption under subsection (F). First, the legislative "intent" does not support an exemption for broker-dealers broader than the exemption set forth in the text of subsection (C); therefore, the final rule does not meet the statutory requirement that exemptions under subsection (F) be consistent with the "intent" of paragraph 11 of section 202(a). Second, because broker-dealers are already expressly addressed in subsection (C), they are not "other persons" under subsection (F); therefore the SEC cannot use its authority under subsection (F) to establish new, broader exemptions for broker-dealers.

The final rule's exemption for broker-dealers is broader than the statutory exemption for broker-dealers under subsection (C). Although the SEC maintains that the intent of paragraph 11 is to exempt broker-dealers who receive special compensation for investment advice [Red Br. 28; Oral Arg. Tape at 31:50], the plain text of subsection (C) exempts only broker-dealers who do not receive special compensation for investment advice. The word "any" is usually understood to be all inclusive. See New York v. EPA, 443 F.3d 880, 885 (D.C.Cir.2006). As "[t]he plain meaning of legislation should be conclusive, except in the `rare cases [in which] the literal application of a statute will produce a result demonstrably at odds with the intentions of its drafters,'" United States v. Ron Pair Enters., Inc., 489 U.S. 235, 242, 109 S.Ct. 1026, 103 L.Ed.2d 290 (1989) (quoting Griffin v. Oceanic Contractors, Inc., 458 U.S. 564, 571, 102 S.Ct. 3245, 73 L.Ed.2d 973 (1982)), the terms of the IAA establish the precise conditions under which broker-dealers are exempt from the IAA. "To read out of a statutory provision a clause setting forth a specific condition or trigger to the provision's applicability is . . . an entirely unacceptable method of construing statutes." Natural Res. Def. Council v. EPA, 822 F.2d 104, 113 (D.C.Cir.1987).

No other indicators of congressional intent support the SEC's interpretation of its authority under subsection (F). The relevant language in the committee reports suggests that Congress deliberately drafted the exemption in subsection (C) to apply as written. Those reports stated that the "term `investment adviser' is so defined as specifically to exclude . . . brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions)." S.Rep. No. 76-1775, at 22 (emphasis added) [HA 164]; see also H.R.Rep. No. 76-2639, at 28 [HA 168]. By seeking to exempt broker-dealers beyond those who receive only brokerage commissions for investment advice, the SEC has promulgated a final rule that is in direct conflict with both the statutory text and the Committee Reports.

The text of subsection (F) confirms this conclusion by the limiting the SEC's exemption authorization to "other persons." We agree with the FPA that when Congress enacted the IAA, Congress identified the specific classes of persons it intended to exempt. As to broker-dealers, subsection (C) applied to "any broker or dealer." Congress, through the use of contrasting [489] text in subsection (F), signaled that it only authorized the SEC to exempt "other persons" when consistent with the intent of the paragraph, and thus only when doing so would not override Congress's determination of the appropriate persons to be exempted from the IAA's requirements.

As the FPA points out, the word "other" connotes "existing besides, or distinct from, that already mentioned or implied." II The Shorter Oxford English Dictionary 1391 (2d ed.1936, republished 1939). See Key v. Allstate Ins. Co., 90 F.3d 1546, 1550 (11th Cir.1996) (citing The American Heritage Dictionary 931 (1981)). There is nothing to suggest that Congress did not intend the words "any" or "other" to have their "ordinary or natural meaning." Smith v. United States, 508 U.S. 223, 228, 113 S.Ct. 2050, 124 L.Ed.2d 138 (1993). So understood, courts have hesitated to allow parties to use language structurally similar to the "other persons" clause in subsection (F) to redefine or otherwise avoid specific requirements in existing statutory exceptions. In Liljeberg v. Health Servs. Acquisition Corp., 486 U.S. 847, 864 n. 11, 108 S.Ct. 2194, 100 L.Ed.2d 855 (1988), for example, the Supreme Court noted that where Federal Rule of Civil Procedure 60(b) contained five explicit grounds for relief, and one non-specific "any other reason" clause, (emphasis added) the structure of the clauses suggested that the final clause could not be used to elude or enlarge the first five—that "clause (6) and clauses (1) through (5) are mutually exclusive." (emphasis added). Accord Pioneer Inv. Servs. Co. v. Brunswick Assocs. Ltd. P'ship, 507 U.S. 380, 393, 113 S.Ct. 1489, 123 L.Ed.2d 74 (1993); Hesling v. CSX Transp. Inc., 396 F.3d 632, 643 (5th Cir. 2005); United States v. Erdoss, 440 F.2d 1221, 1223 (2d Cir.1971). Similarly, in Am. Bankers Ass'n v. SEC, this court explained that:

A universal clause preceding every definition in the statute, which states only "unless the context otherwise requires," cannot provide the authority for one of the agencies whose jurisdictional boundaries are defined in the statute to alter by administrative regulation those very jurisdictional boundaries. To suggest otherwise is to sanction administrative autonomy beyond the control of either Congress or the courts.

804 F.2d 739, 754 (D.C.Cir.1986). Our dissenting colleague attempts to distinguish these two cases as limited to situations in which one agency seeks to redraw the jurisdictional boundaries of another agency. See Dissenting Op. at [7-9]. That interpretation, however, ignores the underlying principle in each case: where the statutory text is clear, an agency may not use general clauses to redefine the jurisdictional boundaries set by the statute.

Just as the text and structure of paragraph of 202(a)(11) make it evident that Congress intended to define "investment adviser" broadly and create only a precise exemption for broker-dealers, so does a consideration of the problems Congress sought to address in enacting the IAA. A comprehensive study conducted by the SEC pursuant to the Public Utility Holding Company Act of 1935 indicated that "many investment counsel have `strayed a great distance from that professed function' of furnishing disinterested, personalized, continuous supervision of investments." Securities and Exchange Commission, Investment Counsel, Investment Management, Investment Supervisory and Investment Advisory Services, at 25 (1939) (quoting testimony of brokerage executive James N. White, of Scudder, Stevens & Clark). Floor debate on the IAA called attention to the fact that while this study was being conducted investment trusts and investment companies had perpetrated "some of the most flagrant abuses and grossest violations of fiduciary duty to investors." 86 Cong. Rec. 2844 (daily ed. Mar. 14, 1940) [490] (statement of Sen. Wagner). Congress reiterated throughout its proceedings an intention to protect investors and bona fide investment advisers.^[6]

The overall statutory scheme of the IAA addresses the problems identified to Congress in two principal ways: First, by establishing a federal fiduciary standard to govern the conduct of investment advisers, broadly defined, see Transamerica Mortgage Advisors v. Lewis, 444 U.S. 11, 17, 100 S.Ct. 242, 62 L.Ed.2d 146 (1979), and second, by requiring full disclosure of all conflicts of interest. As the Supreme Court noted, Congress's "broad proscription against `any . . . practice . . . which operates . . . as a fraud or deceit upon any client or prospective client' remained in the bill from beginning to end." Capital Gains, 375 U.S. at 191, 84 S.Ct. 275.

[T]he Committee Reports indicate a desire to . . . eliminate conflicts of interest between the investment adviser and the clients as safeguards both to `unsophisticated investors' and to `bona fide investment counsel.' The [IAA] thus reflects a . . . congressional intent to eliminate, or at least to expose, all conflicts of interest which might incline an investment adviser—consciously or unconsciously—to render advice which was not disinterested.

Id. at 191-92, 84 S.Ct. 275. This statutory scheme is inconsistent with a construction of the SEC's authority under subsection (F) that would enable persons Congress determined should be subject to the IAA to escape its restrictions.

In an attempt to overcome the plain language of the statute, the SEC asserts that Congress was also concerned about the regulation of broker-dealers under both the IAA and Exchange Act, and that such concern was reflected in the "intent" of the paragraph. See 70 Fed.Reg. 20,430; see also 64 Fed.Reg. 61,228. The SEC points to no convincing evidence that supports these assertions. At the time Congress enacted the IAA in 1940, broker-dealers were already regulated under the Exchange Act. In the IAA, Congress expressly acknowledged that the broker-dealers it covered could also be subject to other regulation. IAA § 208(b), 15 U.S.C. § 80b-8(b). The IAA's essential purpose was to "protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts and to safeguard the honest investment adviser against the stigma of the activities of these individuals by making fraudulent practices by investment advisers unlawful." H.R.Rep. No. 76-2639 at 28; see also id. at 21. As the FPA emphasizes, there is nothing in the committee reports to suggest that Congress was particularly concerned about the regulatory burdens on broker-dealers.

While the SEC's failure to respect the unambiguous textual limitations marked by the phrase "intent of this paragraph" and "other persons" is fatal to the final rule, an additional weakness exists in the SEC's interpretation: It flouts six decades of consistent SEC understanding of its authority under subsection (F). Cf. Commodity Futures Trading Comm'n v. Schor, 478 U.S. 833, 844, 106 S.Ct. 3245, 92 L.Ed.2d 675 (1986); Red Lion Broad. Co. v. FCC, 395 U.S. 367, 380-82, 89 S.Ct. 1794, 23 L.Ed.2d 371 (1969).^[7] Subsection [491] (F) is not a catch-all that authorizes the SEC to rewrite the statute. Rather, as subsection (F)'s terms provide, the authority conferred must be exercised consistent with the "intent of this paragraph" and apply to "other persons." The SEC cannot point to any instance between the 1940 enactment of the IAA and the commencement of the rulemaking proceedings that resulted in the final rule in 2005, when it attempted to invoke subsection (F) to alter or rewrite the exemptions for persons qualifying for exemptions under subsections (A)-(E). Rather, the SEC has historically invoked subsection (F) to exempt persons not otherwise addressed in the five exemptions established by Congress: For example, the adviser to a family trust who was otherwise subject to fiduciary duties, Oral Arg. Tape at 39:20-43:24; or new groups, such as thrift institutions acting in a fiduciary capacity, 69 Fed.Reg. 25,777-90 (May 7, 2004), and World Bank instrumentalities that provide advice only to sovereigns, In re Int'l Bank for Reconstr. & Dev., 2001 SEC LEXIS 1782 (Sept. 4, 2001). As the SEC's own actions for the last 65 years suggest, subsection (F) serves the clear purpose of authorizing the SEC to address persons or classes involving situations that Congress had not foreseen in the statutory text—not to broaden the exemptions of the classes of persons (such as broker-dealers) Congress had expressly addressed.

The SEC unconvincingly attempts to defend its expansive interpretation of subsection (F) by likening it to section 6(c) of the ICA, 15 U.S.C. § 80a-6(c). Section 6(c) of the ICA empowers the SEC to grant exemptions from the ICA, or any rule or regulation adopted under it, "if and to the extent that such exemption is necessary or appropriate in the public interest and consistent with the protection of investors and the purposes fairly intended by the policy and provisions" of the ICA. This court has noted that the SEC "has exercised this authority to exempt persons not within the intent of the [ICA] and generally to adjust its provisions to take account of special situations not foreseen when the [ICA] was drafted." NASD v. SEC, 420 [492] F.2d 83, 92 (D.C.Cir.1969), vacated on other grounds, Investment Co. Inst. v. Camp, 401 U.S. 617, 91 S.Ct. 1091, 28 L.Ed.2d 367 (1971). Reliance on NASD does not advance the SEC's position as the plain text of the ICA is far broader than that of IAA subsection (F). The ICA expressly refers to the SEC's view of "the public interest" as a basis for new exemptions. "[W]e assume that in drafting . . . legislation, Congress said what it meant." United States v. LaBonte, 520 U.S. 751, 757, 117 S.Ct. 1673, 137 L.Ed.2d 1001 (1997). Although Congress amended the IAA in 1970, see supra n. 3, and repeated the same ICA language highlighted in NASD in § 206A of the IAA, 15 U.S.C. § 80b-6a, the SEC disavows any reliance on § 206A in promulgating the final rule, see 70 Fed. Reg. 20,453; Respondent's Br. at 27 n. 10, and thus the court has no occasion to express an opinion on the SEC's authority under it, see SEC v. Chenery Corp., 318 U.S. 80, 95, 63 S.Ct. 454, 87 L.Ed. 626 (1943). But the broader language found in § 206A supports the conclusion that subsection (F) must be read more narrowly. Cf. Duncan v. Walker, 533 U.S. 167, 174, 121 S.Ct. 2120, 150 L.Ed.2d 251 (2001); City of Chicago v. Envtl. Def. Fund, 511 U.S. 328, 338, 114 S.Ct. 1588, 128 L.Ed.2d 302 (1994).

In light of the context in which Congress drafted subsections (C) and (F), we conclude that, as indicated by the structure of § 202(a)(11) and the problems that Congress addressed in the IAA, as well as the other indicators of Congress's intent, under Chevron step one the text of subsections (C) and (F) is unambiguous, and that, therefore, the SEC has exceeded its authority in promulgating the final rule. Our dissenting colleague's analysis fails to confront two realities of statutory construction. First, "[a]mbiguity is a creature not of definitional possibilities but of statutory context." Brown v. Gardner, 513 U.S. 115, 118, 115 S.Ct. 552, 130 L.Ed.2d 462 (1994). Congress has used words having ordinary meaning—"any broker or dealer" in subsection (C) and "other persons" in subsection (F)—and a familiar structure to express its "intent" in addressing problems identified by the industry and the SEC. Second, the absence of a statutory definition of "intent of this paragraph" and "other persons" does not necessarily render their meaning ambiguous. See Goldstein v. SEC, 451 F.3d 873, 878 (D.C.Cir.2006). Again, the meaning of the text is defined by its context as set forth in the normal meaning of the words, the structure of paragraph 11, and the problems Congress sought to address in the IAA. Because the court's duty is to give meaning to each word of a statute, the court cannot properly treat one authorization, under subsection (F), as duplicative of another authorization, under Section 206A. See supra at [491-92]; Dissenting Op. at [498]. Consequently, section 202(a)(11)(F) does not lend itself to alternative meanings; to conclude otherwise would undermine Congress's purpose in enacting the IAA—to protect consumers and honest investment advisers and to establish fiduciary standards and require full disclosure of all conflicts of interests of "investment advisers," broadly defined. The SEC's suggestion that "new" broker-dealer marketing developments fall within the scope of its authority under subsection (F) ignores its own contemporaneous understanding of Congressional intent to capture such developments. See supra at [490-91] and note 7. Although an agency may change its interpretation of an ambiguous statute, all elements of the traditional tools of statutory interpretation confound the SEC's effort to walk away from its long-settled view of the limits of its authority under subsection (F) and our dissenting colleague's attempt to find an alternative meaning at this late date.

[493] The SEC's invocation of its general rulemaking authority under IAA section 211(a),^[8] is likewise to no avail because it suggests no intention by Congress that the SEC could ignore either of the two requirements in subsection (C) for broker-dealers to be exempt from the IAA. See Am. Bankers, 804 F.2d at 755. Paraphrasing an apt observation, while, in the SEC's view, "[t]he statute may be imperfect, . . . the [SEC] has no power to correct flaws that it perceives in the statute it is empowered to administer. Its [subsection (F) authority and its] rulemaking power[s][are] limited to adopting regulations to carry into effect the will of Congress as expressed in the statute." Bd. of Governors v. Dimension Fin. Corp., 474 U.S. 361, 374, 106 S.Ct. 681, 88 L.Ed.2d 691 (1986).

Accordingly, we grant the petition and vacate the final rule. See North Carolina v. Fed. Energy Regulatory Comm'n, 730 F.2d 790, 795-96 (D.C.Cir.1984); cf. K Mart Corp. v. Cartier, Inc., 486 U.S. 281, 294, 108 S.Ct. 1811, 100 L.Ed.2d 313 (1988). The final rule does not contain a severability clause; nor does the SEC suggest it is severable. Paragraph (b) is expressly tied to paragraph (a). Although, absent (a) or (b), paragraph (c) merely states the current law, the SEC identifies paragraph (c) as one of "three separate, yet related, parts" of the final rule. Respondent's Br. at 11, 13. Paragraph (d) defines a term used in paragraphs (a) and (b). The SEC release to the final rule states that paragraph (d) institutes a policy change based on its interpretation of subsection (F), see 70 Fed.Reg.20,439-440, but otherwise identifies paragraph (d) in the release as part and parcel of the final rule, see, e.g., id. at 20,424.

GARLAND, Circuit Judge, dissenting.

The Investment Advisers Act contains five specific exceptions, and further authorizes the SEC to exempt "such other persons not within the intent of this paragraph, as the Commission may designate by rules." 15 U.S.C. § 80b-2(a)(11). Unlike my colleagues, I cannot derive an unambiguous meaning from the terms "such other persons" and "within the intent of this paragraph." As required by Chevron, I would therefore defer to the SEC's reasonable interpretation of the statute it administers and uphold the Commission's fee-based brokerage rule.

I

The Investment Advisers Act (IAA) imposes a series of requirements on "investment advisers." See 15 U.S.C. §§ 80b-3 to -6. Paragraph 11 of section 202(a) of the Act defines an "investment adviser" as "any person who, for compensation, engages in the business of advising others . . . as to the value of securities or as to the advisability of investing in, purchasing, or selling securities," unless that person comes within one of six exceptions. Id. § 80b-2(a)(11).^[9] The first five exceptions include, inter alia, certain banks and bank holding companies, certain lawyers and accountants, and—most relevant here—certain brokers and dealers. The exception [494] relating to broker-dealers—subsection (C)—exempts:

any broker or dealer whose performance of [advisory] services is solely incidental to the conduct of his business as a broker or dealer and who receives no special compensation therefor.

Id. § 80b-2(a)(11)(C). The SEC has construed "special compensation" to mean any compensation other than brokerage commissions (or dealers' "mark-ups" or "mark-downs"). See Certain Broker-Dealers Deemed Not To Be Investment Advisers, 70 Fed.Reg. 20,424, 20,425 & n. 10 (Apr. 19, 2005) [hereinafter Certain Broker-Dealers]. Hence, a broker-dealer who receives any kind of compensation other than commissions does not come within the subsection (C) exception, even if he, too, provides advice solely as an incident to his business as a broker-dealer. See id. at 20,425.

In addition to the five specific exceptions, the IAA's definition of covered investment advisers includes a sixth exception—subsection (F)—which reads as follows:

such other persons not within the intent of this paragraph, as the Commission may designate by rules and regulations or order.

15 U.S.C. § 80b-2(a)(11)(F). That exception is the crux of this case. In the final rule currently under attack, the SEC exercised its authority under subsection (F) to create an exception for broker-dealers whose provision of advice is also solely incidental to their brokerage services, but who receive a particular kind of non-commission compensation. These broker-dealers—a group that did not exist when the IAA was passed in 1940—charge either a fixed fee or a fee based on the amount of assets in the customer's account. In return, they provide the customer with a traditional package of brokerage services that includes investment advice, execution, arranging for delivery and payment, and custodial and recordkeeping services. Certain Broker-Dealers, 70 Fed.Reg. at 20,425. Because these broker-dealers receive fee-based compensation rather than commissions, they receive "special compensation" within the meaning of subsection (C) and hence are not covered by that exception. See id.

As the court states, the question before us is whether subsection (F) gives the SEC the authority to "except from IAA coverage an additional group of broker-dealers beyond the broker-dealers exempted by Congress in subsection (C)." Court Op. at 487. The SEC believes that it does. In the Commission's view, although these broker-dealers receive "special compensation" in a technical sense, they provide investment advice in the same manner as those who are exempt under subsection (C), and exempting them would thus serve the same purpose. See infra Part III.

Under the first step of Chevron analysis, if the terms of subsection (F) unambiguously preclude the SEC's interpretation, we must reject it. See Chevron U.S.A. Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 842-44, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984). If the terms are ambiguous, however, we must proceed to Chevron's second step and defer to the SEC's interpretation if it is reasonable. See id.; Nat'l Cable & Telecomms. Ass'n v. Brand X Internet Servs., 545 U.S. 967, 980, 125 S.Ct. 2688, 162 L.Ed.2d 820 (2005).

II

The court begins and ends its analysis at Chevron step one, concluding that the SEC unambiguously lacks authority under subsection (F) to exempt any broker-dealers beyond those specified in subsection (C). Court Op. at 492. The court reaches this conclusion based on its examination of the [495] subsection (F) terms "such other persons" and "within the intent of this paragraph." I fail to appreciate the clarity of either term. Indeed, apart from the inherent ambiguity of the words themselves, clarity is particularly elusive because subsection (F)'s final clause—"as the Commission may designate by rules"—expressly authorizes the SEC to determine the intent of the paragraph and designate further exceptions by regulation. As the Supreme Court instructed in Chevron, where "there is an express delegation of authority to the agency to elucidate a specific provision of the statute by regulation[,][s]uch legislative regulations are given controlling weight unless they are arbitrary, capricious, or manifestly contrary to the statute." Chevron, 467 U.S. at 843-44, 104 S.Ct. 2778; see Am. Council on Educ. v. FCC, 451 F.3d 226, 232 (D.C.Cir.2006).

A

Like my colleagues, I begin with the term "within the intent of this paragraph." Under Chevron, a statutory term is unambiguous only if Congress has "directly spoken to the precise question at issue." 467 U.S. at 842-43, 104 S.Ct. 2778. The court is obviously correct in stating that "the plain text of subsection (C) exempts only broker-dealers who do not receive special compensation for investment advice"—that is, broker-dealers who do not receive compensation other than commissions. Court Op. at 488 (emphasis added). But that is not the precise question before us. That question is whether Congress intended subsection (F) to permit the SEC to exempt broker-dealers beyond those already exempt under subsection (C).

The court cannot point to any words in paragraph 11, or in any other paragraph of the Act, that suggest a negative answer to that question—or that explain what Congress intended with respect to that question at all. Instead, the court appears to rely on a version of the expressio unius canon—the principle that the mention of one thing implies the exclusion of another—by reasoning that the exception for some broker-dealers in subsection (C) means that coverage of all other broker-dealers must be "within the intent of" paragraph 11. But this court has repeatedly held that expressio unius is "an especially feeble helper in an administrative setting, where Congress is presumed to have left to reasonable agency discretion questions that it has not directly resolved." Martini v. Fed. Nat'l Mortgage Ass'n, 178 F.3d 1336, 1343 (D.C.Cir.1999) (quoting Cheney R.R. Co. v. ICC, 902 F.2d 66, 69 (D.C.Cir.1990)) (internal quotation marks omitted); see Texas Rural Legal Aid, Inc. v. Legal Servs. Corp., 940 F.2d 685, 694 (D.C.Cir.1991) ("[T]he expressio canon is simply too thin a reed to support the conclusion that Congress has clearly resolved the issue."). The canon's negative inference is particularly implausible where—as in subsection (F)—Congress has explicitly authorized additional exceptions beyond those specified in the statute.

Turning from the statutory text to the legislative history, the court quotes a committee report stating that the "`term "investment adviser" is so defined as specifically to exclude . . . brokers (insofar as their advice is merely incidental to brokerage transactions for which they receive only brokerage commissions).'" Court Op. at 488 (quoting S. REP. NO. 76-1775, at 22 (1940)) (emphasis added by the court); see also H.R. REP. NO. 76-2639, at 28 (1940). This quotation, however, has the same problem identified above. The committee was referring only to the specific exclusion provided by subsection (C), and not to the further exclusions permitted by subsection (F). That is made clear by the sentence that follows the one quoted by the court: "In addition, the Commission is authorized by rules and regulations or order, to make certain further exceptions [496] according to prescribed statutory standards." S. REP. NO. 76-1775, at 22 (emphasis added); see also H.R. REP. NO. 76-2639, at 28. There is nothing in the committee report that explains Congress' intentions with respect to those "further exceptions."

B

The court also perceives clarity in the subsection (F) term "such other persons." According to the court, "other persons" excludes any person who is a member of one of the broad categories referenced in paragraph 11's five specific exceptions. Because some broker-dealers are referenced in subsection (C), the court concludes that the subset of broker-dealers covered by the fee-based brokerage rule cannot constitute "other persons" within the meaning of subsection (F). See Court Op. at 488-89. The SEC, by contrast, contends that "other persons" excludes only those persons who actually come within one of the five preceding exceptions. On the SEC's reading, the fee-based brokerage rule is a permissible exercise of the Commission's delegated authority because it exempts broker-dealers other than those exempted by subsection (C).

Because the IAA does not define "other persons," the court turns to the dictionary to find its meaning. There, the court learns that "the word `other' connotes `existing besides, or distinct from, that already mentioned or implied.'" Id. at 489 (quoting 2 THE SHORTER OXFORD ENGLISH DICTIONARY 1391 (2d ed.1936, republished 1939)). But like the text and the legislative history, the dictionary fails to resolve the precise question at issue. It cannot tell us whether the persons "already mentioned" in subsection (C) are "any broker or dealer," as one might reasonably conclude if one looked only at the first four words of the subsection, or instead are "any broker or dealer whose performance of such services is solely incidental to the conduct of his business . . . and who receives no special compensation therefor," as one might reasonably conclude if one looked at all the words of the subsection. The SEC takes the latter approach, and neither the plain text nor the dictionary bars that construction. This should end the Chevron step one inquiry.

Turning away from the IAA altogether, the court next looks to judicial precedents construing two different provisions—Federal Rule of Civil Procedure 60(b) and the Securities Exchange Act of 1934. These cases, however, shed no light on the IAA.

In Liljeberg v. Health Services Acquisition Corp., 486 U.S. 847, 108 S.Ct. 2194, 100 L.Ed.2d 855 (1988), the Supreme Court interpreted Rule 60(b), which allows a court to grant relief from a final judgment for any of five sets of specific reasons (e.g., mistake), or—under the Rule's sixth clause—for "any other reason justifying relief." FED. R. CIV. P. 60(b). Although Liljeberg does state that "`clause (6) and clauses (1) through (5) are mutually exclusive,'" Court Op. at 489 (quoting Liljeberg, 486 U.S. at 864 n. 11, 108 S.Ct. 2194), the case is wholly inapposite. First, the Court was interpreting Rule 60(b) de novo, not reviewing an agency interpretation entitled to Chevron deference. At most, then, the Court's statement indicates what it regarded as the best interpretation of the phrase "any other reason," not what it saw as the only possible interpretation. Second, the reason the Court read Rule 60(b) as it did was that the rule contains a one-year statute of limitations for seeking relief under clause (1), while motions under clause (6) need only be brought within a "reasonable time." Hence, barring a party from basing a clause (6) claim on the same grounds specified in clause (1) was necessary "to prevent clause (6) from being used to circumvent the 1-year limitations period that applies to clause (1)." Liljeberg, 486 U.S. [497] at 864 n. 11, 108 S.Ct. 2194. There is nothing similar in the structure of IAA paragraph 11. Finally, the reading of Rule 60(b)'s "any other reason" clause rejected by the Supreme Court is actually the inverse of the SEC's reading of subsection (F). The Court stated that "a party may `not avail himself of the broad "any other reason" clause' . . . if his motion is based on grounds specified in clause (1)." Id. (emphasis added) (quoting Klapprott v. United States, 335 U.S. 601, 613, 69 S.Ct. 384, 93 L.Ed. 266 (1949)). That is, a person who qualifies for relief under clause (1) cannot also obtain relief under clause (6). Here, by contrast, the SEC employed subsection (F)'s "such other persons" language to create an exception for persons who could not qualify for an exception under any of the preceding subsections.

This circuit's interpretation of the Securities Exchange Act in American Bankers Association v. SEC, 804 F.2d 739 (D.C.Cir. 1986), is likewise inapposite. There, the court declined to accord Chevron deference to an SEC interpretation because it concerned the allocation of jurisdiction between the SEC and other agencies. The Exchange Act expressly excludes "banks," which are regulated by the federal banking agencies, from the definitions of "brokers" and "dealers," which are regulated by the SEC. See id. at 743 (citing 15 U.S.C. § 78c(a)(4)-(5)). The Act also contains a definition of "banks." See id. at 744 (citing 15 U.S.C. § 78c(a)(6)). Although all of the Exchange Act's definitions are preceded by an "unless the context otherwise requires" clause, American Bankers rejected the SEC's effort to use that clause to redefine "banks" so as to subject some to SEC regulation. Such a "rote phrase," the court said, "cannot provide the authority for one of the agencies whose jurisdictional boundaries are defined in the statute to alter by administrative regulation those very jurisdictional boundaries." Id. at 754 (emphasis added). But there is no other agency in the picture in this case. Nor is the Exchange Act's narrow direction to look to "context" to avoid "absurd consequences," id. at 753, equivalent to subsection (F)'s express delegation of authority to the SEC to make further exceptions to the IAA. Indeed, American Bankers itself suggested that, had the Exchange Act contained such an "express delegation," the result in that case might well have been different. Id. at 749.

In short, these cases do not illustrate an "underlying principle" that resolves the interpretive question in this case. Court Op. at 489. To the contrary, they merely tell us how courts have construed dissimilar language in dissimilar circumstances—that is, in situations where, unlike here, Chevron deference is inappropriate. There is, therefore, nothing in the text or structure of paragraph 11—or in any judicial precedent—that compels the statutory construction that the court has adopted.

C

Finally, the court seeks to buttress its arguments from text and structure with three more general considerations. First, it examines "the problems Congress sought to address in enacting the IAA." Id. at 489. That the first item the court turns to in that examination is a 1939 "comprehensive study conducted by the SEC," id., should cast some doubt on whether the court is better equipped to interpret the study's import than the authoring agency. In any event, my colleagues learn little from this or any other aspect of the historical context beyond the fact that "[t]he IAA's essential purpose was to `protect the public from the frauds and misrepresentations of unscrupulous tipsters and touts.'" Id. at 490 (quoting H.R. REP. No. 76-2639, at 28). There is no doubt that this accurately identifies the intent of Congress at a [498] high level of generality. But it, too, fails to address the precise question at issue here—the meaning of subsection (F). Nor should it come as any surprise that—as discussed in Part III below—the SEC neither disputes that the IAA's essential purpose was to protect the public from fraud and misrepresentation, nor believes that its fee-based brokerage rule would be a boon to unscrupulous tipsters and touts.

My colleagues contend that "an additional weakness exists in the SEC's interpretation" because it "flouts six decades of consistent SEC understanding of its authority under subsection (F)." Id. at 490. The only SEC opinions quoted for that proposition are two releases that refer only to subsection (C). Neither mentions subsection (F) at all, and neither considers whether an exception for fee-based brokerage would be appropriate under that (or any other) subsection. See id. at 490-91 n. 7 (citing 43 Fed.Reg. 19,224, 19,226 (May 4, 1978), and 11 Fed.Reg. 10,996 (Sept. 27, 1946) (republishing SEC General Counsel opinion letter of Oct. 28, 1940)).

But even if the SEC had changed its construction of subsection (F), "`change is not invalidating, since the whole point of Chevron is to leave the discretion provided by the ambiguities of a statute with the implementing agency.'" Brand X, 545 U.S. at 981, 125 S.Ct. 2688 (quoting Smiley v. Citibank (S.D.), N.A., 517 U.S. 735, 742, 116 S.Ct. 1730, 135 L.Ed.2d 25 (1996)). It is well-settled that "[a]n agency's interpretation of a statute is entitled to no less deference . . . simply because it has changed over time." Nat'l Home Equity Mortgage Ass'n v. Office of Thrift Supervision, 373 F.3d 1355, 1360 (D.C.Cir.2004). Indeed, Chevron itself deferred to a changed agency interpretation. See Chevron, 467 U.S. at 863-64, 104 S.Ct. 2778. As the Court said in Brand X, "[u]nexplained inconsistency is, at most, a reason for holding an interpretation to be an arbitrary and capricious change from agency practice under the Administrative Procedure Act"—an issue my colleagues do not address. 545 U.S. at 981, 125 S.Ct. 2688. In any event, the SEC's construction is neither inconsistent nor, as discussed in Part III, unexplained.

Last, my colleagues state that "the broader language found in § 206A [of the IAA] supports the conclusion that subsection (F) must be read more narrowly." Court Op. at 492. Whether the exempting power delegated to the SEC under § 206A is in fact broader than that delegated by subsection (F) is unclear. Compare 15 U.S.C. § 80b-6a, with id. § 80b-2(a)(11)(F). But even if it were, the court does not explain how § 206A, which was not added to the IAA until 1970, can provide insights into the intent of the Congress that enacted subsection (F) in 1940.

Because I fail to perceive the clarity required to vacate the SEC's fee-based brokerage rule under the first step of Chevron analysis, I proceed to the second step.

III

Under Chevron step two, "if the implementing agency's construction is reasonable," a court must "accept the agency's construction of the statute, even if the agency's reading differs from what the court believes is the best statutory interpretation." Brand X, 545 U.S. at 980, 125 S.Ct. 2688 (citing Chevron, 467 U.S. at 843-44 & n. 11, 104 S.Ct. 2778).

For the same reasons that I find subsection (F)'s use of the term "such other persons" ambiguous, see supra Part II.B, I conclude that the SEC's construction of that term is reasonable. There is nothing implausible about interpreting those words to encompass anyone not actually exempt under one of the five preceding exceptions. [499] In so doing, the SEC does not "rewrite the statute." Court Op. at 491. Rather, it gives effect to one of two plausible interpretations of the statutory language.

The reasonableness of the SEC's interpretation of "such other persons" does not end the analysis, of course. Any regulatory exception must also be consistent with "the intent of" paragraph 11. The remaining question, then, is whether an exception for broker-dealers who provide investment advice solely incidental to their business as broker-dealers, but who are paid fee-based rather than commission-based compensation, is consistent with that intent.

The SEC has presented a reasonable case for concluding that it is. The Commission explained that, at the time of the IAA's passage in 1940, broker-dealers were providing investment advice and receiving compensation in only two ways: "as an auxiliary part of the traditional brokerage services for which their brokerage customers paid fixed commissions and, alternatively, as a distinct advisory service for which their advisory clients separately contracted and paid a fee." Certain Broker-Dealers, 70 Fed.Reg. at 20,428. Congress was concerned about the potential for fraud and misrepresentation when advice was provided in the latter form— whether it was provided by broker-dealers charging separately for such advice or by others whose only business was to provide advice for a fee. See id. at 20,429-30 & n. 60. In enacting the IAA, however, Congress did not express the same concern about investment advice included within a larger package of brokerage services—as evidenced by the exception contained in subsection (C).

As the SEC interprets the legislative history, subsection (C) was intended to exempt broker-dealers when they gave investment advice as part of a package of traditional brokerage services, but not when they sold advice as a distinct service for a separate fee. See id. at 20,430. The 1940 SEC release quoted by the court, Court Op. at 490-91 n. 7, is to precisely that effect:

Clause (C) . . . amounts to a recognition that brokers and dealers commonly give a certain amount of advice to their customers in the course of their regular business, and that it would be inappropriate to bring them within the scope of the [IAA] merely because of this aspect of their business. On the other hand, that portion of clause (C) which refers to "special compensation" amounts to an equally clear recognition that a broker or dealer who is specially compensated for the rendition of advice should be considered an investment adviser and not be excluded from the purview of the Act. . . .

11 Fed.Reg. 10,996 (Sept. 27, 1946) (emphasis added) (republishing SEC General Counsel opinion letter of Oct. 28, 1940). Since, at the time, the only kind of compensation that exchange rules permitted a broker-dealer to charge for a traditional package of services was the fixed brokerage commission, subsection (C)'s exception for broker-dealers receiving such compensation effectively exempted all broker-dealers who provided advice as part of such a package. See Certain Broker-Dealers, 70 Fed.Reg. at 20,431 & n. 75.

For several decades after the IAA was passed, subsection (C)'s "no special compensation" rule—understood to mean "no compensation other than brokerage commissions"—continued to exempt the only group of broker-dealers who gave advice as part of a traditional package of brokerage services. See id. at 20,431. In 1975, however, the SEC eliminated the requirement that broker-dealers charge only fixed commissions for brokerage services. See id. at 20,431 n. 74. In the 1990s, broker-dealers began to take advantage of the [500] change by offering their customers fee-based brokerage accounts as an alternative to commissions. According to the SEC, these accounts provide customers with the same traditional package of brokerage services, but instead of paying a commission on each trade, a customer pays either a fixed fee or a fee based on the amount of assets in the account. See id. at 20,425.

In 1999, in response to these developments, the SEC first proposed what would become the final rule now before us. The Commission concluded that "these new fee-based brokerage programs . . . were not fundamentally different from traditional brokerage programs" and that broker-dealers had simply "re-priced traditional brokerage programs rather than . . . created advisory programs." Id. at 20,426. Although fee-based brokers receive "special compensation" in the technical sense that they are paid in a form other than brokerage commissions, such brokers provide investment advice only as a part of a traditional package of brokerage services, just like the brokers who have always been exempt from the IAA. And unlike the broker-dealers who Congress intended to include within the Act's coverage via subsection (C)'s bar on "special compensation," the subset of broker-dealers exempted by the final rule do not charge a separate fee or separately contract for investment advice. (The final rule expressly excludes such broker-dealers from the exception. See 17 C.F.R. § 275.202(a)(11)-1(b)(1).) Because the SEC reasonably believed that an exception for the broker-dealers covered by the final rule—a group that did not exist in 1940—would serve the same purpose as the exception that Congress created when it passed the IAA, the Commission reasonably concluded that its final rule was consistent with the intent of paragraph 11. As the Commission explained:

There is no evidence that the "special compensation" requirement was included in section 202(a)(11)(C) for any purpose beyond providing an easy way of accomplishing the underlying goal of excepting only advice that was provided as part of the package of traditional brokerage services. In particular, neither the legislative history of section 202(a)(11)(C) nor the broader legislative history of the Advisers Act as a whole suggests that, in 1940, Congress viewed the form of compensation for the services at issue—commission versus fee-based compensation—as having any independent relevance in terms of the advisory services the Act was intended to reach.

Certain Broker-Dealers, 70 Fed.Reg. at 20,431 (footnote omitted).

The SEC also reasonably explained why its new exception was consistent with the IAA's more general purpose of preventing fraud and misrepresentation. As the Commission points out, broker-dealers who are exempt from the IAA are not free from oversight, but instead are regulated under the Securities Exchange Act of 1934 and by self-regulatory organizations such as the New York Stock Exchange. Id. at 20,424. That regulation, the SEC explained, "provide[s] substantial protections for broker-dealer customers." Id. at 20,433. To supplement that regulation, the final rule further provides that broker-dealers cannot qualify for the exception unless they make specified disclosures about potential conflicts of interest to their customers. 17 C.F.R. § 275.202(a)(11)-1(a)(1).

Moreover, a major impetus to promulgation of the rule was the SEC's concern that commission-based compensation has conflict-of-interest and fraud potential of its own. Charging a commission for each transaction, the SEC said, gives brokers an incentive "to churn accounts, recommend unsuitable securities, and engage in aggressive marketing of brokerage services." [501] Certain Broker-Dealers, 70 Fed. Reg. at 20,425. Under fee-based brokerage programs, by contrast, "compensation no longer depends on the number of transactions . . ., thus reducing incentives . . . to churn accounts, recommend unsuitable securities, or engage in high-pressure sales tactics." Notice of Proposed Rulemaking, 64 Fed.Reg. 61,226, 61,228 (Nov. 10, 1999). The SEC feared that, if fee-based brokers remained subject to the IAA's administrative burdens while commission-based brokers did not, a salutary evolution toward the former would be discouraged. See Certain Broker-Dealers, 70 Fed.Reg. at 20,426.

The Financial Planning Association and its amici advance a host of reasons to question the SEC's judgment that the fee-based brokerage exception will not undermine investor protection. Whatever the validity of those concerns, they reflect policy disputes of the type that Chevron counsels us to leave to agency resolution. As the Supreme Court emphasized:

When a challenge to an agency construction of a statutory provision, fairly conceptualized, really centers on the wisdom of the agency's policy, rather than whether it is a reasonable choice within a gap left open by Congress, the challenge must fail. In such a case, federal judges—who have no constituency— have a duty to respect legitimate policy choices made by those who do.

Chevron, 467 U.S. at 866, 104 S.Ct. 2778.

IV

The SEC's interpretation of the Investment Advisers Act is "a reasonable interpretation of an ambiguous statute." Christensen v. Harris County, 529 U.S. 576, 586-87, 120 S.Ct. 1655, 146 L.Ed.2d 621 (2000). This is not to suggest that my colleagues' interpretation is unreasonable, but only to acknowledge that when there are two reasonable interpretations of a statutory provision, a court must bow to the "interpretation made by the . . . agency." Chevron, 467 U.S. at 844, 104 S.Ct. 2778. Doing so, I respectfully dissent from the opinion of the court.

[1] In the wake of the Enron and WorldCom collapses, Congress enacted the Credit Rating Agency Reform Act of 2006 ("CRARA"), Pub.L. No. 109-291, 120 Stat. 1327, 1337 (2006), which included an amendment to the IAA to add a new exception to the definition of "investment adviser" in § 202(a)(11) for statistical rating organizations. CRARA § 4(b)(3), Pub.L. No. 109-291. Hence, subsection (F) is now found in 15 U.S.C. § 80b-2(a)(11)(G). References in this opinion are to the IAA prior to this 2006 amendment.

[2] We refer to brokers and dealers as "broker-dealers" because their different roles are irrelevant for purposes of this appeal. See IAA, 15 U.S.C. §§ 80b-2(a)(3), (a)(7); Securities Exchange Act, 15 U.S.C. §§ 78c(a)(4) (broker), (a)(5) (dealer).

[3] See, e.g., Pub.L. No. 86-507, 74 Stat. 201 (1960); Pub.L. No. 86-624, 74 Stat. 412 (1960); Pub.L. No. 86-750, 74 Stat. 885 (1960); Pub.L. No. 91-547, 84 Stat. 1430, 1433 (1970) (adding § 206A); Pub.L. No. 94-29, 89 Stat. 163 (1975).

[4] The required disclosure consists of the following statement:

Your account is a brokerage account and not an advisory account. Our interests may not always be the same as yours. Please ask us questions to make sure you understand your rights and our obligations to you, including the extent of our obligations to disclose conflicts of interest and to act in your best interest. We are paid both by you and, sometimes, by people who compensate us based on what you buy. Therefore, our profits, and our salespersons' compensation, may vary by product and over time.

Section (a)(1)(ii), 70 Fed.Reg. 20,454.

[5] The FPA initially filed a petition in 2004 for review of the 1999 temporary rule. See 69 Fed.Reg. 51,620 n. 4 (Aug. 20, 2004). After the SEC promulgated the final rule on April 12, 2005, FPA again petitioned for review. The court consolidated the petitions by Order of May 11, 2005.

[6] See, e.g., 86 Cong. Rec. S2844-45, 2847 (daily ed. Mar. 14, 1940); 86 Cong Rec. S8843 (daily ed. June 21, 1940); 86 Cong. Rec. H9807, 9809, 9815-16 (daily ed. Aug. 1, 1940); 86 Cong. Rec. S10077 (daily ed. Aug. 8, 1940).

[7] Very shortly after enactment of the IAA, the SEC advised that any charges directly related to the giving of investment advice would be special compensation. On October 28, 1940, the SEC General Counsel issued an opinion stating:

Clause (C) of section 202(a)(11) amounts to a recognition that brokers and dealers commonly give a certain amount of advice to their customers in the course of their regular business, and that it would be inappropriate to bring them within the scope of the Investment Advisers Act merely because of this aspect of their business. On the other hand, that portion of clause (C) which refers to "special compensation" amounts to an equally clear recognition that a broker or dealer who is specially compensated for the rendition of advice should be considered an investment adviser and not be excluded from the purview of the Act merely because he is also engaged in effecting market transactions in securities.

11 Fed.Reg. 10,996 (Sept. 27, 1946) (reprinting SEC General Counsel opinion letter of October 28, 1940). Thus, any charges "directly related to the giving of advice" would be special compensation. Id.

This contemporary interpretation was reflected as well when the SEC addressed two-tiered pricing arrangements (including a discounted fee arrangement) in 1978:

[I]f a broker-dealer has in effect, either formally or informally, two general schedules of fees available to a customer, the lower without investment advice and the higher with investment advice[,] and the difference is primarily attributable to this factor . . . the [SEC] would regard the extra charge as "special compensation" for investment advice.

43 Fed.Reg. 19,224, 19,226 (May 4, 1978). The SEC made clear at the time that "[t]his would be the case even in a situation, currently nonexistent, in which a current `full service' firm implements a `discount' or `execution-only' service." Id.; see also Townsend & Assocs., Inc., SEC No-Action Letter, 1994 SEC No-Act. LEXIS 739 (Sept. 21, 1994); Am. Capital Fin. Servs., Inc., SEC No-Action Letter, 1985 SEC No-Act. LEXIS 2209 (Apr. 29, 1985).

[8] Section 211(a) provides:

The Commission shall have authority from time to time to make, issue, amend, and rescind such rules and regulations and such orders as are necessary or appropriate to the exercise of the functions and powers conferred upon the Commission elsewhere in this subchapter. For the purposes of its rules or regulations the Commission may classify persons and matters within its jurisdiction and prescribe different requirements for different classes of persons or matters.

15 U.S.C. § 80b-11(a).

[9] Congress added a seventh exception in 2006. My citations, like the court's, are to the preamendment statute.

38 F.3d 1078 (1994)

[1079] [1080] [1081] Leonard B. Simon and Alan Schulman, Milberg Weiss Bershad Spechthrie & Lerach, San Diego, CA, Sherrie R. Savett, Berger & Montague, Philadelphia, PA, Ronald Litowitz, Bernstein Litowitz Berger & Grossmann, New York City, for plaintiffs-appellants.

Leslie G. Landau, McCutchen, Doyle, Brown & Enersen, San Francisco, CA, for defendant-appellee Deloitte & Touche.

Boris Feldman, Wilson, Sonsini, Goodrich & Rosati, Palo Alto, CA, for defendants-appellees Montgomery Securities and Paine-Webber.

William F. Alderman, Orrick, Herington & Sutcliffe, San Francisco, CA, for amicus curiae.

Before: LAY,^[2] HALL, and THOMPSON, Circuit Judges.

CYNTHIA HOLCOMB HALL, Circuit Judge:

In this case, we again consider the securities-fraud claims raised by disappointed investors in Software Toolworks, Inc., who appeal the district court's summary judgment in favor of auditors Deloitte & Touche and [1082] underwriters Montgomery Securities and PaineWebber, Inc. We affirm in part, reverse in part, and remand.

I.

In July 1990, Software Toolworks, Inc., a producer of software for personal computers and Nintendo game systems, conducted a secondary public offering of common stock at $18.50 a share, raising more than $71 million. After the offering, the market price of Toolworks' shares declined steadily until, on October 11, 1990, the stock was trading at $5.40 a share. At that time, Toolworks issued a press release announcing substantial losses and the share price dropped another fifty-six percent to $2.375.

The next day, several investors ("the plaintiffs") filed a class action alleging that Toolworks, auditor Deloitte & Touche ("Deloitte"), and underwriters Montgomery Securities and PaineWebber, Inc. ("the Underwriters") had issued a false and misleading prospectus and registration statement in violation of sections 11 and 12(2) of the Securities Act of 1933 ("the 1933 Act") and had knowingly defrauded and assisted in defrauding investors in violation of section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 ("the 1934 Act"). Specifically, the plaintiffs claimed that the defendants had (1) falsified audited financial statements for fiscal 1990 by reporting as revenue sales to original equipment manufacturers ("OEMs") with whom Toolworks had no binding agreements, (2) fabricated large consignment sales in order for Toolworks to meet financial projections for the first quarter of fiscal 1991 ("the June quarter"), and (3) lied to the Securities Exchange Commission ("SEC") in response to inquiries made before the registration statement became effective.

Toolworks and its officers quickly settled with the plaintiffs for $26.5 million. After the completion of discovery, the district court granted summary judgment in favor of the Underwriters on all claims and in favor of Deloitte on all claims other than one cause of action under section 11. See In re Software Toolworks, Inc. Sec. Litig., 789 F.Supp. 1489 (N.D.Cal.1992) [Toolworks I]. The district court held that (1) the Underwriters had established a "due diligence" defense under sections 11 and 12(2) as a matter of law, id. at 1494-98, (2) Deloitte had made no material misrepresentations or omissions, other than the OEM revenue statements, on which liability under sections 11 and 12(2) could attach, id. at 1510-11, and (3) the plaintiffs had failed to establish that any defendant acted with scienter, a necessary element of liability under section 10(b), id. at 1498-1510.

The plaintiffs dropped their remaining section 11 claim (regarding OEM revenue) against Deloitte and filed a timely appeal. We dismissed for lack of jurisdiction because the plaintiffs had failed to obtain Rule 54(b) certification to appeal the district court's nonfinal order. See Dannenberg v. Software Toolworks, Inc., 16 F.3d 1073 (9th Cir.1994) [Toolworks II]. The district court subsequently entered a Rule 54(b) order and the merits of the plaintiffs' appeal is now properly before us.

"We conduct de novo review of the district court's grant of summary judgment. In so doing, we are mindful that, although materiality and scienter are both fact-specific issues which should ordinarily be left to the trier of fact, summary judgment may be granted in appropriate cases. Summary judgment may be defeated in a securities fraud derivative suit only by showing a genuine issue of fact with regard to a particular statement by the company [or its professionals]...." Miller v. Pezzani (In re Worlds of Wonder Sec. Litig.), 35 F.3d 1407, 1412 (9th Cir.1994), (citations and quotations omitted) [WOW II].

II.

We first address the plaintiffs' claims against the Underwriters under sections 11 and 12(2) of the 1933 Act.^[3] Section 11 imposes liability "[i]n case any part of [a] registration statement ... contain[s] an untrue statement of a material fact or omit[s] to state a [1083] material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(a). Similarly, section 12(2) imposes liability for using a prospectus "which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading." Id. § 77l(2).

Liability under sections 11 and 12(2) properly may fall on the underwriters of a public offering. See id. §§ 77k(a)(5), 77l(2). Underwriters, however, may absolve themselves from liability by establishing a "due diligence" defense. Under section 11, underwriters must prove that they "had, after reasonable investigation, reasonable ground to believe and did believe ... that the statements therein were true and that there was no omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading." Id. § 77k(b)(3). Similarly, under section 12(2), underwriters must show that they "did not know, and in the exercise of reasonable care, could not have known, of [the] untruth or omission." Id. § 77l (2).

Because section 11's "reasonable investigation" standard is similar, if not identical, to section 12(2)'s "reasonable care" standard, see Sanders v. John Nuveen & Co., 619 F.2d 1222, 1228 (7th Cir.1980), cert. denied, 450 U.S. 1005, 101 S.Ct. 1719, 68 L.Ed.2d 210 (1981), the analysis of each on summary judgment is the same, see Weinberger v. Jackson, [1990-91] Fed.Sec.L.Rep. (CCH) ¶ 95,693 at 98,255, 1990 WL 260676 (N.D.Cal. 1990). In determining whether an underwriter meets the due diligence test under either provision, "the standard of reasonableness shall be that required of a prudent man in the management of his own property." 15 U.S.C. § 77k(c); see 17 C.F.R. § 230.176 (factors affecting the reasonableness of an investigation under section 11). Thus, due diligence is, "[i]n effect, ... a negligence standard." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 208, 96 S.Ct. 1375, 1388, 47 L.Ed.2d 668 (1976).

The district court held that the Underwriters had established due diligence as a matter of law and, accordingly, issued summary judgment against the plaintiffs on the section 11 and 12(2) claims. On appeal, the plaintiffs contend that due diligence is so fact-intensive that summary judgment is inappropriate even where underlying historical facts are undisputed. The plaintiffs further contend that, in any event, the district court erred by ignoring disputed issues of material fact in this case. We hold that, in appropriate cases, summary judgment may resolve due diligence issues but that, in this case, the district court erred by granting summary judgment in favor of the Underwriters on several claims.

A.

The plaintiffs first argue that "due diligence ... [and] the reasonableness of the defendants' investigation ... is a question for the jury, even on undisputed facts." We agree, of course, that summary judgment is generally an inappropriate way to decide questions of reasonableness because "the jury's unique competence in applying the `reasonable man' standard is thought ordinarily to preclude summary judgment." TSC Indus. v. Northway, Inc., 426 U.S. 438, 450 n. 12, 96 S.Ct. 2126, 2133 n. 12, 48 L.Ed.2d 757 (1975). We have, however, squarely rejected the contention that "reasonableness is always a question of fact which precludes summary judgment." West v. State Farm Fire & Casualty Co., 868 F.2d 348, 350 (9th Cir.1989) (emphasis added). Rather, reasonableness "becomes a question of law and loses its triable character if the undisputed facts leave no room for a reasonable difference of opinion." Id. Accordingly, "reasonableness [is] appropriate for determination on [a] motion for summary judgment when only one conclusion about the conduct's reasonableness is possible." Id. at 351. See TSC Indus., 426 U.S. at 450, 96 S.Ct. at 2132-33 (summary judgment proper where "reasonable minds cannot differ") (internal quotation omitted).

Courts therefore may resolve questions of due diligence in those cases where no rational jury could conclude that the defendant had not acted reasonably. Several courts have, in fact, done just that. See Weinberger, [1084] ¶ 95,693 at 98,255 (summary judgment in favor of underwriters); In re Avant-Garde Computing, Inc. Sec. Litig., No. 85-4149 (AET), 1989 WL 103625 at *7-*9 (D.N.J. Sept. 5, 1989) (summary judgment in favor of outside director); Laven v. Flanagan, 695 F.Supp. 800, 811-12 (D.N.J.1988) (summary judgment in favor of outside directors); cf. Bamco 15 v. Buchanan Residential Real Estate Ltd. Partnership, [1986-87] Fed.Sec. L.Rep. (CCH) ¶ 93,062 at 95,285-86, 1986 WL 15333 (S.D.N.Y.1986) (summary judgment in favor of plaintiff where defendant produced no evidence of due diligence).

The district court, therefore, properly held that "the adequacy of due diligence may be decided on summary judgment when the underlying historical facts are undisputed." Toolworks I, 789 F.Supp. at 1496.

B.

The plaintiffs next assert that, even if summary judgment may resolve due diligence issues in some cases, the district court erred in this case because three "hotly disputed" issues of material fact preclude summary judgment on the question of the Underwriters' due diligence. We consider each in turn.

1.

The plaintiffs first argue that the Underwriters failed to investigate properly Toolworks' Nintendo business. Specifically, the plaintiffs assert that the Underwriters should have discovered that, in contravention of statements in the prospectus, Toolworks had lowered prices on its Nintendo games and had "sold" significant inventory on a consignment basis, giving buyers an unqualified right to return unsold merchandise. See WOW II, 35 F.3d at 1418 ("a company that substantially overstates its revenues by reporting consignment transactions as sales makes false or misleading statements of material fact") (quotations omitted).

The district court disagreed, noting that the Underwriters had obtained written representations from Toolworks and Deloitte that the prospectus was accurate, had confirmed with Toolworks' customers that the company did not accept returns of non-defective cartridges, and had surveyed retailers to ensure that the company had not lowered its prices. Toolworks I, 789 F.Supp. at 1497. Thus, the court concluded that the Underwriters had, as a matter of law, "performed a thorough and reasonable investigation of Toolworks' Nintendo business." Id. For the following reasons, we agree.

a.

The plaintiffs argue that the prospectus was false and misleading because it stated that Toolworks' "Nintendo software products have not been subject to price reductions," when, in fact, Toolworks had begun a price-cutting promotion days before the offering. The plaintiffs, however, presented no direct evidence that the Underwriters knew of this promotion. Indeed, the record illustrates that Toolworks' management consistently assured the Underwriters that the company would not reduce prices. [See ER 279:31; ER 280:12; USER 281/Buoy 288; USER 281/Sherry 267]. The plaintiffs nevertheless assert that summary judgment was inappropriate because a jury might infer that the Underwriters knew about the price cuts because Toolworks' management discussed the promotion while on a private plane with the Underwriters. All personnel who were on the plane, however, testified that no conversations regarding price cutting reached the Underwriters. As such, any inference that the Underwriters knew about the sales would not be based in fact and would be unreasonable. See Weinberger, ¶ 95,693 at 98,255. The district court properly granted summary judgment in favor of the Underwriters on this issue.

b.

The plaintiffs also claim that the prospectus was false and misleading because it stated that Toolworks "does not currently provide any product return rights to its retail Nintendo customers," when, in fact, the company had booked several consignment sales prior to the offering. Again, however, the plaintiffs offered no direct evidence that the Underwriters knew about the sales, which represented a significant departure from prior Toolworks' policy. In fact, the record [1085] illustrates that the Underwriters made a substantial effort to ascertain Toolworks' return policy, both before and after the consignment sales occurred. The plaintiffs nevertheless assert that circumstantial evidence permits an inference that the Underwriters knowingly "watered down" the prospectus' risk-disclosure statement about merchandise returns and ignored a memorandum from one Toolworks customer ("Walmart") describing an unlimited right-of-return. This argument, however, misconstrues the full record.

In the process of drafting the prospectus, the Underwriters did change the risk-disclosure statement. An original draft stated that, "[i]n light of increased competition among the [Nintendo] entertainment titles on the market, it may be necessary for [Toolworks] to modify its return policy." [ER 289/322:22]. The final version stated only that "[t]here can be no assurance that [Toolworks] will not be subject to product returns in the future." [ER 289/15:8]. This change, however, is not sufficient to permit a reasonable inference that the Underwriters knew or should have known that Toolworks actually had changed its return policy. In fact, the Underwriters changed the disclosure statement in direct response to assertions by Toolworks' management that the company would never offer return rights and that the prospectus as originally written could prompt customers to seek such concessions in the future. [ER 317/Cartmell:136].

Moreover, although the Underwriters did receive a memorandum from Walmart describing an unqualified right to return nondefective merchandise, [ER 289/11], the record illustrates that Walmart never actually had such rights. Upon receiving the Walmart memorandum, the Underwriters called the retailer and confirmed that the statement regarding returns was erroneous (it should have said that Walmart had an unqualified right to return defective merchandise). [See ER 317/Sherry:252; USER 334/Zuckerman:89]. Thus, in light of this correction, the fact that the actual contract between Toolworks and Walmart provided only for the return of defective items, and the fact that Walmart never returned any undamaged products, an inference that the Underwriters attempted to conceal Toolworks' return policy would be unreasonable. The district court properly granted summary judgment in favor of the Underwriters on this issue.

2.

The plaintiffs next assert that a material issue of fact exists regarding whether the Underwriters diligently investigated, or needed to investigate, Toolworks' recognition of OEM revenue on its financial statements. The plaintiffs claim that the Underwriters "blindly rel[ied]" on Deloitte in spite of numerous "red flags" indicating that the OEM entries were incorrect and that, as a result, the district court erred in granting summary judgment.

An underwriter need not conduct due diligence into the "expertised" parts of a prospectus, such as certified financial statements. Rather, the underwriter need only show that it "had no reasonable ground to believe, and did not believe ... that the statements therein were untrue or that there was an omission to state a material fact required to be stated therein or necessary to make the statements therein not misleading." 15 U.S.C. § 77k(b)(3)(C); see WOW II, 35 F.3d at 1421. The issue on appeal, therefore, is whether the Underwriters' reliance on the expertised financial statements was reasonable as a matter of law.

a.

As the first "red flag," the plaintiffs point to Toolworks' "backdated" contract with Hyosung, a Korean manufacturer. During the fourth quarter of fiscal 1990, Toolworks recognized $1.7 million in revenue from an OEM contract with Hyosung. In due diligence, the Underwriters discovered a memorandum from Hyosung to Toolworks stating that Hyosung had "backdated" the agreement to permit Toolworks to recognize revenue in fiscal 1990. [ER 283:11]. The plaintiffs claim that, after discovering this memorandum, the Underwriters could no longer rely on Deloitte because the accountants had approved revenue recognition for the transaction.

[1086] If the Underwriters had done nothing more, the plaintiffs' contention might be correct. The plaintiffs, however, ignore the significant steps taken by the Underwriters after discovery of the Hyosung memorandum to ensure the accuracy of Deloitte's revenue recognition. The Underwriters first confronted Deloitte, which explained that it was proper for Toolworks to book revenue in fiscal 1990 because the company had contracted with Hyosung in March, even though the firms did not document the agreement until April. [ER 283:12-13]. The Underwriters then insisted that Deloitte reconfirm, in writing, the Hyosung agreement and Toolworks' other OEM contracts. [ER 283:12-13]. Finally, the Underwriters contacted other accounting firms to verify Deloitte's OEM revenue accounting methods. [ER 278:13].

Thus, with regard to the Hyosung agreement, the Underwriters did not "blindly rely" on Deloitte. The district court correctly held that, as a matter of law, the Underwriters' "investigation of the OEM business was reasonable." Toolworks I, 789 F.Supp. at 1498.

b.

The plaintiffs next assert that the Underwriters could not reasonably rely on Deloitte's financial statements because Toolworks' counsel, Riordan & McKinzie, refused to issue an opinion letter stating that the OEM agreements were binding contracts. This contention has no merit because, contrary to the plaintiffs' assertions, Toolworks had never requested the law firm to render such an opinion. [ER 317/Sylvester:36-42]. The plaintiffs attempt to infer wrongdoing in such circumstances is patently unreasonable. The district court correctly granted summary judgment in favor of the Underwriters on this issue.

c.

Finally, the plaintiffs assert that, by reading the agreements, the Underwriters should have realized that Toolworks had improperly recognized revenue. Specifically, the plaintiffs claim that several of the contracts were contingent and that it was facially apparent that Toolworks might not receive any revenue under them. As the Underwriters explain, this contention misconstrues the nature of a due diligence investigation:

[The Underwriters] reviewed the contracts to verify that there was a written agreement for each OEM contract mentioned in the Prospectus—not to analyze the propriety of revenue recognition, which was the responsibility of [Deloitte]. Given the complexity surrounding software licensing revenue recognition, it is absurd to suggest that, in perusing Toolworks' contracts, [the Underwriters] should have concluded that [Deloitte] w[as] wrong, particularly when the OEM's provided written confirmation.

We recently confirmed precisely this point in a case involving analogous facts: "[T]he defendants relied on Deloitte's accounting decisions (to recognize revenue) about the sales. Those expert decisions, which underlie the plaintiffs' attack on the financial statements, represent precisely the type of `certified' information on which section 11 permits nonexperts to rely." WOW II, 35 F.3d at 1421; see also In re Worlds of Wonder Sec. Litig., 814 F.Supp. 850, 864-65 (N.D.Cal.1993) ("It is absurd in these circumstances for Plaintiffs to suggest that the other defendants, who are not accountants, possibly could have known of any mistakes by Deloitte. Therefore, even if there are errors in the financial statements, no defendant except Deloitte can be liable under Section 11 on that basis.") [WOW I], aff'd in relevant part by WOW II, 35 F.3d at 1421.

Thus, because the Underwriters' reliance on Deloitte was reasonable under the circumstances, the district court correctly granted summary judgment on this issue. See Toolworks I, 789 F.Supp. at 1498 ("Given the complexity of the accounting issues, the Underwriters were entitled to rely on Deloitte's expertise.").

3.

The plaintiffs next attack the Underwriters' due diligence efforts for the period after Toolworks filed a preliminary prospectus and [1087] before the effective date of the offering.^[4] During this time, several significant events transpired. First, Barron's published a negative article about Toolworks that questioned the company's "aggressive accounting." [ER 289/22]. Second, in response to the Barron's article, the SEC initiated a review of Toolworks' prospectus. [ER 341/Weeks:32-33]. Third, Toolworks sent two letters responding to the SEC. And, fourth, Toolworks booked several consignment sales that made the company appear to have a prosperous quarter, thereby ensuring success of the offering.

The district court held that the Underwriters satisfied their due diligence obligations during this period primarily by relying on Toolworks' representations to the SEC. Id. at 1497-98. For the following reasons, we conclude that disputed issues of material fact exist regarding the Underwriters' efforts and, accordingly, we reverse and remand for a trial on the merits.

a.

The plaintiffs first contend that the Underwriters should have done more to investigate the Barron's allegations of slumping sales and improper accounting. The Underwriters established, however, that they contacted a representative of Nintendo and several large retailers to confirm the strength of the market in response to the Barron's article. Moreover, as explained above, the Underwriters' reliance on Deloitte's accounting decisions was reasonable as a matter of law. Summary judgment was appropriate on this issue.

b.

Next, the plaintiffs raise the issue of Toolworks' July 4, 1990 letter to the SEC, which described the company's June quarter performance. [ER 316/2006]. In the letter, Toolworks represented that, although preliminary financial data was not available, Toolworks anticipated revenue for the quarter between $21 and $22 million. The plaintiffs claim that Toolworks deliberately falsified these estimates and that the Underwriters knew of this deceit.

The Underwriters claim that they were not involved in drafting the July 4 SEC letter and that, as a result, they have no responsibility for its contents. The plaintiffs presented evidence, however, that the letter was a joint effort of all professionals working on the offering, including the Underwriters. In fact, a Riordan & McKinzie partner specifically testified that, "[w]hen the letter finally went to the SEC, all parties had been involved in the process of creating it. There had been conference calls discussing it and comments and changes made by a lot of different members of the working group." [ER 317/Weeks:40-41]. Others similarly testified that the Underwriters were actively involved in discussions of how to respond to the SEC's inquiries regarding the June quarter. [See ER 317/Barker:23-24; ER 317/Sylvester:18-19].

The Underwriters argue that, even if they participated in initial discussions about the letter, they never knew that Toolworks' financial data actually was available and that, as a result, they could not have known that the letter (and the prospectus) were misleading. Given the Underwriters participation in drafting both documents, however, we think this is an unresolved issue of material fact. A reasonable factfinder could infer that, as members of the drafting group, the Underwriters had access to all information that was available and deliberately chose to conceal the truth. We therefore hold that summary judgment was inappropriate on this issue.

c.

After suffering lagging sales in the first two months of the June quarter, Toolworks booked several large consignment sales in late June, the quarter's final month, thereby enabling the company to meet its earning projections. [ER 289/300:MB10048-49; ER 289/33; ER 289/502; ER 289/505]. [1088] Toolworks later had to reverse more than $7 million of these sales in its final financial statements for the quarter. [ER 322:20-26]. The plaintiffs presented evidence that the Underwriters knew that Toolworks had performed poorly in April, that Toolworks had no orders for the month as of June 8, that the June quarter is traditionally the slowest of the year for Nintendo sales, and that the late June sales accounted for more revenue than the cumulative total of Toolworks' Nintendo sales for the prior two and a half months. For its due diligence investigation of these sales, however, the Underwriters did little more than rely on Toolworks' assurances that the transactions were legitimate. A reasonable inference from this evidence is that Toolworks fabricated the June sales to ensure that the offering would proceed and that the Underwriters knew, or should have known, of this fraud. As a result, we conclude that summary judgment regarding the Underwriters' diligence on this issue was also inappropriate. See Feit v. Leasco Data Processing Equip. Corp., 332 F.Supp. 544, 582 (E.D.N.Y.1971) ("Tacit reliance on management is unacceptable; the underwriters must play devil's advocate.").

C.

Thus, we hold that the district court properly granted summary judgment in favor of the Underwriters on the section 11 and 12(2) issues regarding their due diligence investigation into Toolworks' Nintendo sales practices and description of OEM revenue. The district court erred, however, by granting summary judgment on the section 11 and 12(2) claims regarding the July 4 SEC letter and Toolworks' June quarter results. We remand for a trial on the merits of those claims.

III.

We next consider the plaintiffs' claims against the Underwriters and Deloitte under section 10(b) and Rule 10b-5 of the 1934 Act, which provide liability for deceptive conduct in connection with the sale of securities. 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5. To establish liability under section 10(b), the plaintiffs must show that the defendants acted with scienter, "a mental state embracing intent to deceive, manipulate, or defraud." Hochfelder, 425 U.S. at 194 n. 12, 96 S.Ct. at 1381 n. 12. The plaintiffs may establish scienter by proving either actual knowledge or recklessness. E.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir.1990) (en banc), cert. denied, 499 U.S. 976, 111 S.Ct. 1621, 113 L.Ed.2d 719 (1991). In this context, "recklessness" is conduct "involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it." Id. at 1569 (internal quotation omitted).

The district court granted summary judgment in favor of the Underwriters and Deloitte, holding that the defendants had not acted with scienter as a matter of law. Toolworks I, 789 F.Supp. at 1498-1510. Summary judgment on the scienter issue is appropriate only if "there is no rational basis in the record for concluding that any of the challenged statements was made with the requisite scienter." Schneider v. Vennard (In re Apple Computer Sec. Litig.), 886 F.2d 1109, 1117 (9th Cir.1989), cert. denied, 496 U.S. 943, 110 S.Ct. 3229, 110 L.Ed.2d 676 (1990). We conclude that disputed issues of material fact exist and, as a result, we reverse and remand several of the claims under section 10(b).

A.

The plaintiffs raise the same issues against the Underwriters under section 10(b) as under sections 11 and 12(2). Because we conclude that the Underwriters acted with due diligence in investigating Toolworks' Nintendo business and OEM revenues, we also hold that the Underwriters did not act with scienter regarding those claims. Therefore, the only section 10(b) issue involving the Underwriters is whether disputed issues of material fact exist regarding the July 4 SEC letter or the June quarter financial statements. We hold that they do.

[1089] The plaintiffs presented no evidence of the Underwriters' actual knowledge or fraudulent intent on these issues. As noted above, however, the evidence permits a reasonable inference that "the Underwriters had access to all information that was available and deliberately chose to conceal the truth" about figures in the July 4 SEC letter, supra pages 1087-88, and that "the Underwriters knew, or should have known, of th[e] [alleged] fraud" in the June quarter statements, supra pages 1087-88. This evidence is sufficient to defeat summary judgment on the scienter issue. We therefore remand for trial on these section 10(b) claims.

B.

Regarding Deloitte, the plaintiffs allege that the accountants violated section 10(b) by improperly computing the financial statements included in Toolworks' prospectus, by assisting Toolworks in drafting misleading letters to the SEC, and by enabling Toolworks to issue false financial statements for the June quarter. We consider each contention in turn.

1.

Toolworks included in the prospectus financial statements for fiscal 1990, which had been certified by Deloitte. The plaintiffs allege that Deloitte violated section 10(b) by improperly describing Toolworks' OEM revenues and by failing to discover Toolworks' price reductions and return policies. We disagree.

a.

In the district court, Deloitte conceded that the plaintiffs had raised a genuine issue of material fact as to whether the prospectus properly accounted for the OEM revenues. Toolworks I, 789 F.Supp. at 1504. Deloitte, however, contends that the plaintiffs presented no evidence that would support an inference of scienter with regard to this issue. The plaintiffs presented no direct evidence that Deloitte knew or recklessly disregarded errors in the financial statements. The plaintiffs did, however, produce circumstantial evidence with which they seek to infer that Deloitte acted with scienter. For example, the plaintiffs established that the OEM agreements were poorly documented, informal, and conditional [ER 297/Kumaria:439], that the OEM licensing transactions were risky [ER 296/851], that Toolworks' management was under "extraordinary pressure" for favorable earnings [ER 297/956], and that Deloitte obtained only oral confirmations of some agreements [ER 271:9] and deviated from their audit plan in reviewing the contracts [ER 295:27-28].

The district court found this evidence insufficient to support an inference of scienter. The court noted that Deloitte had reviewed the OEM documentation, obtained oral and written confirmation of the agreements from Toolworks' management, confirmed in writing most of the OEM agreements with outside vendors, obtained and reviewed Toolworks' licensing agreements, and reviewed the progress of Toolworks' collections on the OEM agreements. Id. at 1505. The court concluded that "[t]hese procedures provided Deloitte with ample support for the audit conclusions it reached.... Plaintiffs' contention ... that Deloitte should have performed further inquiries and investigations, arguing with the benefit of hindsight, does not establish that the [] audit was reckless." Id. We agree.

"[T]he proof of scienter in fraud cases is often a matter of inference from circumstantial evidence." Herman & MacLean v. Huddleston, 459 U.S. 375, 390 n. 30, 103 S.Ct. 683, 692 n. 30, 74 L.Ed.2d 548 (1982). However, "[t]he mere publication of inaccurate accounting figures, or a failure to follow GAAP, without more, does not establish scienter." WOW II, 35 F.3d at 1426 (quotations omitted); see, e.g., The Limited, Inc. v. McCrory Corp., 645 F.Supp. 1038, 1045 (S.D.N.Y.1986) (errors in a client's financial statements do not give rise to an inference of fraud on the part of the auditor). Rather, "[s]cienter requires more than a misapplication of accounting principles. The plaintiff must prove that the accounting practices were so deficient that the audit amounted to no audit at all, or an egregious refusal to see the obvious, or to investigate the doubtful, or that the accounting judgments [1090] which were made were such that no reasonable accountant would have made the same decisions if confronted with the same facts." WOW II, 35 F.3d at 1426 (quotations omitted).

In this case, the plaintiffs have not satisfied this standard. At most, the evidence establishes that Deloitte was negligent in auditing Toolworks, not that Deloitte recklessly or knowingly falsified the financial statements. The plaintiffs' expert, Albert Rossi, does not help their case. Although Rossi testified that Deloitte "knew that the OEM agreements did not meet Toolworks' or GAAP's requirements for revenue recognition," [ER 295:33-34], he provided no factual basis for these allegations of knowledge by Deloitte. As a result, his testimony merely "consists of self-righteous statements that, because Deloitte did not audit [Toolworks] as he would have done, Deloitte must have acted fraudulently. Such evidence is not sufficient." Id. at 1426; see WOW I, 814 F.Supp. at 871 n. 15 ("this is not the first time that a district court has awarded summary judgment to an auditor on the scienter issue in the face of a declaration by Rossi").

We therefore affirm the district court's summary judgment on the OEM revenue issue.

b.

The plaintiffs also claim that Deloitte should have included in the 1990 financial statements a description of Toolworks' return and price protection policies. Deloitte correctly notes, however, that Toolworks did not grant return rights or price guarantees until fiscal 1991, after the 1990 audit was complete. The plaintiffs presented no evidence that Deloitte knew, or should have known, that Toolworks would change its policies. In fact, Toolworks acquired the Nintendo business only at the very end of fiscal 1990. [ER 296/15:F-9]. The failure of Deloitte to include statements about Toolworks' not-yet-implemented return and pricing policies does not give rise to a reasonable inference of scienter. See Laven, 695 F.Supp. at 812 ("summary judgment can be granted if plaintiff fails to present credible evidence of scienter"). The district court's summary judgment in favor of Deloitte on this issue was therefore appropriate.

2.

The plaintiffs next contend that Deloitte violated section 10(b) by participating in drafting the two letters that Toolworks sent to the SEC.^[5] As noted above, the plaintiffs allege that the letters falsely stated that Toolworks did not have preliminary financial data available for the June quarter and misleadingly described the nature of Toolworks' OEM contracts.

a.

On July 3, 1990, the SEC told Toolworks that it should disclose "preliminary results" for the June quarter in the prospectus. [ER 316/35]. In its July 4 response, Toolworks stated that "[p]reliminary financial data is not now available," but that the company "anticipated" revenues for the quarter to range between $21 and $22 million. [ER 316/2006]. Toolworks, however, had acknowledged to the professionals participating in the offering that some financial data for the quarter actually was available. [ER 317/ Weeks:77-82]. The plaintiffs allege that, as a result, the statement to the SEC was a deliberate falsehood and that Deloitte violated [1091] section 10(b) by suggesting in the July 4 SEC letter that preliminary data was not available and by acquiescing to financial projections which they knew, or should have known, to be false. We agree for the same reasons that we have reversed the summary judgment in favor of the Underwriters on this issue. Specifically, we conclude that "[a] reasonable factfinder could infer that, as members of the drafting group, [Deloitte] had access to all information that was available and deliberately chose to conceal the truth" about Toolworks' poor June quarter performance, supra pages 1087-88. Summary judgment was inappropriate on this issue.

b.

In its July 1 letter to the SEC, Toolworks attached a "model" OEM agreement for the SEC to review. [ER 296/234]. The plaintiffs claim that the letter was false and misleading because the model agreement differed from the agreements that Toolworks actually used. We agree.

The model OEM agreement stated that "in no event shall the OEM be relieved from any minimum payment obligations." [ER 296/234]. None of Toolworks' actual OEM contracts, however, contained such language. Deloitte therefore should have been aware that the model agreement was false and misleading, and inclusion of the model agreement with the July 1 SEC letter gives rise to a reasonable inference that Deloitte knew or recklessly disregarded this falsehood. Deloitte claims that it did not draft, or even see, the model agreement and cannot therefore be liable for it. Deloitte, however, ignores the fact that the misleading language of the model agreement was actually quoted in the body of the July 1 SEC letter itself, which Deloitte admittedly saw. [ER 296/234:6]. We hold that summary judgment was therefore inappropriate as to this issue.

3.

Finally, the plaintiffs allege that Deloitte violated section 10(b) by enabling Toolworks to issue preliminary financial statements for the June quarter. See Toolworks I, 789 F.Supp. at 1506-07. The plaintiffs admit, however, that "[a]s to the[se] quarterly financial statements, the Complaint [only] charged Deloitte with aiding and abetting" Toolworks' primary violation of section 10(b). As a result, under Central Bank the plaintiffs' claims are no longer viable. Central Bank, ___ U.S. at ___, 114 S.Ct. at 1455 ("a private plaintiff may not maintain an aiding and abetting suit under § 10(b)"). We therefore affirm the district court's summary judgment in favor of Deloitte on this issue.

C.

In summary, we conclude that, although the district court properly granted summary judgment in favor of the Underwriters and Deloitte on most of the section 10(b) claims, summary judgment was inappropriate on the issues regarding the SEC letters and Toolworks' June quarter results. We remand those claims.

IV.

The district court properly granted summary judgment in favor of the Underwriters on the section 11 and 12(2) claims regarding Toolworks' Nintendo sales and OEM accounting. The court erred, however, by ignoring disputed issues of material fact regarding the Underwriters' due diligence investigation of Toolworks' financial performance in the June quarter and the description of that performance in the July 4 SEC letter. Summary judgment was inappropriate on those issues.

Furthermore, the district court properly granted summary judgment in favor of the Underwriters on all the section 10(b) claims other than those arising from the July 4 SEC letter and the June quarter statements. The court also properly granted summary judgment in favor of Deloitte on the section 10(b) claims regarding recognition of OEM revenues in the audited financial statements appended to the prospectus. The district court erred, however, in granting summary judgment in favor of Deloitte on the section 10(b) claims regarding the SEC letters and Toolworks' unaudited financial statements for the June quarter.

[1092] We therefore affirm in part, reverse in part, and remand for further proceedings consistent with this opinion.

AFFIRMED in part. REVERSED in part. REMANDED.

[1] This panel unanimously agrees that this case is appropriate for submission without oral argument. Fed.R.App.P. 34(a); 9th Cir.R. 34-4.

[2] The Honorable Donald P. Lay, Senior Circuit Judge for the Eighth Circuit, sitting by designation.

[3] The plaintiffs do not appeal the district court's partial summary judgment in favor of Deloitte on the section 11 and 12(2) claims.

[4] The Underwriters' contention that the events of this period are inapplicable to sections 11 and 12(2) liability is clearly incorrect. Both statutory provisions require disclosure of information needed in order to make a prospectus truthful and not misleading. As the Underwriters' own experts testified, poor first quarter earnings prior to the effective date of the offering would definitely constitute material information and would have to be disclosed.

[5] The district court analyzed this issue in terms whether Deloitte was liable for "aiding and abetting" Toolworks' primary violation of section 10(b). See Toolworks I, 789 F.Supp. at 1507-09. After the district court issued its opinion, however, the Supreme Court concluded that aiding and abetting liability does not exist under section 10(b). See Central Bank v. First Interstate Bank, ___ U.S. ___, 114 S.Ct. 1439, 128 L.Ed.2d 119 (1994).

Despite Central Bank, we nevertheless consider this issue because the plaintiffs' complaint clearly alleges that Deloitte is primarily liable under section 10(b) for the SEC letters. In fact, the July 1 SEC letter stated that it "was prepared after extensive review and discussions with ... Deloitte" and actually referred the SEC to two Deloitte partners for further information. [ER 296:234]. Similarly, the plaintiffs presented evidence that Deloitte played a significant role in drafting and editing the July 4 SEC letter. [ER 317/Weeks:40-41]. This evidence is sufficient to sustain a primary cause of action under section 10(b) and, as a result, Central Bank does not absolve Deloitte on these issues.

41 A.3d 432 (2012)

[433] Stuart M. Grant, Esquire, Megan D. McIntyre, Esquire, Christine M. Mackintosh, Esquire, Grant & Eisenhofer P.A., Wilmington, Delaware; Christine S. Azar, Esquire, Charles B. Vincent, Esquire, Labaton Sucharow LLP, Wilmington, Delaware; Mark Lebovitch, Esquire, Jeremy Friedman, Esquire, Bernstein Litowitz Berger & Grossmann LLP, New York, New York, Ira Schochet, Esquire, Labaton Sucharow LLP, New York, New York, Attorneys for Plaintiffs.

Donald J. Wolfe, Jr., Esquire, T. Brad Davey, Esquire, Samuel L. Closic, Esquire, Potter Anderson & Corroon LLP, Wilmington, Delaware; Paul K. Rowe, Esquire, Stephen R. DiPrima, Esquire, Bradley R. Wilson, Esquire, Michael Gerber, Esquire, Benjamin D. Schireson, Esquire, Wachtell, Lipton, Rosen & Katz, New York, New York, Attorneys for Defendants Juan Carlos Braniff, David W. Crane, Douglas L. Foshee, Robert W. Goldman, Anthony W. Hall, Jr., Thomas R. Hix, Ferrell P. McClean, Timothy J. Probert, Steven Shapiro, J. Michael Talbert, Robert F. Vagt, and John L. Whitmire.

Collins J. Seitz, Jr., Esquire, Bradley R. Aronstam, Esquire, Seitz Ross Aronstam & Moritz LLP, Wilmington, Delaware; Joseph S. Allerhand, Esquire, Seth Goodchild, Esquire, Michael Bell, Esquire, Weil, Gotshal & Manges LLP, New York, New York, Attorneys for Defendants Kinder Morgan, Inc., Sherpa Merger Sub, Inc., and Sherpa Acquisition, LLC.

Gregory V. Varallo, Esquire, Raymond J. DiCamillo, Esquire, Kevin M. Gallagher, Esquire, Richards, Layton & Finger, P.A., Wilmington, Delaware; John L. Hardiman, Esquire, Sullivan & Cromwell, LLP, New York, New York; Bruce D. Oakley, Esquire, Hogan Lovells U.S. LLP, Houston, Texas, Attorneys for The Goldman Sachs Group, Inc. and Goldman, Sachs & Co.

OPINION

STRINE, Chancellor.

I.

Stockholder plaintiffs seek a preliminary injunction to enjoin a merger between El Paso Corporation and Kinder Morgan, Inc. (the "Merger").

The chief executive officer of El Paso, a public company, undertook sole responsibility for negotiating the sale of El Paso to Kinder Morgan in the Merger. Kinder [434] Morgan intended to keep El Paso's pipeline business and sell off El Paso's exploration and production, or "E & P," business to finance the purchase. The CEO did not disclose to the El Paso board of directors (the "Board") his interest in working with other El Paso managers in making a bid to buy the E & P business from Kinder Morgan. He kept that motive secret, negotiated the Merger, and then approached Kinder Morgan's CEO on two occasions to try to interest him in the idea. In other words, when El Paso's CEO was supposed to be getting the maximum price from Kinder Morgan, he actually had an interest in not doing that.

This undisclosed conflict of interest compounded the reality that the Board and management of El Paso relied in part on advice given by a financial advisor, Goldman, Sachs & Co., which owned 19% of Kinder Morgan (a $4 billion investment) and controlled two Kinder Morgan board seats. Although Goldman's conflict was known, inadequate efforts to cabin its role were made. When a second investment bank was brought in to address Goldman's economic incentive for a deal with, and on terms that favored, Kinder Morgan, Goldman continued to intervene and advise El Paso on strategic alternatives, and with its friends in El Paso management, was able to achieve a remarkable feat: giving the new investment bank an incentive to favor the Merger by making sure that this bank only got paid if El Paso adopted the strategic option of selling to Kinder Morgan. In other words, the conflict-cleansing bank only got paid if the option Goldman's financial incentives gave it a reason to prefer was the one chosen. On top of this, the lead Goldman banker advising El Paso did not disclose that he personally owned approximately $340,000 of stock in Kinder Morgan.

The record is filled with debatable negotiating and tactical choices made by El Paso fiduciaries and advisors. Absent a conflict of interest, these debatable choices could be seen as the sort of reasonable, if arguable, ones that must be made in a world of uncertainty. After discovery, however, these choices now must be viewed more skeptically, as the key negotiator on behalf of the Board and a powerfully influential financial advisor each had financial motives adverse to the best interests of El Paso's stockholders. In the case of the CEO, he was the one who made most of the important tactical choices, and he never surfaced his own conflict of interest. In the case of Goldman, it claimed to step out of the process while failing to do so completely and while playing a key role in distorting the economic incentives of the bank that came in to ensure that Goldman's conflict did not taint the Board's deliberations. This behavior makes it difficult to conclude that the Board's less than aggressive negotiating strategy and its failure to test Kinder Morgan's bid actively in the market through even a quiet, soft market check were not compromised by the conflicting financial incentives of these key players.

The record thus persuades me that the plaintiffs have a reasonable likelihood of success in proving that the Merger was tainted by disloyalty. Because, however, there is no other bid on the table and the stockholders of El Paso, as the seller, have a choice whether to turn down the Merger themselves, the balance of harms counsels against a preliminary injunction. Although the pursuit of a monetary damages award may not be likely to promise full relief, the record does not instill in me the confidence to deny, by grant of an injunction, El Paso's stockholders from accepting a transaction that they may find desirable in current market conditions, despite the [435] disturbing behavior that led to its final terms.

II.

The plaintiffs are stockholders of El Paso and seek to enjoin a vote on a proposed Merger with Kinder Morgan that offers El Paso a combination of cash, stock, and warrants now valued at $30.37 per share, or a 47.8% premium over El Paso's stock price thirty days before Kinder Morgan made its first bid.^[1] At the time of signing, the Merger consideration was worth $26.87 per share, and has appreciated since the announcement because Kinder Morgan's stock has grown in value. In order to obtain a preliminary injunction, the plaintiffs must demonstrate: (1) a reasonable probability of success on the merits; (2) that they will suffer irreparable harm if an injunction does not issue; and (3) that the balance of the equities favors the issuance of an injunction.^[2]

The Merger resulted from a non-public overture that Kinder Morgan made in the wake of El Paso's public announcement that it would spin off its E & P business. El Paso is an energy company composed of two main business segments: a pipeline business, which transports natural gas throughout the United States, and the E & P business, which looks for and exploits opportunities to drill and produce oil and natural gas. The market had reacted favorably to the May 24, 2011 announcement of the spin-off, and El Paso's stock price had risen, although El Paso believed that its stock price would rise further when the spin-off was actually effected. El Paso understood that Kinder Morgan was trying to preempt any competition by other bidders for what would be the separate pipeline business, which is the business Kinder Morgan wanted to buy, by making a bid before El Paso divided into two companies.^[3]

The first time after the spin-off announcement that Kinder Morgan expressed its interest in acquiring El Paso was on August 30, 2011, when Kinder Morgan offered El Paso $25.50 per share in cash and stock.^[4] The El Paso Board fended this off weakly, despite believing that the price was not attractive and that Kinder Morgan was hoping to preempt any market competition for El Paso's pipeline business by acquiring all of El Paso before the spin-off was effected. On September 9, 2011, Kinder Morgan threatened to go public with its interest in buying El Paso. Rather than seeing this as a chance to force Kinder Morgan into an expensive public struggle, the Board entered into negotiations with Kinder Morgan. The Board looked to its longtime advisor Goldman Sachs (which as noted owns 19% of Kinder Morgan, fills two seats on the Kinder Morgan board under a voting agreement with Kinder Morgan's CEO and controlling stockholder, Rich Kinder, and is part of the control group which [436] collectively holds 78.4% of the voting power of Kinder Morgan stock)^[5] and a new advisor, Morgan Stanley & Co., LLC, for financial and tactical advice in making that decision and for developing its negotiating strategy. On September 16, 2011, El Paso asked Kinder Morgan for a bid of $28 per share in cash and stock, deploying the company's CEO, Doug Foshee, as its sole negotiator.^[6] Foshee reached an agreement in principle with Rich Kinder two days later on a deal at $27.55 per share in cash and stock, subject to due diligence by Kinder Morgan. The basic terms of the agreement in principle were memorialized in a series of term sheets exchanged between the parties between September 20, 2011 and September 22, 2011.

Soon thereafter, on September 23, 2011, Kinder said "oops, we made a mistake. We relied on a bullish set of analyst projections in order to make our bid. Our bad. Although we were tough enough to threaten going hostile, we just can't stand by our bid."

Instead of telling Kinder where to put his drilling equipment, Foshee backed down. In a downward spiral, El Paso ended up taking a package that was valued at $26.87 as of signing on October 16, 2011, comprised of $25.91 in cash and stock, and a warrant with a strike price of $40—some $13 above Kinder Morgan's then-current stock price of $26.89 per share^[7]—and no protection against ordinary dividends.^[8]

Still, the deal was at a substantial premium to market,^[9] and the Board was advised by Morgan Stanley (and also by the analyses of Goldman—which had, and continued to, advise El Paso on the spin-off of the E & P business) that the offer was more attractive in the immediate term than doing the spin-off and had less execution risk, because Kinder Morgan had agreed to a great deal of closing certainty. Thus, the Board approved the Merger.

On October 16, 2011, the parties entered into the "Merger Agreement." The Merger Agreement contains a commitment from El Paso to assist Kinder Morgan in the sale of the E & P business, which Kinder Morgan hoped could be accomplished before the closing of the Merger.^[10] The [437] Merger Agreement also contains a "no-shop" provision preventing El Paso from affirmatively soliciting higher bids, but gives the Board a fiduciary out in the event it receives a "Superior Proposal" from a third party for more than 50% of El Paso's equity securities or consolidated assets.^[11] These measures preclude El Paso from abandoning the Merger in order to pursue a sale of the E & P assets because the E & P assets make up less than 50% of El Paso's consolidated assets.^[12] By contrast, El Paso could terminate the Merger Agreement to pursue a sale of the pipeline business (which makes up more than 50% of the company's consolidated assets), but Kinder Morgan has a right to match any such Superior Proposal.^[13] In the event that the Board accepts a Superior Proposal, El Paso must pay a $650 million termination fee to Kinder Morgan.^[14] In terms of the overall deal size, the termination fee represents 3.1% of the equity value and 1.69% of the enterprise value of El Paso as implied by the Merger Agreement.^[15] Thus, to buy just the pipeline business, an interloper would have to pay a termination fee that was, say, 5.1% of the equity value and 2.5% of the enterprise value of El Paso's pipeline business, assuming it comprised around 60.3% of El Paso's equity value and 67% of El Paso's enterprise value at the time of signing.^[16]

Since the signing of the Merger Agreement, the price of Kinder Morgan's shares has risen, increasing the value of the Merger consideration.

III.

Despite the premium to market, the plaintiffs contend that the Merger is tainted by the selfish motivations of both Doug Foshee and Goldman Sachs. As the plaintiffs point out, there were numerous decisions made by the El Paso Board during the process that could be seen as questionable. These include:

• The failure of the Board to shop El Paso as a whole or its two key divisions separately to any other bidder after Kinder Morgan made its initial overture, despite knowing that Kinder Morgan was hoping to preempt competition by bidding for the whole company,^[17] and despite knowing that although there would be a number of bidders for the company's two key divisions if marketed separately, there was unlikely to be any rival to Kinder [438] Morgan willing to purchase El Paso as a whole;^[18]

• The failure of the Board to reject Kinder Morgan's initial overtures and force it to go public and face the market pressure to raise its offer to a level where it could prevail in a hostile takeover bid;

• Charging Foshee with handling all negotiations with Kinder Morgan without any presence or close supervision by an independent director or legal advisor;

• Allowing Kinder Morgan (a supposedly tough, potential hostile bidder) to renege on an agreement in principle to pay cash and stock equal to $27.55 entered into on September 18, 2011 (a package that would likely be worth $31.76 today assuming current market prices^[19]) based on the (arguably ludicrous) assertion that it had based its bid on the cash flow estimates of the most bullish analyst covering El Paso's stock;

• Signing on to deal protection measures that would effectively preclude a post-signing market check for bids for the separate divisions because of the limited fiduciary out, which precludes the Board from accepting a topping bid for the E & P business, and which makes the emergence of a topping bid for the pipeline business difficult because of the $650 million termination fee and Kinder Morgan's matching rights; and

• Eventually agreeing to a deal that only provided El Paso stockholders with cash and stock equal to $25.91 in value (excluding the warrant), far less than the $27.55 previously agreed to by Kinder Morgan.

The plaintiffs also take issue with the fact that the final price of $25.91 in cash and stock was reached when Foshee, without Board approval, told Kinder Morgan that he would be open to a deal whereby Kinder Morgan would only pay $26 per share in cash and stock, a full $0.50 per share less than the counter-offer that the Board had authorized him to put on the table.^[20] Even then, Foshee did not get $26 in cash and stock. Instead, he got only $25.91 in cash and stock, with Kinder Morgan adding in a warrant with a high strike price and weak protection against dividends to Kinder Morgan stockholders. [439] The Board valued this package at $26.87 on the date of signing, $0.68 below the $27.55 per share that Kinder Morgan had agreed to after threatening to go hostile just weeks earlier. Despite that, the Board decided that the lower price should be accepted and was more favorable to El Paso's stockholders than the strategic alternative, which involved the previously announced spin-off of El Paso's E & P business.

IV.

Although a reasonable mind might debate the tactical choices made by the El Paso Board, these choices would provide little basis for enjoining a third-party merger approved by a board overwhelmingly comprised of independent directors, many of whom have substantial industry experience. The Revlon doctrine, after all, does not exist as a license for courts to second-guess reasonable, but arguable, questions of business judgment in the change of control context, but to ensure that the directors take reasonable steps to obtain the highest value reasonably attainable and that their actions are not compromised by impermissible considerations, such as self-interest.^[21] So long as the directors made reasonable decisions for a proper purpose, they meet their duty under Revlon and this court must defer.^[22]

By contrast, when there is a reason to conclude that debatable tactical decisions were motivated not by a principled evaluation of the risks and benefits to the company's stockholders, but by a fiduciary's consideration of his own financial or other personal self-interests, then the core animating principle of Revlon is implicated.^[23] As Revlon itself made clear, the potential sale of a corporation has enormous implications for corporate managers and advisors, and a range of human motivations, including but by no means limited to greed, can inspire fiduciaries and their advisors to be less than faithful to their contextual duty to pursue the best value for the company's stockholders.^[24]

Here, the defendants allege that the current case fits neatly within that line of cases where this court deferred to boards that made reasonable, if questionable, decisions in deciding how to consummate a change of control transaction.^[25] They argue [440] that a well-motivated board, with an excellent, well-motivated CEO, used the favorable market reaction to the company's announced spin-off to secure an even more favorable outcome: a sales transaction securing for El Paso a large premium to market with far less execution risk than the spin-off entailed. The defendants begrudgingly concede that El Paso's long-standing financial advisor, Goldman, had a "potential conflict"^[26] because: (1) it owned approximately 19%, or $4 billion worth, of Kinder Morgan stock; (2) it controlled two of Kinder Morgan's board seats; (3) it had placed two senior Goldman principals on the Kinder Morgan board who thus owed Kinder Morgan fiduciary duties; and (4) the lead Goldman banker working for El Paso, Steve Daniel, personally owned approximately $340,000 of Kinder Morgan stock.^[27] But, the defendants argue that Goldman was walled off from giving strategic advice about the Kinder Morgan bid early in the process and another top-tier bank, Morgan Stanley, came in and gave unconflicted advice.

Regrettably for the defendants, the record developed in expedited discovery belies their argument that there is no reason to question the motives behind the decisions made by El Paso in negotiating the Merger Agreement. Although it is true that measures were taken to cabin Goldman's conflict (for example, Goldman formally set up an internal "Chinese wall" between the Goldman advisors to El Paso and the Goldman representatives responsible for the firm's Kinder Morgan investment)^[28] —which was actual and potent, not merely potential—those efforts were not effective. Goldman still played an important role in advising the Board by suggesting that the Board should avoid causing Kinder Morgan to go hostile and by presenting information about the value of pursuing the spin-off instead of the Kinder Morgan deal. Indeed, Goldman's advice to placate Kinder Morgan by entering into due diligence "raised [El Paso] management's concerns" that the Goldman team was "receiving pressure from other parts of Goldman Sachs to avoid a strategy that might result in [Kinder Morgan] going public and making a hostile approach on [El Paso],"^[29] prompting El Paso to exclude Goldman from internal tactical discussions about how to respond to Kinder Morgan from September 15, 2011 onwards.^[30]

[441] Even then, though, Goldman was not out of the picture entirely, as El Paso management only thought it was necessary to limit Goldman's involvement in the Kinder Morgan side of the advisory work. Goldman continued its role as primary financial advisor to El Paso for the spin-off, and was asked to continue to provide financial updates to the Board that would enable the El Paso directors to compare the spin-off to the Merger.

The fact that Goldman continued to have its hands in the dough of the spin-off is important, because the Board was assessing the attractiveness of the Merger relative to the attractiveness of the spin-off. That was critical because the Board, at the recommendation of Foshee, Goldman, and Morgan Stanley, decided not to risk Kinder Morgan going hostile and not to do any test of the market with other possible buyers of El Paso as a whole, or of either or both of its two key business segments separately. Thus, the Board was down to two strategic options: the spin-off or a sale to Kinder Morgan. Therefore, because Goldman stayed involved as the lead advisor on the spin-off, it was in a position to continue to exert influence over the Merger. The record suggests that there were questionable aspects to Goldman's valuation of the spin-off and its continued revision downward that could be seen as suspicious in light of Goldman's huge financial interest in Kinder Morgan.^[31]

[442] Heightening these suspicions is the fact that Goldman's lead banker failed to disclose his own personal ownership of approximately $340,000 in Kinder Morgan stock, a very troubling failure that tends to undercut the credibility of his testimony and of the strategic advice he gave.^[32]

Even worse, Goldman tainted the cleansing effect of Morgan Stanley. Goldman clung to its previously obtained contract to make it the exclusive advisor on the spin-off and which promised Goldman $25 million in fees if the spin-off was completed. Despite the reality that Morgan Stanley was retained to address Goldman's bias toward a suboptimally priced deal with Kinder Morgan and thus Morgan Stanley's work in evaluating whether the spin-off was a more valuable option was critical to its integrity-enforcing role, Goldman refused to concede that Morgan Stanley should be paid anything if the spin-off, rather than the Merger, was consummated. Goldman's friends in El Paso management—and that is what they seem to have been—easily gave in to Goldman.^[33] This resulted in an incentive structure like this for Morgan Stanley:

• Approve a deal with Kinder Morgan (the entity of which Goldman owned 19%)—get $35 million; or

• Counsel the Board to go with the spin-off or to pursue another option—get zilch, nada, zero.^[34]

This makes more questionable some of the tactical advice given by Morgan Stanley and some of its valuation advice, which can be viewed as stretching to make Kinder Morgan's offers more favorable than other available options.^[35] Then, despite [443] saying that it did not advise on the Merger—a claim that the record does not bear out in large measure—Goldman asked for a $20 million fee for its work on the Merger. Of course, by the same logic it used to shut out Morgan Stanley from receiving any fee for the spin-off, Goldman should have been foreclosed from getting fees for working on the Merger when it supposedly was walled off from advising on that deal. But, Goldman's affectionate clients, more wed to Goldman than to logical consistency, quickly assented to this demand.^[36]

Worst of all was that the supposedly well-motivated and expert CEO entrusted with all the key price negotiations kept from the Board his interest in pursuing a management buy-out of the Company's E & P business. Knowing that Kinder Morgan intended to sell the E & P business in order to finance its overall purchase of El Paso, Foshee spoke with fellow El Paso manager Brent Smolik, the head of the E & P business, about approaching Kinder Morgan with a management bid for the E & P assets. The record does not make clear exactly when the idea of an MBO first occurred to Foshee, but an email exchange between Smolik and John Sult (the CFO of El Paso) suggests that Smolik and Foshee were discussing the MBO opportunity while Foshee was negotiating the Merger terms with Rich Kinder.^[37] Rather than disclose that he was contemplating an MBO to the Board, Foshee kept this information to himself, and even told Smolik that he wanted to discuss the MBO "as late [in the process] as possible."^[38] After the Merger price was finally set and the Merger Agreement entered into, Foshee went to Rich Kinder not once, but twice, to try to get Kinder interested in letting El Paso management bid. Although Kinder did not embrace Foshee's idea of an El Paso management led buy-out of the E & P business, the reality is that Foshee was interested in being a buyer of a key part of El Paso at the same time he was charged with getting the highest possible price as a seller of that same asset. At no time did [444] Foshee come clean to his board about his self-interest, and he never sought permission from the Board before twice going to the CEO of the company's negotiating adversary.

At a time when Foshee's and the Board's duty was to squeeze the last drop of the lemon out for El Paso's stockholders, Foshee had a motive to keep juice in the lemon that he could use to make a financial Collins for himself and his fellow managers interested in pursuing an MBO of the E & P business. The defendants defend this by calling Foshee's actions and motivations immaterial and frivolous.

It may turn out after trial that Foshee is the type of person who entertains and then dismisses multi-billion dollar transactions at whim. Perhaps his interest in an MBO was really more of a passing fancy, a casual thought that he could have mentioned to Kinder over canapés and forgotten about the next day.

It could be.

Or it could be that Foshee is a very smart man, and very financially savvy. He did not tell anyone but his management confreres that he was contemplating an MBO because he knew that would have posed all kinds of questions about the negotiations with Kinder Morgan and how they were to be conducted. Thus, he decided to keep quiet about it and approach his negotiating counterpart Rich Kinder late in the process—after the basic deal terms were set—to maximize the chance that Kinder would be receptive. Of course, for an MBO to be attractive to management and to Kinder Morgan, not forcing Kinder Morgan to pay the highest possible price for El Paso was more optimal than exhausting its wallet, because that would tend to cause Kinder Morgan to demand a higher price for the E & P assets. Not only that, a fist fight of a negotiation might leave a bloodied Kinder unreceptive to a bid from Foshee and his team. Admittedly, the defendants would have me consider incredible the notion that ideas like this would have crossed the mind of Foshee while he was negotiating. But then again, the idea of an MBO had crossed his mind, he purposely decided not to tell the Board about it, he purposely decided to keep it quiet from Kinder Morgan until the deal was baked, and then had not one, but two discussions with his rival CEO in the negotiations seeking to pursue it. I do not find at this stage I can conclude it was a lark.

The concealed motives of Foshee, the concealed financial interest of Goldman's lead banker in Kinder Morgan, Goldman's continued influence over the Board's assessment of the spin-off, and the distortion of Morgan Stanley's incentives that arose as a result of El Paso management's acquiescence to its Goldman friends' demands leave me persuaded that the plaintiffs have a reasonable probability of success on a claim that the Merger is tainted by breaches of fiduciary duty. The Board, and Foshee as key negotiator on behalf of the Board, made many questionable tactical decisions. Allowing Kinder to play the tough hostile bidder and then back off the $27.55 per share price can certainly be seen by a rational mind as oddly timid, especially because once El Paso stockholders realized that Kinder Morgan—a supposedly mature market player making an unsolicited bid—had agreed to pay that price, they would be reluctant to accept less. If, as seems to be the case, Kinder Morgan wanted El Paso's pipeline business badly, more backbone might well have resulted in a better result. Likewise, as mentioned, there are odd aspects to some of the financial analyses presented, which seem to go some way to making the Kinder Morgan bid look more favorable in comparison to other options [445] than perhaps a more consistent approach to valuation would have done. The failure to use the emergence of Kinder Morgan as a bidder to do a soft test of the market for El Paso's attractive business units is, of course, relevant to any Revlon inquiry, but particularly when questions of loyalty exist.^[39] And that failure was compounded by a deal protection package that (1) precluded termination of the Merger Agreement if a favorable bid for the E & P business emerged; and (2) made it very expensive for a bidder for the pipeline business to make an offer because of the $650 million termination fee and Kinder Morgan's matching rights. This is important because it was clear that the most valuable alternative to the Merger other than the announced spin-off was likely a sale of El Paso's two main businesses to separate buyers (the kind of break-up that was de rigeur in the 1980s), or a sale of one business while retaining the other as a standalone public company (a twist on the spin-off).

Perhaps most troubling is that Foshee's velvet glove negotiating strategy—which involved proffering counter-offers at levels below the level he was authorized by the Board to advance—can now be viewed as having been influenced by an improper motive. Rather than having only the best interests of El Paso's stockholders in mind, Foshee had something else important on his mind—his interest in working with some of his fellow managers on a bid for the E & P business, which had been valued between $6 billion and $10 billion at various times by Goldman during 2011. That sort of deal would allow him to monetize a large part of his company-specific investment in El Paso, while permitting him the chance to continue to participate in managing key assets he knew and for another equity pop in the future. That goal, however, gave him an incentive different from maximizing what Kinder Morgan would pay El Paso, because the more Kinder Morgan had to pay El Paso, the more it might want for the E & P assets. And as mentioned, the bloodier the negotiation, the more Foshee risked having Kinder not wish to deal with him.

When anyone conceals his self-interest— as both Foshee and Goldman banker Steve Daniel did—it is far harder to credit that person's assertion that that self-interest did not influence his actions.^[40] That is particularly true when a court is reviewing the actions of businessmen and investment bankers. People like Foshee and Daniel get paid the big money because they are masters of economic incentives, and keenly aware of them at all times.

For similar reasons, the court is not swayed by Goldman's assertions that it was not influenced by its own economic incentives to maximize its $4 billion investment in Kinder Morgan by steering El Paso towards a deal with Kinder Morgan at a suboptimal price. Why? Goldman's claim that it was capable of putting aside its $4 billion investment in Kinder Morgan when advising El Paso on its strategic options is hard to square with the record [446] evidence demonstrating the lengths to which Goldman would go to secure an advisory fee of $20 million from El Paso—a fraction of the dollar size of its Kinder Morgan investment—in connection with the Merger.^[41] For starters, Goldman maneuvered in the context of the Morgan Stanley fee negotiations to ensure that Goldman would not go uncompensated in the event the Board decided to abandon the spin-off in favor of the Merger.^[42] What's more, earlier in the deal process, Goldman had Lloyd Blankfein, its CEO and Chairman, give Foshee a personal, obsequious phone call to thank him for El Paso's retention of Goldman over the years and to try to secure a continuing role in working for El Paso during the pendency of the Kinder Morgan bid despite what Goldman deemed an "appearance of conflict."^[43] And despite now claiming that it was not a key strategic advisor in the Kinder Morgan deal, Goldman sought credit as an advisor in the press release announcing the Merger, a move at self-promotion its rival Morgan Stanley called Goldman "at its most shameless."^[44] At this stage, I am unwilling to view Goldman as exemplifying an Emersonian non-foolishly inconsistent approach to greed, one that involves seeking lucre in a conflicted situation while simultaneously putting the chance for greater lucre out of its "collective" mind. At this stage, I cannot readily accept the notion that Goldman would not seek to maximize the value of its multi-billion dollar investment in Kinder Morgan at the expense of El Paso, but, at the same time, be so keen on obtaining an investment banking fee in the tens of millions.

Likewise, Daniel and Foshee each had an incentive to secure an undervalued bid for El Paso, and rather than disclose these incentives, each chose to conceal them. [447] Daniel knew about Goldman's conflict and he knew that his client El Paso knew about it. He also knew that he personally owned Kinder Morgan stock, but he did not disclose that fact. Foshee knew that he was discussing and considering an MBO of the E & P business when he was negotiating price terms with Kinder Morgan, but he did not disclose that fact. He did not even disclose his discussions with Kinder about an MBO after the deal was baked to the Board.

This kind of furtive behavior engenders legitimate concern and distrust.^[45] Given that there are numerous debatable tactical choices that now seem to have been made in large measure based on Foshee's advice and with important influence from Goldman, I believe that the plaintiffs have a probability of showing that more faithful, unconflicted parties could have secured a better price from Kinder Morgan.^[46]

The question is what to do about it.

The El Paso stockholders arguably have much to gain by seeing this Merger proceed. No one can tell what would have happened had unconflicted parties negotiated the Merger. That is beyond the capacity of humans.

The price being offered by Kinder Morgan is one that reasonable El Paso stockholders might find very attractive. But it nags, of course, that it is not all that it might have been had things been done the way they should have been. The absence of a pre-signing market check also grates, when the decision not to explore the market and instead do a safe, friendly deal rather than stretch for value or push Kinder Morgan into a public, hostile fight might have been influenced by selfish considerations, rather than the desire to strike the best risk-reward balance for El Paso's stockholders.

In terms of the traditional analysis, the question is of course this: do the plaintiffs face a threat of irreparable injury, and if so does the balance of the hardships tip in favor of an injunction?^[47]

Here, although the plaintiffs do not have the basis for claiming irreparable injury that exists when the plaintiff is a bidder,^[48] the adequacy of monetary damages as a remedy to them as stockholders is not apparent.^[49] By way of example, the difference in value of Kinder Morgan's original agreement in principle bid of $27.55 in cash and stock and the one agreed to of $26.87 equaled approximately [448] $534 million in value as of the time of signing, even giving full value to Morgan Stanley's less than certain estimate of the value of the warrant component.^[50]

On this record, it appears unlikely that the independent directors of El Paso—who are protected by an exculpatory charter provision—could be held liable in monetary damages for their actions.^[51] Although they should have been more keen to Goldman's conflict, they were given reason to believe that that conflict had been addressed by the hiring of Morgan Stanley and by cabining Goldman's role. The extent to which the independent directors understood the perverse incentives created for Morgan Stanley by Goldman and El Paso management by the terms of Morgan Stanley's engagement is not spelled out in the record and is the type of issue that independent directors tend to look to advisors to address. Most important, the independent directors' reliance upon Foshee seems to have been made in good faith. From the standpoint of the independent directors, Foshee seems to have been well positioned as a large holder of El Paso stock and as a trusted executive to get the best deal for El Paso's stockholders.^[52] The independent directors were not trusted with the information that Foshee (and El Paso managers like Sult and Smolik) were mulling over a bid to Kinder Morgan for the E & P assets.

Although Foshee is a wealthy man, it is unlikely that he would be good for a verdict of more than half a billion dollars. And although Goldman has been named as an aider and abettor and it has substantial, some might say even government-insured, financial resources, it is difficult to prove an aiding and abetting claim.^[53] Given that Goldman's largest conflict was surfaced fully and addressed, albeit in incomplete and inadequate ways, whether the plaintiffs could ultimately prove Goldman liable for any shortfall is, at best, doubtful, despite Daniel's troubling individual failure of disclosure.

Nor do I find any basis to conclude that Kinder Morgan is likely to be found culpable as an aider and abettor. It bargained hard, as it was entitled to do. From its perspective, it appeared that steps were taken by El Paso and Goldman to address Goldman's conflict of interest. And Foshee's concealed interest in an MBO was not expressed by Foshee to Kinder until after the deal terms were firmed up and signed [449] into agreement, and it is not clear that Rich Kinder had any reason to know Foshee was acting without the consent of the El Paso Board.

For present purposes, therefore, I am willing to accept that the plaintiffs have shown that there is a likelihood of irreparable injury if the Merger is not enjoined.

That raises the hardest question, which is whether the threat of irreparable injury justifies an injunction in light of the risks that an injunction itself would present to the stockholders of El Paso. Putting aside the expectations of Kinder Morgan, which is arguably stuck with the risk of having dealt with potentially faithless fiduciaries,^[54] the real question is whether the court should intervene when the El Paso stockholders have a chance to turn down the Merger at the ballot box. Unlike a situation when this court will enjoin a transaction whose tainted terms are precluding another available option that promises higher value,^[55] no rival bid for El Paso exists.^[56]

The plaintiffs' own request for an injunction is oddly telling. In their many papers, they do not seek a preliminary injunction against the Merger Agreement in its traditional form, which is one that lasts until it is overturned on appeal. Such an injunction would likely persist beyond June 30, 2012, the drop-dead date in the Merger Agreement. That would allow Kinder Morgan to walk away on that date.

Rather, the plaintiffs want an odd mixture of mandatory injunctive relief whereby I affirmatively permit El Paso to shop itself in parts or in whole during the period between now and June 30, 2012, in contravention of the no-shop provision of the Merger Agreement, and allow El Paso to terminate the Merger Agreement on grounds not permitted by the Merger Agreement and without paying the termination fee set forth in the Merger Agreement, but then to lift the injunction and then force Kinder Morgan to consummate the Merger "if no superior transactions emerge."^[57]

That is not a traditional negative injunction that can be done without an evidentiary hearing or undisputed facts.^[58] Furthermore, [450] that sort of injunction would pose serious inequity to Kinder Morgan, which did not agree to be bound by such a bargain.^[59] We all wish we could have it all ways. But that is not real life, nor is it equitable.

The injunction the plaintiffs posit would be one that would sanction El Paso in breaching many covenants in the Merger Agreement and that would bring about facts that would mean that El Paso could not satisfy the conditions required for Kinder Morgan to have an obligation to close.^[60] The injunction the plaintiffs posit also illustrates that they share the concern I have, which is that an injunction could pose more harm than good.

They seek to keep Kinder Morgan bound but to allow El Paso to prospect for more. I understand that, but they are stuck with the requirements of equity, which is that they accept the risks that come with enjoining the Merger, including the risk that Kinder Morgan will walk when the drop-dead date expires. At oral argument, however, upon questioning by the court, the plaintiffs clarified that they would be willing to accept the traditional injunctive relief of preventing the stockholders from voting on the Merger.

But the plaintiffs' understandable reluctance in their papers to deny the El Paso stockholders the ultimate chance to take the deal with Kinder Morgan despite the troubling behavior in the record is one that I share. It is the stockholders' money, not mine, and the plaintiffs could not possibly bond the risk fully.

I share the plaintiffs' frustration that the traditional tools of equity may not provide the kind of fine instrument that enables optimal protection of stockholders in this context. The kind of troubling behavior exemplified here can result in substantial wealth shifts from stockholders to insiders that are hard for the litigation system to police if stockholders continue to display a reluctance to ever turn down a premium-generating deal when that is presented. The negotiation process and deal [451] dance present ample opportunities for insiders to forge deals that, while "good" for stockholders, are not "as good" as they could have been, and then to put the stockholders to a Hobson's choice. Think about some of the early management buyouts of the cappuccino market of 2006 and 2007 in that regard, where the early actions of poorly policed, conflicted CEOs in baking up deals with their favorite private equity sponsors before any market check (or often even board knowledge) likely dampened the competition among private equity firms that could have generated the highest price if proper conduct occurred and the right process had been used. The resulting deals might have been good for investors, but the suspicion that they were not on the "best" terms available lingers for rational reasons.

Be that as it may, that reality cannot justify the sort of odd injunction that the plaintiffs desire, which would violate accepted standards for the issuance of affirmative injunctions and attempt to force Kinder Morgan to consummate a different deal than it bargained for.

Fundamentally, the plaintiffs say that I can issue a preliminary injunction that allows El Paso a free option. It can shop any or all of itself, terminate the Merger Agreement without paying the break fee, and do what it wishes until the injunction expires. If something it likes comes along, El Paso should be able to take it, cost free. But if nothing does, then the injunction will expire and Kinder Morgan would somehow—by judicial compulsion, I assume—be forced to close, despite the pervasive breach of fundamental provisions of the Merger Agreement, including the one requiring El Paso to help Kinder Morgan to sell for itself the same assets the plaintiffs seek to have El Paso market. If my assumption about judicial compulsion is right, the plaintiffs do not seek a traditional negative injunction, but rather mandatory relief that can only be granted after a trial and a careful evaluation of Kinder Morgan's legitimate interests.^[61] If the plaintiffs do not view the injunction as one involving the court compelling Kinder Morgan to close upon the injunction's expiration if the El Paso stockholders approve the Merger, then the plaintiffs are asking me to enter an injunction that, to my view, would likely relieve Kinder Morgan of any obligation to close because its contractual rights would have been materially breached.

Given that the El Paso stockholders are well positioned to turn down the Kinder Morgan price if they do not like it, I am not persuaded that I should deprive them of the chance to make that decision for themselves.^[62] Although an after-the-fact monetary damages claim against the defendants [452] is not a perfect tool, it has some value as a remedial instrument, and the likely prospect of a damages trial is no doubt unpleasant to Foshee, other El Paso managers who might be added as defendants, and to Goldman. And, of course, the defendants themselves should be mindful of the reality that in the period of truncated, expedited discovery, troubling facts arose about the interests of certain key players in this M & A drama. After full discovery, it would hardly be unprecedented for additional troubling information to emerge, given the suspicious instances of non-disclosure that have already been surfaced.

For now, however, I reluctantly deny the plaintiffs' motion for a preliminary injunction, concluding that the El Paso stockholders should not be deprived of the chance to decide for themselves about the Merger, despite the disturbing nature of some of the behavior leading to its terms.

IT IS SO ORDERED.

[1] Using Kinder Morgan's unadjusted closing stock price of $35.26 on February 28, 2012, and El Paso's unadjusted closing stock price of $20.55 on July 29, 2011. See Yahoo Finance, Kinder Morgan, Inc. Historical Stock Prices, http://finance.yahoo.com/q/hp?s= KMI+Historical+Prices (last visited Feb. 29, 2012).

[2] See Revlon v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del.1986).

[3] Ps. Op. Br. Ex. 40 (handwritten notes) at EP00013940 ("limit competition—pre rather than post spin."), EP00013942 ("KM—wants to limit competition by doing pre-spin.").

[4] In September 2010, when Kinder Morgan was still a private company, it made its first overture to acquire El Paso at a value of $16.50 per share. The El Paso Board rejected this proposal, and no merger discussions took place between the two companies until Kinder Morgan renewed its interest in acquiring El Paso on August 30, 2011.

[5] See El Paso Corp. Schedule 14A filed on Jan. 31, 2011 ("Proxy Statement"), at 70. The Goldman directors on the Kinder Morgan board recused themselves from Kinder Morgan discussions regarding the Merger once Rich Kinder made his intention to bid for El Paso known to the Kinder Morgan board before August 30, 2011.

[6] Foshee is the only non-independent director on El Paso's 12-person Board.

[7] See Yahoo Finance, Kinder Morgan, Inc. Historical Stock Prices, http://finance.yahoo. com/q/hp?s=KMI+Historical+Prices (last visited Feb. 29, 2012) (Kinder Morgan unadjusted closing stock price on October 14, 2011 of $26.89).

[8] The breakdown of the final per share Merger consideration is as follows: $14.65 in cash, 0.4187 in Kinder Morgan stock (for an aggregate cash/stock value of $25.91 reflecting Kinder Morgan's prior closing stock price of $26.89), and 0.640 of a warrant to purchase Kinder Morgan stock, which for tax purposes has an indicative value of $0.96. Because the stock component of the deal is not fixed in dollar terms, and contains no collar, the Merger consideration will fluctuate depending on Kinder Morgan's stock price, subject to a 57%/43% proration between the cash/stock components of the aggregate consideration. See Proxy Statement at 7.

[9] El Paso's unadjusted closing stock price on October 14, 2011 was $19.59, implying a 37% premium. See Yahoo Finance, El Paso Corp. Historical Stock Prices, http://finance.yahoo. com/q/hp?s=EP+Historical+Prices (last visited Feb. 29, 2012).

[10] Ps. Op. Br. Ex. 3 ("Merger Agreement") § 5.16. Recently, El Paso and Kinder Morgan announced that El Paso has agreed to sell the E & P assets to a private equity group led by Apollo Global Management LLC for $7.15 billion. See Letter to the Court from Counsel for El Paso Defs. (Feb. 27, 2012) at Ex. A (El Paso Corp. Form 8-K) at 2.

[11] Merger Agreement §§ 5.3(a), (d), (f).

[12] El Paso Corp. Form 10-Q filed on Nov. 7, 2011, at 24 (El Paso had $24.078 billion total consolidated assets as of September 30, 2011, of which $4.724 billion were E & P assets).

[13] See Merger Agreement § 5.3(d).

[14] Id. § 7.3(b).

[15] Assuming $12.8 billion in consolidated net debt as of August 31, 2011, and $4.5 billion in minority interest. See El Paso Defs. Ans. Br. Ex. 45 (Morgan Stanley Presentation (October 16, 2011)) at EP00021383.

[16] Using an approximate mid-point pipeline business enterprise valuation of $26 billion, and an approximate mid-point pipeline business equity valuation of $12.74 billion. See El Paso Defs. Ans. Br. Ex. 40 (Goldman Sachs Presentation (October 6, 2011)) at EP00000459 (adjusting for certain planned debt deconsolidation of $1.5 billion in pipeline-related debt). These are rough approximations and I have applied my own training as a humanities major to arrive at the results. Rely upon them with this caution in mind.

[17] Ps. Op. Br. Ex. 40 (handwritten notes) at EP00013940 ("limit competition—pre rather than post spin."), EP00013942 ("KM—wants to limit competition by doing pre-spin.").

[18] See Foshee Tr. 167 ("[T]he collective wisdom of the group was that there wasn't a natural ... other buyer for the whole that would compete within a short time window.. . ."); Cox Tr. 196 ("In our view, those parties that would be most interested in either the pipeline business or the [E & P] business, and principally the pipeline business, and those parties that were in a position to pay a significant price . . . were parties that ... not only largely didn't have the financial means to acquire both, but in our judgment would, even if they did in some cases have the financial means, would be disinclined to do so.").

[19] The term sheet reflecting the $27.55 per share Merger price provided for a consideration breakdown of 60% cash and 40% stock. As of September 18, 2011, when the agreement in principle was reached, this translated to a cash/stock mix of $16.53 in cash and 0.4322 shares of Kinder Morgan, reflecting Kinder Morgan's closing stock price of $25.50 as of its last trading day (September 16, 2011). Assuming that this cash/stock mix stayed constant, and that the stock value would float with Kinder Morgan's prevailing market price, at today's prices this consideration would be worth $31.76.

[20] See El Paso Defs. Ans. Br. Ex. 36 (El Paso Corp. Board Minutes (Sept. 30, 2011)) at EP00000416 ("The Board ... re-iterated [to Foshee] that the floor value for the cash and stock consideration was $26.50 ...."); see also Foshee Tr. 293 ("Q. But they said to you, they reiterated that the floor value for the cash and stock consideration was 26.50; right? A. Uh-huh. Q. That wasn't expressed as a preference; right? A. No, they reiterated that the floor value for the cash and stock was 26.50.").

[21] See Paramount Commc'ns Inc. v. QVC Network Inc., 637 A.2d 34, 45 (Del. 1994) ("[A] court applying enhanced judicial scrutiny should be deciding whether the directors made a reasonable decision, not a perfect decision. If a board selected one of several reasonable alternatives, a court should not second-guess that choice even though it might have decided otherwise or subsequent events may have cast doubt on the board's determination.'").

[22] See In re Answers Corp. S'holders Litig., 2011 WL 1366780, at *3 (Del.Ch. Apr. 11, 2011) ("[D]irectors are generally free to select the path to value maximization, so long as they choose a reasonable route to get there.") (internal quotation omitted).

[23] See In re Toys "R" Us, Inc. S'holder Litig., 877 A.2d 975, 1002 (Del.Ch.2005) (noting that the "paradigmatic context for a good Revlon claim ... is when a supine board under the sway of an overweening CEO bent on a certain direction [ ] tilts the sales process for reasons inimical to the stockholders' desire for the best price.").

[24] Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 176 (Del.1986) (where Revlon's CEO, Michel Bergerac, rebuffed Pantry Pride's acquisition overtures in part because of the "strong personal antipathy" felt by Bergerac towards Pantry Pride's CEO, Ron Perelman, who was an upstart from Philly and not someone whom the Supreme Court believed Bergerac wanted running his storied company).

[25] See, e.g., In re OPENLANE, Inc., 2011 WL 4599662, at *6 (Del.Ch. Sept. 30, 2011); In re Dollar Thrifty S'holder Litig., 14 A.3d 573, 616 (Del.Ch.2010); In re Lear Corp. S'holder Litig., 926 A.2d 94, 116-18 (Del.Ch.2007); Toys "R" Us, 877 A.2d at 975; In re Pennaco Energy, Inc., 787 A.2d 691, 705 (Del.Ch.2001); see also Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1288 (Del.1989).

[26] Indeed, Goldman's answering brief used the phrase "potential conflict" to describe its position fifteen times.

[27] Daniel owns shares issued by a Kinder Morgan affiliate with an estimated market value of at most $300,000 (as of the time of Daniel's deposition on December 22, 2011), see Daniel Tr. 15-16, and he holds an investment in a Goldman fund that is itself invested in Kinder Morgan shares, an indirect interest in Kinder Morgan worth approximately $39,000, see Schmidt Aff. ¶ 3.

[28] See Ps. Op. Br. Ex. 45 (Email from Metz-Dworkin to Sikhtian et. al. (September 6, 2011)).

[29] El Paso Defs. Ans. Br. Ex. 23 (El Paso Corp. Board Minutes (Sept. 15, 2011)) at EP00000392; see also Foshee Tr. 187 (testifying that "the thought crossed my mind" that Daniel getting pressured by other parts of Goldman "was a possibility."). Goldman's advice was especially peculiar given that El Paso had a built-in defense to a hostile bid with the spin-off, which did not require a stockholder vote and was close to receiving approval by the S.E.C. Foshee Tr. 180-82. Thus, not even Foshee was worried about Kinder's threat to go public, because, as Foshee put it, "time was on our side." Foshee Tr. 179.

[30] Interestingly, the record suggests that it was Goldman's close clients in El Paso management who suspected at times that Goldman was not honoring the Chinese wall and who decided that Goldman be walled off from Merger discussions and negotiations. The court is aware of the inconsistency that emerges from this evidence. On the one hand, there are many indications in the record that El Paso management was very close to Goldman, viewed Goldman as their trusted advisor, and wanted Goldman near the scene at all times. But, at the same time there are indications that El Paso management was suspicious that Goldman's advice about how to react to Kinder Morgan's overture was tilted by its investment in Kinder Morgan and its desire to avoid Kinder Morgan having to go hostile. Because we are at a preliminary injunction stage with a limited factual record, it is not yet necessary or prudent to try to fully resolve these inconsistencies in light of the benefit that a more developed factual record would afford.

[31] Goldman primarily used a comparable companies analysis to value the E & P business following the spin-off. Due to declining EV/EBITDA trading multiples of peer companies, Goldman indicated that the E & P business had lost $2 billion in value when valued under that method from the time the Board announced the spin-off in May 2011—before Kinder Morgan had come on the scene and presented a rival strategic option—and October 2011, when the Board abandoned the spin-off in favor of the Merger. In its final presentation to the Board on October 6, 2011, Goldman estimated that the E & P business had an enterprise value worth only $6-8 billion, as opposed to its mid-September valuation at $7-9 billion, and its May valuation at $8-10 billion. By way of comparison. Kinder Morgan's investment banker estimated on September 28, 2011—only a week earlier— that it could sell the E & P assets for $7.846 billion.

Goldman's valuation can be seen as questionable because these market multiples were at depressed levels due to short-term volatility in commodity prices, and were not meant to provide a long-term indicator of the E & P business's value. Rather, as testified to by lead Goldman banker Steve Daniel, the analysis was only to serve as "a depiction of an estimate of the [enterprise value] range based on then-market conditions, and again, assuming that the company was already out freely trading on its own. . . . This is just a current [picture] at that time fixture of what [the value based on trades in minority blocks] looked like." Daniel Tr. 157. Furthermore, solely looking to market multiples to generate a hypothetical trading value fails to take into account the control premium that could be achieved upon a sale of the E & P business. See Bradford Cornell, Corporate Valuation 49 (1993) (noting that valuations calculated using current market trading prices of stock are "based on the prices at which minority positions trade in the market," and therefore "will not take into account a `control premium.'"). It is unclear from the record whether the Board understood the limitations to Goldman's analysis.

[32] See Foshee Tr. 159-61; see also id. at 160 ("Q. Would [the fact that Daniel had a personal financial stake in Kinder Morgan] matter to you? A. It might. Q. Why?. . . . A. It would just be one more piece of information for the potential for conflict. That is not between two divisions, but between one person's brain.").

[33] See Daniel Tr. 195 ("It was more like . . . [Morgan Stanley] had asked—so [John Sult, El Paso's CFO] was asking but he was going to be okay with wherever we went with it."); Sult Tr. 243 ("I wasn't going to force Goldman Sachs to [amend its exclusivity agreement]. I signed an agreement and I would live by the agreement.").

[34] In fairness to Morgan Stanley, it is not clear from the record when in the advisory process it was first made aware of this fee arrangement. But, it is clear that by at least October 5, 2011, Morgan Stanley was aware that it would only get a lucrative banking fee if El Paso did a deal with Kinder Morgan, and that it would get nothing if El Paso decided to move forward with the spin-off. Following October 5, 2011, Morgan Stanley met with the Board twice, and each time advised the Board that the final Merger consideration offered by Kinder Morgan was fair.

[35] The record includes evidence that supports a plausible argument that Morgan Stanley's analysis undervalued El Paso's stock and overvalued Kinder Morgan's stock. For example, the plaintiffs argue that Morgan Stanley used an unreasonably low terminal multiple for a portion of its discounted cash flow analysis of the pipeline business. Rather than use a perpetual growth model to calculate the pipeline business's terminal value, Morgan Stanley used a mid-point exit EV/EBITDA multiple of 10x, which implied a perpetual growth rate of only 0.7%. That is, Morgan Stanley calculated that the pipeline business would grow only 0.7% from 2016 into perpetuity—a rate less than half of the estimated rate of inflation (2%)—an implication which is inconsistent with Foshee's testimony that the pipeline business had strong growth prospects, see Foshee Tr. 65-66, and with the projections prepared by El Paso's management and used by Morgan Stanley, which included both maintenance and growth capital expenditures. See El Paso Defs. Ans. Br. Ex. 30 (Morgan Stanley Presentation (Sept. 26, 2011)) at EP00000687. Evidence also suggests that Morgan Stanley used values for Kinder Morgan's cost of equity in an internally inconsistent way, using a higher cost of equity (11.8%) when benchmarking El Paso's cost of equity, but a lower number (7.5%) when valuing Kinder Morgan directly. In this way, Morgan Stanley's analysis arguably skewed in favor of the Merger by using a deflated cost of equity when valuing Kinder Morgan, in turn overvaluing the Kinder Morgan stock portion of the Merger consideration.

[36] Indeed, key El Paso executives believed that Goldman deserved this $20 million fee for all of its work on the spin-off that would go unrewarded if the Board entered into the Merger with Kinder Morgan, thus depriving Goldman of its $25 million fee contingent on the consummation of the spin-off. See Foshee Tr. 198; Sult Tr. 242. Moreover, these executives wanted to reward Goldman for its "eight [and a half] years worth of strategic advisory work for El Paso." Foshee Tr. 199. Never mind that Goldman was paid $150,000 annually through a retainer agreement it had in place with El Paso, and on top of that had received approximately $9.7 million in fees from El Paso between 2008 through May 2011 alone. See Sult Tr. 101.

[37] Although when Foshee and Smolik discussed the idea of an MBO is unclear, the October 11, 2011 email exchange between Sult and Smolik, in which Sult expressed his interest in an MBO, and Smolik responded that he had "discussed [the possibility] with Doug [Foshee]" and Foshee "wants to hold the discussion as late as possible, but is willing (maybe even desires) to have the discussion with [Kinder Morgan]," Ps. Op. Br. Ex. 41 (Email Exchange between Sult and Smolik (October 11, 2011)), suggests that Sult caught on to an idea that Foshee and Smolik were already well along in exploring, but that Foshee wished to keep quiet until a deal with Kinder Morgan was solidified.

[38] Id.; see also Foshee Tr. at 271 (confirming that when Smolik brought up the idea of an MBO before the Merger Agreement was signed, Foshee told Smolik, "now is probably not the time to have that conversation").

[39] See In re Netsmart Techs., Inc. S'holders Litig., 924 A.2d 171, 199 (Del.Ch.2007); see also Barkan v. Amsted Indus., Inc., 567 A.2d 1279, 1287 (Del. 1989) ("When the board is considering a single offer and has no reliable grounds upon which to judge its adequacy, this concern for fairness demands a canvas of the market to determine if higher bids may be elicited.").

[40] See Mills Acquisition Co. v. Macmillan, Inc., 559 A.2d 1261, 1282 (Del.1989) (stating that corporate officers' "knowing concealment of [a] tip at [a] critical board meeting... utterly destroys their credibility," and finding that "[g]iven their duty of disclosure under the circumstances, this silence [was] an explicit acknowledgment of their culpability.").

[41] E.g., In re El Paso Corp. S'holder Litig., C.A. No. 6949 at 242 (Del. Ch. Feb. 9, 2012) (TRANSCRIPT) (counsel for Goldman stating that "Goldman was asked to advise El Paso [on the Kinder Morgan deal]" and that "Goldman wanted to get in on the [Kinder Morgan] deal. I'm not denying that.").

[42] As illuminated by the testimony of Morgan Stanley's Jonathan Cox:

And we were interested in having a letter signed with respect to [the spin-off], and we were told that Goldman was being asked as to whether they would amend the letter to remove the word "exclusive," and you will see on October 12, that [El Paso's general counsel] says no, they haven't given on the exclusive issue. They were accommodating on other issues, but not on exclusivity, to paraphrase. So I said, I see. Does that mean that we are exclusive on [the Merger?] Does that mean that what you are granting Goldman Sachs on [the spin-off] is something you would grant us on [the Merger?] And we were told no, it was a rhetorical question. I simply said, I understand, we appreciate the business.

Cox Tr. 190.

[43] According to Blankfein's draft script for the call, which was prepared by Steve Daniel, Blankfein was to tell Foshee the following:

Hello Doug—it's been a long time since we have had the chance to visit/[I] wanted to reach out and say thank you for everything from [Goldman]. . . ./You have been very good to [Goldman] in having us help on all kinds of transactions over the years. . . ./And of course I was very pleased you reached out to us on this most recent matter [the Kinder Morgan proposal]—which I understand is very serious. . . ./I know you are aware of [Goldman's] investment [in Kinder Morgan] and that we are very sensitive to the appearance of conflict/We have asked our board members to recuse themselves and I know you have taken on a second advisor. . . ./Really just wanted to reach out and say thank you. . . ./Please call me any time/I'll be watching this situation very closely. . . .

El Paso Defs. Ans. Br. Ex. 16 (Email from Daniel to Blankfein (Sept. 7, 2011)).

[44] El Paso Defs. Ans. Br. Ex 15 (Email Exchange between Cox and Munger (Oct. 16, 2011)).

[45] See Macmillan, 559 A.2d at 1282.

[46] For its part, Kinder Morgan characterizes the negotiations as hard fought, and it says that it was not willing to pay a penny more for El Paso. E.g., In re El Paso Corp. S'holder Litig., C.A. No. 6949 at 234 (Del. Ch. Feb. 9, 2012) (TRANSCRIPT) (Kinder Morgan's counsel stating that "the negotiations extracted, at least from us, the last pennies that we were prepared to pay."). But, Kinder Morgan, of course, says this at a time when it has a powerful self-interest as a buyer and a defendant to portray the negotiations in that way.

[47] See Macmillan, 559 A.2d at 1278-79; Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 179 (Del. 1986); Cantor Fitzgerald, L.P. v. Cantor, 724 A.2d 571, 579 (Del.Ch.1998).

[48] Compare Revlon, 506 A.2d at 184-85 (agreeing with the Court of Chancery that "unless the lock-up and other aspects of the agreement were enjoined. Pantry Pride's opportunity to bid for Revlon was lost," and "the need for both bidders to compete in the marketplace outweighed any injury to Forstmann.").

[49] The adequacy of money damages, of course, typically means that the irreparable injury required to grant an injunction is absent. E.g., Gradient OC Master, Ltd. v. NBC Universal, Inc., 930 A.2d 104, 132 (Del.Ch. 2007).

[50] $0.68 * approximately 786 million shares of El Paso on a diluted basis = $534,480,000. See El Paso Defs. Ans. Br. Ex. 45 (Morgan Stanley Presentation (October 16, 2011)) at EP00021383 (assuming 786 million fully diluted El Paso shares).

[51] See 8 Del. C. § 102(b)(7); see also In re Del Monte Foods Co. S'holders Litig., 25 A.3d 813, 838 (Del.Ch.2011) ("Exculpation under Section 102(b)(7) can render empty the promise of post-closing damages.").

[52] Foshee stands to receive approximately $90 million upon consummation of the Merger. Of that $90 million, approximately $55 million would come from unrestricted stock and vested options, and another approximately $26 million would come from unvested stock options, restricted shares and stock units that will vest as a result of the Merger. See Proxy Statement at 171-72; El Paso Defs. Ans. Br. Ex. 2 (El Paso Corp. Schedule 14A) at 27, 58-59; El Paso Defs. Ans. Br. Ex. 46 (El Paso Corp. Preliminary Form S-4) at 170-71.

[53] See Binks v. DSL.net, Inc., 2010 WL 1713629, at *10 (Del.Ch. Apr.29, 2010) ("The standard for an aiding and abetting claim is a stringent one, one that turns on proof of scienter of the alleged abettor."); Allied Capital Corp. v. GC-Sun Holdings, L.P., 910 A.2d 1020, 1039 (Del.Ch.2006) ("[T]he test for stating an aiding and abetting claim is a stringent one . . .—a plaintiff must prove: (1) the existence of a fiduciary relationship, (2) a breach of the fiduciary's duty and (3) knowing participation in that breach by the non-fiduciary.").

[54] See Paramount Commons Inc. v. QVC Network Inc., 637 A.2d 34, 51 (Del. 1994) ("To the extent that a contract, or a provision thereof, purports to require a board to act or not act in such a fashion as to limit the exercise of fiduciary duties, it is invalid and unenforceable."); Restatement (Second) of Contracts § 193 (1981) ("A promise by a fiduciary to violate his fiduciary duty or a promise that tends to induce such a violation is unenforceable on grounds of public policy.").

[55] See Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., 506 A.2d 173, 184-85 (Del. 1986) (granting a preliminary injunction against preclusive merger provisions that were impeding the ability of competing potential buyer to have its higher bid accepted); QVC Network, Inc. v. Paramount Commc'ns, Inc., 635 A.2d 1245, 1273 n. 50 (Del.Ch. 1993), aff'd, 637 A.2d 34 (Del. 1994) ("Since the opportunity for shareholders to receive a superior control premium would be irrevocably lost if injunctive relief were not granted, that alone would be sufficient to constitute irreparable harm.").

[56] Although it is true that the absence of a pre-signing market check and the presence of strong deal protections may explain the absence of a competing bid, the reality is that this is a high-profile transaction, litigation has been pending since early autumn 2011, and no bidder has emerged indicating that it would bid for any part of El Paso absent the deal protections. In the era in which Revlon was decided, bidders wishing to disrupt transactions actually made their presence known and litigated to achieve their objectives. Even in these more genteel times, that happens.

[57] Ps. Op. Br. at 75.

[58] In re Toys "R" Us, Inc. S'holder Litig., 877 A.2d 975, 1022-23 (Del.Ch.2005).

[59] See NACCO Indus., Inc. v. Applica Inc., 997 A.2d 1, 35 (Del.Ch.2009) ("Delaware upholds the freedom of contract and enforces as a matter of fundamental public policy the voluntary agreements of sophisticated parties.").

[60] The plaintiffs' desire for an injunction to allow El Paso to shop the E & P and pipeline businesses conflicts with several covenants and representations and warranties in the Merger Agreement. For example, the Merger Agreement requires El Paso to help Kinder Morgan market the E & P assets so that Kinder Morgan can sell them to help finance the purchase. Merger Agreement § 5.16. If El Paso sought to sell the E & P assets for itself, that would breach the covenant. El Paso also committed not to shop the company under the Merger Agreement. Id. § 5.3(a). See also id. § 5.2(a)(iii) (El Paso covenants not to sell any of its assets with a fair market value of more than $75 million); id. § 3.6(c) (El Paso represents and warrants that neither it nor its subsidiaries have taken the action described in § 5.2(a)(iii)); id. § 5.4(a) (El Paso agrees to use its reasonable best efforts to cause closing conditions to be "satisfied as promptly as practicable."). El Paso also agreed not to terminate the Merger Agreement except on certain specified conditions, including its compliance with the match right and termination fee provisions, all of which the plaintiffs seek me to enjoin. Id. § 7.1(d)(iii). El Paso's representations, warranties and covenants are brought down to the date of closing under §§ 6.2(a) and (b) of the Merger Agreement, and any incurred breach of these provisions would give Kinder Morgan the right to walk. See id. § 7.1(c)(iii) (giving Kinder Morgan a termination right "if [El Paso] shall have breached or failed to perform any of its representations, warranties, covenants or agreements set forth in this Agreement ... which breach or failure . . . would (if it occurred or was continuing as of the Closing Date) give rise to the failure of a condition set forth in Section 6.2(a) or (b)" and such failure is not cured by El Paso within 30 days of Kinder Morgan receiving notice of it.).

[61] See Toys "R" Us, 877 A.2d at 1022-23 (refusing to "blue pencil" provisions in a merger agreement "before a trial has even been held," noting that "[t]o grant that sort of mandatory relief would ... be inappropriate on disputed facts, and plaintiffs who seek such relief should move promptly, not for a preliminary injunction hearing, but for an expedited trial."); Alpha Natural Res., Inc. v. Cliff's Natural Res., Inc., 2008 WL 4951060, at *2 (Del.Ch. Nov. 6, 2008) (noting that a mandatory preliminary injunction is "extraordinary relief of a sort that the court does not issue lightly" and "requires ... a showing that the petitioner is entitled as a matter of law to the relief it seeks based on undisputed facts."); ID Biomedical Corp. v. TM Techs., Inc., 1995 WL 130743, at *15 (Del.Ch. Mar. 16, 1995) ("The Court will only award a mandatory injunction in a clear case, free from doubt."); Si-Lake, Inc. v. Conroy, 1994 WL 728824, at *4 (Del.Ch. Dec. 16, 1994) ("To succeed on an application for a mandatory injunction, the burden on the moving party increases. The moving party must clearly establish it is legally entitled to relief.").

[62] See, e.g., In re Netsmart Techs., Inc. S'holders Litig., 924 A.2d 171, 208 (Del.Ch.2007) ("In . . . cases when a potential Revlon violation occurred but no rival bid is on the table, the denial of injunctive relief is often premised on the imprudence of having the court enjoin the only deal on the table, when the stockholders can make that decision for themselves."); Toys "R" Us, 877 A.2d at 1023 ("[T]he bottom line is that the public shareholders will have an opportunity ... to reject the merger if they do not think the price is high enough in light of the Company's stand-alone value and other options.").

Matthew Theodore Martens, Jeffrey Thomas Infelise, Kenneth R. Lench, Reid Anthony Muoio, Thomas D. Silverstein, Securities and Exchange Commission (DC), Washington, DC, for Plaintiff.

Brad Scott Karp, Susanna Michele Buergel, Theodore Von Wells, Jr., Paul, Weiss, Rifkind, Wharton & Garrison LLP, New York, NY, for Defendant.

OPINION AND ORDER

JED S. RAKOFF, District Judge.

On October 19, 2011, the U.S. Securities and Exchange Commission (the S.E.C.) filed this lawsuit, accusing defendant Citigroup Global Markets Inc. (Citigroup) of a substantial securities fraud. According to the S.E.C.'s Complaint, after Citigroup realized in early 2007 that the market for mortgage-backed securities was beginning to weaken, Citigroup created a billion-dollar Fund (known as Class V Funding III) that allowed it to dump some dubious assets on misinformed investors. This was accomplished by Citigroup's misrepresenting that the Fund's assets were attractive investments rigorously selected by an independent investment adviser, whereas in fact Citigroup had arranged to include in the portfolio a substantial percentage of negatively projected assets and had then taken a short position in those very assets it had helped select. Complaint 1, 2, 58. Having structured the Fund as a vehicle for unloading these dubious assets on unwitting investors, id. 44, Citigroup realized net profits of around $160 million, id. 63, whereas the investors, as the S.E.C. later revealed, lost more than $700 million. See S.E.C.'s Memorandum of Law in Response to Questions Posed by the Court Regarding Proposed Settlement (SEC Mem.) at 17.

In a parallel Complaint filed the same day against Citigroup employee Brian Stoker, see U.S. Securities and Exchange Commission v. Brian H. Stoker, 11 Civ. 7388(JSR),^[1] the S.E.C. alleged that Citigroup knew in advance that it would be difficult to sell the Fund if Citigroup disclosed its intention to use it as a vehicle to unload its hand-picked set of negatively projected assets, see Stoker Complaint 25. Specifically, paragraph 25 of the Stoker Complaint alleges (in language some of which is notably missing from the Citigroup Complaint) that:

Citigroup knew it would be difficult to place the liabilities of [the Fund] if it disclosed to investors its intention to use the vehicle to short a hand-picked set of [poorly rated assets].... By contrast, Citigroup knew that representing to investors that an experienced third-party investment adviser had selected the portfolio would facilitate the placement of the [Fund's] liabilities. (emphasis supplied)

Although this would appear to be tantamount to an allegation of knowing and fraudulent intent ( scienter, in the lingo of securities law), the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence, in violation of Sections 17(a)(2) and (3) of the Securities Act, 15 U.S.C. 77q(a)(2) and (3). Complaint 65.

Simultaneously with the filing of its Complaint against Citigroup, the S.E.C. presented to the Court for its signature a Final Judgment As To Defendant Citigroup Global Markets Inc. (the Consent Judgment), together with a Consent of Defendant Citigroup Global Markets Inc. (the Consent) that recited that Citigroup consented to the entry of the Consent Judgment [w]ithout admitting or denying the allegations of the complaint.... Consent 2. The Consent Judgment (I) permanently restrained and enjoined Citigroup and its agents, employees, etc., from future violations of Sections 17(a)(2) and (3) of the Securities Act, (II) required Citigroup to disgorge to the S.E.C. Citigroup's $160 million in profits, plus $30 million in interest thereon, and to pay to the S.E.C. a civil penalty in the amount of $95 million, and (III) required Citigroup to undertake for a period of three years, subject to enforcement by the Court, certain internal measures designed to prevent recurrences of the securities fraud here perpetrated.

Upon receipt of these submissions, the Court, by Order dated October 27, 2011, put some questions to the parties concerning the proposed Consent Judgment, to which the parties responded both in writing, see SEC Mem., supra, and Memorandum on Behalf of Citigroup Global Markets Inc. in Support of the Proposed Final Judgment and Consent (Citigroup Mem.), and orally, see transcript of oral argument, 11/9/11 (Tr.). Since then, the Court has spent long hours trying to determine whether, in view of the substantial deference due the S.E.C. in matters of this kind, the Court can somehow approve this problematic Consent Judgment. In the end, the Court concludes that it cannot approve it, because the Court has not been provided with any proven or admitted facts upon which to exercise even a modest degree of independent judgment.

The Court turns first to the standard of review. In its original Memorandum in support of the proposed Consent Judgment, filed before the case had been assigned to any judge, the S.E.C. expressly endorsed the standard of review set forth by this Court in its Bank of America decisions, i.e., whether the proposed Consent Judgment ... is fair, reasonable, adequate, and in the public interest. Memorandum By Plaintiff Securities and Exchange Commission in Support of Proposed Settlement at 5 (quoting with approval SEC v. Bank of America Corp., 653 F.Supp.2d 507, 508 (S.D.N.Y.2009) ( Bank of America I )); see also SEC v. Bank of America Corp., 2010 WL 624581, at *6 (S.D.N.Y. Feb. 22, 2010) ( Bank of America II ). This was also the S.E.C.'s stated position in another, intervening proceeding before this Court, SEC v. Vitesse Semiconductor Corp., 771 F.Supp.2d 304 (S.D.N.Y.2011).

In its most recent filing in this case, however, the S.E.C. partly reverses its previous position and asserts that, while the Consent Judgment must still be shown to be fair, adequate, and reasonable, the public interest ... is not part of [the] applicable standard of judicial review. SEC Mem. at 4 n. 1. This is erroneous. A large part of what the S.E.C. requests, in this and most other such consent judgments, is injunctive relief, both broadly, in the request for an injunction forbidding future violations, and more narrowly, in the request that the Court enforce future prophylactic measures (here, for a three-year period). The Supreme Court has repeatedly made clear, however, that a court cannot grant the extraordinary remedy of injunctive relief without considering the public interest. See, e.g., eBay, Inc. v. MercExchange, 547 U.S. 388, 391, 126 S.Ct. 1837, 164 L.Ed.2d 641 (2006) (According to well-established principles of equity, a plaintiff seeking a permanent injunction ... must demonstrate ... that the public interest would not be disserved by a permanent injunction.). Indeed, the Court has held that In exercising their discretion, courts ... should pay particular regard for the public consequences in employing the extraordinary remedy of injunction. Winter v. Natural Resources Defense Council, Inc., 555 U.S. 7, 24, 129 S.Ct. 365, 172 L.Ed.2d 249 (2008) (quoting Weinberger v. RomeroBarcelo, 456 U.S. 305, 312, 102 S.Ct. 1798, 72 L.Ed.2d 91 (1982)). Similarly, the Second Circuit has repeatedly stated, most recently in Salinger v. Colting, 607 F.3d 68, 80 (2d Cir.2010), that a court must ensure that the public interests would not be disserved by the issuance of an injunction. Id. at 80.

As a fall-back, the S.E.C. suggests that, if the public interest must be taken into account, the S.E.C. is the sole determiner of what is in the public interest in regard to Consent Judgments settling S.E.C. cases. See SEC Mem. at 4 n. 1 (citing SEC v. Randolph, 736 F.2d 525, 529 (9th Cir.1984)). That, again, is not the law. Although in its somewhat delphic decision in Randolph the Ninth Circuit found that, on the facts of that case, there was no difference between the requirement of reasonableness and the requirement of being in the public interest, it was emphatic in upholding the appropriateness of a requirement that the decree be in the public interest. Id. at 529. More pertinently, the D.C. Circuit, in United States v. Trucking Employers, Inc., 561 F.2d 313 (D.C.Cir.1977), reaffirmed that prior to approving a consent decree a court must satisfy itself of the settlement's overall fairness to beneficiaries and consistency with the public interest. Id. at 319 (quoting United States v. AlleghenyLudlum Industries, 517 F.2d 826, 850 (5th Cir.1975) (emphasis supplied)). As these and similar authorities make plain, a court, while giving substantial deference to the views of an administrative body vested with authority over a particular area, must still exercise a modicum of independent judgment in determining whether the requested deployment of its injunctive powers will serve, or disserve, the public interest. Anything less would not only violate the constitutional doctrine of separation of powers but would undermine the independence that is the indispensable attribute of the federal judiciary.

As a practical matter, moreover, and as Randolph implies, the requirement that a consent judgment be in the public interest is not meaningfully severable from the requirements, still acknowledged by the S.E.C., that the consent judgment be fair, reasonable, and adequate; for all these requirements inform each other. For example, before the Court determines whether the proposed Consent Judgment is adequate, it must answer a preliminary question: adequate for what purpose? The answer, at least in part, is that the settlement must be adequate to ensure that the public interest is protected. See Randolph, 736 F.2d at 529 (the SEC ought to always be required to serve the public interest). The same analysis applies to the determination of the fairness of the settlement. Before the Court determines whether the settlement is fair, it must ask a preliminary question: fair to whom? As the holding of Trucking Employers quoted above makes plain, the answer is fair to the parties and to the public.

Without multiplying examples, it is clear that before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.

Applying these standards to the case in hand, the Court concludes, regretfully, that the proposed Consent Judgment is neither fair, nor reasonable, nor adequate, nor in the public interest. Most fundamentally, this is because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards. Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint.^[2] But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt,^[3] the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.

Here, the S.E.C.'s long-standing policyhallowed by history, but not by reasonof allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations,^[4] deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact. There is little real doubt that Citigroup contests the factual allegations of the Complaint. In colloquy with the Court, counsel for Citigroup expressly reconfirmed that his client was not admitting the allegations of the Complaint, see tr. 13. He also noted, correctly, that he was freenotwithstanding the S.E.C.'s gag order precluding Citigroup from contesting the S.E.C.'s allegations in the media^[5] to fully contest the facts in any parallel litigation; and he strongly hinted that Citigroup would do just that. Tr. 2627; see also Citibank Mem. at 78, 11.

The S.E.C., by contrast, took the position that, because Citigroup did not expressly deny the allegations, the Court, and the public, somehow knew the truth of the allegations. Tr. 1213. This is wrong as a matter of law and unpersuasive as a matter of fact. As a matter of law, an allegation that is neither admitted nor denied is simply that, an allegation. It has no evidentiary value and no collateral estoppel effect. It is precisely for this reason that the Second Circuit held long ago, in Lipsky v. Commonwealth United Corp., 551 F.2d 887 (2d Cir.1976), that a consent judgment between a federal agency and a private corporation which is not the result of an actual adjudication of any of the issues ... can not be used as evidence in subsequent litigation. Id. at 893. It follows that the allegations of the complaint that gives rise to the consent judgment are not evidence of anything either. Indeed the Lipsky court went so far as to hold that neither [an S.E.C.] complaint nor reference to [such] a complaint which results in a consent judgment may properly be cited in the pleadings in a parallel private action and must instead be stricken. Id.

As for common experience, a consent judgment that does not involve any admissions and that results in only very modest penalties is just as frequently viewed, particularly in the business community, as a cost of doing business imposed by having to maintain a working relationship with a regulatory agency, rather than as any indication of where the real truth lies. This, indeed, is Citigroup's position in this very case. See Citigroup Mem. at 68.

Of course, the policy of accepting settlements without any admissions serves various narrow interests of the parties. In this case, for example, Citigroup was able, without admitting anything, to negotiate a settlement that (a) charges it only with negligence, (b) results in a very modest penalty, (c) imposes the kind of injunctive relief that Citigroup (a recidivist) knew that the S.E.C. had not sought to enforce against any financial institution for at least the last 10 years, see SEC Mem. at 23, and (d) imposes relatively inexpensive prophylactic measures for the next three years. In exchange, Citigroup not only settles what it states was a broad-ranging four-year investigation by the S.E.C. of Citigroup's mortgage-backed securities offerings, Tr. 27, but also avoids any investors' relying in any respect on the S.E.C. Consent Judgment in seeking return of their losses. If the allegations of the Complaint are true, this is a very good deal for Citigroup; and, even if they are untrue, it is a mild and modest cost of doing business.

It is harder to discern from the limited information before the Court what the S.E.C. is getting from this settlement other than a quick headline. By the S.E.C.'s own account, Citigroup is a recidivist, SEC Mem. at 21, and yet, in terms of deterrence, the $95 million civil penalty that the Consent Judgment proposes is pocket change to any entity as large as Citigroup.^[6] While the S.E.C. claims that it is devoted, not just to the protection of investors but also to helping them recover their losses, the proposed Consent Judgment, in the form submitted to the Court, does not commit the S.E.C. to returning any of the total of $285 million obtained from Citigroup to the defrauded investors but only suggests that the S.E.C. may do so. Consent Judgment at 3. In any event, this still leaves the defrauded investors substantially short-changed. To be sure, at oral argument, the S.E.C. reaffirmed its long-standing purported support for private civil actions designed to recoup investors' losses. Tr. 10. But in actuality, the combination of charging Citigroup only with negligence and then permitting Citigroup to settle without either admitting or denying the allegations deals a double blow to any assistance the defrauded investors might seek to derive from the S.E.C. litigation in attempting to recoup their losses through private litigation, since private investors not only cannot bring securities claims based on negligence, see, e.g., Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), but also cannot derive any collateral estoppel assistance from Citigroup's non-admission/non-denial of the S.E.C.'s allegations. Nor, as noted, does the public, especially the business public, have any reason to credit those allegations, which remain entirely unproven.^[7]

The point, however, is not that certain narrow interests of the parties might not be served by the Consent Judgment, but rather that the parties' successful resolution of their competing interests cannot be automatically equated with the public interest, especially in the absence of a factual base on which to assess whether the resolution was fair, adequate, and reasonable. Even after giving the fullest deference to the S.E.C.'s viewswhich have more than once persuaded this Court to approve an S.E.C. Consent Judgment it found dubious on the merits, see, e.g., Bank of America II, suprathe Court is forced to conclude that a proposed Consent Judgment that asks the Court to impose substantial injunctive relief, enforced by the Court's own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest.

It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? It is not fair, because, despite Citigroup's nominal consent, the potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged is patent. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. And, most obviously, the proposed Consent Judgment does not serve the public interest, because it asks the Court to employ its power and assert its authority when it does not know the facts.

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on factscold, hard, solid facts, established either by admissions or by trialsit serves no lawful or moral purpose and is simply an engine of oppression.

Finally, in any case like this that touches on the transparency of financial markets whose gyrations have so depressed our economy and debilitated our lives, there is an overriding public interest in knowing the truth. In much of the world, propaganda reigns, and truth is confined to secretive, fearful whispers. Even in our nation, apologists for suppressing or obscuring the truth may always be found. But the S.E.C., of all agencies, has a duty, inherent in its statutory mission, to see that the truth emerges; and if it fails to do so, this Court must not, in the name of deference or convenience, grant judicial enforcement to the agency's contrivances.

Accordingly, the Court refuses to approve the proposed Consent Judgment. Instead, the Court hereby consolidates this case with the Stoker action, adopts the Case Management Order in that action as equally applicable to the instant case, and directs the parties to be ready to try this case on July 16, 2012.

SO ORDERED.

[1] Nothing in this Opinion and Order has any bearing on the case against Stoker, which is currently scheduled to commence trial on July 16, 2012.

[2] When the private parties go further and ask a court to retain jurisdiction to enforce the settlement, a court has total discretion whether or not to do so, see generally Kokkonen v. Guardian Life Insurance Co., 511 U.S. 375, 381, 114 S.Ct. 1673, 128 L.Ed.2d 391 (1994), and many judges in this District routinely decline to approve a stipulation of the parties that so provides.

[3] The Second Circuit has described the contempt power as among the most formidable weapons in the court's arsenal. United States v. Local 18041, Int'l Longshoremen's Ass'n, AFLCIO, 44 F.3d 1091, 1095 (2d Cir.1995).

[4] See Vitesse, 771 F.Supp.2d at 30810 (tracing the history of the policy).

[5] On its face, the SEC's no-denial policy raises a potential First Amendment problem. See Vitesse, 771 F.Supp.2d at 309 ([H]ere an agency of the United States is saying, in effect, Although we claim that these defendants have done terrible things, they refuse to admit it and we do not propose to prove it, but will simply resort to gagging their right to deny it ); see also Crosby v. Bradstreet Co., 312 F.2d 483, 485 (2d Cir.1963) (reversing a consent settlement between two parties because the injunction, enforceable through the contempt power, constitute[d] a prior restraint by the United States against the publication of facts which the community has a right to know).

[6] Although the S.E.C. asserts that the fact that it is only charging negligence limits the amount of money it can recover from Citigroup, either by way of civil penalty or by way of disgorgement, see SEC Mem. at 17, it acknowledges in a footnote that the Second Circuit has assumed that equitable restitution is available in any government enforcement action. SEC Mem. at 17 n. 6 (citing F.T.C. v. Verity Int'l, Ltd., 443 F.3d 48, 66 (2d Cir.2006)).

[7] The Court is also troubled when it compares the proposed Consent Judgment with the consent judgment entered last year between the SEC and Goldman Sachs (Goldman). See SEC v. Goldman Sachs & Co. et al., No. 10 Civ. 3229(BSJ), Dkt. 25 (Goldman Consent Judgment). Goldman involved a similar but arguably less egregious factual scenario in that Goldman was charged with not disclosing that an outside hedge fund, Paulson & Co., had played a significant role in the portfolio selection process and had maintained a short position in the assets it had selected. See SEC v. Goldman Sachs & Co., supra, Dkt. 1 (Goldman Complaint) 2. Nonetheless, the consent judgment in Goldman required Goldman to pay a $535 million penalty, even though it made only $15 million in profits. Goldman Consent Judgment 2. Here, as noted above, Citigroup made $160 million in profits and paid only a $95 million fine. The SEC argues that Goldman was charged with scienter-based violations, and that those violations make possible a more significant sanction. SEC Mem. at 19. This logic is circular, however, because the SEC does not explain how Goldman's actions were more culpable or scienter-based than Citigroup's actions here. Furthermore, the consent judgment in Goldman contained several terms that are notably missing from the proposed Consent Judgment here. First, the consent judgment included the following express admission from Goldman:

Goldman acknowledges that the marketing materials for the ABACUS 2007ACI transaction contained incomplete information. In particular, it was a mistake for the Goldman marketing materials to state that the reference portfolio was selected by ACA Management LLC without disclosing the role of Paulson & Co. Inc. in the portfolio selection process and that Paulson's economic interests were adverse to [portfolio] investors. Goldman regrets that the marketing materials did not contain that disclosure.

(Goldman Consent Judgment 3.) Second, Goldman agreed to additional remedial measures beyond those agreed to by Citigroup in the instant case. Third, Goldman agreed to cooperate with the SEC in a number of ways, such as making its employees available for interviews by SEC staff and ordering its employees to testify at trial and other judicial proceedings when requested by Commission staff. Id. 17. By contrast, Citigroup has not agreed to cooperate with the SEC in any cognizable respect. SEC Mem. 21.

752 F.3d 285 (2014)

[287] Michael A. Conley, Deputy General Counsel, Securities and Exchange Commission [288] (Jacob H. Stillman, Solicitor, Mark Pennington, Assistant General Counsel, Jeffrey A. Berger, Senior Counsel, on the brief), Washington, D.C., for Plaintiff-Appellant-Cross-Appellee United States Securities and Exchange Commission.

Brad S. Karp, Paul, Weiss, Rifkind, Wharton & Garrison, LLP (Theodore V. Wells, Jr., Mark F. Pomerantz, Walter Rieman, Susanna M. Buergel, on the brief), New York, N.Y., for Defendant-Appellee-Cross-Appellant Citigroup Global Markets, Inc.

John R. Wing, Lankler Siffert & Wohl LLP (Patrick P. Garlinger, on the brief), New York, N.Y., Appointed Pro Bono Counsel for the United States District Court for the Southern District of New York (Jed S. Rakoff, J.).

Mark A. Perry, Gibson, Dunn & Crutcher, LLP, Washington, D.C., for Amicus Curiae Business Roundtable, in support of reversal.

William Michael Cunningham, Temple Hills, MD, Amicus Curiae pro se, in support of affirmance.

Dennis M. Kelleher (Stephen W. Hall, Katelynn O. Bradley, on the brief) Washington, D.C., for Amicus Curiae Better Markets, Inc., in support of the affirmance.

Matthew G. Yeager, PH.D., Department of Sociology, King's University College, London, Ontario (William Calathes, Department of Criminal Justice, New Jersey City University, Jersey City, N.J., on the brief), Amici Curiae pro se, in support of affirmance.

Barbara J. Black, Charles Hartsock Professor of Law & Director, Corporate Law Center, University of Cincinnati College of Law, Cincinnati, OH, for Amici Curiae Securities Law Scholars Jayne W. Barnard, Douglas M. Branson, Chris J. Brummer, Samuel W. Buell, John C. Coffee, Jr., James D. Cox, James Fanto, Jill E. Fisch, Tamar Frankel, Theresa Gabaldon, Joan MacLeod Heminway, Thomas W. Joo, Lawrence E. Mitchell, Jennifer O'Hare, Alan R. Palmiter, Margaret V. Sachs, Faith Stevelman, and Lynn A. Stout, in support of affirmance.

Akshat Tewary, Edison, N.J., for Amicus Curiae Occupy Wall Street-Alternative Banking Group, in support of affirmance.

Teresa Marie Goody, Kalorama Legal Services, PLLC, Washington, D.C., for Amicus Curiae Harvey L. Pitt, in support of affirmance.

Lori Alvino McGill, Latham & Watkins LLP, (Robin S. Conrad, Rachel Brand, National Chamber Litigation Center, Inc.; James M. Spears, Melissa B. Kimmel, Pharmaceutical Research and Manufacturers of America, on the brief), Washington, D.C., for Amici Curiae Chamber of Commerce of the United States and Pharmaceutical Research and Manufacturers of America, in support of reversal.

Annette L. Nazareth, Davis Polk & Wardwell LLP (Edmund Polubinski III, Gina Caruso, on the brief) New York, N.Y., for Amicus Curiae Securities Industry and Financial Markets Association, in support of reversal.

Daniel P. Chiplock, Lieff Cabraser Heimann & Bernstein, LLP, New York, N.Y., for Amicus Curiae National Association of Shareholder and Consumer Attorneys, in support of reversal.

Before: POOLER, LOHIER, and CARNEY, Circuit Judges.

POOLER, Circuit Judge:

The United States Securities and Exchange Commission ("S.E.C.") in conjunction with Citigroup Global Markets, Inc. ("Citigroup") appeals from the November 28, 2011 order of the United States District Court for the Southern District of [289] New York (Rakoff, J.) refusing to approve a consent decree entered into by the parties and instead setting a trial date. Our Court stayed that order and referred the matter to a merits panel for consideration of the underlying questions. S.E.C. v. Citigroup Global Markets, Inc., 673 F.3d 158 (2d Cir.2012). We now hold that the district court abused its discretion by applying an incorrect legal standard in assessing the consent decree and setting a date for trial.

BACKGROUND

I. Complaint and proposed consent judgment.

In October 2011, the S.E.C. filed a complaint against Citigroup, alleging that Citigroup negligently misrepresented its role and economic interest in structuring and marketing a billion-dollar fund, known as the Class V Funding III ("the Fund"), and violated Sections 17(a)(2) and (3) of the Securities Act of 1933 (the "Act"). The complaint alleges that Citigroup "exercised significant influence" over the selection of $500 million worth of the Fund's assets, which were primarily collateralized by subprime securities tied to the already faltering U.S. housing market. Citigroup told Fund investors that the Fund's investment portfolio was chosen by an independent investment advisor, but, the S.E.C. alleged, Citigroup itself selected a substantial amount of negatively projected mortgage-backed assets in which Citigroup had taken a short position. By assuming a short position, Citigroup realized profits of roughly $160 million from the poor performance of its chosen assets, while Fund investors suffered millions of dollars in losses.

Shortly after filing of the complaint, the S.E.C. filed a proposed consent judgment. In the proposed consent judgment, Citigroup agreed to: (1) a permanent injunction barring Citigroup from violating Act Sections 17(a)(2) and (3); (2) disgorgement of $160 million, which the S.E.C. asserted were Citigroup's net profits gained as a result of the conduct alleged in the complaint; (3) prejudgment interest in the amount of $30 million; and (4) a civil penalty of $95 million. Citigroup also agreed not to seek an offset against any compensatory damages awarded in any related investor action. Citigroup consented to make internal changes, for a period of three years, to prevent similar acts from happening in the future. Absent from the consent decree was any admission of guilt or liability.

The S.E.C. also filed a parallel complaint against Citigroup employee Brian Stoker. See S.E.C. v. Brian H. Stoker, 11 Civ. 7388(JSR). The Stoker complaint alleged that Stoker negligently violated Sections 17(a)(2) and (3) of the Act in connection with his role in structuring and marketing the collateralized debt obligations in the Fund.

II. Proceedings before the district court.

The district court scheduled a hearing in the matter, and presented the S.E.C. and Citigroup with a list of questions to answer. The questions included:

• Why should the Court impose a judgment in a case in which the S.E.C. alleges a serious securities fraud but the defendant neither admits nor denies wrongdoing?

• Given the S.E.C.'s statutory mandate to ensure transparency in the financial marketplace, is there an overriding public interest in determining whether the S.E.C.'s charges are true? Is the interest even stronger when there is no parallel criminal case?

[290] • How was the amount of the proposed judgment determined? In particular, what calculations went into the determination of the $95 million penalty? Why, for example, is the penalty in this case less than one-fifth of the $535 million penalty assessed in S.E.C. v. Goldman Sachs & Co....? What reason is there to believe this proposed penalty will have a meaningful deterrent effect?

• The proposed judgment imposes injunctive relief against future violations. What does the S.E.C. do to maintain compliance? How many contempt proceedings against large financial entities has the S.E.C. brought in the past decade as a result of violations of prior consent judgments?

• Why is the penalty in this case to be paid in large part by Citigroup and its shareholders rather than by the "culpable individual offenders acting for the corporation?" [] If the S.E.C. was for the most part unable to identify such alleged offenders, why was this?

• How can a securities fraud of this nature and magnitude be the result simply of negligence?

Both the S.E.C. and Citigroup submitted written responses to the district court's questions. On November 9, 2011, the district court conducted a hearing to explore the questions presented. A few weeks later, the district court issued a written opinion declining to approve the consent judgment. S.E.C. v. Citigroup Global Markets Inc., 827 F.Supp.2d 328 (S.D.N.Y. 2011) ("Citigroup I"). The district court stated that

before a court may employ its injunctive and contempt powers in support of an administrative settlement, it is required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest.

Id. at 332. It found that the proposed consent decree

is neither fair, nor reasonable, nor adequate, nor in the public interest ... because it does not provide the Court with a sufficient evidentiary basis to know whether the requested relief is justified under any of these standards. Purely private parties can settle a case without ever agreeing on the facts, for all that is required is that a plaintiff dismiss his complaint. But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.

Id. (footnotes omitted).

The district court criticized the relief obtained by the S.E.C. in the consent decree, comparing it unfavorably with settlements entered in S.E.C. v. Bank of America Corp., No. 09 Civ. 6829(JSR), 2010 WL 624581 (S.D.N.Y. Feb. 22, 2010), and in S.E.C. v. Goldman Sachs & Co. et al., No. 10 Civ. 3229(BSJ), Docket No. 25 (S.D.N.Y. July 20, 2010). See Citigroup I, 827 F.Supp.2d at 330-31, 334 n. 7. In both Bank of America and Goldman Sachs, the district court noted, the parties stipulated to certain findings of facts. Without such an evidentiary basis in this case, the district court reasoned, "the Court is forced to conclude that a proposed Consent Judgment [291] that asks the Court to impose substantial injunctive relief, enforced by the Court's own contempt power, on the basis of allegations unsupported by any proven or acknowledged facts whatsoever, is neither reasonable, nor fair, nor adequate, nor in the public interest." Id. at 335. Thus, the district court concluded:

An application of judicial power that does not rest on facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts — cold, hard, solid facts, established either by admissions or by trials — it serves no lawful or moral purpose and is simply an engine of oppression.

Id.

The district court refused to approve the consent judgment, and instead consolidated this case with the Stoker action and ordered the parties to be prepared to try both cases on July 16, 2012.

III. Prior proceedings before this Court.

The S.E.C. and Citigroup filed immediate notices of appeal. The S.E.C. also moved in the district court for an emergency stay pending the outcome of the appeal, but before the district court could decide the stay motion before it, the S.E.C. sought an emergency stay in our Court. As an alternative basis for relief, the S.E.C. also filed a petition for a writ of mandamus to set the order aside.

Prior to our Court's ruling on the stay motion and mandamus petition, the district court issued its decision denying the motion for a stay. S.E.C. v. Citigroup Global Markets Inc., 827 F.Supp.2d 336 (S.D.N.Y. 2011) ("Citigroup II"). The district court reasoned that our Court lacked jurisdiction to hear an interlocutory appeal from the denial of approval of a consent judgment. Id. at 338-39. As to the S.E.C.'s proposal to file a writ of mandamus as an alternative to a statutory appeal, the district court similarly found that such action would not divest it of jurisdiction, and, consequently, declined to consider the S.E.C.'s request for a stay. Id. at 339-40.

Our Court disagreed, granting the motion for a stay pending before us. S.E.C. v. Citigroup Global Markets Inc., 673 F.3d 158 (2d Cir.2012) ("Citigroup III"). We concluded that the S.E.C. demonstrated a strong likelihood of success on the merits, because the district court did not accord the S.E.C.'s judgment adequate deference. Id. at 163-65. As both parties before us advocated for approving the consent order, we ordered counsel appointed to advocate for the district court's order. Id. at 169. Before us now is the merits appeal.

ANALYSIS

We review the district court's denial of a settlement agreement under an abuse of discretion standard. See S.E.C. v. Wang, 944 F.2d 80, 85 (2d Cir.1991). A district court abuses its discretion if it "(1) based its ruling on an erroneous view of the law," (2) made a "clearly erroneous assessment of the evidence," or (3) "rendered a decision that cannot be located within the range of permissible decisions." Lynch v. City of New York, 589 F.3d 94, 99 (2d Cir.2009) (internal quotation marks omitted).

I. Appellate jurisdiction.

The S.E.C. argues that we have jurisdiction to consider this interlocutory appeal pursuant to 28 U.S.C. § 1292(a)(1). We agree. Section 1292(a)(1) states in relevant part:

[292] (a) [T]he courts of appeals shall have jurisdiction of appeals from:

(1) Interlocutory orders of the district courts of the United States, ... or of the judges thereof, granting, continuing, modifying, refusing or dissolving injunctions, or refusing to dissolve or modify injunctions....

"Because § 1292(a)(1) was intended to carve out only a limited exception to the final-judgment rule, we have construed the statute narrowly to ensure that appeal as of right under § 1292(a)(1) will be available only in circumstances where an appeal will further the statutory purpose of permitting litigants to effectually challenge interlocutory orders of serious, perhaps irreparable, consequence." Carson v. Am. Brands Inc., 450 U.S. 79, 84, 101 S.Ct. 993, 67 L.Ed.2d 59 (1981) (internal quotation marks omitted). Thus, "[u]nless a litigant can show that an interlocutory order of the district court might have a serious, perhaps irreparable, consequence, and that the order can be effectually challenged only by immediate appeal, the general congressional policy against piecemeal review will preclude interlocutory appeal." Id. (internal quotation marks omitted).

In Carson, the consent decree at issue permanently enjoined an employer and a union from discriminating against African-American employees, required changes to the way seniority and benefits were awarded, established hiring goals, and granted job bidding preferences. 450 U.S. at 84, 101 S.Ct. 993. The Carson court found the district court's refusal to approve the consent decree constituted irreparable harm because:

the District Court made clear that it would not enter any decree containing remedial relief provisions that did not rest solidly on evidence of discrimination and that were not expressly limited to actual victims of discrimination. In ruling so broadly, the court did more than postpone consideration of the merits of petitioners' injunctive claim. It effectively foreclosed such consideration. Having stated that it could perceive no vestiges of racial discrimination on the facts presented, and that even if it could, no relief could be granted to future employees and others who were not actual victims of discrimination, the court made clear that nothing short of an admission of discrimination by respondents plus a complete restructuring of the class relief would induce it to approve remedial injunctive provisions.

Id. at 87 n. 12, 101 S.Ct. 993 (internal quotation marks omitted). Moreover, the Carson court found that "[b]ecause a party to a pending settlement might be legally justified in withdrawing its consent to the agreement once trial is held and final judgment entered, the District Court's order might thus have the `serious, perhaps irreparable, consequence' of denying the parties their right to compromise their dispute on mutually agreeable terms." Id. at 87-88, 101 S.Ct. 993 (footnote omitted). Finally, by delaying approval of the consent decree, the plaintiffs were losing access to the "specific job opportunities and the training and competitive advantages that would come with those opportunities." Id. at 89 n. 16, 101 S.Ct. 993.

In New York v. Dairylea Cooperative, Inc., the parties entered into a settlement to resolve a civil antitrust action. 698 F.2d 567, 568-69 (2d Cir.1983). The settlement included a provision labeled "Injunction" that:

would enjoin Dairylea from participating in any agreement to fix the price of milk or allocate customers during the next six years.... Dairylea [also] agreed to allow New York access to its books, records and personnel and to publicize, among its employees, the terms of the [293] arrangement for the purpose of ensuring Dairylea's compliance with the decree's provisions.

Id. at 569. We found that the proposed injunction did not meet the requirements of Carson because the settlement agreement proposed minimal injunctive relief: defendants were enjoined from violating the law. Id. at 570. The parties argued that "because the proposed settlement would enjoin Dairylea from participating in any conspiracy to fix prices or allocate customers," the "order disapproving the settlement is in effect the denial of an injunction." Id. We disagreed:

Taken to its extreme [] this argument would render the disapproval of every proposed settlement appealable. It would be a simple matter for the settling parties to include in the agreement an injunctive provision forbidding one party from violating the law. The mere existence of an injunctive clause, therefore, cannot be sufficient to render the disapproval of a proposed settlement agreement appealable.

Id.

Thus, to bring an interlocutory appeal from a district court's denial of settlement approval, a party must demonstrate "that (1) the district court, by refusing to approve a settlement, effectively denied a party injunctive relief and (2) in the absence of an interlocutory appeal, a party will suffer irreparable harm." Grant v. Local 638, 373 F.3d 104, 108 (2d Cir.2004). That standard is satisfied here. The rejected consent decree provided for two types of injunctive relief: (1) enjoining Citigroup from violating provisions of the Act in the future, and (2) requiring Citigroup to undertake steps aimed at preventing future occurrences of securities fraud, and periodically demonstrate compliance to the S.E.C. The S.E.C. also demonstrated irreparable harm: unlike the court in Dairylea, here the district court expressed no willingness to revisit the settlement agreement with the parties, instead setting a trial date. See, e.g., Grant, 373 F.3d at 111 ("It bears repeating that the Carson court relied heavily on the district court's warning that it would never approve a settlement similar to the one the parties made." (citing Carson, 450 U.S. at 87 n. 12, 101 S.Ct. 993)). We are satisfied that our Court may exercise jurisdiction over this interlocutory appeal.

II. The scope of the consent decree.

We quickly dispense with the argument that the district court abused its discretion by requiring Citigroup to admit liability as a condition for approving the consent decree. In both the briefing and at oral argument, the district court's pro Bono counsel stated that the district court did not seek an admission of liability before approving the consent decree. With good reason-there is no basis in the law for the district court to require an admission of liability as a condition for approving a settlement between the parties. The decision to require an admission of liability before entering into a consent decree rests squarely with the S.E.C. As the district court did not condition its approval of the consent decree on an admission of liability, we need not address the issue further.

III. The scope of deference.

We turn, then, to the far thornier question of what deference the district court owes an agency seeking a consent decree. Our Court recognizes a "strong federal policy favoring the approval and enforcement of consent decrees." Wang, 944 F.2d at 85. "To be sure, when the district judge is presented with a proposed consent judgment, he is not merely a `rubber stamp.'" S.E.C. v. Levine, 881 F.2d 1165, 1181 (2d Cir.1989). The district [294] court here found it was "required, even after giving substantial deference to the views of the administrative agency, to be satisfied that it is not being used as a tool to enforce an agreement that is unfair, unreasonable, inadequate, or in contravention of the public interest." Citigroup I, 827 F.Supp.2d at 332. Other district courts in our Circuit view "[t]he role of the Court in reviewing and approving proposed consent judgments in S.E.C. enforcement actions [as] `restricted to assessing whether the settlement is fair, reasonable and adequate within the limitations Congress has imposed on the S.E.C. to recover investor losses.'" S.E.C. v. CR Intrinsic Investors, LLC, 939 F.Supp.2d 431, 434 (S.D.N.Y.2013) (quoting S.E.C. v. Cioffi, 868 F.Supp.2d 65, 74 (E.D.N.Y. 2012)); see also United States v. Peterson, 859 F.Supp.2d 477, 478 (E.D.N.Y.2012) ("A district court has the duty to determine whether a consent decree based on a proposed settlement is `fair and reasonable.'").

The "fair, reasonable, adequate and in the public interest" standard invoked by the district court finds its origins in a variety of cases. Our Court previously held, in the context of assessing a plan for distributing the proceeds of a proposed disgorgement order, that "once the district court satisfies itself that the distribution of proceeds in a proposed S.E.C. disgorgement plan is fair and reasonable, its review is at an end." Wang, 944 F.2d at 85. The Ninth Circuit — in circumstances similar to those presented here, a proposed consent decree aimed at settling an S.E.C. enforcement action — noted that "[u]nless a consent decree is unfair, inadequate, or unreasonable, it ought to be approved." S.E.C. v. Randolph, 736 F.2d 525, 529 (9th Cir. 1984).

Today we clarify that the proper standard for reviewing a proposed consent judgment involving an enforcement agency requires that the district court determine whether the proposed consent decree is fair and reasonable, with the additional requirement that the "public interest would not be disserved," eBay, Inc. v. MercExchange, 547 U.S. 388, 391, 126 S.Ct. 1837, 164 L.Ed.2d 641 (2006), in the event that the consent decree includes injunctive relief. Absent a substantial basis in the record for concluding that the proposed consent decree does not meet these requirements, the district court is required to enter the order.

We omit "adequacy" from the standard. Scrutinizing a proposed consent decree for "adequacy" appears borrowed from the review applied to class action settlements, and strikes us as particularly inapt in the context of a proposed S.E.C. consent decree. See Fed.R.Civ.P. 23(e)(2) ("If the proposal would bind the class members, the court may approve it only after a hearing and on a finding that it is fair, reasonable, and adequate."). The adequacy requirement makes perfect sense in the context of a class action settlement — a class action settlement typically precludes future claims, and a court is rightly concerned that the settlement achieved be adequate. By the same token, a consent decree does not pose the same concerns regarding adequacy — if there are potential plaintiffs with a private right of action, those plaintiffs are free to bring their own actions. If there is no private right of action, then the S.E.C. is the entity charged with representing the victims, and is politically liable if it fails to adequately perform its duties.

A court evaluating a proposed S.E.C. consent decree for fairness and reasonableness should, at a minimum, assess (1) the basic legality of the decree, see Benjamin v. Jacobson, 172 F.3d 144, 155-59 (2d Cir.1999) (terminating existing consent [295] decrees as required by the Prison Litigation Reform Act); (2) whether the terms of the decree, including its enforcement mechanism, are clear, see, e.g., Angela R. ex rel. Hesselbein v. Clinton, 999 F.2d 320, 325 (8th Cir.1993) (district court abused its discretion by approving consent decree that did not properly define the enforcement mechanisms); (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind. Cf. Kozlowski v. Coughlin, 871 F.2d 241, 244 (2d Cir.1989) ("Before entering a consent judgment, the district court must be certain that the decree 1) springs from and serves to resolve a dispute within the court's subject-matter jurisdiction, 2) comes within the general scope of the case made by the pleadings, and 3) furthers the objectives of the law upon which the complaint was based." (internal quotation marks and alternations omitted)). Consent decrees vary, and depending on the decree a district court may need to make additional inquiry to ensure that the consent decree is fair and reasonable. The primary focus of the inquiry, however, should be on ensuring the consent decree is procedurally proper, using objective measures similar to the factors set out above, taking care not to infringe on the S.E.C.'s discretionary authority to settle on a particular set of terms.

It is an abuse of discretion to require, as the district court did here, that the S.E.C. establish the "truth" of the allegations against a settling party as a condition for approving the consent decrees. Citigroup I, 827 F.Supp.2d at 332-33. Trials are primarily about the truth. Consent decrees are primarily about pragmatism. "[C]onsent decrees are normally compromises in which the parties give up something they might have won in litigation and waive their rights to litigation." United States v. ITT Continental Baking Co., 420 U.S. 223, 235, 95 S.Ct. 926, 43 L.Ed.2d 148 (1975). Thus, a consent decree "must be construed as ... written, and not as it might have been written had the plaintiff established his factual claims and legal theories in litigation." United States v. Armour & Co., 402 U.S. 673, 682, 91 S.Ct. 1752, 29 L.Ed.2d 256 (1971). Consent decrees provide parties with a means to manage risk. "The numerous factors that affect a litigant's decision whether to compromise a case or litigate it to the end include the value of the particular proposed compromise, the perceived likelihood of obtaining a still better settlement, the prospects of coming out better, or worse, after a full trial, and the resources that would need to be expended in the attempt." Citigroup III, 673 F.3d at 164; see also Randolph, 736 F.2d at 529 ("Compromise is the essence of settlement. Even if the Commission's case against [defendants] is strong, proceeding to trial would still be costly. The S.E.C.'s resources are limited, and that is why it often uses consent decrees as a means of enforcement." (citation omitted)). These assessments are uniquely for the litigants to make. It is not within the district court's purview to demand "cold, hard, solid facts, established either by admissions or by trials," Citigroup I, 827 F.Supp.2d at 335, as to the truth of the allegations in the complaint as a condition for approving a consent decree.

As part of its review, the district court will necessarily establish that a factual basis exists for the proposed decree. In many cases, setting out the colorable claims, supported by factual averments by the S.E.C., neither admitted nor denied by the wrongdoer, will suffice to allow the district court to conduct its review. Other cases may require more of a showing, for example, if the district court's initial review [296] of the record raises a suspicion that the consent decree was entered into as a result of improper collusion between the S.E.C. and the settling party. We need not, and do not, delineate the precise contours of the factual basis required to obtain approval for each consent decree that may pass before the court. It is enough to state that the district court here, with the benefit of copious submissions by the parties, likely had a sufficient record before it on which to determine if the proposed decree was fair and reasonable. On remand, if the district court finds it necessary, it may ask the S.E.C. and Citigroup to provide additional information sufficient to allay any concerns the district court may have regarding improper collusion between the parties.

As noted earlier, when a proposed consent decree contains injunctive relief, a district court must also consider the public interest in deciding whether to grant the injunction. See eBay, 547 U.S. at 391, 126 S.Ct. 1837; Salinger v. Colting, 607 F.3d 68, 80 (2d Cir.2010). eBay makes clear that

a plaintiff seeking a permanent injunction must satisfy a four-factor test before a court may grant such relief. A plaintiff must demonstrate: (1) that it has suffered an irreparable injury; (2) that remedies available at law, such as monetary damages, are inadequate to compensate for that injury; (3) that, considering the balance of hardships between the plaintiff and defendant, a remedy in equity is warranted; and (4) that the public interest would not be disserved by a permanent injunction.

547 U.S. at 391, 126 S.Ct. 1837. "eBay strongly indicates that the traditional principles of equity it employed are the presumptive standard for injunctions in any context," be they preliminary or permanent. Salinger, 607 F.3d at 78; see also World Wide Polymers, Inc. v. Shinkong Synthetic Fibers Corp., 694 F.3d 155, 160-61 (2d Cir.2012) (applying the eBay test to a permanent injunction sought to remedy a breach of an exclusive distributorship agreement).

Our analysis focuses on the issue reached by the district court: that the district court must assure itself the "public interest would not be disserved" by the issuance of a permanent injunction. eBay, 547 U.S. at 391, 126 S.Ct. 1837; cf. WPIX, Inc. v. ivi, Inc., 691 F.3d 275, 278 (2d Cir.2012) (describing the test as "non-disservice of the public interest by issuance of a preliminary injunction.")^[1]

The job of determining whether the proposed S.E.C. consent decree best serves the public interest, however, rests squarely with the S.E.C., and its decision merits significant deference:

[F]ederal judges — who have no constituency — have a duty to respect legitimate policy choices made by those who do. The responsibilities for assessing the wisdom of such policy choices and resolving the struggle between competing views of the public interest are not judicial ones: "Our Constitution vests such responsibilities in the public branches."

Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467 U.S. 837, 866, 104 S.Ct. 2778, 81 L.Ed.2d 694 (1984) (quoting TVA v. Hill, 437 U.S. 153, 195, 98 S.Ct. 2279, 57 L.Ed.2d 117 (1978)); see also In re Cuyahoga Equip. Corp., 980 F.2d 110, 118 (2d [297] Cir.1992) ("Appellate courts ordinarily defer to the agency's expertise and the voluntary agreement of the parties in proposing the settlement.").

The district court correctly recognized that it was required to consider the public interest in deciding whether to grant the injunctive relief in the proposed injunction. Citigroup I, 827 F.Supp.2d at 331. However, the district court made no findings that the injunctive relief proposed in the consent decree would disserve the public interest, in part because it defined the public interest as "an overriding interest in knowing the truth." Id. at 335. The district court's failure to make the proper inquiry constitutes legal error. On remand, the district court should consider whether the public interest would be disserved by entry of the consent decree. For example, a consent decree may disserve the public interest if it barred private litigants from pursuing their own claims independent of the relief obtained under the consent decree. What the district court may not do is find the public interest disserved based on its disagreement with the S.E.C.'s decisions on discretionary matters of policy, such as deciding to settle without requiring an admission of liability.

To the extent the district court withheld approval of the consent decree on the ground that it believed the S.E.C. failed to bring the proper charges against Citigroup, that constituted an abuse of discretion. See Citigroup I, 827 F.Supp.2d at 330. In comparing the complaint filed by the S.E.C. against Citigroup with the complaint filed by the S.E.C. against Stoker, the district court noted that "[a]lthough this would appear to be tantamount to an allegation of knowing and fraudulent intent (`scienter,' in the lingo of securities law), the S.E.C., for reasons of its own, chose to charge Citigroup only with negligence, in violation of Sections 17(a)(2) and (3) of the Securities Act, 15 U.S.C. § 77q(a)(2) and (3)." Id. The exclusive right to choose which charges to levy against a defendant rests with the S.E.C. See, e.g., United States v. Microsoft Corp., 56 F.3d 1448, 1459 (D.C.Cir.1995) ("[T]he district court is not empowered to review the actions or behavior of the Department of Justice; the court is only authorized to review the decree itself."); see also Heckler v. Chaney, 470 U.S. 821, 831, 105 S.Ct. 1649, 84 L.Ed.2d 714 (1985) ("[A]n agency's decision not to prosecute or enforce, whether through civil or criminal process, is a decision generally committed to an agency's absolute discretion."). Nor can the district court reject a consent decree on the ground that it fails to provide collateral estoppel assistance to private litigants — that simply is not the job of the courts.

Finally, we note that to the extent that the S.E.C. does not wish to engage with the courts, it is free to eschew the involvement of the courts and employ its own arsenal of remedies instead. See, e.g., Exchange Act § 21C(a), 15 U.S.C. § 78u-3(a); Securities Act § 8A(a), 15 U.S.C. § 77h-1(a). The S.E.C. can also order the disgorgement of profits. Exchange Act § 21B(e), 15 U.S.C. § 78u-2(e); Securities Act § 8A(e), 15 U.S.C. § 77h-1(e). Admittedly, these remedies may not be on par with the relief afforded by a so-ordered consent decree and federal court injunctions. But if the S.E.C. prefers to call upon the power of the courts in ordering a consent decree and issuing an injunction, then the S.E.C. must be willing to assure the court that the settlement proposed is fair and reasonable. "Consent decrees are a hybrid in the sense that they are at once both contracts and orders; they are construed largely as contracts, but are enforced as orders." Berger v. Heckler, 771 F.2d 1556, 1568-69 (2d Cir.1985) (citation [298] omitted). For the courts to simply accept a proposed S.E.C. consent decree without any review would be a dereliction of the court's duty to ensure the orders it enters are proper.

CONCLUSION

For the reasons given above, we vacate the November 28, 2011 order of the district court and remand this case for further proceedings in accordance with this opinion. As we exercise jurisdiction pursuant to Section 1292(a)(1), the petition for a writ of mandamus is denied as moot.

LOHIER, Circuit Judge, concurring:

I thank my panel colleagues for addressing many of my concerns in this case. In particular, today's majority opinion makes clear that district courts assessing a proposed consent decree should consider principally four factors: "(1) the basic legality of the decree; (2) whether the terms of the decree, including its enforcement mechanism, are clear; (3) whether the consent decree reflects a resolution of the actual claims in the complaint; and (4) whether the consent decree is tainted by improper collusion or corruption of some kind." Majority Op., ante, at 294-95 (citations omitted). I write separately to make two more observations.

First, in my view, the "fair and reasonable" standard for assessing the appropriateness of monetary relief (as opposed to injunctive relief) involves a straightforward analysis of only the four factors identified by the majority and described above. If all four factors are satisfied, the perceived modesty of monetary penalties proposed in a consent decree is not a reason to reject the decree.

Second, I would be inclined to reverse on the factual record before us and direct the District Court to enter the consent decree. It does not appear that any additional facts are needed to determine that the proposed decree is "fair and reasonable" and does not disserve the public interest. Nor, to use the words of the majority opinion's holding, is there a "substantial basis ... for concluding" that further development of the record will show that the proposed terms of this decree are not fair, reasonable, and in the public interest. Under the circumstances, though, it does no harm to vacate and remand to permit the very able and distinguished District Judge to make that determination in the first instance.

[1] The district court did not address, and the parties do not brief, whether the remaining eBay factors were satisfied here. We therefore do not address this issue, except to note that the proposed consent decree waived Citigroup's right to challenge any enforcement action on the ground that the consent decree fails to conform to the requirements of Rule 65 of the Federal Rules of Civil Procedure.