In 1994, [Alvin Gebhart] began working at Mutual of New York (MONY) in San Diego, where he sold annuities and mutual funds. While at MONY, Gebhart met Jack Archer, a fellow MONY salesperson. In 1995, Archer told Gebhart about a business venture, Community Service Group (CSG), run by James Scovie. CSG was in the business of converting mobile home parks to resident ownership. CSG purchased parks from the owners and then assisted residents in purchasing them. In late 1996, Scovie and another person, David Mounier, created MHP Conversions, LLC (MHP), to facilitate the conversion process.

MHP issued promissory notes that were sold to individual investors to raise funds for CSG’s purchase of the parks. The MHP notes had one-year terms with fi xed interest rates of 18 percent for new investments and 14 percent for reinvested funds. Each note stated that it would “ultimately be secured by a deed of trust” on the particular park to be purchased with the funds, but that “until such time as said deed of trust is recorded, the sole asset of [the issuer] will be a deed of trust for the property known as Eastern Trailer Park.”

Archer told Gebhart about the MHP program, and * * * Gebhart arranged for Archer to make a presentation of the MHP program to three of his clients, all of whom made investments in the program.

In early 1996, Gebhart moved from MONY to another fi nancial services fi rm, Mutual Service Corporation (MSC), a broker-dealer and member of the NASD [National Association of Securities Dealers].

His wife, Donna Gebhart, joined him at MSC, and the two opened and operated a MSC branch in Rancho Bernardo, California, where they sold insurance and annuities and provided fi nancial planning services to clients. In October 1996, Archer approached the Gebharts about selling MHP notes to their MSC clients. * * * Archer told them that the MHP program had been approved by the compliance offi cer at Archer’s fi rm, MONY. This was not true, however. Archer also told the Gebharts “that the parks were in good shape and he always assured us that they had a lot of equity in them * * * .”

The Gebharts conducted no independent investigation into the MHP program, either in 1996 or over the next four years, during which time they sold MHP [fi nancial] notes to their clients. They failed to obtain any fi nancial statements for CSG or MHP, ascertain who were the owners, offi cers, or shareholders of CSG or MHP, determine what compensation would be paid to CSG or MHP or their offi cers, verify that trust deeds securing the notes were being recorded, or obtain copies of recorded trust deeds. * * *

Although the Gebharts believed that their clients’ loans would be secured by second trust deeds, they did not inquire why they were not fi rst trust deeds or who held the fi rst trust deeds. In lieu of an independent investigation, the Gebharts relied on Archer’s representations.

* * * *

Between the Gebharts’ meeting with Archer in October 1996 and CSG’s collapse in 2000, the Gebharts sold nearly \($2.4\) million in MHP promissory notes to 45 of their clients, earning about \($105\),000 in commission fees. The sales were based on several statements by the Gebharts that, it later became clear, were false. The Gebharts told their clients that the MHP notes were a proven investment that offered substantial returns and were secured by recorded deeds of trust. They said that in the worst case scenario their clients would be part owners of the mobile home parks and would be able to recover their investments.

In fact, the trust deeds were not recorded and the parks were signifi cantly over-encumbered [had excessive debt]. The Gebharts failed to disclose that their statements were based on information provided by Archer rather than their own, independent investigation.

* * * At the time of MHP’s collapse

[in 2000], the Gebharts’ clients had over \($1.5\) million invested in outstanding MHP notes. MSC terminated the Gebharts’ employment in August 2000.

As a result of these events, in 2002 the NASD’s Department of Enforcement fi led a complaint against the Gebharts for securities fraud. * * * A NASD hearing panel found that the Gebharts had acted in good faith and therefore rejected the fraud charges, but the NASD National Adjudicatory Council

(NAC) reversed. The NAC found that the Gebharts had committed fraud, imposed a lifetime bar on Alvin Gebhart, and imposed a one-year suspension and a \($15\),000 fine on Donna Gebhart. The SEC [Securities and Exchange Commission] upheld the NASD decision in 2006.

The Gebharts petitioned for review of the SEC decision.

* * * *

To establish a violation of Section 10

(b) and Rule 10b-5, the SEC is required to “show that there has been a misstatement or omission of material fact, made with scienter.”

“The plaintiffs may establish scienter by proving either actual knowledge or recklessness.”

* * * *

Scienter * * * is a subjective inquiry. It turns on the defendant’s actual state of mind. Thus, although we may consider the objective unreasonableness of the defendant’s conduct to raise an inference of scienter, the ultimate question is whether the defendant knew his or her statements were false, or was consciously reckless as to their truth or falsity. [Emphasis added.]

* * * *

The Gebharts contend that the SEC applied an erroneous scienter standard in this case by focusing exclusively on * * * objective inquiry and disregarding evidence of subjective good faith. We disagree.

The SEC considered all of the evidence bearing on the Gebharts’

actual state of mind, including the Gebharts’ extreme departure from ordinary standards of care, and found that the Gebharts were consciously aware of the risk that their statements were false. There was no error.

The SEC certainly considered the objective unreasonableness of the Gebharts’ actions as part of its analysis. The SEC found that the Gebharts failed to perform any meaningful investigation into the MHP promissory notes—an extreme departure from ordinary standards of care that “created the substantial

[and obvious] risk * * * that their representations were not true.” The SEC found that the Gebharts “made no effort to investigate or understand why their clients were being sold second (and not fi rst) deeds of trust; no effort to identify the fi rst trust deed holders or the amounts of those outstanding trust deeds;

and no effort to ensure their clients’

investments were actually being secured by recorded trust deeds.”

The Gebharts made “no effort” to corroborate [substantiate] Archer’s representations that the parks were not overly encumbered.

The SEC properly considered the objective unreasonableness of the Gebharts’ actions as some evidence supporting the inference that the Gebharts acted with scienter, but did not treat it as dispositive [a deciding factor]. The * * * [SEC] evaluated

“the evidence the Gebharts put forward to demonstrate their good faith beliefs” as “part of the complete mix of facts bearing on an evaluation of their [actual] state of mind” and concluded that the

“evidence from the Gebharts about their subjective belief [was] not suffi cient to overcome” the inference of scienter created by the evidence as a whole. The Gebharts’ assertions of good faith were “not plausible”

and lacked “credibility.” Based on the evidence as a whole, the SEC determined that the Gebharts “knew they had no direct knowledge of the truth or falsity” of their statements, and made their statements “despite not knowing whether they were true or false.” The SEC correctly applied the appropriate scienter standard.

Questions:-

1. At one point in the opinion (not included here), the court noted that “there is no evidence in the record that the Gebharts ever intended to defraud anyone.” Why, then, did the court conclude that the Gebharts had acted with scienter?

2. According to the court, if the evidence before an agency is “susceptible to more than one rational interpretation,”
the court “may not substitute its judgment for that of the agency.” Why do the courts show such deference to agency rulings?