Mark R. Schneider, Appellant,
The Kansas Securities Commissioner, Appellee.
scope of judicial review of an administrative agency's
action is defined by the Kansas Judicial Review Act, K.S A.
77-601 et seq. Under the KJRA, an appellate court
exercises the same statutorily limited review of the
agency's action as does the district court.
Interpretation of a statute or an administrative regulation
is a question of law over which an appellate court has
unlimited review. In doing so, courts no longer defer to the
agency's interpretation. When a statute is clear and
unambiguous, courts give effect to legislative intent
expressed through the words of the statute, rather than make
a determination of what the law should or should not be.
K.S.A. 2016 Supp. 77-621(c)(4) requires courts to grant
relief if the agency erroneously interpreted or applied the
K.S.A. 2016 Supp. 77-621(c)(7) requires courts to grant
relief if an agency action is based on a determination of
fact, made or implied by the agency, that is not supported by
evidence that is substantial when viewed in light of the
record as a whole. This includes the evidence both supporting
and detracting from an agency's finding. Substantial
competent evidence is relevant evidence that provides a
substantial basis of fact from which the issues can
reasonably be determined.
purpose of the Kansas Uniform Securities Act, K.S.A.
17-12a101 et seq., is to place the traffic of
promoting and dealing in speculative securities under strict
governmental regulation and control in order to protect
investors and thereby prevent the sale of fraudulent and
worthless speculative securities.
K.S.A. 17-12a412(d)(13) of the Kansas Uniform Securities Act
provides that a person may be disciplined where he or she
"has engaged in dishonest or unethical practices in the
securities, commodities, investment, franchise, banking,
finance, or insurance business within the previous 10
years." Violations of this provision include (1) making
unsuitable recommendations in violation of K.A.R. 81-14-5(d)
and (2) breaching the fiduciary duty to an investment client
in violation of K.A.R. 81-14-5(c), by making unsuitable
Unsuitable securities recommendations to an investment client
under K.A.R. 81-14-5(d)(1) are recommendations for the
"purchase, sale, or exchange of any security without
reasonable grounds to believe that the recommendation is
suitable for the client on the basis of information furnished
by the client after reasonable inquiry concerning the
client's investment objectives, financial situation and
needs, and any other information known by the investment
adviser or investment adviser representative."
Under K.A.R. 81-14-5(c) an investment adviser representative
"shall not fail to observe high standards of commercial
honor and just and equitable principles of trade in the
conduct of the person's business. An investment adviser
or investment adviser representative is a fiduciary and shall
act primarily for the benefit of its clients."
Financial Industry Regulatory Authority, Inc. (FINRA) is a
private entity that acts as a self-regulatory organization
for broker-dealers. From time to time it issues notices to
its members. Under the facts presented, the Kansas Securities
Commissioner did not use FINRA Notice 09-31 regarding certain
investment vehicles and the expert witness' testimony
regarding the information contained in the Notice as the
legal standard for measuring appellant's conduct, but
rather merely as evidence bearing upon whether appellant
engaged in dishonest or unethical practices in violation of
the Kansas Uniform Securities Act.
Under the Rules and Regulations Filing Act, K.S.A. 2016 Supp.
77-415 et seq., "any standard, requirement or
other policy of general application may be given binding
legal effect only if it has complied with the requirements of
the rules and regulations filing act." K.S.A. 2016 Supp.
77-415(b)(1). Under K.S.A. 77-425 "[a]ny rule and
regulation not filed and published as required by this act
shall be of no force or effect."
rule or regulation is defined by the Rules and Regulations
Filing Act as "a standard, requirement or other policy
of general application that has the force and effect of law,
including amendments or revocations thereof, issued or
adopted by a state agency to implement or interpret
legislation." K.S.A. 2106 Supp. 77-415(c)(4).
a general principle of administrative law, agency decisions
must be based on known rules and standards. Thus, rules and
regulations must be filed and published so that members of
the public, and others affected thereby, are not subjected to
agency rules and regulations whose existence is known only by
agency personnel. When an administrative agency arbitrarily
applies a rule that is not embodied in the statutes or
published as a rule or regulation, a respondent to an agency
action is deprived of fair notice and due process.
policy is a rule or regulation requiring filing and
publication under the Rules and Regulations Filing Act if (1)
the agency does not exercise discretion in applying it; (2)
it has general application to those having to do business
with the agency; and (3) the agency treats it as having the
effect of law.
Under the facts presented, the agency's use of FINRA
Notice 09-31 did not violate the Rules and Regulations Filing
Act, K.S.A. 2016 Supp. 77-415 et seq. The notice was
merely provided as evidence, not as agency policy, an agency
regulation, or the governing legal standard.
nondelegation doctrine prohibits the delegation of
governmental power to unelected and politically unaccountable
bodies. The nondelegation doctrine flows from the separation
of powers principles embodied in Art. 2, § 1 of the
Kansas Constitution, which provides that "[t]he
legislative power of this state shall be vested in a house of
representatives and senate." Under the nondelegation
doctrine, State agencies may not delegate their power to make
obligatory rules to private individuals or nongovernmental
Kansas Securities Commissioner's references to FINRA
Notice 09-31did not constitute a cession of governmental
authority to a private entity in violation of the
Scienter is not required to prove a breach of fiduciary duty.
The requirements of a claim of breach of fiduciary duty are
existence of a duty, breach of that duty, and damages
resulting from the breach. In the careless management of an
investment and the failure to keep the client advised
regarding the status of the investment, there is no scienter
requirement to establish a breach of fiduciary duty.
from Shawnee District Court; Rebecca W. Crotty, judge.
N. Walter and Trevor C. Wohlford, of Morris, Laing, Evans,
Brock & Kennedy, Chtd., of Topeka, for appellant.
E. Knutzen, Ryan A. Kriegshauser, and Christopher D. Mann, of
the Office of the Kansas Securities Commissioner, for
McAnany, P.J., Malone, J., and Stutzman, S.J.
Schneider appeals the district court's decision affirming
the Kansas Securities Commissioner's order finding that
he engaged in a "'dishonest or unethical'"
practice in the investment advisory business in violation of
the Kansas Uniform Securities Act, K.S.A. 17-12a101 et
seq., by selecting an investment for his client that he
had no reasonable grounds to believe was suitable. Schneider
contends: (1) the district court and the Commissioner
erroneously adopted and applied the wrong legal standard in
concluding that he violated the Kansas Uniform Securities
Act; and (2) the Commissioner's factual findings are not
supported by substantial competent evidence when viewed in
light of the record as a whole.
is an investment adviser representative and broker-dealer
registered in the State of Kansas and associated with the
investment firm Plan, Inc., a Financial Industry Regulatory
Authority (FINRA) member-firm. Schneider has a bachelor's
degree in accounting and business administration, and he has
held a certified financial planner designation since 1987.
For Schneider to be designated a certified financial planner
involved a 3-year process of taking classes and passing
is a regulatory organization for broker-dealers and
broker-dealer agents. As a member of FINRA, Schneider
regularly received rules or regulation notices intended to
provide guidance to FINRA members.
served as Mary Lou and Jeffrey Silverman's investment
adviser for more than 20 years, managing the Silvermans'
assets, tax returns, and life insurance. Schneider had full
discretionary authority over the Silvermans' investments,
and he had the ability to trade on behalf of the Silvermans
without their approval.
battling lymphocytic leukemia for 15 years, Jeffrey died on
January 3, 2010. Mary Lou received $1, 150, 000 in death
benefits from Jeffrey's life insurance policy, which she
initially deposited in bank accounts that were not under
Schneider's control. Prior to his death, Jeffrey handled
all of the family's finances including the investment
decisions. His assets-consisting mainly of cash with a
limited amount of mutual funds and large cap equities-were
conservatively managed by Schneider.
after Jeffrey's death, Mary Lou called Schneider to
discuss her investments. Consistent with the approach he
typically took with clients who had recently lost a spouse,
Schneider advised Mary Lou not to change her investment
portfolio for at least a year. But a few months later, Mary
Lou contacted Schneider again to discuss a strategy for
generating income from the life insurance proceeds that she
received after her husband's death. Mary Lou was not
employed outside the home and still had children in school,
so she sought a way to invest the money to achieve financial
independence and to support her family. Because Mary Lou was
not a sophisticated investor, she sought advice from
2010, Schneider compiled a financial plan for Mary Lou which
analyzed her cash flow, expenses, retirement needs, and
income requirements. The objective of the plan was to invest
her money to generate income in order for her to achieve
financial independence. Schneider's analysis showed that
Mary Lou needed monthly income of approximately $10, 000 to
pay her expenses. In order to generate the level of income
Mary Lou desired, Schneider projected that she needed an
annual investment return of 6.7%.
decided to pursue a short-term investment strategy in an
attempt to meet Mary Lou's investment goals. He chose to
place Mary Lou's assets in inverse investment products
that were exchange traded funds (ETFs).
first became aware of inverse investment products in November
2000 after a downturn in investment markets. In 2001 and
2002, Schneider conducted numerous seminars in order to
educate his clients about these products. He visited the
headquarters of Rydex, one of the vendors of inverse funds,
and spent a week visiting with managers about these
investment products. Inverse investment funds became an
integral part of Schneider's investment management
2006, Schneider starting using ETFs for his clients'
investments. Schneider said he preferred ETFs to inverse
mutual funds. He noted that the ETFs had lower internal
expenses and the ability to trade like stock on equity
2009, FINRA issued Regulation Notice 09-31,
"Non-Traditional ETFs, " an interpretative
statement to provide guidance to FINRA members and their
agents in recommending and selling securities to clients.
This notice indicated that nontraditional ETFs are useful for
some sophisticated trading strategies. But the notice
cautioned members that they are "highly complex
financial instruments" and unsuitable for retail
investors who hold them for more than one trading session,
particularly in volatile markets.
read FINRA Notice 09-31 when it was released, yet he did not
interpret the notice as an absolute statement that holding
these investments for more than 1 day was always unsuitable
for his clients. Schneider claimed there was no difference in
the level of care required between nontraditional ETFs and
other investment products. According to Schneider, the risk
comes from the market, not the particular investments.
being aware of the information in FINRA Notice 09-31,
Schneider placed essentially all of his 160 retail clients in
nontraditional ETFs, including Mary Lou, and he held the
nontraditional ETFs for periods lasting longer than 1 day.
middle of 2010, Schneider believed investment markets were
overvalued and that a stock market crash similar to what
occurred a few years earlier was imminent. Schneider met with
Mary Lou and discussed investing in inverse funds as a
short-term investment strategy. Inverse funds are
counter-cyclical: they typically go up as the market
declines. Schneider explained that his two-step strategy was
first to invest in inverse funds in order to take advantage
of a declining market, and then to invest in dividend paying
equities after the anticipated market correction occurred.
Schneider stated that he "was under the impression that
[Mary Lou] agreed to that."
liquidated the positions held in Mary Lou's discretionary
accounts and began buying leveraged and inverse ETFs.
market was very volatile during this period of time. From
June 2010 to August 2010, Schneider placed stop-losses on
these positions, which liquidated the investment when the
investment declined by a certain percentage. But every time a
stop-loss was triggered, Schneider placed a larger one in its
place. Schneider first put the stop-losses at 3%, then 4%,
and finally at 10%. Schneider said he increased the stop-loss
parameters because Mary Lou's positions were being
continually stopped out. Schneider eventually removed the
stop-losses entirely in September 2010.
to the advice in FINRA Notice 09-31, Schneider held various
leveraged and inverse ETF positions in Mary Lou's
discretionary accounts for periods exceeding 1 day. The
prospectus warned investors that these nontraditional ETFs
were not intended to achieve their investment objectives for
a period longer than 1 day. Many of Mary Lou's positions
were held for over 100 days, and three positions were held
for 182 days.
Lou saw some gains through the summer of 2010, but those
gains did not continue. By the end of 2010, Mary Lou's
accounts managed by Schneider suffered a net out-of-pocket
loss of $68, 327.69, or 3.4% of Mary Lou's total assets.
time did Schneider inform Mary Lou that he was using
nontraditional ETFs, the risks associated with those
investments, or that he planned on using them in
contravention of how they were designed to be used. He did
not advise her that her investments exposed her to the
potential for large losses. Schneider's unilateral
decision to invest Mary Lou's funds in nontraditional
ETFs cost Mary Lou $94, 710.
October 2, 2012, the Kansas Securities Commissioner gave a
notice of intent to impose administrative sanctions against
Schneider under K.S.A. 17-12a412 of the Kansas Uniform
Securities Act. The notice alleged that Schneider violated
K.A.R. 81-14-5(d)(1). The Commissioner contended that
Schneider's "purchases of the inverse and
leveraged-inverse ETFs on behalf of Ms. Silverman constitute
unsuitable recommendations and a breach of his fiduciary duty
as an investment adviser representative."
requested a hearing, and the administrative law judge
conducted a hearing on October 23-24, 2014.
Duval testified as an expert for the Commissioner. Duval
stated that nontraditional ETFs were not suitable investments
for investors needing income and growth, such as Mary Lou.
Duval said that investing in nontraditional ETFs for more
than 1 day is unsuitable for the average retail investor. In
Duval's opinion, investing in the nontraditional ETFs for
longer than a day is contrary to the prospectuses because
these ETFs are speculative investments that are subject to
testified that if an investment adviser intended to use
nontraditional ETFs in a manner not prescribed by the
prospectus, it is a breach of fiduciary duty to fail to
explain the products and their associated risks to the
investor, especially when the investments are made under
discretionary authority. In addition, Duval said that an
investment adviser breaches his or her fiduciary duty by
failing to inform a growth and income client that he or she
is investing in speculative products-such as nontraditional
ETFs-even if the investments conformed to the prospectuses.
During his testimony, Duval referred to FINRA Regulatory
Notice 09-31 and an article written by Duval,
"Leveraged and Inverse ETFs: Trojan Horses for
testified that inverse and leveraged ETFs should not be held
for more than 1 day because the investment will necessarily
erode and lose money as a result of the constant leveraging
trap. The constant leveraging trap refers to the daily
internal rebalancing to keep the fund leverage ratio constant
and consistent with the target relationship to the fund's
underlying index. According to Duval, this daily rebalancing
works against the investor and causes the investment to erode
in value and lose money. Duval testified that an investment
adviser representative exercising his or her discretion in
investing in and holding nontraditional ETFs for longer than
1 day constituted a breach of the investment adviser
representative's fiduciary duty. Duval testified that the
investment adviser would also have a duty to explain the
product and the risks associated with the product before
reviewed Mary Lou's account statements and found that
many inverse ETFs were held for long periods of time, many
longer than 30 days. The investments were unsuitable because
they were used contrary to the way they were designed. Duval
concluded: (1) Mary Lou's losses were a direct result of
Schneider's misuse of the ETFs; (2) nontraditional ETFs
were unsuitable investments for Mary Lou; and (3) it is a
breach of a fiduciary duty to place a client's assets
into unsuitable investments.
February 5, 2015, the ALJ issued his order, ruling that
Schneider violated K.S.A. 17-12a412(d)(13), K.A.R.
81-14-5(d)(1), and K.A.R. 81-14-5(c). The ALJ found Duval to
be a credible witness. He also found that Schneider appeared
arrogant at the hearing, and he took no responsibility for
the fact that he might have been wrong in his decision to
invest Mary Lou's assets in nontraditional ETFs. The ALJ
indicated that Schneider claimed to know how nontraditional
ETFs were to be used, but "the evidence presented showed
a total disregard for the accepted wisdom regarding the
suitability of Non-Traditional ETFs." The ALJ found
evidence presented that indicated that nontraditional ETFs
were not designed to achieve their investment objectives over
a period of time longer than 1 day.
parties filed petitions for review. On May 1, 2015, following
oral arguments, the Commissioner confirmed the ALJ's
findings of fact and conclusions of law in a final order. The
Commissioner also made additional findings of fact and
conclusions of law, including the following:
"Various regulatory notices and advisories indicate that
an adviser must be intimately familiar with Non-Traditional
ETFs. It is clear from the respondent's testimony, when
taken as a whole, that he: 1) was not nearly as knowledgeable
as he should have been regarding the product; 2) disregarded
accepted industry practice in how the product was to be used;
3) ignored regulatory guidance; 4) failed to trade the
product as intended; 5) failed to monitor the investments
appropriately; and 5) lost Silverman a significant sum of
money as a result."
Commissioner upheld Schneider's violations. Schneider was
ordered to pay restitution of $94, 720.60 and a civil penalty
of $25, 000.
29, 2015, Schneider filed a petition for review with the
district court under the Kansas Judicial Review Act (KJRA),
K.S.A. 77-601 et seq. After reviewing the agency
record and the briefs, the district court affirmed the
Commissioner's final order. Schneider then appealed to
scope of judicial review of a state administrative agency
action is defined by the KJRA, K.S.A. 77-601 et seq.
We review decisions on petitions for judicial review of
agency actions as in other civil cases. K.S.A. 77-623. The
party asserting the invalidity of an agency's action
bears the burden of proving invalidity. Likewise, the burden
of proving the invalidity of the Commissioner's actions
and decision is on the party asserting invalidity. K.S.A.
2016 Supp. 77-621(a)(1); Golden Rule Ins. Co. v.
Tomlinson, 300 Kan. 944, 953, 335 P.3d 1178 (2014).
Under the KJRA, we exercise the same statutorily limited
review of the agency's action as does the district court.
Kansas Dept. of Revenue v. Powell, 290 Kan. 564,
567, 232 P.3d 856 (2010).
of a statute or an administrative regulation is a question of
law over which we have unlimited review. In re Tax Appeal
of LaFarge Midwest,293 Kan. 1039, 1043, 271 P.3d 732
(2012). In making the unlimited review of a Kansas statute,
we no longer defer to the agency's interpretation. See
Douglas v. Ad Astra Information Systems, 296 Kan.
552, 559, 293 P.3d 723 (2013). When a statute is clear and
unambiguous, we give effect to legislative intent expressed
through the words of the statute, ...