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Initial Decision of an SEC Administrative Law JudgeIn the Matter of
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In the Matter of DAVID T. BARR |
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INITIAL DECISION July 27, 2000 |
APPEARANCES: David E. Marder and Peter W. Gillies for the Division of Enforcement, Securities and Exchange Commission
Andrew W. Sidman for Respondent David T. Barr
BEFORE: Brenda P. Murray, Chief Administrative Law Judge
The Securities and Exchange Commission ("Commission") initiated this proceeding with an Order Instituting Public Administrative and Cease-and-Desist Proceedings ("OIP") on April 24, 1998. The OIP cited Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b)(6) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") as operative authority. The OIP directed public hearings on the allegations by the Commission's Division of Enforcement ("Division") that between February and August 1993, Mr. Barr, using the means or instruments of interstate commerce or the mails, willfully violated: (1) Sections 5(a) and 5(c) of the Securities Act by selling unregistered International Trade & Commerce Corp. ("ITC") stock, and (2) Section 17(a) of the Securities Act by distributing materially false, written information to potential ITC investors in knowing or reckless disregard of its falsity.
On May 15, 1998, the Commission initiated a civil action in the United States District Court in Florida. SEC v. Phebe W. Erdman, Hans L. Erdman and David M. Lemon, Defendants, and Rebecca W. Erdman and Leslie Chekin, Relief-Defendants, No. 98-6500-CIV-MOORE (S.D. Fla. May 15, 1998). The complaint charged that Phebe W. Erdman, Hans L. Erdman, and David M. Lemon made fraudulent representations and omitted relevant information while soliciting investors to purchase unregistered ITC stock. (Resp. Ex. M.)1 The complaint alleged further that Phebe W. Erdman, Hans L. Erdman, Rebecca W. Erdman, and Leslie Chekin realized proceeds of approximately $240,000 from their sale of approximately 370,000 shares of ITC stock to forty investors. (Resp. Ex. M at 1-2.)
I take official notice that on January 8, 1999, January 11, 1999, and June 30, 1999, Hans L. Erdman, Phebe W. Erdman and David Lemon, respectively, consented to the entry of final judgments permanently restraining and enjoining them from violating Sections 5(a), 5(c), and 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.2 17 C.F.R. § 201.323; Final Judgment of Permanent Injunction Against Defendant Hans L. Erdman, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. Jan. 8, 1999); Final Judgment of Permanent Injunction Against Defendant Phebe W. Erdman, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. Jan. 11, 1999); Final Judgment of Permanent Injunction Against Defendant David Lemon, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. June. 30, 1999). Phebe Erdman and Hans Erdman were ordered to disgorge $139,010 and $55,240, respectively, and to pay prejudgment interest. The court waived payment of disgorgement and the imposition of civil penalties on the Erdmans based on their showings that they were unable to pay. Final Judgment of Permanent Injunction Against Defendant Hans L. Erdman, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. Jan. 8, 1999); Final Judgment of Permanent Injunction Against Defendant Phebe W. Erdman, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. Jan. 11, 1999).
I also take official notice that on July 27, 1999, Rebecca Erdman and Leslie Chekin consented to the entry of Final Judgments of Disgorgement that ordered them to pay disgorgement of $20,211 and $27,110, respectively, plus prejudgment interest. Based on a demonstrated inability to pay, the court waived payment as to Leslie Chekin and waived payment of all but $5,000, from Rebecca Erdman. Final Judgment of Disgorgement Against Relief-Defendant Leslie Chekin, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. July 27, 1999); Final Judgment of Disgorgement Against Relief-Defendant Rebecca Erdman, No. 98-6500-CIV-DIMITROULEAS (S.D. Fla. July 27, 1999).
I held hearings for three days in Miami, Florida; for one day in Greensboro, North Carolina; and for two days in Syracuse, New York in June and August 1998. The Division presented evidence from seventeen witnesses, including one expert, and introduced ninety-two exhibits. Mr. Barr presented evidence from four witnesses and introduced sixteen exhibits.
The Division filed Proposed Findings of Fact and Conclusions of Law and Second Opposition to Respondent Barr's Motion for Summary Disposition on October 13, 1998. Respondent Barr filed Proposed Findings of Fact and Conclusions of Law and Brief in Further Support of Motion for Summary Disposition on November 18, 1998, and the Division filed a Post-Hearing Reply Memorandum on December 8, 1998.3
Counsel filed a Motion to Supplement Respondent's Proposed Findings of Fact and Conclusions of Law with a two-page addition on November 25, 1998. The Division filed a Motion to Supplement Post-Trial Conclusions of Law with an additional paragraph on January 4, 1999. Respondent filed a Response to Division's Motion to Supplement Post-Trial Conclusions of Law and Cross-Motion to Supplement Respondent's Proposed Conclusions of Law on January 8, 1999. I grant all motions.
I. ISSUES
1. Did Mr. Barr willfully violate Sections 5(a) and 5(c) of the Securities Act by selling unregistered ITC stock?
2. Did Mr. Barr willfully violate Section 17(a) of the Securities Act by distributing to potential ITC investors materially false press releases in knowing or reckless disregard of their falsity, and by not disclosing material facts necessary to make the releases not misleading?
II. MOTION TO DISMISS
Respondent filed a Memorandum of Law in Support of Motion for Summary Disposition ("Memorandum of Law") on June 17, 1998, and moved for summary disposition pursuant to Rule 250 of the Commission's Rules of Practice when the Division finished its direct evidentiary presentation on August 19, 1998. 17 C.F.R. § 201.250. (Tr. 983-90.) The Division replied on the record and filed a Memorandum in Opposition on August 20, 1998. (Tr. 990-1002.) Inasmuch as there were disputed issues of material fact, I advised the parties at the hearing that I would defer a ruling on the motion. (Tr. 1003.) On September 21, 1998, I received Respondent's Reply Memorandum in Further Support of Motion for Summary Disposition.
In his Memorandum of Law, Respondent alleges that mailing two press releases and selling half the ITC stock shares, the respective bases for the Section 17(a) and Section 5 violations, occurred five years before the Commission initiated this proceeding, and thus they cannot be used to support a cease and desist order, a civil penalty, or a suspension from association with a broker-dealer. (Memorandum of Law 2-4 (citing Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996)).) The Respondent also contends that under the holding of Cope v. Anderson, 331 U.S. 461 (1947), 28 U.S.C. § 2462 applies to a claim for equitable relief where it is connected to a claim for legal relief. Second, the Division cannot prove a violation of Section 17(a)(1) because Mr. Barr did not make a misrepresentation or omission but merely transmitted material prepared by others, and it cannot show a violation of either Section 17(a)(2) or 17 (a)(3) because Mr. Barr did not obtain money as the result of his transmittal of the two releases. Third, there is no Section 5 violation because Mr. Barr acted reasonably under the circumstances. (Memorandum of Law 9-10 (citing SEC v. Culpepper, 270 F.2d 241, 251 (2d Cir. 1959) (broker must "reasonably explor[e]" facts); Stone Summers & Co., 45 S.E.C. 105, 109 (1972) (broker must make "reasonable inquiry" to assure himself that he is not participating in the sale of unregistered securities); Distribution by Broker-Dealers of Unregistered Securities, Exchange Act Rel. No. 33-4445, 1962 SEC Lexis 74, *4 (Feb. 2, 1962) (the amount of inquiry required necessarily varies with the circumstances of the particular case)).) Finally, even assuming the Division can show an underlying violation that is not precluded by the statute of limitations, it will not be able to prove a likelihood of future violations and thus is not entitled to a cease and desist order. (Memorandum of Law 10-11.)
In its Memorandum of Opposition, the Division responds that there is no statute of limitations applicable to the Section 17(a) allegation because the relief sought is a cease and desist order; it finds Respondent's reliance on Richard M. Kulak, 64 SEC Docket 1615 (May 20, 1997) misplaced, citing Kedar Gupta, 65 SEC Docket 2573, (Nov. 3, 1997) (order denying motion to dismiss) and Warren G. Trepp, 65 SEC Docket 614, (Aug. 8, 1997) (initial decision). The Division maintains that Respondent has misinterpreted Cope v. Anderson, 331 U.S. 461 (1947). There the court held that the decision not to allow equitable relief is applicable only where the court is exercising concurrent jurisdiction and legal relief was time barred. The Division also argues that Cope does not apply in administrative law. The Division cites several cases for the proposition that circulating misleading material can cause a violation of Section 17(a) without a finding that a recommendation occurred. The Division reiterates support for its claim of a Section 5 violation, and notes two rulings holding that a cease and desist does not require a finding that a future violation is likely, Joel Zbar, 56 SEC Docket 1784 (Mar. 18, 1994) and Stires & Co., 67 SEC Docket 2359 (Aug. 11, 1998).
Summary judgment is granted on a claim about which there is no genuine issue of material fact and upon which the movant is entitled to prevail as a matter of law. See Black's Law Dictionary 1449 (7th ed. 1999). Summary dismissal is more limited in administrative proceedings than it is under the Federal Rules of Civil Procedure, and a hearing is often necessary to determine a respondent's state of mind and the need for remedial sanctions if liability is found. See Final Rules, 59 SEC Docket 1546, 1575-76 (1995) (supplementary information regarding Commission Rule 250). I deny the Motion for Summary Disposition because there is a legal basis for finding violations as a matter of law if the facts in the OIP are true as alleged. Respondent's Brief repeats most of the arguments in his Memorandum of Law, and I will address them in the Conclusions of Law portion of this decision.
III. FINDINGS OF FACT
My findings are based on the record and my observation of the witnesses' demeanor. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91, 102 (1981). I have considered all posthearing submissions by the parties.
Ellis Erdman and International Trade & Commerce Corp.
Ellis ("Woody") Erdman, who died in 1997, was a very clever confidence man, i.e. a person who swindles using a confidence game. See Webster's II New Riverside University Dictionary 297 (1984). (Tr. 132-33, 547-48, 551, 1064.) Mr. Erdman possessed a magnetic personality and his career included some distinctive achievements. He founded a radio station in Ithaca, New York, in the late 1950s or early 1960s and operated the station and lived in the area with his family until the station went bankrupt in 1982.4 (Tr. 717, 931-32.) Mr. Erdman and his wife Phebe Weeks Erdman ("Mrs. Erdman" or "Phebe Erdman") married in 1949. (Tr. 686.) After their divorce in 1985, Mrs. Erdman continued to reside in Freeville, New York, as did their children, Hans Erdman, Rebecca Erdman, and Leslie Erdman Chekin before they became adults.5 (Tr. 73-74.)
On April 12, 1992, the Harrisburg, Pennsylvania, Sunday Patriot-News, described Mr. Erdman as someone who had owned "a string of radio stations in New York; did radio play-by-play for the New York Giants football team; ran a business with Whitey Ford, Pat Summerall and other retired sports stars; and in 1969 became chairman of the board of the Boston Celtics, pro basketball's most prized franchise" and who over the last twenty years left a lot of bitter people who claimed he cost them thousands of dollars. (P. Ex. 163.) On June 23, 1992, the Boston Globe wrote:
The wheeling and dealing that Erdman has done in the two decades since running the Celtics - mostly by offering his services to financially troubled companies - has certainly produced its share of enemies. A lot of these people would like to know where Erdman is today. Very much so. These inquiring minds include creditors, co-investors, ex-business partners, at least one angry attorney - and the Internal Revenue Service.
(P. Ex. 191 at 4.) Mr. Erdman was the subject of numerous legal proceedings, state and federal. He consented to the entry of a judgment for securities fraud in the U.S. District Court for the District of Columbia,6 and was the subject of multiple judgments totaling several million dollars and federal tax liens of over $1 million.7 (Tr. 78-79; P. Ex. 163.)
ITC and Pump and Dump Insurance Scheme
In 1988, Dr. Joseph Bailey and Thomas Charles Frederick paid between $90,000 and $100,000 for Expedite, Inc., a public shell company incorporated in Nevada in 1987, in expectation of acquiring a software company and taking it public. (Tr. 719-20, 769-71; P. Ex. 166.) Mr. Erdman, who passed himself off as a Cornell Law School graduate experienced in taking companies public, advised on the purchase but did not supply any funds. (Tr. 689, 769, 771, 777.) On September 20, 1988, Expedite, Inc. changed its name to ITC. (Tr. 770, 774; P. Ex. 166 at SEC 7194.) The Commission files do not contain any filed registration statements from Expedite, Inc., or ITC. (P. Ex. 165.) ITC attempted a number of diverse business ventures, but none of them were successful - a software company, a yacht building venture in Mexico, a lead reclaiming operation in Mexico, exporting prefabricated homes to Israel, and a hotel acquisition in Atlanta. (Tr. 772-73, 954-56, 970.)
Mr. Frederick received phone calls from unknown persons who described Mr. Erdman's illegal activities. (Tr. 783-84.) Based on this information, Mr. Frederick did not want to have any further association with ITC and he resigned as chairman, chief executive officer ("CEO"), and director on March 20, 1992. (Tr. 783-84; P. Ex. 166.) Dr. Bailey reacted similarly. He and Mr. Frederick signed over all their ITC stock to Mr. Erdman and sent Mr. Erdman their stock certificates along with other ITC shares issued to third parties. (Tr. 784-96; P. Ex. 139.) Mr. Frederick, who had been a bishop in the Church of Latter Day Saints, and Dr. Bailey were ITC's sole source of funds. Their total contributions, including the purchase price, were about $300,000. (Tr. 802.) ITC had few assets when they relinquished ownership in 1992. (Tr. 780, 803.)
On December 31, 1992, ITC had 144 shareholders, 8.006 million shares issued of which 6.006 million shares were restricted. (P. Ex. 174.) In 1992-93, Mr. Erdman made all the decisions about ITC; he referred to himself as chairman of the executive committee or corporate counsel committee and "attorney in fact"; and he was the source of the stock certificates. (Tr. 276, 369-73, 637-38, 640-41, 702, 844-45, 933, 935; P. Exs. 20, 48, 119, 151.) Mr. Erdman represented that he had "solid control" of ITC through a private family trust, Second Manhattan Securities ("Second Manhattan"),8 that he established for his three children, and that ITC had "several hundred shareholders" located throughout the United States.9 (Tr. 689-90, 727, 757; P. Ex. 1.) The transfer agent issued, removed restrictive legends, and cancelled ITC shares at Mr. Erdman's direction. (Tr. 640-41, 843-48.)
Stanley R. Cohen earned a degree in business from Boston University in 1963. (Tr. 195.) Mr. Cohen's experience in the insurance industry began in 1989 when he bought Academy Insurance Services, an insurance company in Fort Lauderdale, Florida. (Tr. 197, 200-02.) Mr. Cohen's prior employment included seven years with the General Electric Company in various management positions; experience as a vice president of a candy and tobacco distributor; and work as an executive vice president of a 25-store retail chain, fundraiser, and owner of a computer sales company. (Tr. 196-98, 287.) In 1992, Mr. Cohen's company had nine employees, operated three offices, and wrote policies that resulted in $2 to $3 million in premiums.10 (Tr. 201-02.)
In late 1992, Mr. Cohen's friend, Marc Joseph responded to an advertisement that Mr. Erdman placed in the Wall Street Journal offering ITC as a public shell available for taking an operating business public.11 (Tr. 204-08, 392-95; P. Ex. 1.) Mr. Erdman responded to Mr. Joseph by letter dated December 4, 1992. (P. Ex. 77.) Simultaneously, Mrs. Erdman requested Mr. Barr -- who the family knew socially from living in the Ithaca area for approximately forty years -- to sell ITC stock held by her and her children. (Tr. 716, 732-33.)
At about a half dozen meetings in Florida beginning in December 1992 and continuing through April 1993, Mr. Erdman convinced Mr. Cohen, his attorney Richard Greene, and Mr. Joseph, that they could use ITC to achieve Mr. Cohen's plan to roll up a lot of independent insurance agencies into one entity and take it public. (Tr. 204, 207-08, 392-95, 398; P. Exs. 1, 77.) As part of the stock purchase and employment agreements dated February 5, 1993, ITC acting through Mr. Erdman agreed to issue 3.75 million shares to Mr. Cohen if Mr. Cohen would obtain letters of intent from a number of independent insurance companies representing $40 million worth of "net earned insurance premiums less cancellations." (Tr. 237-39, 386; P. Exs. 67, 74, 117, 140.) Mr. Erdman told Mr. Cohen that there were additional unrestricted shares for sale from the Advest, Inc. ("Advest") Ithaca office from a family trust. (Tr. 275.) Mr. Cohen and Mr. Erdman signed an employment agreement on February 5, 1993, that named Mr. Cohen as ITC's CEO, president, and chairman of the board of directors. (Tr. 241; P. Ex. 117.)
Mr. Erdman wrote and Mr. Cohen distributed a number of releases about ITC that contained false information. (Tr. 246-47, 302-03; P. Exs. 12, 13.) Mr. Erdman and Mr. Cohen knew when they wrote and distributed these releases to the public that ITC had no commitment from any underwriter to participate in a public offering; that ITC was a shell corporation without assets, operations, income, financial statements, a board of directors, office space, substantial bank accounts or shareholder meetings; and that ITC did not engage in export trade for U.S. products and services.12 (Tr. 276-78, 372-76, 628-29, 634-35, 649-50, 660-63, 779-82; P. Exs. 13, 28.)
In February 1993, Mr. Cohen sent out two press releases that Mr. Erdman prepared that contained blatantly false information about ITC. (Tr. 302-03.) One release described ITC as a public corporation engaged in exporting U.S. products and services, and announced that ITC would sign contracts by February 8, 1993, resulting in 1 million dollars of sales in 1993-94, continuing through 1999. (P. Exs. 13, 28.) The release stated that ITC was acquiring the assets of over eighty financial services offices located in the Southeast markets, that ITC would make a public stock offering and the proceeds would be used to complete the acquisitions without incurring bank debt, and that ITC projected 5% pre-tax earnings on current sales of 1 million dollars. (P. Exs. 13, 28.)
Another release announced that Stanley R. Cohen, president and CEO of Academy Insurance, Fort Lauderdale, Florida, would become ITC president and would proceed with announced plans to acquire insurance offices throughout the state of Florida beginning on or before February 8, 1993, followed by a public offering of ITC stock. This release projected 1993-94 sales revenue at $100 million with pre-tax earnings of over $5 million. (P. Exs. 12, 29.)
A third release repeated these same misstatements with the additional information that the public stock offering would raise $30 million. (P. Ex. 31.) It projected that ITC would have operations at 149 Florida locations and 500 employees that would generate 225,000 insurance policies, $116,586,000 in premiums, $37,220,081 in revenues, and $17,816,559 in pre-tax earnings for the year ending September 30, 1994. (P. Ex. 31.) The same release forecast that ITC would have another $2 million of earnings from its wholly owned insurance and finance companies, and that President Cohen would recommend a dividend to the Board from 1993-94 earnings. (P. Ex. 31.)
ITC publicly professed that it intended to raise $15 to $30 million through a public offering of ITC shares priced at between $5 and $10 per share. (Tr. 215-16; P. Ex. 18 at 00017, P. Ex. 31, P. Ex. 184 at 3.) At Mr. Erdman's direction, Mr. Cohen spoke to Mr. Lemon, ITC's chief financial officer in Atlanta, Georgia. (Tr. 272, 274.) Mr. Lemon was to review the letters of intent that Mr. Cohen obtained and to find an underwriter for the public offering.13 (Tr. 272, 275, 413-19.) Mr. Cohen believed that the proceeds of the planned public offering would be used to pay ITC's cost of acquiring the independent insurance companies. (Tr. 239.)
Mr. Cohen grew suspicious of Mr. Erdman in March-April 1993 and considered ending their relationship, but Mr. Erdman visited Florida and convinced Mr. Cohen and his attorney, Richard Greene, to continue the relationship. (Tr. 256-57, 262; P. Ex. 8.) In June 1993, Mr. Erdman sent Mr. Greene certificates for 4.560 million shares of ITC stock to be retained in escrow for Mr. Cohen and Mr. Joseph or his designee.14 (Tr. 386; P. Exs. 69, 74.)
To support his representation that an IPO would happen, Mr. Erdman sent Mr. Cohen a copy of an August 2, 1993, unsigned letter to Mr. Erdman written on the letterhead of CC&Q Investors Diversified, Inc. of Atlanta ("CC&Q"), a member of the National Association of Securities Dealers ("NASD") and the Pacific Stock Exchange, which referred to CC&Q's role as underwriter in connection with "recent discussions regarding a $35 million secondary public offering of securities by" ITC. (Tr. 280-81; P. Ex. 100.) However, the writer of the unsigned letter intended it only as an example of what a letter of intent would look like if a due diligence investigation revealed that Mr. Erdman's description of ITC was accurate.15 (Tr. 1017-18.)
In late August 1993, Mr. Cohen transmitted to Mr. Erdman what he considered to be letters of intent from eighty-two insurance offices whose combined annual premiums were about $84 million, along with copies of their income tax filings or certifiable financials. (Tr. 264-66.) On September 18, 1993, Mr. Erdman sent Mr. Greene a letter stating that Mr. Cohen had not satisfied the terms of the employment agreement, and by letter dated October 11, 1993, he notified Mr. Greene that the agreement was rescinded.16 (P. Exs. 20, 75.) Mr. Greene released the 3.750 million shares of ITC stock that he held in escrow for Mr. Cohen to Mr. Erdman, and Mr. Cohen took back ownership of his insurance agency. (Tr. 267.)
Mr. Erdman orchestrated a classic "pump and dump" scheme in the unregistered shares of ITC using the enthusiastic selling efforts of Mr. Cohen and Mr. Cohen's family and friends, and Mr. Cohen's belief that ITC would engage in a public offering of securities. (Tr. 245-48, 293, 296, 472, 481-89; P. Exs. 12, 13, 28, 29, 31, 181.) Mr. Cohen and his sons told people that Advest's Ithaca office had ITC shares for sale. Mr. Cohen's sister, his sister-in-law, two friends who were rabbis, his dentist, and other relatives, friends and acquaintances of Mr. Cohen and his sons, Marc and Steven, purchased the stock on their recommendation. (Tr. 282-84, 293, 297-300.)
William H. Purcell, an expert on underwriting securities, presented persuasive evidence that the press releases were false and misleading because ITC could not have financed the acquisitions of over eighty financial services offices through a public offering of stock.17 (Tr. 331-32; P. Exs. 167, 168, 184.) Mr. Purcell's unchallenged expert opinion is that an ITC stock offering was not viable because no underwriter would participate for the following reasons:18
1. Two major shareholders prominent in the offering, Mr. Erdman and Mr. Joseph, had judgments against them for securities fraud. (Tr. 361; P. Ex. 184 at 7.)
2. Funding the consolidation or rolling up of individual businesses through a public offering is common, but the process is extremely complex. (Tr. 347; P. Ex. 184 at 7.) Neither Mr. Cohen nor Mr. Lemon, ITC president, and executive vice president and treasurer, respectively, had any experience doing complicated and time consuming roll ups.19 (Tr. 359-61; P. Ex. 184 at 7-8.)
3. ITC had no audited financial statements, yet for a shell company to be used in a public offering it would have to have audited financials showing that it was "clean" in every way, i.e., that the numbers, the footnotes, and the contingent liabilities had all been checked. (Tr. 346-47; P. Ex. 184 at 8.)
4. The "letters of intent" that Mr. Cohen obtained do not provide strong evidence that ITC could acquire eighty or so insurance agencies at an acceptable price and are not what the industry considers to be letters of intent.20 (Tr. 341; P. Ex. 184 at 8.)
5. Underwriters would not accept this offering where investors would end up owning only 40% of ITC while the owners of the shell owned 60%.21 The prevailing industry standard is that sponsors who do not contribute equity receive a 10% to 20% ownership position and investors receive 80% to 90% ownership. (Tr. 351-53, 362-64; P. Ex. 184 at 8-9.)
6. ITC's 1993 press releases were inaccurate because ITC could not possibly realize $100 million in revenues in 1993 from a proposed public offering because it would take six to nine months to complete the offering and acquisitions that ITC proposed even assuming there was a willing underwriter with a workable plan in place. (P. Ex. 184 at 9.)
The Erdman Family
Phebe Erdman worked at the Erdman-owned radio station from the mid-1970s until 1980 and was responsible for keeping the books and records. (Tr. 717.) Mrs. Erdman declared personal bankruptcy in 1987 or 1988; in 1992 and 1993, her income was derived from social security. (Tr. 755.) Mr. Erdman did not live with Phebe Erdman in 1993, but they spoke once or twice a week, and Mrs. Erdman served as Mr. Erdman's bookkeeper and typed many of his letters, contracts, and press releases. (Tr. 688-89, 692-93, 739-40, 744; P. Ex. 1.)
Mrs. Erdman opened individual accounts for herself and her daughter Leslie Chekin with Mr. Barr at Advest on December 4, 1992, and she opened an account for Hans Erdman with Mr. Barr on February 12, 1993.22 (Tr. 93, 95, 141, 946; P. Ex. 47 at 2-4.) On the account application, Phebe Erdman indicated that Hans Erdman had never been an officer of any public corporation. (Tr. 947.) In February 1993, Mrs. Erdman told Mr. Barr that she and her children received unrestricted ITC stock shares a long time ago as a gift from Mr. Erdman who received them for his work as a consultant to ITC.23 (Tr. 690-91, 704-05, 722-23, 745, 1044.) Mrs. Erdman told Mr. Barr that no sales solicitations would be necessary, and she provided some names of individuals and sales representatives who would call Advest looking to purchase the stock. (Tr. 120, 1044-45, 1063-64; P. Ex. 37 at 2.) In response to Mr. Barr's questions, Mrs. Erdman represented that the family had owned the stock for a long time; that Mr. Erdman did not own ITC stock; that Mr. Erdman did not control ITC; that he was not an officer or director; that he was or had been a consultant to ITC; and that the family owned 4% of the shares outstanding. (Tr. 108-10, 745-47, 1040-44; P. Ex. 37.) Mrs. Erdman did not tell Mr. Barr that Mr. Erdman directed her to sell ITC shares through Advest or that Mr. Erdman was hyping ITC sales by misleading Mr. Cohen and others that a roll up of insurance companies would be financed by a public offering of ITC shares. (Tr. 1048-51.)
The transfer agent's records shows that on December 31, 1992, there were approximately 8.006 million shares of ITC stock outstanding, 6.006 million were restricted, and the Erdmans and Second Manhattan owned 1,292,500 shares or 16% of the number outstanding:24
Unrestricted
Restricted
Phebe W. Erdman
125,000
Hans L. Erdman
100,000
Leslie Chekin
100,000
Rebecca W. Erdman
100,000
Second Manhattan
15,000
852,500
(Tr. 835-36; P. Ex. 174.)
However, in early February 1993, Mrs. Erdman told Mr. Barr that the Erdman family members owned 425,000 legended,25 restricted or lettered shares and 237,500 unlettered or readily negotiable shares or a total of 662,500 ITC shares.26 (Tr. 98-99, 103-04, 107-08; P. Ex. 37.)27 Mrs. Erdman represented that she had 100,000 unlettered shares, Hans Erdman and Leslie Chekin, each had 50,000 unlettered shares, and her daughter Rebecca Erdman had 37,500 unlettered shares. (Tr. 101; P. Ex. 37.) Hans deposited 50,000 shares in his account on February 17, 1993. (P. Ex. 38.) Mrs. Erdman deposited 100,000 shares on December 11, 1992; 100,000 shares on March 25, 1993; 50,000 shares on August 17, 1993; and 100,000 shares on November 26, 1993. (P. Ex. 39.) Leslie Chekin deposited 50,000 shares in her account on February 19, 1993. (P. Ex. 40.)
Phebe Erdman requested that Mr. Barr keep the name of the ITC stock seller confidential, but instructed him to refer inquiries to herself or to Hans Erdman. (Tr. 121, 177, 1134; P. Ex. 93.) From February 1993 to August 1993, Mr. Barr received requests from people wanting to purchase ITC stock. (Tr. 753.) Mr. Barr called Mrs. Erdman who authorized the sale and priced the shares.28 (Tr. 753-54, 1067, 1076-78; P. Ex. 93.) Mrs. Erdman realized over $100,000 from the sale of ITC stock. She used $50,000 either to give to Mr. Erdman directly or to pay his expenses. (Tr. 708-09, 754-55.)
Hans Erdman has attended several colleges but did not earn a degree. (Tr. 968-69.) He was an ITC vice president and a Board member from 1989, until he resigned sometime in 1992.29 (Tr. 932-33, 935, 953-54.) Hans Erdman assisted Mr. Erdman's attempts to sell ITC in 1992-93. (Tr. 933-34, 957-58.) He also spoke with Mr. Cohen and Dr. Richard I. Lipman, who invested in ITC shares. (Tr. 934-36, 963-64.)
The evidence is persuasive that Mrs. Erdman and Hans Erdman assisted in the fraudulent sale of worthless ITC shares. (Tr. 282, 288-89, 724-26, 1171; P. Ex. 94.)
David Barr
Mr. Barr's father founded J.S. Barr & Co., Inc. ("J.S. Barr"), a broker-dealer firm and New York Stock Exchange member, with a single office in Ithaca, New York, in 1924. (Tr. 24, 1025.) Mr. Barr attended St. Lawrence University for two years. (Tr. 43.) He became a registered representative with J.S. Barr in 1957 and managed the firm from 1974 until 1984 when Advest acquired it. (Tr. 44-46, 1025-27.) Under Mr. Barr's direction, J.S. Barr opened offices in three upstate New York communities. (Tr. 1027.) Mr. Barr managed Advest's Ithaca office from 1984 until June 1998 when he was relieved of his managerial position because of this proceeding. (Tr. 44, 46, 1028, 1100, 1177.) Mr. Barr continues to serve his list of individual clients as a registered representative. (Tr. 24, 46, 1028.) In 1992-93, the Advest office in Ithaca had seven employees - four account executives and three support staff. (Tr. 46.) Mr. Barr's business consisted mainly of transactions in mutual funds but he also handled transactions in listed stocks, bonds and treasuries. (Tr. 24, 46, 1029-30.) Mr. Barr's customers accounted for almost half the $150 million in in-house assets under Advest management. (Tr. 1178.)
Mr. Barr and members of the Erdman family knew each other as long time Ithaca residents where Mr. Barr has long been active in civic affairs. (Tr. 249, 1029, 1034-35.) Mr. Barr first met Mr. Erdman in the mid-1950s when Mr. Erdman purchased cars and was friends of the owners of the car dealership where Mr. Barr worked prior to joining J.S. Barr. (Tr. 1034.) Hans Erdman has known Mr. Barr since he was a child and attended school with Mr. Barr's daughter and they were friends. (Tr. 959.) On one occasion, Hans sold some stock through Mr. Barr. (Tr. 1110.) Mrs. Barr, a former professional Canadian ice skater, provided ice skating instruction to many students, including Rebecca Erdman. (Tr. 959, 1028, 1034.) Mr. Barr was a founder of area youth hockey activities, and Hans Erdman was manager of his high school hockey team. (Tr. 959-60, 1029.)
On December 4, 1992, the same day she typed Mr. Erdman's response to Mr. Joseph concerning the sale of the ITC public shell, Phebe Erdman, at Mr. Erdman's direction, contacted Mr. Barr and asked him to sell ITC stock for her and her children. (Tr. 692-95; P. Exs. 47, 77.) Mr. Barr was unaware of Mr. Erdman's activities since Mr. Erdman ostensibly left the Ithaca area in the 1980s, and did not know that Mr. Erdman was directing Mrs. Erdman to sell the stock. (Tr. 1035-36.) In 1992-93, Mr. Barr knew that Mr. and Mrs. Erdman were divorced and that Mrs. Erdman had been previously employed in some office positions but was unemployed at the time; that Leslie Chekin was an instructor at Cornell working on a doctorate; and that Hans Erdman was a park ranger in Minnesota. (Tr. 718, 1036, 1038.) Mr. Barr believed Mrs. Erdman when she told him she was selling the stock because she needed the money. (Tr. 1045, 1052-53.) Mr. Barr was unaware that Mrs. Erdman was sharing the proceeds from the sales with Mr. Erdman. (Tr. 1079.)
In 1993, Phebe Erdman transmitted several press releases hyping the sales of ITC stock to Mr. Barr. (Tr. 184-87, 1079; P. Exs. 28, 29, 31, 92.) On April 24, 1993, Mr. Barr sent Joseph Frimerman, who had purchased $9,000 worth of ITC stock the previous month, copies of two press releases after Mr. Frimerman called and requested information. (Tr. 190-91, 1083-84, 1148-52; P. Exs. 134; R. Ex. L.) These releases included the fraudulent claims that ITC shares were going to be offered to the public and that ITC would have estimated revenues of $100 million in 1993-1994. (P. Ex. 134.) On or about March 30, 1993, Mr. Barr also sent Larry Robinson who called and requested information about ITC a copy of one of the news releases. (Tr. 191, 1080-81; P. Ex. 112.)
From February through August 1993, no registration statement was in effect or on file for ITC shares, and the shares were not exempt from the registration requirement. (P. Ex. 181.) In the same period, Mr. Barr was the broker of record for the Erdmans as sellers on forty non-solicited sales of approximately 357,000 shares of ITC. (Tr. 161, 1063, 1067-68; P. Ex. 44.) The ITC sales at issue were accomplished using the means of interstate commerce and the mails. (Tr. 169, 175.) Mr. Barr conveyed Mrs. Erdman's price to the prospective purchasers, and she instructed Mr. Barr on which Erdman family member account would fill the buy order. (Tr. 158, 164, 1066-68, 1076-78.) All but a few sales were for prices of between fifty and sixty cents a share. (Tr. 157-58.) Most of the people who purchased ITC shares between February and August 1993, were from Florida and were either relatives or friends of Mr. Cohen or his sons. (Tr. 436, 471-72.) The buyers or their brokers called Advest's Fort Lauderdale office where Daniel J. Fischer, a registered representative, entered the order. (Tr. 1066, 1068; P. Exs. 25, 44.) Four or five buyers who had accounts in the Ithaca office called Mr. Barr directly. (Tr. 1068.) In those situations, Mr. Barr represented both the buyer and the seller. (Tr. 1133-34.) Mr. Barr and Mr. Fischer required buyers to sign non-solicitation letters. (Tr. 172, 434.) In April 1993, when another brokerage firm refused to clear the trade, a person at Advest's over the counter trading desk advised Mr. Barr that the trade would be possible as a cross trade between Advest customers if the buyer opened an account at Advest. (Tr. 918-21; P. Ex. 112.) Mr. Barr followed this procedure. (Tr. 922; P. Ex. 112.) In 1998, ITC stock was worthless. (Tr. 1171.)
Mr. Barr earned commissions of $5,279.72 from the sale of ITC stock in 1993. (Tr. 821.) Mr. Barr has not been the subject of any customer complaints during his thirty-six years in the securities industry. (Tr. 194, 1030-31, 1178.) The only incident in Mr. Barr's professional life occurred in 1977 when he and J.S. Barr entered into a settlement with the NASD by which they accepted a censure and were fined $500 based on a complaint concerning the firm's books and records. (Tr. 1032-33; P. Ex. 164.)
IV. CONCLUSIONS OF LAW
Sections 5(a) and 5(c) of the Securities Act
Section 5, "Prohibitions Relating to Interstate Commerce and the Mails," is often referred to as the heart of the Securities Act. Section 5(a) declares it unlawful for any person, directly or indirectly, to make use of the means of interstate commerce or the mails to sell or to deliver after sale any security unless a registration statement is in effect as to that security. Section 5(c) makes it unlawful for any person, directly or indirectly, to make use of the means of interstate commerce or the mails to offer to sell or to offer to buy any security, unless a registration statement has been filed as to such security.
The Division characterizes Mr. Erdman as an issuer because he controlled ITC, the Erdman family members as underwriters because they sold ITC shares for the issuer, Mr. Erdman, and as a control group for which Advest was the underwriter. (Div. Br. 39-41.) The Division notes "a host of suspicious facts," which indicated that a searching inquiry was necessary, and it details thirteen, which should have heightened Mr. Barr's duty to inquire. (Div. Br. 42-44.) The Division believes that Mr. Barr's investigation of whether or not the ITC shares were registered was totally inadequate. It notes the investigatory responsibilities of a branch manager, and alleges that Mr. Barr's failure to investigate was inexcusable, and thus, he violated Sections 5(a) and 5(c). (Div. Br. 45.)
Mr. Barr does not deny that he was involved in the distribution of unregistered securities. The thrust of his defense is that he did not willfully violate Section 5 because he exercised the required degree of care and he acted reasonably under the circumstances. (Resp. Br. 9-10 (citing Kane v. SEC, 842 F.2d 194 (8th Cir. 1971); Quinn & Co. v. SEC, 452 F.2d 943 (10th Cir. 1971); SEC v. Culpepper, 270 F.2d at 251; Terry T. Steen, 64 SEC Docket 244 (Mar. 7, 1997) (initial decision), aff'd, 67 SEC Docket 837 (June 2, 1998); Paulson Inv. Co., 50 SEC Docket 336, (Nov. 14, 1991); Stone Summers & Co., 45 S.E.C. at 109; Distribution by Broker-Dealers of Unregistered Securities, Release No. 33-4445, 1962 WL 3571, *2 (Feb. 2, 1962)).) Mr. Barr maintains it was reasonable for him to accept representations by Phebe Erdman, whom he had known for some forty years and had no reason to think would lie to him about her ex-husband and the ITC stock. (Tr. 1046; Resp. Br. 53-54.)
The Division claims that Mr. Barr was required to conduct "a searching inquiry" where, as here, a customer asks a registered representative to sell a "substantial block of a little-known security . . .[and] the surrounding circumstances raise a question as to whether" the sellers are underwriters. (Div. Br. 42 (citing Distribution by Broker-Dealers of Unregistered Securities, Exchange Act Rel. No. 33-4445, 1962 WL 3571 *2 (Feb. 2, 1962)).)
Findings
The following elements are required to establish a prima facie violation of Section 5: (1) no registration statement was in effect or had been filed as to the securities; (2) Respondent, directly or indirectly, sold or offered to sell the securities; and (3) the sale was made through the use of interstate facilities or the mails. See SEC v. Continental Tobacco Co., 463 F.2d 137, 155 (5th Cir. 1972). "Absent an exemption, section 5 of the 1933 Act strictly prohibits all selling efforts prior to the filing of a registration statement. It also restricts selling efforts and absolutely prohibits sales until the registration statement has become effective." Thomas Lee Hazen, The Law of Securities Regulation, 60 (2d ed. 1990) (footnotes omitted). Scienter is not required. See, e.g., Stokes v. Lokken, 644 F.2d 779, 784 (8th Cir. 1981).
Since there was no registration statement in effect or on file for the ITC shares, the Respondent had the burden of showing that the shares were exempt. See SEC v. Murphy, 626 F.2d 633, 641 (9th Cir. 1980) (citing SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953)). Mr. Barr did not attempt to show that the ITC shares were exempt from registration. Mr. Barr participated in the distribution of unregistered ITC shares to the public using the means of interstate commerce and the mails. Therefore, Mr. Barr comes within the statutory definition of an underwriter. See Section 2(11) of the Securities Act; SEC v. Culpepper, 270 F.2d at 247 (a direct or indirect participation in the distribution brings a dealer within the definition of underwriter.)
The case law and Commission pronouncements set out the standard of care required of a registered representative in Mr. Barr's position.
[A] dealer who offers to sell, or is asked to sell a substantial amount of securities must take whatever steps are necessary to be sure that this is a transaction not involving an issuer, person in a control relationship with an issuer or an underwriter. For this purpose, it is not sufficient for him merely to accept "self-serving statements of his sellers . . . without reasonably exploring the possibility of contrary facts."
The amount of inquiry called for necessarily varies with the circumstances of particular cases. . . . [W]hen a dealer is offered a substantial block of a little-known security, either by persons who appear reluctant to disclose exactly where the securities came from, or where the surrounding circumstances raise a question as to whether or not the ostensible sellers may be merely intermediaries for controlling persons or statutory underwriters, then searching inquiry is called for.
Distribution By Broker-Dealers of Unregistered Securities, Securities Act Rel. No. 33-4445, 1962 SEC Lexis 74, *2 (Feb. 2, 1962) (footnote omitted).
I reject the Division's position that a "searching inquiry" standard was applicable in these circumstances. I do so because even though Mr. Barr was asked to sell a "substantial block of a little-known security," Mrs. Erdman was not at all reluctant to identify her ex-husband as the source of the shares and her explanation that they were a gift to her and her children from her ex-husband was reasonable. Furthermore, in response to Mr. Barr's questions, Mrs. Erdman blatantly lied and represented that the family did not control the corporation and family members were not officers of the corporation. (Tr. 117-18, 745-48.) Ordinarily a dealer cannot rely on a seller's self-serving statements, but here, Mr. Barr had no reason to suspect that all four members of a family whom he had known for many, many years and who were law-abiding members of the community would engage in illegal activities and deliberately conspire to deceive him. These individuals were a divorced senior citizen, Phebe Erdman; a professor's wife and Cornell graduate student, Leslie Chekin; a recent Cornell graduate, Rebecca Erdman; and a park ranger, Hans Erdman. Mr. Barr had no indication that Mrs. Erdman was an accomplished liar who in concert with her former husband was part of a fraudulent "pump and dump" scheme.30 The preponderance of the evidence supports Mr. Barr's position that he did not know of Mr. Erdman's legal difficulties after Mr. Erdman ostensibly left the Ithaca area in 1985. There is no evidence that Mr. Barr knew that Mr. Erdman returned periodically and lived with Mrs. Erdman and that the two were in close communication. There is no evidence that the Ithaca newspapers published reports similar to what appeared in the Harrisburg, Pennsylvania and Boston newspapers about Mr. Erdman's illegal activities. And there is no evidence that contradicts Mr. Barr's position that he did not read either article. Finally, on August 3, 1988, Rebecca Erdman deposited 50,000 unlettered shares of ITC, then known as Expedite, in an account she opened with Mr. Barr at Advest. (Tr. 86-87; P. Exs. 36, 47.) Mr. Barr was the broker of record for Rebecca Erdman in 1988 when acting through a market maker she sold 12,500 ITC shares: 10,000 shares at approximately $0.06 a share and 2,500 shares at approximately $0.15 a share. (Tr. 86-90, 103, 164; P. Ex. 47.) It was reasonable for Mr. Barr in 1993 to rely on the fact that Rebecca Erdman had sold ITC stock in 1988 without any repercussions.
My finding that Mr. Barr violated Section 5 is because he made no inquiries - absolutely none - to determine whether the ITC shares Mrs. Erdman gave him to sell were registered. (Tr. 108-09, 116, 118, 121-29, 131, 139-40, 1121-24, 1135.) I find that even though Mr. Barr believed Mrs. Erdman, he was required to make some inquiries before participating in the sale of ITC shares in view of the following facts. The Advest branch manager compliance guide warned that stocks like ITC - speculative unknown securities valued at under two dollars - were a potential problem area. Mrs. Erdman told him the family had 400,000 restricted shares, and restricted shares indicated a connection with the issuer. Mr. Barr knew someone was hyping ITC stock. Mrs. Erdman told him people would be making unsolicited offers to buy ITC shares when he knew there was no market for the stock. As branch manager, Mr. Barr had compliance responsibilities. Finally, Mr. Barr considered ITC to be an odd or special situation and he had never handled anything similar. See SEC v. Culpepper, 270 F.2d at 250 ("It is clear that all of the appellants were aware, or with slight investigation would have been aware, that the stock they sold was unregistered."); Quinn and Co. v. SEC, 452 F.2d. at 946-47 (securities industry professionals "are expected to secure compliance with the requirements of the [Securities] Act to protect the public from illegal offerings"). (Tr. 60-61, 98, 101-03, 119-20, 173, 191, 1055, 1086, 1095, 1139; P. Ex. 46 at 15.)
An essential factor in concluding that Mr. Barr violated Section 5 is that the evidence does not support Mr. Barr's position that he faxed the notes of his conversation with Phebe Erdman to Mr. Urban and requested that the compliance department determine whether the transaction was permissible. (Tr. 132-33, 1053-56.) Mr. Urban, Advest's assistant director of compliance responsible for branch office compliance at the time, denies that he received Mr. Barr's notes from his conversation with Mrs. Erdman or that he and Mr. Barr discussed whether the transaction was permissible. (Tr. 873-75.) If he had received such an inquiry, Mr. Urban, in the normal course of events, would have set up an ITC file, but he did not do so. (Tr. 875-76.) Mr. Barr has no documentation showing that he faxed the notes to Mr. Urban or notes of a conversation with Mr. Urban about selling ITC shares although it was his common practice to take notes when discussing "pertinent" matters. (Tr. 138-39, 1091-92.)
For all these reasons, I find that Mr. Barr violated Sections 5(a) and 5(c) of the Securities Act when he sold unregistered ITC stock.
Section 17(a)(1) of the Securities Act
The Division claims that Mr. Barr, acting with scienter, violated Section 17(a)(1) by circulating materially fraudulent press releases.31 (Div. Br. 45 (citing SEC v. North Am. Research and Dev. Corp., 424 F.2d 63, 75-77 (2d. Cir. 1970)).) It cites authority for the proposition that recklessness satisfies the scienter requirement. (Div. Br. 45 (citing Coleco Indus., Inc. v. Berman, 567 F.2d 569, 574 (3rd Cir. 1977)).) The Division contends that "[i]n view of the outlandish claims in the releases, the suspicious circumstances surrounding the Erdmans' sales of ITC stock . . . and Barr's long experience in the securities industry, his distribution of the releases without making any attempt to investigate their veracity was reckless." (Div. Br. 46 (citing as an example Jay Houston Meadows, 61 SEC Docket 2444, 2454 (May 1, 1996) (holding that experienced securities professional acted recklessly by failing to investigate and verify optimistic assertions before repeating them to others), aff'd, 119 F.3d 1219 (5th Cir. 1997)).) The Division disagrees with Respondent that to violate Section 17(a)(1) a broker needs to do more that just circulate fraudulent material, he or she must have also recommended the securities. (Div. Br. 46-47 (citing as examples Dlugash v. SEC, 373 F.2d 107 (2d Cir. 1976); Everest Sec., Inc. v. SEC, 116 F.3d 1235 (8th Cir. 1997)).) Finally, the Division cites cases where persons other than brokers have been held liable for circulating erroneous information prepared by others. (Div. Br. 47.)
The Respondent claims the Division has not cited a single case in which a person like Mr. Barr, a broker who was not involved in soliciting the purchase of a security, committed fraud by transmitting a document prepared by someone else to two persons who did not buy the security after receiving the document. (Resp. Br. 62-64.) Respondent contends that the antifraud allegation fails for the following reasons. First, there is no evidence of fraud in the "offer of a security" as to Mr. Robinson because Mr. Barr sent the release only after Mr. Robinson called and asked for information about ITC with no mention of ITC shares. Second, Mr. Barr did not owe either Mr. Robinson or Mr. Frimerman a duty of disclosure so he cannot be found to have failed to provide them with information. They initiated the contact with Mr. Barr, and they did not seek his advice or place a purchase order for ITC with him. Since Mr. Barr did not recommend ITC, he had no affirmative duty to investigate the information in the press releases. Finally, Mr. Frimerman did not consider the press releases to be representations by Mr. Barr so there is no evidence that by sending the releases, Mr. Barr made representation about a security to Mr. Frimerman.32 (Resp. Br. 61.)
Respondent maintains that Mr. Barr did not act with scienter, i.e. he did not engage in "knowing misconduct" or an "extreme departure" from the standards of ordinary care. Mrs. Erdman deceived Mr. Barr and Mr. Barr, like Mr. Cohen and Mr. Greene, believed the information in the releases was plausible. (Resp. Br. 64.)
Respondent distinguishes the cases cited by the Division where brokers were found liable by stressing that Mr. Barr did not solicit Mr. Robinson or Mr. Frimerman to purchase ITC and did not recommend ITC shares to them. It distinguishes the cases involving non-brokers because Mr. Barr did not adopt or entangle himself with the contents of the releases. (Resp. Br. 63-64.) Finally, Respondent contends that the releases were not material in that Mr. Frimerman did not consider them important and because they referred to transactions that were suppose to have already happened in past months.
In reply, the Division insists that Mr. Barr acted with scienter in that the press releases he distributed contained "outlandish" claims and a reasonable broker would have known that the transactions described were suspicious. (Reply Br. 14-15.) It maintains that Mr. Barr had a duty to investigate the contents of the press releases because it is well settled that even a party under no duty to disclose material facts must not circulate misleading information when it decides to make disclosure. (Reply Br. 15 (citing Panter v. Marshall Field & Co., 646 F.2d 271, 292 (7th Cir. 1981)).) The Division remains confident that the cases it cited support the proposition that a registered representative who circulates misleading documents can be liable whether or not he or she recommends the security. (Reply Br. 16.) The Division claims that Mr. Barr has not cited any case where a registered representative who circulates misleading information is only liable if he recommends the security. The Division reads the cases to hold that adoption may be implied by circulation. (Reply Br. 16.)
Finally, the Division contends that Mr. Frimerman's testimony is irrelevant because the issue is not how he viewed the press releases but whether a reasonable person would have viewed them as altering the total mix of information. Further, Mr. Barr's warning to Mr. Frimerman about ITC did not address the false information in the releases, and the releases contained more misinformation than stale forecasts. (Reply Br. 16-17.)
Findings
Section 17(a)(1) prohibits any person in the offer or sale of any securities by use of the means of interstate commerce or the mail, directly or indirectly, to employ any device, scheme, or artifice to defraud. To violate this antifraud provision, a person must have acted with scienter defined as "a mental state embracing intent to deceive, manipulate, or defraud." Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976); see also SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996) (explaining that the elements of a §17(a)(1) claim essentially mirror those of §10(b) of the Exchange Act and Rule 10b-5 thereunder) (citations omitted).
I find that Mr. Barr did not violate Section 17(a)(1) for the following reasons. The fact that Mr. Barr twice responded to requests for information about ITC by sending out press releases prepared by a third party which he did not know contained materially false information does not raise to the level of a "device, scheme, or artifice to defraud." There is no persuasive evidence that Mr. Barr acted with scienter in that he intended to deceive, manipulate, or defraud in the offer of ITC shares by mailing a press release to Mr. Robinson on or about March 30, 1993, and two press releases to Mr. Frimerman on April 24, 1993. These two people, who were not customers of Mr. Barr, called him and asked for information about ITC. Mailing these releases is the only evidence the Division relies on that Mr. Barr violated Section 17(a)(1). (Tr. 170-71, 1067-68.)
The cases that the Division cited do not support a finding of a violation in that they involved conduct which was far more egregious than Mr. Barr's conduct.33 In SEC v. North American Research and Development Corp., the court found that "[n]o amount of denials or so-called explanations by individual defendants on the witness stand could possibly convince any rational person that this series of events was purely coincidental and not by the design of those whom the SEC seeks to restrain." 424 F.2d at 68. Neither the Division in this proceeding nor the Commission in the civil proceeding, have suggested that Mr. Barr was part of a conspiracy to defraud investors as occurred in North American Research. In Coleco Industries, Inc. v. Berman, the court upheld the trial court's determination that the defendants who sold a company were not reckless. 567 F.2d at 573-74. The sellers had relied on an accounting firm for financials that turned out to be inaccurate. The court found that reliance on the accounting firm was within the bounds of commercial prudence, and that the sellers had been forthright and did not deliberately misrepresent the company's status or operation. Id. at 574. Mr. Barr was similarly frank in that he had all the buyers sign non-solicitation letters, he made no deliberate misrepresentations, and his reliance on information provided by Mrs. Erdman and the Erdman children was reasonable in these circumstances.
The respondent in Jay Houston Meadows, a registered representative, was one of three principals in two new companies. 61 SEC Docket at 2445-46. Mr. Meadows participated in efforts to encourage people to invest in the companies and was present at meetings where false statements were made about the investment risks, the companies' prospects for success, and the speed with which investors would recoup their investments. Id. at 2446-48. In contrast, Mr. Barr did not have anywhere near the knowledge and degree of involvement that Mr. Meadows exhibited, and he did not solicit any investors.
In Dlugash v. SEC, respondents, a broker-dealer and a registered representative, sold shares in a company using a report prepared by a company organizer. 373 F.2d 107 (2d Cir. 1976). The broker-dealer and the organizer had an arrangement whereby the broker-dealer would enter bids and ask quotations supplied by the organizer who had agreed to repurchase at a profit to the broker-dealer any shares that the broker-dealer had to make as a result of the bids it entered. Id. at 109. The court rejected respondents' defense that they did not know that the information in the report that their sales people used to sell the shares was false. Id. The court noted that the respondents had seen the company's financials and knew its condition was not favorable. Id. Again, the factual scenario, the level of involvement, and knowledge of material information are completely unlike Mr. Barr's situation.
The respondents in Everest Securities, Inc. v. SEC, a broker-dealer and its president, a registered representative and financial and operations principal, contracted to provide financial advisory and investment banking services to a corporation in connection with a private placement and subsequent public offering. 116 F.3d 1235, 1236 (8th Cir. 1997). The court upheld a Commission finding that the private placement memorandum was deceptive in not disclosing that the company was no longer pursuing its original business, and because it found respondents to be dilatory and remiss in their investigation, rejected their defense that they relied on others. Id. at 1238-40. Mr. Barr's involvement and actions are not comparable to these respondents.
Panter v. Marshall Field & Co. was an action by shareholders who claimed violations of the antifraud provisions which occurred in connection with Marshall Field & Co.'s successful efforts to thwart a takeover by Carter Hawley Hall. 646 F.2d 271 (7th Cir. 1981). The court held that the company was under no duty to reveal tentative projections made to enlighten management. Id. at 291-93. In its discussion, the court noted that while management was under no duty to disclose financial projections, it is axiomatic that once partial disclosure is made, full disclosure is required to avoid making statements misleading. Id. at 292 (citing Sundstrand Corp. v. Sun Chem. Corp., 553 F.2d 1033 (7th Cir.), cert. denied, 434 U.S. 875 (1977)). I do not agree that this language supports a Section 17(a)(1) violation based on Mr. Barr's failure to verify the contents of the press releases he mailed to two people with whom he had no relationship and who did not purchase ITC shares after receiving the releases.
I reject the Division's argument that Mr. Frimerman's testimony is irrelevant as to whether Mr. Barr committed the alleged violations. The reasonable person standard is applicable generally to determine the issue of materiality. Here, however, the total illegal activities consisted of two mailings that Mr. Barr made to two individuals. I find Mr. Frimerman's testimony relevant as to whether the elements of a Section 17 (a)(1) violation are present in Mr. Barr's conduct towards one individual. Mr. Frimerman bought about $9,000 worth of ITC shares based on information he received from a friend of Mr. Cohen's about a month before he requested information from Mr. Barr. (Tr. 1145-46.) Mr. Frimerman did not believe that Mr. Barr had verified or had attempted to verify any of the information in the two press releases Mr. Barr sent to him. (Tr. 1156.) Mr. Frimerman did not consider that Mr. Barr was recommending ITC shares by sending him the releases he asked for, and Mr. Frimerman did not rely on the information Mr. Barr sent him to purchase additional ITC shares. (Tr. 1155-58, 1166-71.) Mr. Frimerman also received press releases from ITC after he received them from Mr. Barr. (Tr. 1155, 1163-66; P. Exs. 133, 135.) Mr. Robinson, the second person to whom Mr. Barr sent a press release, is not listed as a purchaser of ITC shares in the period from December 1992 to September 1994. (Tr. 1083; P. Ex. 26.)
A showing of recklessness can satisfy the scienter requirement. See e.g., Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1568-69 (9th Cir. 1990) (en banc) (as amended). Recklessness is defined as "an extreme departure from the standards of ordinary care . . . which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must been aware of it." Meyer Blinder, 50 S.E.C. 1215, 1229-30 (1992).
I reject the Division's argument that the contents of the press releases that Mr. Barr sent out to Mr. Frimerman and Mr. Robinson were so obviously erroneous that Mr. Barr was reckless in not verifying the information. Mr. Barr did not investigate the truthfulness of the press releases and mailed them to two people because the sellers, people he knew and trusted, lulled him into complacency. 34 In their initial meeting, Mrs. Erdman told him there were willing buyers for ITC, and Mr. Barr saw his role as putting them together with her and doing the paper work on a negotiated sale. (Tr. 173, 1055.) Mr. Barr mistakenly thought he could, in effect, have Advest "do the paper work on what was negotiated sales" by having buyers sign non-solicitation letters that made it clear that he did not solicit their purchases of ITC stock. (Tr. 172-74, 1074; Resp. Ex. A) Perhaps Mr. Barr said it best: "It's unfortunate that I was taken advantage of and it makes me not look too smart, I have to admit. But the facts are the facts and this is the real world." (Tr. 1100.) Even if Mr. Barr had carefully reviewed the press releases, it is not clear that he would have concluded, as did the Division's expert, that an offering could not happen for lack of an underwriter The Division's expert's analysis was done with the benefit of hindsight, and his education and business experience brought to the exercise a level of sophisticated analysis that was beyond Mr. Barr's resources. On the other hand, both Mr. Greene, a specialist in corporate securities and transactional law, and Mr. Cohen, an experienced businessman, found the information in the press releases plausible. I do not give much weight to Mr. Fischer's view that the press releases looked suspicious when he willingly represented most of the buyers after he could not find any information on ITC and after consultation with his supervisor at Advest. (Tr. 432-35.) Mr. Fischer of Advest's Fort Lauderdale office required buyers to sign a non-solicitation letter, pay one-third of the purchase price up front, and open an account at Advest. (Tr. 434.)
For all the reasons stated, I find that Mr. Barr's mailing of the two press releases at issue did not violate Section 17(a)(1).
V. PUBLIC INTEREST
The Division seeks a cease and desist order, a lengthy suspension from association with a broker-dealer, and a substantial monetary penalty for the violations of Section 5.35 (Div. Br. 51-54, Div. Reply 22-25.)
Cease and Desist
Section 8A of the Securities Act provides that the Commission may order a person found to be violating, to have violated, or about to violate a provision of the Securities Act or any rule or regulation thereunder, to cease and desist where the person knew or should have known that his or her actions caused or contributed to the violations.
Respondent argues that the Division has failed to show that Mr. Barr will likely commit a future violation and cites many different sources, authorities, and arguments for his position that the likelihood of future violation is a prerequisite to the exercise of administrative cease and desist authority.36 (Resp. Br. 66-70 (citing Citizens State Bank v. FDIC, 751 F.2d 209, 214-15, 215 n.9 (8th Cir. 1984); Borg-Warner Corp. v. FTC, 746 F.2d 108, 110-11 (2d Cir. 1984); NLRB v. Savin Bus. Machs. Corp., 649 F.2d 89, 93 (1st Cir. 1981); Precious Metals Assocs., Inc. v. CFTC, 620 F.2d 900, 912 (1st Cir. 1980); Orlando Joseph Jett, 67 SEC Docket 1901, 1948-49 n.60 (July 21, 1998) (initial decision); Warren G. Trepp, 65 SEC Docket 614 (Aug. 18, 1997) (initial decision), proceedings dismissed, 70 SEC Docket 2037 (Sept. 24, 1999); 73A C.J.S. Public Administrative Law and Procedure § 159 at 147).)
The Division believes that the plain language of the statute authorizes issuance of a cease and desist order based on a finding that Respondent has committed a violation without a finding that he will likely violate the Securities Act in the future. Even so, the Division believes it is likely Mr. Barr will commit a future violation because "Respondent is a second time violator of the securities laws who continues to be employed as a broker and refuses to recognize the seriousness of his violations." (Div. Br. 53.)
Findings
The scant legislative history of Section 8A indicates that the Commission was granted cease and desist authority so that it would have a broad range of remedies to address effectively the wide variety of circumstances it had to deal with, especially situations of ongoing fraudulent activity. Securities Law Enforcement Remedies Act of 1989, Hearings on S. 647 Before the Subcomm. on Sec. of the Senate Comm. on Banking, Hous. and Urban Affairs, 101st Cong. 56-57 (1990) (written statement of Richard C. Breeden, Commission Chairman). Section 8A gives the Commission discretion whether or not to issue a cease and desist order. In making its determination, the Commission has indicated that it will be guided by the factors cited by the court in Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). See Joseph J. Barbato, 69 SEC Docket 178, 200 & n.31 (Feb. 10, 1999).
The issue of whether or not a cease and desist order is a penalty remains a debatable issue; however, Mr. Barr violated Section 5 in connection with the sale of some 139,000 ITC shares after April 24, 1993. Therefore, the Commission is clearly empowered to impose a penalty for these violations which occurred within the five year statute of limitations if it deems it in the public interest to do so. (Memorandum of Law 3 and Appendix C.) The pre-April 24, 1993, sales of some 210,700 ITC shares cannot be the basis of a penalty under the holding in Johnson v. SEC, 87 F.3d 484, 492 (D.C. Cir. 1996); however, conduct outside the limitations period may be used to determine motive, intent, or course of conduct. See Joseph J. Barbato, 69 SEC Docket at 197 (citing United States v. Gavin, 565 F.2d 519, 523 (8th Cir. 1977)).
The preponderance of the evidence indicates that Mr. Barr's illegal actions were an aberration occurring over seven months in his otherwise thirty-six year sterling career in the securities industry, and there were mitigating, although not exculpatory, circumstances.37 There are no ongoing violations. I disagree that a 1977 settlement by J.S. Barr and Mr. Barr with the NASD that resulted in a censure and $500 fine indicates that a cease and desist order is in the public interest here because Mr. Barr is a "second time violator" likely to commit further violations. (Tr. 51-52; P. Ex. 164.) The violations alleged in the 1976 complaint concerned the books and records of J.S. Barr and occurred a long time ago shortly after Mr. Barr became president of J.S. Barr following his father's death in 1974. (Tr. 47, 1026-27; P. Ex. 163.)
One of the Steadman factors to be considered is the degree of scienter involved. I find that Mr. Barr did not act either with the intent to deceive, manipulate, or defraud, or recklessly in selling ITC shares. I find that Mr. Barr acted negligently but that a cease and desist order is not required in the public interest.
As noted, the preponderance of the evidence is that Mrs. Erdman lied and deliberately misled Mr. Barr about almost every material issue relevant to whether the ITC shares were registered. Also, Mr. Barr relied on the fact that the certificates of ITC stock deposited with Advest did not bear a legend. This reliance is no defense to the substantive Section 5 violations, but I find it to be a mitigating public interest factor in that it was generally accepted at Advest that shares which did not bear a restrictive legend were registered. (Tr. 868-70.) Another mitigating fact is that Mr. Barr did not act to achieve considerable financial benefit as he only earned commissions of $5,280 on ITC sales. (Tr. 821.) Mr. Barr's gross commissions in 1993 were $461,000. (Tr. 1034.)
There is nothing in the record to contradict Mr. Barr's statement that, with the benefit of hindsight, he would act differently if this situation occurred today.
I learned a major lesson. And, I would have done much more investigation on my own. I would have gone to the transfer agent, like I should have. I would have gone to the SEC to see the filings, the state of incorporation. I would have checked the information that I got from Mrs. Erdman. I was duped, big.
(Tr. 1097.) I accept as sincere, Mr. Barr's testimony that he would not repeat his actions and that since the day he had his first interview about this issue in 1995, there has not been a day when he has not "had this in [his] mind. Not a day. And it's been very, very hard to deal with." (Tr. 1101.) The Division does not cite any support for its claim that Mr. Barr refuses to recognize the seriousness of his violations. (Div. Br. 53.) A cease and desist order has significant impact on an individual, especially one involved in the securities industry. Andrew M. Smith, SEC Cease-and-Desist Orders, 51 Adm. L. Rev. 1197, 1217-24 (1999).
For all these reasons, I find that a cease and desist order with respect to the Section 5(a) and 5(c) violations is not warranted in these particular circumstances.
On January 21, 2000, after briefing ended, the Court of Appeals denied Respondent's petition for review in Jacob Wonsover where the Commission suspended a registered representative from association with a broker or dealer for a period of six months and ordered him to cease and desist from committing or causing any present or future violations of Sections 5(a) and 5(c) of the Securities Act. 69 SEC Docket 694 (Mar. 1, 1999), petition denied, 205 F.3d 408 (D.C. Cir. 2000). I find that the Commission's determination in Wonsover does not indicate that similar measures are called for here because, even though Mr. Barr violated Section 5, his conduct does not equate with what the Commission concluded was reckless conduct by Mr. Wonsover. Id. at 706-07. Mr. Wonsover ignored numerous "red flags" that included the fact that he knew the company's chairman, president, and founder actively managed the accounts which held the stock he agreed to trade. Id. at 696, 706. The individuals who presented the stock to Mr. Wonsover were plainly statutory underwriters. Id. at 713. Mr. Wonsover reviewed forms which indicated that the shares could not have been held for the length of time that the owners of the shares claimed. Id. at 706-07. Mr. Wonsover's trades for a group of seven shareholders was approximately 60% of the company's total public float. Id. at 713. Mr. Wonsover gave contradictory testimony and admitted to no culpability. Id. at 699, 716. For all the reasons stated in my legal conclusions and my assessment that Mr. Barr gave credible testimony and is committed to lawful conduct I find that the sanctions awarded in Wonsover are not justified here.
Remedial Sanctions and Monetary Penalty
Where it is in the public interest to do so, Sections 15(b)(6) and 19(h) of the Exchange Act authorize the Commission to censure, limit the activities of, suspend for up to twelve months, or bar from association with a broker or dealer or from participation in a penny stock offering a person associated with a broker-dealer, and to suspend or bar someone from being associated with a national securities exchange or registered securities association who has willfully violated any provision of the Securities Act. Mr. Barr's Section 5 violations were willful, defined as intending to commit the acts which constitute the violation. See Arthur Lipper Corp., 547 F.2d 171, 180 (2d Cir. 1976); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965); James E. Ryan, 47 S.E.C. 759, 761 n.9 (1982). Section 21B of the Exchange Act authorizes the imposition of civil penalties in any proceeding instituted pursuant to Section 15(b)(6) where there has been a willful violation of the Securities Act and a penalty is in the public interest.
The criteria for determining what, if any, sanction is in the public interest are set out in Steadman:
the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
603 F.2d at 1140; see also Donald T. Sheldon, 51 S.E.C. 59, 86 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995). The severity of a sanction depends on the facts of each case and the value of the sanction in preventing a recurrence. See Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
The Division claims the following additional factors must be examined citing Section 21B(c) of the Exchange Act and James Thornton, 64 SEC Docket 554, 560 (Mar. 25, 1997), aff'd, 69 SEC Docket 49, and aff'd, 199 F.3d 440 (5th Cir. 1999) (Table): (1) whether Mr. Barr's acts involved fraud or deliberate or reckless disregard for regulatory requirements; (2) the harm to others from Mr. Barr's acts; (3) the extent to which Mr. Barr was unjustly enriched; (4) whether Mr. Barr has been previously found to have violated the securities laws or the rules of a self-regulatory organization; and (5) the need to deter Mr. Barr from future violations. (Div. Br. 53.)
Findings
Mr. Barr bears some responsibility, which he acknowledges, for the fact that some forty people lost over $200,000 by purchasing worthless ITC stock and he was unjustly enriched in the amount of $5,279.72.38 (Div. Br. 54.)
On the other hand there are significant mitigating factors. As detailed in the findings and legal conclusions, Mr. Barr's violations were limited to representing one family in selling one security. Mr. Barr did not act with scienter. Outside of these violations, Mr. Barr has had an enviable record of compliance in the securities industry for thirty-six years. Mr. Barr acknowledged the mistakes that resulted in the Section 5 violations, and he is committed not to repeat them. Based on my observation of the witness, I conclude that there is no likelihood that he will commit any future violations as a securities professional. I assess that he is deeply remorseful that his actions have harmed others and by the loss of professional reputation. (Tr. 1098-1101.)
Securities professionals are required to be vigilant and they should be held accountable when they violate the securities statutes whatever their motivation. I find it appropriate and in the public interest therefore to censure Mr. Barr and fine him $50,000. At least twenty people bought approximately 139,000 unregistered shares of ITC after April 23, 1993. Mr. Barr's violations of Section 5 in connection with these sales can be the subject of a civil penalty. The $50,000 total is within the $5,000 per act limit for violations at the first tier specified in Section 21B. (P. Ex. 44.)
VI. RECORD CERTIFICATION
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b), I certify that the record includes the items described in the record index issued by the Secretary of the Commission on May 6, 1999.
VII. ORDER
Based on the findings and conclusions set forth above:
I ORDER that pursuant to Sections 15(b)(6) and 19(h) of the Exchange Act, that David T. Barr is censured;
I FURTHER ORDER, pursuant to Section 21B of the Exchange Act, that David T. Barr shall pay a total civil penalty of $50,000.
Payment of the civil penalty shall be made on the first day following the day this decision becomes final by certified check, United States postal money order, bank cashier's check, or bank money order payable to the U.S. Securities and Exchange Commission. The check and a cover letter identifying Mr. Barr as a Respondent in Administrative Proceeding No. 3-9585, should be delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center 6432 General Green Way, Stop O-3, Alexandria, Virginia 22312. A copy of the cover letter should be sent to the Commission's Division of Enforcement.
This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. § 201.360 (1998). Pursuant to that rule, a petition for review of this initial decision may be filed within twenty-one days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one days after service of the initial decision upon such party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
______________________________
Brenda P. Murray
Chief Administrative Law Judge
1 "(Tr. __.)" refers to the transcript of the hearing. The Division designated its exhibits as Plaintiff's Trial Exhibits. I will refer to the Division and Respondent exhibits as "(P. Ex. __.)," and "(Resp. Ex. __.)," respectively.
2 Mr. Lemon was not enjoined from violating Sections 5(a) and 5(c) of the Securities Act.
3 I will refer to the Division's initial posthearing filing as "(Div. Br.__.)"; the Respondent's initial posthearing filing as "(Resp. Br.__.)"; and the Division's second posthearing filing as "(Div. Reply __.)."
4 Ivy Broadcasting, a private Erdman family corporation that owned a radio station, sold a half interest in the station in 1981 to V.V.F. Communications whose parent was the Vietnam Veterans Foundation. (Tr. 926-32.) Valley View Investors, Inc., a private Erdman holding company owned the building and the site where the transmitter was located. (Tr. 926.) All these entities went bankrupt, and the bankruptcy court subsequently ousted V.V.F. Communications. (Tr. 931.)
5 Mrs. Erdman contradicted herself by testifying that Mr. Erdman continued to live with her following their divorce until late 1992 and that she was not with Mr. Erdman between 1988 and 1992. (Tr. 686-87, 702, 718, 723.) In April 1992, Mr. Erdman was leasing an apartment in Harrisburg, Pennsylvania. (P. Ex. 163.) Mr. Barr knew Mrs. Erdman as a divorced woman living alone. (Tr. 84.) Mrs. Erdman often could not remember facts until confronted by her prior investigative testimony; she was hostile, evasive and not credible. (Tr. 719-20, 724-26, 732-34, 747-54.)
6 SEC v. VVF Indus., Inc., No. 82-3571 (D.D.C. Dec. 16, 1982). (P. Ex. 126.)
7 The Sunday Patriot-News article on April 12, 1992, reported that Mr. Erdman owed the Internal Revenue Service $1.4 million in back taxes and that courts in Pennsylvania, New York, Washington, Virginia and Indiana had judgments against him in hundreds of thousands of dollars. (P. Ex. 163.)
8 Expedite, Inc. filed a document with the State of Nevada in September 1988, signed by Mr. Erdman as the "Trustee for stockholder Second Manhattan Securities." (P. Ex. 166.) Second Manhattan was supposed to be one of the many irrevocable trusts that Mr. Erdman established. The beneficiaries were his children, and he and Mrs. Erdman were trustees. Hans Erdman, the executor of Mr. Erdman's estate, could not locate documentation for the trust. (Tr. 690, 939-40.) Mr. Erdman also created Davis and Klinger, a trust used to purchase a house with $20,000 from the sale of ITC stock in 1992-93. (Tr. 690, 712-13.)
9 A letter on Second Manhattan letterhead stationery dated November 21, 1992, shows Hans Erdman's address in Minneapolis, Minnesota, and Mrs. Erdman's phone number in Freeville, New York. (Tr. 728-29; P. Ex. 1.) Mrs. Erdman claimed not to know if Second Manhattan owned ITC shares. (Tr. 757.)
10 Mr. Cohen's company sold personal auto and commercial products. (Tr. 202.) It did not write its own policies, but it had broker agreements with about twenty companies which wrote personal auto policies and thirty companies which wrote commercial property and casualty polices. These carriers paid Mr. Cohen's company a commission for selling the policies. If someone bought his company, they would have to enter a new contract with these insurance companies because the agreements were with Mr. Cohen not with his company. (Tr. 203.)
11 On November 23, 1992, the U.S. District Court for the Southern District of Florida entered a final judgment against Mr. Joseph on consent. The complaint alleged that Mr. Joseph violated Section 15(a)(1) of the Exchange Act. (Tr. 324-25; P. Ex. 173, P. Ex. 184 at 3.)
12 According to Mr. Lemon, ITC was not in good standing in Nevada during the relevant time period because its filings were not current. (Tr. 631-32, 634.) Mr. Cohen never saw any ITC financial statements or annual reports. (Tr. 275-76.)
13 Mr. Lemon has an undergraduate degree from Michigan State University and an MBA from the University of Indiana. He met Mr. Erdman in the early 1980s and appears to have been associated with him in various ventures. (Tr. 612-13.) Mr. Lemon signed an employment contract with ITC dated February 5, 1993. (P. Ex. 98.) He did not prepare financials, did not have control of bank accounts, and did not get paid. (Tr. 628-32.) Mr. Lemon worked with Mr. Erdman at least through August 1993. (Tr. 679.) In this 1992-93 time frame, Mr. Lemon also claims to have been part of a money laundering sting for the U.S. Drug Enforcement Administration. (Tr. 613-15, 669-71.)
14 Specifically, 3.66 million shares were for Mr. Cohen and 900,000 thousand were for Mr. Joseph. (P. Ex. 74.) The transfer agent was to supply additional amounts. (P. Ex. 74.)
15 Jack Sandler Bloom of Bloom & Company Securities ("Bloom Securities"), a graduate of Harvard and MIT's Sloan School of Management, wrote the letter. (Tr. 1006-07.) In June and July 1993, when his family was paying his expenses, Mr. Erdman managed to convince people at CC&Q and Mr. Bloom that he might supply the $5 million needed to capitalize a merger of Bloom Securities and CC&Q. (Tr. 1008-11.) Mr. Bloom ended his contacts with Mr. Erdman when Mr. Erdman suggested that CC&Q and Bloom Securities go forward with an underwriting for ITC, and that he would take $5 million from the underwriting and provide it to CC&Q as his investment. (Tr. 1021-22.) Mr. Bloom told Mr. Erdman that "that was a scheme that would not work." (Tr. 1022.)
16 Hans Erdman testified that the proposed acquisition and subsequent public offering did not occur because Mr. Cohen did not fulfill the terms of the agreement and that the Florida Office of Insurance barred Mr. Cohen and Mr. Iodice, his associate, from the insurance industry. (Tr. 964-65.)
17 Mr. Purcell graduated with honors in economics from Princeton University in 1964, and was first in his class when he obtained an MBA from the New York University Graduate School of Business in 1966. From 1966 to 1990, Mr. Purcell was an investment banker with Dillon Read & Co., Inc. In 1990, he was part of a group that achieved management control of the AmBase Corp. where he is now a senior consultant. In addition, he is engaged in matters of corporate finance as a managing director of Taylor Strategic Divestitures that specializes in mergers and acquisitions and as an advisor to Gruntal Capital Markets and Schneider Securities, two investment banking firms. (Tr. 335-37; P. Ex. 167, P. Ex. 184 at 1.)
18 "Underwriters perform `due diligence' to ensure that the issuer's representations are accurate, its plan is attainable and its principal actors are competent and of appropriate integrity." (P. Ex. 184 at 6.) Mr. Purcell described the underwriter's decision-making process as a series of stepping stones: am I going to deal with these people; am I going to deal with this investment vehicle, here a public shell; does the proposed plan make sense; and are the ownership ratios appropriate. (Tr. 354-55.)
19 Mr. Cohen's experience of merging six candy distributors is not comparable "in terms of complexity" to "pulling together eighty insurance companies." (Tr. 333-34.) In addition, Mr. Cohen's contracts with the major insurance companies which wrote the policies ran to him personally so that ITC would have to renegotiate the contracts. (Tr. 203.) I find that Mr. Lemon had no experience in the insurance industry despite Mr. Lemon's claim that he worked on export insurance matters while with the Export-Import Bank. (Tr. 617-19; P. Ex. 184 at 4.)
20 Mr. Purcell characterized the letters that Mr. Cohen collected as "bare-bones letters of intent." (Tr. 341.)
21 There were 12.75 million shares outstanding before the offering - 8 million shares outstanding in the beginning, issuance of 3.75 million shares issued to Mr. Cohen, and 1 million shares to Mrs. Joseph's firm. (R. Ex. 184 at 8.) Assuming a $30 million offering at $4 per share indicates that 7.25 million shares would be newly issued. The total of 7.25 million and 12.75 million is 20 million shares; 7.25 million is approximately 40% of 20 million, which is the percentage of ITC that the public would own as a result of the offering. (Tr. 350-51; P. Ex. 184 at 8.)
22 On February 8, 1993, Hans Erdman wrote Mr. Barr that he would like to sell for a dollar a share, "but I need to satisfy some pressing needs out here." (P. Ex. 89.)
23 This stock had been issued to third persons who had assigned their rights to the shares. (Tr. 150-51, 692; P. Exs. 88, 111, 123, 124, 125.)
24 Mr. Erdman also had possession of additional shares held in third party names as for example, Dr. Bailey, Mr. and Mrs. Frederick, and others. (Tr. 792-97.)
25 Mrs. Erdman told Mr. Barr that she owned 125,000 lettered ITC stock shares and each of the three children had 100,000 lettered shares so that the family owned a total of 425,000 shares of lettered stock. (Tr. 98-99, 1043-44; P. Ex. 37.)
26 In the same conversation, she also made the inconsistent representation that the Erdmans owned 400,000 unlettered shares. (Tr. 107.) Mr. Barr used the term "lettered shares" to mean stock restricted from public sale because it is either closely held or it comes from a corporate officer. (Tr. 98.) The shares are usually stamped with the date when the restriction expires. (Tr. 98.)
27 Mrs. Erdman said that the family owned less than 4% of ITC shares outstanding but 662,500 is slightly more than 8% of 8.006 million. (Tr. 111-12.)
28 Mrs. Erdman does not remember pricing the stock but does not deny authorizing the sales. (Tr. 753-54.) Based on my observation of Mrs. Erdman and Mr. Barr, I find his testimony to be the credible version.
29 Hans Erdman was vice president and general manager of the radio station and its parent company from 1979 to 1984. (Tr. 926, 928.)
30 The Division does not deny that the Commission's complaint against the Erdmans in the civil case alleged that Mrs. Erdman lied to Mr. Barr. (Resp. Br. 54.)
31 There is no question that the false information about ITC was material because someone making an investment decision would consider it important as part of the "total mix" of information available. Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988) (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976)).
32 When Mr. Frimerman, who had previously purchased ITC based on information from a friend, called Mr. Barr looking for additional shares, Mr. Barr warned him that he would have to sign a document stating that he understood the risks of investing in ITC. (Tr. 1153.) When Mr. Frimerman bought ITC shares, Mr. Fischer warned him that ITC "wasn't a publicly-traded company, that it wasn't listed on any exchange and that there was a very good chance that every penny I put into it I will lose." (Tr. 1147.)
33 I have not discussed every case cited and have not distinguished those that involve Section 10(b) of the Exchange Act and Rule 10b-5 thereunder or those that involve the NASD Rules.
34 Mrs. Erdman's status was somewhere between a friend and a causal acquaintance. (Tr. 85.) Mrs. Erdman testified that most of her conversations with Mr. Barr centered on old times. (Tr. 700.)
35 In view of my conclusions of law, the Division's request for a cease and desist order in connection with Section 17(a)(1) is moot.
36 In his response to the Division's request for sanctions, the Respondent sets out public interest factors which he believes also show that a cease and desist is not warranted. (Resp. Br. 70-71.)
37 Mr. Barr began working as a registered representative in 1957 and the relevant period is between February and August 1993.
38 The Division's initial brief states that the Erdman's realized over $215,000 from sales of ITC stock citing Tr. 821; P. Exs. 36, 38-40. The final judgments of permanent injunction in the civil action ordered total disgorgement of $241,571: $139,010 against Phebe Erdman; $55,240 against Hans Erdman; $27,110 against Leslie Chekin; and $20,211 against Rebecca Erdman.
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