John P. Flannery v. Securities & Exchange Commission

United States Court of Appeals
For the First Circuit
No. 15-1080
JOHN P. FLANNERY,
Petitioner,
v.
SECURITIES & EXCHANGE COMMISSION,
Respondent.
No. 15-1117
JAMES D. HOPKINS,
Petitioner,
v.
SECURITIES & EXCHANGE COMMISSION,
Respondent.
PETITIONS FOR REVIEW OF AN ORDER OF
THE SECURITIES AND EXCHANGE COMMISSION
Before
Lynch, Stahl, and Kayatta,
Circuit Judges.
Mark W. Pearlstein, with whom Laura McLane, Fredric D.
Firestone, David H. Chen, and McDermott Will & Emery LLP were on
brief, for petitioner John P. Flannery.
John F. Sylvia, with whom Andrew N. Nathanson, Jessica C.
Sergi, and Mintz Levin Cohn Ferris Glovsky & Popeo PC were on

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brief, for petitioner James D. Hopkins.
Lisa K. Helvin, Senior Counsel, with whom Michael A. Conley,
Deputy General Counsel, John W. Avery, Deputy Solicitor, and
Benjamin L. Schiffrin, Senior Litigation Counsel, Securities and
Exchange Commission, were on brief, for respondent.
Jonathan G. Cedarbaum, Christopher Davies, Daniel Aguilar,
John Byrnes, Wilmer Cutler Pickering Hale and Dorr LLP, Kate
Comerford Todd, Steven P. Lehotsky, and U.S. Chamber Litigation
Center, Inc., on brief for the Chamber of Commerce of the United
States of America, amicus curiae in support of petitioners.
December 8, 2015

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LYNCH, Circuit Judge. In 2010, the United States
Securities and Exchange Commission ("SEC" or "Commission") issued
an Order Instituting Proceedings against two former employees of
State Street Bank and Trust Company ("State Street"): (1) James D.
Hopkins, a former vice president and head of North American Product
Engineering, and (2) John P. Flannery, a former chief investment
officer ("CIO"). The Commission alleged that during the 2007
subprime mortgage crisis, Hopkins and Flannery "engaged in a course
of business and made material misrepresentations and omissions
that misled investors" about two substantially identical State
Street–managed funds collectively known as the Limited Duration
Bond Fund ("LDBF"). Hopkins and Flannery were charged with
violating Section 17(a) of the Securities Act of 1933 (15 U.S.C.
§ 77q(a)), Section 10(b) of the Securities Exchange Act of 1934
(15 U.S.C. § 78j(b)), and Exchange Act Rule 10b-5 (17 C.F.R.
§ 240.10b-5). After an eleven-day hearing, involving nineteen
witnesses and about five hundred exhibits, the SEC's Chief
Administrative Law Judge ("ALJ") dismissed the proceeding, finding
that neither Hopkins nor Flannery was responsible for, or had
ultimate authority over, the documents at issue and that these
documents did not contain materially false or misleading
statements or omissions.
The SEC Division of Enforcement ("Division") appealed
the ALJ's decision to the Commission. In 2014, the Commission, in

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a 3-2 decision, reversed the ALJ with regard to a slide that
Hopkins used at a May 10, 2007, presentation to a group of
investors, and two letters, dated August 2 and August 14, 2007,
that Flannery wrote or had seen before they were sent to investors.
See In re John P. Flannery & James D. Hopkins, Securities Act
Release No. 9689, Exchange Act Release No. 73,840, Investment
Company Act Release No. 31,374, 2014 WL 7145625 (Dec. 15, 2014).
The Commission found Hopkins liable under Securities Act Section
17(a)(1) ("Section 17(a)(1)"), Securities Exchange Act Section
10(b) ("Section 10(b)"), and Exchange Act Rule 10b-5 ("Rule 10b-
5"); it found Flannery liable under Securities Act Section 17(a)(3)
("Section 17(a)(3)"). The Commission imposed cease-and-desist
orders on Hopkins and Flannery, suspended Hopkins and Flannery
from association with any investment adviser or company for one
year, imposed a $65,000 civil monetary penalty on Hopkins, and
imposed a $6,500 civil monetary penalty on Flannery. These
petitions for review followed.
We conclude that the Commission's findings are not
supported by substantial evidence. With regard to Hopkins, we
find that the Division's materiality showing was marginal, and
that there was not substantial evidence supporting scienter in the
form of recklessness. With regard to Flannery, we conclude that
at least the August 2 letter was not misleading, and therefore, as
we explain, we need not reach the issue of whether the August 14

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letter was misleading. We grant the petitions for review and
vacate the Commission's order.
I.
We take the underlying facts from the record before the
Commission. See Rizek v. SEC, 215 F.3d 157, 159 (1st Cir. 2000).
State Street Global Advisors ("SSgA") is the investment
management arm of State Street Corporation. 1 It advises and
manages State Street–affiliated registered mutual funds and
unregistered collective trust funds. 2 On March 1, 2002, SSgA
created the LDBF, a combination of two unregistered fixed-income
funds that were invested in various fixed-income products. The
LDBF was offered and sold only to institutional investors.
Investments in the LDBF came from three sources: first, other State
Street funds invested directly in the LDBF; second, clients of
internal advisory groups invested in the LDBF based on SSgA's
recommendation to those groups; and third, independent
institutional investors invested directly in the LDBF.
The LDBF was heavily invested in asset-backed securities
("ABS"), which included residential mortgage-backed securities
("RMBS"). Until 2007, the LDBF had outperformed its benchmark
1 State Street is a wholly owned subsidiary of State Street
Corporation. State Street Corporation is a publicly traded
corporation.
2 State Street and SSgA were used interchangeably during
the proceeding.

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index. In January and February 2007, it underperformed its
benchmark index because of its investment in certain lower-rated
securities. April and May 2007, however, were two of the best
months in the LDBF's history. Then, beginning in June 2007, during
the subprime mortgage crisis, the LDBF experienced substantial
underperformance. The Division's charges against Hopkins and
Flannery involve communications about the LDBF that Hopkins and
Flannery either made or were involved with in 2007.
A. Vice President Hopkins
Hopkins worked at State Street from 1998 until 2010,
when he was offered retirement as a result of the SEC proceeding.
From 2006 to 2007, he was a vice president and head of North
American Product Engineering. During that time, Hopkins was the
senior product engineer responsible for fixed-income funds,
including the LDBF. He served as a liaison between the portfolio
managers and the client-facing people, which included salespeople
and consultant relations people. Hopkins was one of several people
that would make presentations to potential clients. He was also
responsible for correcting inaccuracies in LDBF "fact sheets,"
two-page quarterly documents made available to clients and
prospective clients that showed the LDBF's strategy and
performance numbers. Apart from the SEC charges, Hopkins worked
in the securities industry for thirty-five years with an
unblemished record.

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SSgA used a standard PowerPoint presentation when
presenting information about the LDBF. In 2006 and 2007, this
presentation included a slide titled "Typical Portfolio Exposures
and Characteristics -- Limited Duration Bond Strategy" ("Typical
Portfolio Slide"). We describe the slide:
Under the slide title, it read:
 Exposure to non-correlated fixed income
asset classes
 High quality
 No interest rate risk
Below, it had a box containing the following table:
Limited Duration
Bond Fund
Average quality AA
Modified adjusted duration 0.09 years
Yield over One Month LIBOR 50 bps
Average life 2.5 years
It then had a heading "Breakdown by market value" and contained
two bar graphs. The graph on the left was titled "By sector" and
contained the following information:
 ABS: 55%
 CMBS: 25%
 MBS: 10%
 Agency: 5%
 Corporates: 0%
 Cash: 5%
The graph on the right was titled "By quality" and contained the
following information:
 AAA: 45%
 AA: 40%

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 A: 10%
 BBB: 5%
Importantly, the Typical Portfolio Slide portrayed
percentages for both sector allocations and quality of
investments. It is the sector allocations (going to
diversification) which disturb the SEC. The typical sector
allocation graph showed that the LDBF was 55% invested in ABS, 25%
invested in commercial mortgage-backed securities ("CMBS"), and
10% invested in mortgage-backed securities ("MBS"). In 2006 and
2007, the LDBF's actual investment in ABS reached 80% to nearly
100%. One expert testified that along with "Conditional Value at
Risk," credit ratings are used to determine the risk of a portfolio
like the LDBF.
Hopkins did not update the Typical Portfolio Slide's
sector breakdown from at least December 2006 through the summer of
2007. He would, however, bring notes on the actual investments
when he made presentations, but he did not necessarily discuss the
information in his notes if it did not come up in a question.
Hopkins used the Typical Portfolio Slide at several presentations.
He did not recall ever being asked a question about the LDBF's
actual portfolio composition, including at the specific
presentation next described.
On May 10, 2007, Hopkins made a presentation to the
National Jewish Medical and Research Center ("NJC"), which was a

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client of Yanni Partners, an institutional investment consulting
firm. David Hammerstein, Yanni Partners' chief strategist, who
was at the meeting, testified that Hopkins presented the Typical
Portfolio Slide. According to Hammerstein, Hopkins used the slide
to demonstrate that the LDBF was of very high quality and
diversified. It is true the Typical Portfolio Slide labeled the
LDBF as "high quality."
The Division alleged that Hopkins violated Section
17(a), Section 10(b), and Rule 10b-5 in several ways, including by
being responsible for and using fact sheets that contained false
and misleading information; by misleading investors with the
Typical Portfolio Slide; by failing to update a slide that stated
the LDBF had reduced its exposure to the index of lower-rated
securities that had contributed to the January and February 2007
underperformance; and by making or acting negligently in
connection with materially misleading statements in two different
letters. The ALJ found that Hopkins was not responsible for the
documents at issue and that he did not make any material
misrepresentations or omissions.
After the Division appealed the ALJ's decision
dismissing the proceeding, the Commission found that the Typical
Portfolio Slide included material misrepresentations that Hopkins
knew were misleading and that he "made" the misrepresentations in
the slide, at least with regard to the May 10, 2007, presentation

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to the NJC. The Commission held Hopkins liable for this
presentation under Section 17(a)(1), Section 10(b), and Rule 10b-
5. See 15 U.S.C. § 77q(a)(1); 15 U.S.C. § 78j(b); 17 C.F.R.
§ 240.10b-5.
B. CIO Flannery
Flannery joined SSgA in 1996 as a product engineer. In
2005, he became SSgA's Fixed Income CIO for the Americas. As CIO,
Flannery had general supervisory oversight for SSgA's operations.
However, he was not involved in the LDBF's investment decisions or
its daily management. Flannery worked at SSgA until his position
was eliminated in 2007. Before joining SSgA, Flannery had worked
in the fixed-income area for about sixteen years, first in bond
sales, then in managing fixed-income investments. He had an
unblemished record in the industry and a reputation for being very
honest and having a great deal of integrity.
In May 2006, Flannery expressed that he was concerned
about mortgage risk in the real estate market and requested SSgA's
fixed-income team to provide him with an analysis on the subject.
After the LDBF began underperforming in June 2007, Flannery
requested on June 25, 2007, that members of SSgA's management team
and a member of its risk team re-examine the subprime market. That
day, the head of Global Structured Projects gave Flannery a
memorandum that stated, "[w]e remain constructive on the
fundamentals" and that foreclosures were lower than the 10-year

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average except in California and the Rust Belt states. The
memorandum indicated that "we think there will be continued
weakness in certain parts of the country . . . but we don't believe
there is an imminent 'melt down' scenario. Subprime borrowers
need loans, lenders are making loans, the street continues to fund
these loans via the securitization market, and we expect this to
continue going forward."
By the end of July 2007, as the subprime crisis worsened,
Flannery became personally involved with managing the LDBF and had
daily contact with the SSgA risk team during the summer and fall
of 2007. He filled in as chair at a July 25, 2007, SSgA Investment
Committee meeting. According to meeting minutes, Flannery
discussed two ways to provide liquidity if clients wanted to leave
the LDBF: (1) by selling the LDBF's top-rated (AAA) bonds; or (2)
by selling a pro-rata share of assets across the portfolio.
Flannery noted that although AAA-rated bonds were liquid, if the
liquidity gained from the sales were siphoned off, then they would
be left with a lower quality portfolio. After discussion among
the meeting's participants, the Investment Committee decided on an
approach incorporating both options, where they would increase
liquidity in the fund and sell a pro-rata share of assets to cover
any withdrawals from the fund. The committee also agreed to reduce
the LDBF's exposure to AA-rated assets. In the two days following
the July 25 meeting, the portfolio management team sold about $1.6

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billion in AAA-rated bonds and $200 million in AA-rated bonds,
which paid for investor redemptions and repurchase commitments.
These transactions caused the LDBF's portfolio composition to
change from approximately 48% investment in AAA-rated securities
to less than 5%, and from 46% investment in AA-rated securities to
more than 80%.
1. August 2, 2007, Letter (Not From Flannery)
On August 2, 2007, Relationship Management sent a letter
to clients in at least twenty-two fixed-income funds, signed by
the individual Relationship Managers and including fund specific
performance information. A draft of this letter had been sent to
the legal department as well as several people to review. Flannery
had also received a draft, and he made a number of edits, some of
which stayed in the final version. However, Flannery had not been
included on several e-mail exchanges related to edits on the letter
prior to its distribution. The final version of the letter
included the following paragraph:
We believe that what has occurred in the
subprime mortgage market to date this year has
been more driven by liquidity and leverage
issues than long term fundamentals.
Additionally, the downdraft in valuations has
had a significant impact on the risk profile
of our portfolios, prompting us to take steps
to seek to reduce risk across the affected
portfolios. To date, in the Limited Duration
Bond Strategy, we have reduced a significant
portion of our BBB-rated securities and we
have sold a significant amount of our AAA-
rated cash positions. Additionally, AAA-rated

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exposure has been reduced as some total return
swaps rolled off at month end. Throughout
this period, the Strategy has maintained and
continues to be AA in average credit quality
according to SSgA's internal portfolio
analytics. The actions we have taken to date
in the Limited Duration Bond Strategy
simultaneously reduced risk in other SSgA
active fixed income and active derivative-
based strategies.
2. August 14, 2007, Letter (From Flannery)
On August 14, 2007, Flannery sent a letter to LDBF
investors, in an attempt to explain what was taking place in the
housing-related securities market. Flannery was normally not
responsible for client communications, and the Chief Executive
Officer ("CEO") of SSgA said it would not be a good idea, asking
why Flannery would want to "raise [his] head up." Flannery
understood the CEO to be saying that "this [was] kind of an ugly
situation . . . why stand up and take a bullet," but Flannery wrote
the letter because he thought it was "the right thing to do."
Flannery said that "up to the limits that [he] was given by legal,
[he] wanted to take responsibility for this disaster . . . and . . .
to tell something of the arc of the story to put it in context."
He said he "wanted to be as just completely straightforward as
[he] could be." The draft of the letter Flannery prepared included
the following paragraph:
The situation is extreme and difficult to
manage. While we believe that the subprime
markets clearly convey far greater risk than
they have historically[,] we feel that forced

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selling in this chaotic and illiquid market is
unwise. Even if mortgage delinquencies soar
beyond our expectations we would expect
significantly higher values for our sub-prime
holdings. While recent events may have
repriced the risk of these assets for the
foreseeable future and it is unlikely that
they will retrace to values at the turn of the
year we believe that liquidity will slowly re-
enter the market and the segment will regain
its footing. While we will continue to
liquidate assets for our clients when they
demand it, our advice is to hold the positions
for now.
The last sentence was then edited to read, "While we will continue
to liquidate assets for our clients when they demand it, our advice
is to hold the positions in anticipation of greater liquidity in
the months to come." Deputy General Counsel Mark Duggan revised
that sentence to read, "While we will continue to liquidate assets
for our clients when they demand it, we believe that many judicious
investors will hold the positions in anticipation of greater
liquidity in the months to come." Flannery kept Duggan's change
because Flannery believed both his original language and the
revised language were accurate. In addition to Duggan, a number
of people reviewed the letter, including the co-heads of
Relationship Management, SSgA's president and CEO, and outside
legal counsel.
3. SEC Proceeding
In the Division's appeal of the ALJ's decision, the
Commission held Flannery liable under Section 17(a)(3) for

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misleading statements in both the August 2 and August 14 letters.
With regard to the August 2 letter, the Commission found the
statement that SSgA reduced its risk in part by selling "a
significant amount" of its "AAA-rated cash positions" was
"misleading because LDBF's sale of the AAA-rated securities did
not reduce risk in the fund. Rather, the sale ultimately increased
both the fund's credit risk and its liquidity risk because the
securities that remained in the fund had a lower credit rating and
were less liquid than those that were sold." The Commission found
that "even if [Flannery] did suggest minor edits to the letter
that were never incorporated, and even if others were 'heavily
involved' in its drafting . . . those facts . . . do not excuse
his decision to approve misleading language."
With regard to the August 14 letter, the Commission found
the "many judicious investors" language Duggan inserted was
misleading "because it suggested that SSgA viewed holding onto the
LDBF investment as a 'judicious' decision when, in fact, officials
at SSgA had taken a contrary view, redeeming SSgA's own shares in
LDBF and advising SSgA advisory group clients to redeem their
interests, as well." The Commission found that the
misrepresentations in both letters were material and that Flannery
acted negligently in both cases. The SEC went on to hold, as a
matter of law, that two misstatements were sufficient to find a
violation of Section 17(a)(3)'s prohibition on "engag[ing] in any

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. . . course of business which operates or would operate as a fraud
or deceit upon the purchaser." We need not reach that issue of
law.
II.
"The SEC's factual findings control if supported by
substantial evidence, . . . and its orders and conclusions must
not be 'arbitrary, capricious, an abuse of discretion, or otherwise
not in accordance with law.'" Cody v. SEC, 693 F.3d 251, 257 (1st
Cir. 2012) (citations omitted) (quoting 5 U.S.C. § 706(2)(A)
(2006)). "Substantial evidence is 'such relevant evidence as a
reasonable mind might accept as adequate to support a conclusion.'"
Penobscot Air Servs., Ltd. v. FAA, 164 F.3d 713, 718 (1st Cir.
1999) (quoting Universal Camera Corp. v. NLRB, 340 U.S. 474, 477
(1951)). We consider the whole record, and "[t]he substantiality
of evidence must take into account whatever in the record fairly
detracts from its weight." Universal Camera, 340 U.S. at 488.
When the Commission and the ALJ "reach different
conclusions, . . . the [ALJ]'s findings and written decision are
simply part of the record that the reviewing court must consider
in determining whether the [SEC]'s decision is supported by
substantial evidence." NLRB v. Int'l Bhd. of Teamsters, Local
251, 691 F.3d 49, 55 (1st Cir. 2012) (citing Universal Camera, 340
U.S. at 493). Because "evidence supporting a conclusion may be
less substantial when an impartial, experienced examiner who has

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observed the witnesses and lived with the case has drawn
conclusions different from the [Commission]'s than when [the ALJ]
has reached the same conclusion," id. at 55 (quoting Universal
Camera, 340 U.S. at 496), "where the [Commission] has reached a
conclusion opposite of that of the ALJ, our review is slightly
less deferential than it would be otherwise," id. (quoting Haas
Elec., Inc. v. NLRB, 299 F.3d 23, 28–29 (1st Cir. 2002)).
A. Hopkins
Liability under Section 17(a)(1), Section 10(b), and
Rule 10b-5 requires materiality and scienter. See SEC v. Ficken,
546 F.3d 45, 47 (1st Cir. 2008); see also Matrixx Initiatives,
Inc. v. Siracusano, 131 S. Ct. 1309, 1318 (2011). "[T]o fulfill
the materiality requirement 'there must be a substantial
likelihood that the disclosure of the omitted fact would have been
viewed by the reasonable investor as having significantly altered
the "total mix" of information made available.'" Basic Inc. v.
Levinson, 485 U.S. 224, 231–32 (1988) (quoting TSC Indus., Inc. v.
Northway, Inc., 426 U.S. 438, 449 (1976)). "Scienter is an
intention 'to deceive, manipulate, or defraud.'" Ficken, 546 F.3d
at 47 (quoting Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194 n.12
(1976)); see also Aaron v. SEC, 446 U.S. 680, 686 n.5 (1980).
Hopkins concedes that scienter can be established by proving "a
high degree of recklessness," but denies that he was reckless.
Compare Ficken, 546 F.3d at 47 ("In this circuit, proving scienter

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requires 'a showing of either conscious intent to defraud or "a
high degree of recklessness."'" (quoting ACA Fin. Guar. Corp. v.
Advest, Inc., 512 F.3d 46, 58 (1st Cir. 2008))), with Matrixx
Initiatives, 131 S. Ct. at 1323 ("We have not decided whether
recklessness suffices to fulfill the scienter requirement.").
Questions of materiality and scienter are connected.
City of Dearborn Heights Act 345 Police & Fire Ret. Sys. v. Waters
Corp., 632 F.3d 751, 757 (1st Cir. 2011). "If it is questionable
whether a fact is material or its materiality is marginal, that
tends to undercut the argument that defendants acted with the
requisite intent or extreme recklessness in not disclosing the
fact." Id.
Here, assuming the Typical Portfolio Slide was
misleading, 3 evidence supporting the Commission's finding of
materiality was marginal. The Commission's opinion states that
3 While the actual investment in ABS exceeded that which
was on the slide, the slide was clearly labeled "Typical Portfolio
Exposures and Characteristics -- Limited Duration Bond Strategy"
and did not purport to show the actual exposures to each sector at
any given time. The Commission contends that the allocation the
slide represented was still not typical during the 2006–2007 time
period. In response to the ALJ's question of whether the sector
breakdown "was, in fact, what existed at that time," Hopkins
responded, "I think it probably was -- in terms of the sector
breakdown on this page, it was not . . . what was typical." We
assume this was an admission that the slide was misleading as to
its "typicality."
We also assume that the Commission did not err in its
finding that Hopkins in fact presented the Typical Portfolio Slide
in his presentation to the NJC on May 10, 2007.

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"reasonable investors would have viewed disclosure of the fact
that, during the relevant period, LDBF's exposure to ABS was
substantially higher than was stated in the slide as having
significantly altered the total mix of information available to
them." Yet the Commission identifies only one witness other than
Hopkins relevant to this conclusion. Hammerstein, Yanni Partners'
chief strategist, 4 testified that at the May 10 meeting, Hopkins
spoke for about thirty minutes, 5 presented the Typical Portfolio
Slide, and said that the fund was of very high quality.
Hammerstein said that the information on the Typical Portfolio
Slide was important to him because "[i]t led to the impression
that the fund was well diversified, and therefore that State Street
took steps to reduce the risks or control the risks." Hammerstein
testified that when he later learned that the LDBF's ABS exposure
actually approached 100 percent, he was surprised in light of the
May 10 meeting. This led Yanni Partners to advise its clients to
liquidate their positions in the LDBF. Hammerstein said they came
to this conclusion because they "felt that State Street did not
adequately inform [them] of the risks in the portfolio, and [they]
4 Hammerstein himself was not actually an investor. He
was the chief strategist at Yanni Partners, which is an investment
consulting firm that works with investors. The Commission points
to no actual investors to support a finding of materiality.
5 Amanda Williams, who co-presented with Hopkins, wrote in
a note the day after the meeting that they had only about fifteen
minutes for their presentation.

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cited the example of the presentation that State Street made to
National Jewish on May 10 when State Street stated that . . . the
typical allocation was 55 percent to the ABS sector, but as
recently as March 31 of 2007, the actual ABS allocation was 100
percent." The Division presented a letter Yanni Partners sent to
every client invested in the LDBF, signed by the field consultant
responsible for the specific client, recommending that they
liquidate their holdings and citing the May 10 meeting where "[t]he
LD Bond Fund Portfolio Manager . . . did not disclose the actual
sector exposure at the time, instead presenting 'typical'
portfolio characteristics . . . ."
On the other hand, the slide was clearly labeled
"Typical." As far as Hammerstein was aware, through May 2007,
Yanni Partners never asked SSgA for a breakdown of the LDBF's
actual investment by sector nor was he aware of any request from
Yanni Partners for the LDBF's audited financial statements.
Further, the Commission has not identified any evidence in the
record that the credit risks posed by ABS, CMBS, or MBS were
materially different from each other, 6 arguing instead that the
6 We also note that the LDBF's composition in terms of
credit quality of holdings remained relatively constant, and, if
anything, improved. The Typical Portfolio Slide represented that
85% of the LDBF's investment was in AAA- and AA-rated bonds (45%
and 40% respectively), while the March 31, 2007, fact sheet
disclosed that 94.46% of its investment was in AAA- and AA-rated
bonds (62.2% and 32.26% respectively).

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percent of investment in ABS and diversification as such are
important to investors.
Context makes a difference. According to a report
Hammerstein authored the day after the meeting, the meeting's
purpose was to explain why the LDBF had underperformed in the first
quarter of 2007 and to discuss its investment in a specific index
that had contributed to the underperformance. The Typical
Portfolio Slide was one slide of a presentation of at least twenty.
Perhaps unsurprisingly, the slide was not mentioned in
Hammerstein's report.
Hopkins presented expert testimony from John W. Peavy
III ("Peavy") that "[p]re-prepared documents such as . . .
presentations . . . are not intended to present a complete picture
of the fund," but rather serve as "starting points," after which
due diligence is performed. Peavy explained that "a typical
investor in an unregistered fund would understand that it could
specifically request additional information regarding the fund." 7
And not only were clients given specific information upon request,
information about the LDBF's actual percent of sector investment
was available through the fact sheets and annual audited financial
7 Peavy also opined that "in the hundreds of . . . meetings
and presentations [he has] attended, [he did] not recall a single
instance in which the discussion was based solely on the content
of material prepared beforehand or a rote reading of a PowerPoint
presentation slide deck."

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statements. 8 The March 31, 2007, fact sheet, available six weeks
prior to the May 10, 2007, presentation, included that the LDBF
was 100% invested in ABS. The June 30, 2007, fact sheet included
that the LDBF was 81.3% invested in ABS. These facts weigh against
any conclusion that the Typical Portfolio Slide had "significantly
altered the 'total mix' of information made available." Basic,
485 U.S. at 232 (quoting TSC Indus., Inc., 426 U.S. at 449)
(internal quotation mark omitted).
This thin materiality showing cannot support a finding
of scienter here. 9 See Geffon v. Micrion Corp., 249 F.3d 29, 35
(1st Cir. 2001). Hopkins testified that in his experience,
8 Information was also provided on SSgA's website through
the password protected "Client's Corner" and "Consultant's Corner"
sections. However, the information available on these parts of
the website varied by fund and client. Hopkins presented evidence
that during 2007, the Client's Corner section was logged into
28,969 times by 465 unique users. Hopkins also presented evidence
that Hammerstein was copied on an e-mail about the Client's Corner
section of the website, but Hammerstein had no recollection of
seeing the e-mail.
We do not suggest that the mere availability of accurate
information negates an inaccurate statement. Rather, when a slide
is labeled "typical," and where a reasonable investor would not
rely on one slide but instead would conduct due diligence when
making an investment decision, the availability of actual and
accurate information is relevant.
9 Our determination is based on how a reasonable investor
would react. Given our conclusion that the Commission abused its
discretion in holding Hopkins liable under Section 17(a)(1),
Section 10(b), and Rule 10b-5, we need not decide whether the level
of sophistication of the LDBF investors would have made any
misrepresentation immaterial. Cf. SEC v. Happ, 392 F.3d 12, 21–
23 (1st Cir. 2004).

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investors did not focus on sector breakdown when making their
investment decisions and that LDBF investors did not focus on how
much of the LDBF investment was in ABS versus MBS. 10 In fact,
Hopkins did not recall ever discussing the Typical Portfolio Slide
or being asked a question about the actual sector breakdown when
presenting the slide. 11 He did not update the Typical Portfolio
Slide's sector breakdowns because he did not think the typical
sector breakdowns were important to investors. To the extent that
an investor would want to know the actual sector breakdowns,
Hopkins would bring notes with "the accurate information" so that
he could answer any questions that arose. We cannot say that these
handwritten notes provide substantial evidence of recklessness,
much less intentionality to mislead -- particularly in light of
Hopkins's belief that this information was not important to
investors. Cf. City of Dearborn Heights, 632 F.3d at 757 ("[T]he
question of whether Defendants recklessly failed to disclose [a
fact] is . . . intimately bound up with whether Defendants either
actually knew or recklessly ignored that the [fact] was material
10 Hopkins was not alone in his belief. Lawrence J.
Carlson, the co-head of Relationship Management at SSgA in 2007,
testified that at least prior to the summer of 2007, he did not
recall clients ever asking for a sector breakdown of the LDBF, and
expert witness Peavy testified that it was common for clients "not
to ask for holdings."
11 Outside of the presentations, prior to the May 10
meeting, there were at least occasional inquiries about the LDBF's
holdings, to which Hopkins provided answers.

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and nevertheless failed to disclose it." (alterations in original)
(quoting City of Phila. v. Fleming Cos., 264 F.3d 1245, 1265 (10th
Cir. 2001))). Given the evidence weighing against the materiality
of the portion of the slide to which the SEC objects, we cannot
say there is substantial evidence that Hopkins's presentation of
a slide containing sector breakdowns labeled "typical," with notes
of the actual sector breakdown ready at hand, constitutes "a highly
unreasonable [action], involving not merely simple, or even
inexcusable[] negligence, but an extreme departure from the
standards of ordinary care . . . that is either known to [Hopkins]
or is so obvious [Hopkins] must have been aware of it." Ficken,
546 F.3d at 47–48 (second alteration in original) (quoting SEC v.
Fife, 311 F.3d 1, 9–10 (1st Cir. 2002)). We conclude that the
Commission abused its discretion in holding Hopkins liable under
Section 17(a)(1), Section 10(b), and Rule 10b-5.
B. Flannery
Section 17(a)(3) deems it unlawful "for any person in
the offer or sale of any securities . . . to engage in any
transaction, practice, or course of business which operates or
would operate as a fraud or deceit upon the purchaser." 15 U.S.C.
§ 77q(a)(3). "[N]egligence is sufficient to establish liability
under . . . § 17(a)(3)." Ficken, 546 F.3d at 47.
The Commission concluded "that the August 2 and August
14 letters were materially misleading, particularly when their

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cumulative effect is taken into account." It found that "[w]hen
considered together -- and as part of a larger effort to convince
investors to remain in the poorly performing LDBF -- the letters
misleadingly downplayed LDBF's risk and encouraged investors to
hold onto their shares, even though SSgA's own funds and internal
advisory group clients were fleeing the fund." We disagree. At
the very least, the August 2 letter was not misleading -- even
when considered with the August 14 letter -- and so there was not
substantial evidence to support the Commission's finding that
Flannery was "liable for having engaged in a 'course of business'
that operated as a fraud on LDBF investors." 12
The Commission's primary reason for finding the August
2 letter misleading was its view that the "LDBF's sale of the AAA-
rated securities did not reduce risk in the fund. Rather, the
sale ultimately increased both the fund's credit risk and its
liquidity risk because the securities that remained in the fund
had a lower credit rating and were less liquid than those that
were sold." At the outset, we note that neither of the
Commission's assertions -- that the sale increased the fund's
credit risk and increased its liquidity risk -- are supported by
substantial evidence.
12 In light of this conclusion, we do not reach Flannery's
argument that the Commission's interpretation of Section 17(a)(3)
as applying to misstatements is incorrect.

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First, although credit rating alone does not necessarily
measure a portfolio's risk, the Commission does not dispute the
truth of the letter's statement that the LDBF maintained an average
AA-credit quality. Second, expert testimony presented at the
proceeding explained that the July 26 AAA-rated bond sale reduced
risk because these bonds "entailed credit and market risk that
were substantially greater than those of cash positions. In
addition, a portion of the sale proceeds was used to pay down
[repurchase agreement] loans and reduce the portfolio leverage."
Further, testimony throughout the proceeding indicated that the
LDBF's bond sales in July and August reduced risk by decreasing
exposure to the subprime residential market, by reducing leverage,
and by increasing liquidity, part of which was used to repay loans.
To be sure, the Commission maintained that the bond
sale's potentially beneficial effects on the fund's liquidity risk
were immediately undermined by the "massive outflows of the sale
proceeds . . . to early redeemers." But this reasoning falters
for two reasons. First, the Commission acknowledged that between
$175 and $195 million of the cash proceeds remained in the LDBF as
of the time the letter was sent; it offered no reason, however,
why this level of cash holdings provided an insufficient liquidity
cushion. Second and more fundamentally, even if the Commission
was correct that the liquidity risk in the LDBF was higher
following the sale than it was prior to the sale, it does not

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follow that the sale failed to reduce risk. Rather, to treat as
misleading the statement in the August 2 letter that State Street
had "reduced risk," the Commission would need to demonstrate that
the liquidity risk in the LDBF following the sale was higher than
it would have been in the counterfactual world in which the
financial crisis had continued to roil -- and in which large
numbers of investors likely would have sought redemption -- and
the LDBF had not sold its AAA holdings. But the Commission has
not done this.
Independently, the Commission has misread the letter.
The August 2 letter did not claim to have reduced risk in the LDBF.
The letter states that "the downdraft in valuations has had a
significant impact on the risk profile of our portfolios, prompting
us to take steps to seek to reduce risk across the affected
portfolios" (emphasis added). Indeed, at oral argument, the
Commission acknowledged that there was no particular sentence in
the letter that was inaccurate. It contends that the statement,
"[t]he actions we have taken to date in the [LDBF] simultaneously
reduced risk in other SSgA active fixed income and active
derivative-based strategies," misled investors into thinking SSgA
reduced the LDBF's risk profile. This argument ignores the word
"other." The letter was sent to clients in at least twenty-one
other funds, and, if anything, speaks to having reduced risk in
funds other than the LDBF.

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Even beyond that, there is not substantial evidence that
SSgA did not "seek to reduce risk across the affected portfolios."
As one expert testified, there are different types of risk
associated with a fund like the LDBF, including market risk,
liquidity risk, and credit or default risk. The LDBF was facing
a liquidity problem, and at the July 25 meeting, Michael Wands,
the Director of Active North American Fixed Income, explained that
"[i]t's hard to predict if the market will hold on or if there
will be a large number of withdrawals by clients. We need to have
liquidity should the clients decide to withdraw." Flannery noted
that "if [they didn't] raise liquidity [they] face[d] a greater
unknown." Robert Pickett, the LDBF's lead portfolio manager, noted
that selling only AAA-rated bonds would affect the LDBF's risk
profile. After discussion of both of these concerns, the
Investment Committee ultimately decided to increase liquidity,
sell a pro-rata share to warrant withdrawals, and reduce AA
exposure. And that is what it did. On July 26 and 27, 2007,
LDBF's portfolio management team sold approximately $1.6 billion
in AAA-rated bonds and about $200 million in AA-rated bonds;
between approximately July 31 and August 24, 2007, it sold about
$1.2 billion of AA-rated bonds; and on August 7 and 8, 2007, it
sold about $100 million of A-rated bonds. The August 2 letter
does not try to hide the sale of the AAA-rated bonds; it candidly
acknowledges it. At the proceeding, Flannery testified that

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selling AAA-rated bonds itself reduces risk, and here, in
combination with the pro-rata sale, was intended to maintain a
consistent risk profile for the LDBF. Pickett testified that the
goal of the pro-rata sale was to treat all shareholders -- both
those who exited the fund and those who remained -- as equally as
possible and maintain the risk-characteristics of the portfolio to
the extent possible. These actions are not inconsistent with
trying to reduce the risk profile across the portfolios.
Finally, we note that the Commission has failed to
identify a single witness that supports a finding of materiality.
Cf. SEC v. Phan, 500 F.3d 895, 910 (9th Cir. 2007) ("The SEC, which
both bears the burden of proof and is the party moving for summary
judgment, submitted no evidence to the district court
demonstrating the materiality of the misstatement about the
payment terms."). We do not think the letter was misleading, and
we find no substantial evidence supporting a conclusion otherwise.
We need not reach the August 14 letter. 13 In its opinion,
the Commission stated that while Section 17(a)(1) and Rule 10b-
5(a) & (c) "would proscribe even a single act of making or drafting
a material misstatement to investors, Section 17(a)(3) is not
13 We also do not reach the defense of whether the last
sentence of the relevant paragraph was no more than a non-
actionable "opinion," protected under Omnicare, Inc. v. Laborers
Dist. Council Constr. Indus. Pension Fund, 135 S. Ct. 1318, 1327
(2015).

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susceptible to a similar reading. Of course, one who repeatedly
makes or drafts such misstatements over a period of time may well
have engaged in a fraudulent 'practice' or 'course of business,'
but not every isolated act will qualify." See also In re Anthony
Fields, CPA, Securities Act Release No. 9727, Exchange Act Release
No. 74,344, Investment Company Act Release No. 31,461, 2015 WL
728005, at *10 (Feb. 20, 2015) ("[A]n isolated misstatement
unaccompanied by other conduct does not give rise to liability
under [Section 17(a)(3)]."). Even were we to assume that the
August 14 letter was misleading, in light of the SEC's
interpretation of Section 17(a)(3) and our conclusion about the
August 2 letter, we find there is not substantial evidence to
support the Commission's finding that Flannery engaged in a
fraudulent "practice" or "course of business."
III.
For the reasons above, we grant the petitions for review
and vacate the Commission's order.

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