Fog Cutter Capital Group Inc. v. Securities & Exchange Commission

 United States Court of Appeals
         FOR THE DISTRICT OF COLUMBIA CIRCUIT



Argued November 20, 2006            Decided January 23, 2007

                         No. 06-1071

             FOG CUTTER CAPITAL GROUP INC.,
                      PETITIONER

                              v.

          SECURITIES AND EXCHANGE COMMISSION,
                       RESPONDENT


          On Petition for Review of an Order of the
           Securities and Exchange Commission



     Meredith Moss argued the cause for petitioner. With her on
the briefs were Lanny J. Davis and James A. Meyers.

     Dominick V. Freda, Senior Counsel, Securities & Exchange
Commission, argued the cause for respondent. With him on the
brief were Brian G. Cartwright, General Counsel, Andrew N.
Vollmer, Deputy General Counsel, Jacob H. Stillman, Solicitor,
and Randall W. Quinn, Assistant General Counsel. Eric
Summergrad, Deputy Solicitor, entered an appearance.

   Before: GINSBURG, Chief Judge, and RANDOLPH and
ROGERS, Circuit Judges.

    Opinion for the Court filed by Circuit Judge RANDOLPH.
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     RANDOLPH, Circuit Judge: The National Association of
Securities Dealers (NASD) delisted Fog Cutter Capital Group’s
public stock from Nasdaq. The Securities and Exchange
Commission dismissed Fog Cutter’s petition for review. In re
Fog Cutter Capital Group, Inc., Exchange Act Release No. 34-
5,2993, 2005 WL 3500274, at *4 (Dec. 21, 2005). The issue in
this petition for judicial review is whether the Commission’s
dismissal was “arbitrary, capricious, an abuse of discretion, or
otherwise not in accordance with law,” 5 U.S.C. § 706(2)(A).

      The NASD is a registered “national securities association”
under the Securities Exchange Act of 1934, 15 U.S.C. § 78o-
3(b). At all times relevant to this case, the NASD operated
Nasdaq, an electronic securities exchange. As a self-regulatory
organization, the NASD must maintain rules to protect investors
and the public interest. 15 U.S.C. § 78o-3(b)(6). One of these
rules, approved by the Commission, stated that the NASD “will
exercise broad discretionary authority over the initial and
continued inclusion of securities in Nasdaq in order to maintain
the quality and public confidence in its market.” See NASD
Marketplace Rule 4300. To that end, the NASD will delist
securities if, in its “opinion,” events occur that render it
“inadvisable or unwarranted” to continue listing the securities
“even though the securities meet all enumerated criteria for”
listing. Id.

     For Fog Cutter, the disqualifying events centered on the
criminal investigation, indictment, and conviction of its Chief
Executive Officer and Board Chairman, Andrew Wiederhorn,
and the manner in which the company dealt with this
development. Wiederhorn founded Fog Cutter in 1997 and, with
family members, controlled approximately fifty-three percent of
the company’s stock. The company operated a national
restaurant chain and engaged in banking, financing, and real
estate investment activities.
                                3


     In March 2001, federal prosecutors informed Wiederhorn
and Lawrence Mendelsohn, a former president of Fog Cutter,
that they were targets of a grand jury investigation into the
collapse of Capital Consultants, LLC, an investment adviser for
union pension plans. Other than the fact that Wiederhorn and
Mendelsohn were investigated for actions unrelated to Fog
Cutter, the details of the criminal case are unnecessary to
recount. Mendelsohn pleaded guilty and agreed to cooperate
with the government. Wiederhorn later entered into a plea
agreement and pleaded guilty to a two-count indictment
charging him with giving an illegal gratuity and filing a false tax
return, both felonies. The district court sentenced him to
eighteen months in prison and ordered him to pay a $25,000 fine
and $2 million to the Capital Consultants receiver.

     On June 2, 2004, the day before Wiederhorn entered into
the plea deal, he finalized a leave-of-absence agreement with
Fog Cutter. The agreement acknowledged Wiederhorn’s plea
agreement and imminent incarceration, and provided that during
his absence he would retain his titles and responsibilities. Fog
Cutter agreed to pay Wiederhorn his $350,000 annual salary,
bonuses, and other benefits while he was imprisoned. The
company also agreed to pay him a $2 million “leave of absence
payment” to retain his “good will, cooperation and continuing
assistance, and in recognition of Wiederhorn’s past service to
the Company, to help avoid litigation and for . . . other reasons.”
Fog Cutter knew Wiederhorn would use the $2 million payment
to pay the restitution his plea agreement ordered. In its filings
with the Commission, Fog Cutter disclosed this information and
the $4.75 million cost of its agreement with Wiederhorn.

    In July 2004, NASD staff decided that it was contrary to the
public interest for Fog Cutter to remain listed on Nasdaq with
Wiederhorn exercising substantial influence over the company
                               4

while incarcerated. See In re Fog Cutter, 2005 WL 3500274, at
*3. An NASD Panel determined that the Board’s willingness to
amend Wiederhorn’s employment agreement, acquiescence to
Wiederhorn’s demands for financial support during his
imprisonment, payment of his court-ordered restitution, and
retention of him in his executive and director positions during
his imprisonment were contrary to the public interest. The
NASD Listing and Hearing Review Council affirmed the
Panel’s decision “in order to protect the quality of and public
confidence in The Nasdaq Stock Market, and to protect investors
and the public interest.” See id. Fog Cutter applied to the
Securities and Exchange Commission for review of the
Council’s decision. The Commission dismissed the application
for review, focusing, as had NASD, on Wiederhorn’s status as
a convicted felon and the Board’s actions supporting and
retaining Wiederhorn on the Board and in management.

     Fog Cutter’s main complaint is that the Commission failed
to take into account the company’s sound business reasons for
acting as it did. The decision to enter into the leave-of-absence
agreement was, Fog Cutter argues, in the best interest of its
shareholders. The company tells us that Wiederhorn’s
continuing commitment to the company and his return to an
active role in the company after his incarceration were essential
to preserving Fog Cutter’s core business units.

     The company focuses on its 2002 purchase of a majority
interest in George Elkins Mortgage Banking Co., Inc. (GEMB).
The Stock Purchase Agreement conditioned Fog Cutter’s
majority interest in GEMB upon Wiederhorn’s serving as either
a member of the Board or as CEO of Fog Cutter. If he occupied
neither position, the minority shareholders had an option to
repurchase their interest in GEMB, unless Wiederhorn’s absence
was due to his death or disability. Fog Cutter claims such a
                                5

repurchase would be at “fire sale” prices, and that keeping
Wiederhorn on board was therefore essential.

     The company has presented nothing to support the
likelihood that the options would be exercised. Nor has the
company ever specified how much it would have lost from the
exercise of the options. All we have is Fog Cutter’s obscure
assertion, without any citation to the record, that GEMB was
“potentially valued at up to $10 million.” See Opening Br. of
Pet’r 22. Even if we put aside the “potentially,” we are still left
with no information about the difference between the option
price and the fair market value – or potential value – of Fog
Cutter’s GEMB stock. What we do know is that Fog Cutter
made a deal with Wiederhorn that cost the company
$4.75 million in a year in which it reported a $3.93 million net
loss. We know as well that Fog Cutter handed Wiederhorn a
$2 million bonus right before he went off to prison, a bonus
stemming directly from the consequences of Wiederhorn’s
criminal activity.

     Under Section 19(f) of the Exchange Act, 15 U.S.C.
§ 78s(f), the Commission must dismiss an application for review
of an NASD delisting order if (1) the “specific grounds” “exist
in fact,” (2) the decision was in accordance with NASD rules,
(3) the rules are and were applied in a manner consistent with
the Exchange Act, and (4) the decision imposes no unnecessary
or inappropriate burden on competition under the Act. Whether
the Commission acted arbitrarily, capriciously, or unlawfully
depends on whether its review of the NASD’s decision complied
with Section 19(f).

     Here there was ample evidence supporting the NASD’s
grounds for taking action against Fog Cutter: Wiederhorn’s
guilty plea, the leave of absence deal and its cost to the
company, the Board’s determination that Wiederhorn should
                                6

retain his positions with Fog Cutter, and the concern that
Wiederhorn would continue to exert influence on company
affairs even while he was in prison. The decision was in
accordance with NASD rules giving the organization broad
discretion to determine whether the public interest requires
delisting securities in light of events at a company. That rule is
obviously consistent with the Exchange Act, and NASD’s
decision did not burden competition.

     Fog Cutter claims that it had to pay Wiederhorn and retain
him because if it fired him in light of his guilty plea, it would
have owed him $6 million. This scarcely speaks well for the
company’s case. The potential obligation is a result of an
amendment the Board granted Wiederhorn in 2003 while he was
under investigation. Wiederhorn’s employment agreement
stated that if terminated “for cause,” he was entitled only to his
base salary through the date of termination and payment of
unreimbursed business expenses. If it terminated Wiederhorn
without cause, Fog Cutter would have owed him three times his
annual salary, three times his largest annual bonus from the last
three years, unreimbursed business expenses, and accrued but
unpaid base salary and bonuses – which Fog Cutter estimates
would amount to $6 million – all as a lump-sum payment within
ten days. Before the amendment to Wiederhorn’s employment
agreement in 2003, termination “for cause” included the
conviction of any felony other than a traffic offense. In the 2003
amendment, the relevant provision allowed the Board to
terminate Wiederhorn “for cause” upon conviction of a felony
involving Fog Cutter. The Board had known about the
investigation of Wiederhorn in connection with Capital
Consultants for more than two years when it agreed to this
amendment.

    Fog Cutter thinks NASD’s action was “unfair.” But it was
the company that bowed to Wiederhorn’s demand for an
                                7

amendment to his employment agreement, knowing full well
that it was dramatically increasing the cost of firing him. Now
it argues that terminating Wiederhorn would have been too
expensive. One is reminded of the old saw about the child who
murders his parents and then asks for mercy because he is an
orphan. The makeup of Fog Cutter’s Board was virtually
unchanged between the time it amended the employment
agreement and entered into the leave-of-absence agreement. In
re Fog Cutter, 2005 WL 3500274, at *2 n.6. It was, to say the
least, not arbitrary or capricious for the Commission to find that
Wiederhorn exercised thorough control over the Board, and to
find this troubling. We agree that the Board provided little or no
check on Wiederhorn’s conduct, and that the Board’s actions
only aggravated the concerns Wiederhorn’s conviction and
imprisonment raised.

     That Fog Cutter did not itself violate the securities laws and
that it disclosed the relevant events does not demonstrate any
error in the delisting decision. The NASD’s rules state that it
may apply criteria more stringent than the minimum standards
for listing. See NASD Marketplace Rule 4300. Fog Cutter’s
disclosure of its arrangements with Wiederhorn did not change
the nature of those arrangements, which is what led the NASD
to find that the company’s actions were contrary to the public
interest and a threat to public confidence in the Nasdaq
exchange.

     Fog Cutter points to the continued listing of two companies
– Steve Madden and Martha Stewart Living Omnimedia – in
spite of the fact that Steve Madden and Martha Stewart, the
chief executives of the companies, were convicted and
imprisoned. This amounts to a selective prosecution argument,
and it goes nowhere. To prove selective prosecution, a claimant
must be part of a protected class under the Equal Protection
Clause, U.S. CONST. amend. XIV, § 1, and show not only that
                              8

prosecutors acted with bad intent, but also that “similarly
situated individuals [outside the protected category] were not
prosecuted.” United States v. Armstrong, 517 U.S. 456, 465
(1996). Fog Cutter clearly cannot prove all, if any, of these
factors. As the Commission points out, Martha Stewart Living
Omnimedia is listed on the New York Stock Exchange, not
Nasdaq. And it is the NASD, not the Commission, that
institutes the delisting investigations and renders delisting
decisions. The Commission’s role is as a reviewing body, not
an initiator.

     In delisting Fog Cutter, the NASD was concerned with the
integrity and the public’s perception of the Nasdaq exchange in
light of both Wiederhorn’s legal troubles and the Board’s
ongoing acquiescence to his demands. The Commission amply
supported these concerns and was well within its authority to
dismiss Fog Cutter’s application for review of the NASD’s
delisting decision. We therefore deny Fog Cutter’s petition for
judicial review.

                                                   So ordered.