INTRODUCTION

On February 22, 2011 the Commission submitted its response to Black's

Appellant Brief. Black had petitioned the Commission for reinstatement as an

investment adviser following the Commission's April 9, 2009 adoption of

regulations which now require all entities regulated by the Commission to use a

methodology for valuing securities similar or identical in all material aspects with

the methodology incorporated in the computer model Black was using in 1997 to

value the portfolio of investments owned by one of his companies.1 By authorizing

that methodology in 2009, the Commission effectively negated the substance of the

1997 charges against Black. The Commission does not dispute with that fact.

Nonetheless, while removing that portion of the industry bar imposed under the

Securities and Exchange Act, the Commission refused to vacate the portion of the

ban imposed pursuant to the Investment Advisers Act. The Commission denied

Black's petition leading to this appeal even though they have had the model in their

possession since 1997. The Commission does not deny the model is in full

compliance with the existing regulations.

1
Black's companies were Devon Capital Management ["Devon"], a registered
investment adviser, and Financial Management Sciences ["FMS"], an unregistered,
private corporation.
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 THE COMMISSION'S ARGUMENTS

I. There is an injunction in place

The Commission's argument for not reinstating Black is an injunction in

place and, pursuant to 15 USC§80b-3(f), the Commission is refusing to lift that

portion of the industry bar. This argument is circular, much the same as an endless

computer "do...loop".

Imagine you ran a white only school in Arkansas in 1953. You obtained an

injunction to prevent blacks from entering your school, perfectly legal in 1953.

Then in 1955 the Supreme Court requires integration in Brown v Board of

Education. If the Commission's interpretation of the law were correct, the schools

would still have troops escorting students in Little Rock. Obviously, the

Commission's reliance on an injunction issued in 1997, based upon Black's

following a methodology, now permitted by the Commission's own regulations, is

likewise absurd.

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II. The Injunction does not comply with 15 USC 80b-3(f)

Between the commencement of the case in 1997 until May 9, 2001 the court,

the government and Black construed the Commission's complaint as an allegation

of breach of contract for Black's failure to have securities equal to the fair value of

the Collateralized Investment Agreement ["CIA"], the investment product owned

by Black's clients. As detailed below, the government even stipulated that the CIA

was a two party contract. The injunction entered did not state the "in connection

with" requirement of a fraudulent transaction with the CIA.

On May 9, 2001, at the request of the Commission, the court determined that

Black's clients owned a security, the CIA. [Addendum] Its value is derived from

"a reasonable expectation of profits", the identical methodology incorporated in

Black's computer model. When the court, at the request of the Commission, held

the CIAs were securities, the clients owned a security with a fair value in excess of

its cost. Collateralization became meaningless.

More to the point, the injunction issued in 1997, four years before the court's

May 9, 2001 order, could not have been issued based upon facts supporting fraud

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"...in connection with the purchase or sale of a security" because the Commission

never alleged that the CIA's value was misrepresented or that there was a

fraudulent transaction.

The Commission states several times in the Reply that Black had defrauded

his clients. While 15 USC § 80b-6 does not require violations be "in connection

with the purchase or sale of a security", the Commission failed to state how the

fraud was accomplished. The Commission does not dispute that the CIA's fair

value was accurately represented, based upon a reasonable expectation of profits.

The Commission has also refused to explain how normal business expenses of a

corporation could have been paid with client funds. When the client invested in the

CIA it was in a common enterprise. The identity of each client's dollar was not

maintained, a trait common with investing in an enterprise, just as the owner of a

company's stock cannot claim ownership of a unit of production.

The Commission states that it found Black's argument were "...not

'persuasive' and lacked 'evidentiary support.'" [Brief, page 9] The Commission did

not disagree with Black's valuation method nor show how Black's methodology

does not conform to existing regulation. However, they intentionally attempt to

mislead this Court by stating that Black assumes "...that the assets would

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appreciate in value at an average of 14% per year indefinitely - an assumption for

which ...Black provided no evidence." [Brief, page 10]. The Commission knows

that no assumptions are permitted in the valuation method Black employed because

no assumptions are permitted under the Arbitrage Regulations or FASB 157.

Black's model requires observable facts as inputs. Those facts are: (1) the cash

flows of the EEN7 based upon observable mortgage prepayment speeds; (2) the

future yield curve as observed in the Eurodollar futures market; (3) the

mathematics of determining the coupon to be received on the EEN7 as determined

pursuant to its prospectus; and, (4) the resultant earnings to be derived from the

assets not invested in the EEN7, determined again from the Eurodollar futures

curve. [Appendix, Valuation of FNR G93-32S, pg 36] These are the inputs

required under Financial Accounting Standards Board Regulation 157. The

Commission has known how Black's model operated since 1997 when they first

possessed it and the Commission's attempt to confuse this Court is disingenuous.2

2
The Commission claims that Black waived the "in connection with" argument by not making it
before the Commission. However, the Brief also states the "in connection with" mandate of the
law for withholding Black's registration. [Brief, pg 5, footnote 2] The "in connection with"
provision is a minimum threshold for subject matter jurisdiction which Black cannot waive. It is
the responsibility of the Commission to determine their jurisdiction and to enter their finding on
the record. If the Commission has now found or finds that there was no nexus to interstate
commerce in their action, they acted without subject matter jurisdiction. In contrast to City of
Portland v EPA, 507 F.3d 706, 710 (D.C. Cir. 2007), cited by the Commission as "support" that
Black waived subject matter jurisdiction, the actions taken by the Commission were not taken
during a rulemaking process which allows input from interested parties.
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 COUNTERSTATEMENT OF THE CASE

I. Facts

The facts in this case are much more complicated than the representations

made by the Commission in their Reply Brief ["Reply"].

The 1997 complaint filed by the Commission did not detail a single instance

where the CIA, was offered, sold or purchased at other than fair value. The

Commission's claim before the district court in 1997 was that the forced liquidation

value of the assets owned by FMS and "...pursuant to which FMS guarantees a

fixed rate of return..." was less than the fair value of the CIAs outstanding.

[Appendix, Complaint, pg 6, ¶21]

According to the CIA, FMS agrees to secure or collateralize each LGU's

[client] principal by securities having a fair market value equal to 100% of the
investment in accordance with Pennsylvania law. [Appendix, Complaint, pg 6, ¶
22 also Brief, pg 3]

But there were two tests contained in the CIA. "...FMS agreed to secure OR

(emphasis added) collateralize..." the client's funds. The purpose for the two prong

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test was to avoid the event where the client owned a security outright but FMS

would still have to maintain securities equal to that investment.

However, the Commission argued to the district court that the CIA was a

contract that Black had breached by not maintaining collateral equal to the fair

value of the contract. The Commission alleged that Black's breach of contract

caused a violation of the Investment Advisers Act 15 USC§ 80b-6(1), (2) and (4)

as well as violations of 15 USC § 77q(a) and 15 USC § 78j(b), the twin anti-fraud

provisions of the Securities and the Exchange Acts.

That court granted the Commission's complaint and issued a temporary

restraining order and asset freeze in ex parte proceedings, thereby preventing FMS

from fulfilling its contract with the clients. Because FMS could not fulfill its

obligation with the clients, the default caused millions of dollars of unnecessary

losses to Black's clients.

Black agreed to the permanent injunction because, unlike the Securities or

the Exchange Acts, 15 USC§ 80b-6 of the Investment Advisers Act does not

require alleged violations to be in connection with the purchase or sale of a

security. Because the Commission did not allege any fraudulent transaction, and

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did not allege a purchase or sale of a security at fraudulent values, the injunction

was entered by the court without a determination that there was purchase or sale of

a security.

The Commission chose not to pursue the alleged violations of 15 USC §

77q(a) and 15 USC§ 78j(b). It can only be surmised that the Commission chose not

to prosecute those allegations because there was no fraudulent transaction, a

minimum requirement under those acts. Without a transaction there is no nexus to

interstate commerce and, without a security, no violation of the Securities or the

Exchange Acts.

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II. The Joint Stipulation

On January 24, 2000 the government contracted with Black in the Joint

Stipulation of Facts ["JSF"]. Among the facts, the government stated:

1.) The CIA " was a contract between Devon, on behalf of a client, and

FMS as a guarantor of a specified rate of return to the client."3. [Appendix, pg 81]

2.) There were 49 clients invested through the CIA program. [Appendix,

pg 82]

3.) Black did not cause the loss, but because interest rates rose, "...all

fixed rate securities, including securities deposited as collateral for the investments

of client beneficiaries of CIA‘s, sustained losses which reduced the fair market

value of the collateral assets...." [Appendix, pg 83]

4.) The assets of FMS were generating profits of almost $23 million per

year. "...Devon clients holding CIA's had outstanding investments of

approximately $233,000,000.00. Under the correct fair market valuation of the

3
Black maintains that the CIA was only ever offered, purchased or sold at fair
value without a public solicitation, to a select group of institutional investors who
solicited bids for their investment. The CIA was not a debt instrument. Debt
instruments are governed by their terms and are not subject to enforcement
pursuant to 15 U.S.C. § 77q(a), Section 10(b) of the Exchange Act, 15 U.S.C. §
78j(b), and Rule 10b-5. [See: Lorenz v. CSX Corp., 1 F.3d 1406 (3d Cir. 1993)
and United States SBA v. Katawczik, 107 Fed. Appx. 281 (3rd Cir. 2004]
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EEN7, the assets of FMS and those held by it as collateral for the CIA's of Devon

clients in or around September 1997 amounted only to approximately

$164,000,000.00, and approximately $7,000,000.00 of FMS assets. As of

September 26, 1997, the yield for the CIA portfolio was approximately fourteen

percent annually." [Appendix, pg 89]

III. The Guilty Plea

The Commission tries to confuse the Court stating that Black pled guilty to

investment adviser fraud. However, Black did not plead guilty to the elements of

fraud.

Black's indictment alleged that he had "... falsely represented the market

value of the CIA as being equal to the remaining liabilities of Devon to the client."

However, the government moved the court to amend the indictment, removing the

allegation of misrepresentation of the CIA's value and the court modified the

indictment. From the transcript: [Appendix, pg 30]

AUSA RODRIGUEZ: Your Honor, I'm sorry, if I may. Prior to the defendant
answering, can I clarify one point. To the extent that the first paragraph of the
count speaks to the use of market value in monthly statements, that is actually at
variance with the representations that the defendant is making in the stipulated
factual basis. Rather, it is agreed that there was a mailing of monthly statements.

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But as to the market value representation, that is not a point agreed upon. However,
the mailing itself is sufficient to establish the counts as there are further
stipulations of fact contained within the stipulated factual basis, Your Honor.

THE COURT: So you would be looking at the allegations in paragraph 63?

MR. RODRIGUEZ: I simply move to strike that portion of it.

Despite the court having approved the Joint Stipulation of Facts stating the

CIA was a two party contract, the district court determined on May 9, 2001, at the

request of the Commission, that the clients owned a security, the CIA. The

Commission argued and the court found that the clients owned an investment

contract. According to the Commission and the court, an investment contract is

"...investments of money...in a common enterprise...with a reasonable expectation

of profits derived from the entrepreneurial or managerial efforts of others."

[Appendix, pg 130-A and Addendum] The court stated that the CIA's value was to

be determined by a reasonable expectation of profits, not forced liquidation of

assets.

The government had stipulated that the enterprise was producing profits of

approximately $23 million per year. There was no need for "collateralization"

because the CIA, the security owned by Black's clients, was priced at fair value

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and the Commission and the government have had Black's computer model

verifying that value since 1997.

CONCLUSION

It is absurd for the Commission to argue that they refuse to lift the industry

bar against Black because of an injunction issued fourteen years ago for a business

practice that is now sanctioned by the Commission. Black respectfully requests

that this Court instruct the Commission to do whatever steps are necessary to have

the injunction set aside.

In 1997, the Commission alleged that Black had failed to maintain assets

equal to the fair value of his clients' investments. In 2001, the Commission argued

and the court found that, contrary to the government's stipulation, the CIA was a

security whose value is to be determined by a reasonable expectation of profits

generated through the efforts of others and not by the forced liquidation of assets.

That value of the CIA has never been litigated. The Commission has chosen not to

litigate the value for almost fourteen years and has therefore forfeited the right of

contesting the value now. This Court need look no further than the fact that the

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Commission, rather than admit that the value of the CIA was never litigated chose

to lift the industry bar portion imposed under the Securities and Exchange Acts.

There remain the allegations under the Advisers Act, 15 USC § 80b-6, for

which there is no "in connection with" requirement. However, since the value of

the only security that matters here, the CIA, was not fraudulently represented, the

injunction could not have been issued "in connection with" a security transaction

because all of those transactions were conducted at fair value. And certainly, if

Black knew the Commission construed the CIA to be a security whose value was

to be determined pursuant to a reasonable expectation of profits, he would not have

agreed to the permanent injunction.

The conclusion here is inescapable. There was no fraudulent transaction with

the CIA. Black has admitted that he determined the value of the FMS portfolio and

the CIAs pursuant to a mathematical model. The Commission does not deny that

valuing securities pursuant to a model is permitted under current regulations.

Possibly Black should have released the details of his model to his clients, but,

under the securities laws and regulations, there is no requirement to release

proprietary information. The model in the Commission's possession since 1997

clearly reflects that the single CMO must also be held in conjunction with $400

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million of other investments. The resulting portfolio value is far in excess of the

underlying securities individually, the classic definition of securitized cash flows.

Because there was no fraudulent misrepresentation of the CIA's value, the

injunction issued in 1997 could not have been in connection with the purchase and

sale of a security, as required under 15 USC § 80b-3(f). The Commission has not

used the precedent of this case to bring another enforcement action against any

other firm or individual for the same grounds alleged in this action, the liquidation

value of securitized assets being less than the market value of the securities sold to

acquire those assets. As of fourth quarter 2010, there were approximately $9

trillion dollars4 of asset backed securities outstanding, all predicated upon the

securitizing of cash flows and the issuance of securities to be repaid from those

cash flows; with the fair value of the securities sold greatly exceeding the

liquidation value of the underlying assets.

Black respectfully requests this Court to direct the Commission to do

whatever is necessary to have Black's injunction set aside or rescinded and to lift

the industry bar against him.

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Source: Securities Industry and Financial Markets Securitization Report,
Quarter 4 of 2010
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