Byron G. Borgardt and Eric M. Banhazl Rel. No. IC-26169

SECURITIES ACT OF 1933
Rel. No. 8274 / August 25, 2003

INVESTMENT COMPANY ACT OF 1940
Rel. No. 26169 / August 25, 2003

Admin. Proc. File No. 3-9730

In the Matter of

BYRON G. BORGARDT

and

ERIC M. BANHAZL

ORDER IMPOSING SANCTIONS

On the basis of the Commission's opinion issued this day it is

ORDERED that Byron G. Borgardt and Eric M. Banhazl cease and desist from committing or causing any violations or future violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act of 1933 and Section 34(b) of the Investment Company Act of 1940.

By the Commission.

Jonathan G. Katz
Secretary

1 Byron G. Borgardt, Initial Decision Rel. No. 167 (June 1, 2000), 72 SEC Docket 1675.
2 15 U.S.C. §§ 77q(a)(2), 77q(a)(3). Section 17(a)(2) prohibits the sale of securities by means of "any untrue statement of a material fact or any omission to state a material fact necessary in order to make the statements made, in light of the circumstances under which they were made, not misleading." Section 17(a)(3) prohibits a sellerof securities from "engag[ing] in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser."
3 15 U.S.C. § 80a-33(b). Section 34(b) prohibits the making of any untrue statement of a material fact in any registration statement filed with the Commission. It also prohibits the omission from such a registration statement of any fact necessary in order to prevent the statements made therein from being materially misleading.
4 In its briefs, the Division also requested that we adopt a standard for issuance of cease-and-desist orders that does not require a finding of likelihood of future violations, and apply that standard here. Subsequent to the close of briefing in this matter, we articulated, in another litigated case, a standard for issuance of cease-and-desist orders that calls for a determination of some risk of future violations. See KPMG Peat Marwick LLP, Exchange Act Rel. No. 43862 (Jan. 19, 2001), 74 SEC Docket 384, 429-30, 435-36, motion for reconsideration denied, Exchange Act Rel. No. 44050 (Mar. 8, 2001), 74 SEC Docket 1351, petition for review denied, 289 F.3d 109 (D.C. Cir. 2002). That standard, which Division counsel acknowledged at oral argument is the governing standard, is explicated infra at nn. 48-50 and accompanying text.
5 Carpenter became president of Concord in early 1992.
6 Concord expected the Fund to reimburse these expenditures over time. It did so, within the first year and a half of the Fund's operation.
7 The Fund's initial registration statement was filed on January 21, 1992, and was declared effective on October 8, 1992. The filings at issue here constitute amendments to the January 1992 statement. In the interest of simplicity, we refer to them in this opinion generally as registration statements, as did the Order Instituting Proceedings ("OIP") and the initial decision.
8 The Fund had a diversification requirement that limited its participation interest in any given loan to five percent or less of the Fund's net assets; this level of participation was too small to interest some providers. Other providers refused to do business with the Fund because they could obtain capital more cheaply elsewhere. The Fund rejected some prospective providers because they offered unacceptable rates or posed unacceptable risks.
9 Concord's screening and servicing costs were significant, in part because many of the companies to which it provided capital were new, small, or undercapitalized and had inadequate back-office operations. Finding prospective borrowers, determining their credit worthiness, negotiating loan agreements, tracking accounts receivable, and running its in-house system of financial controls involved substantial expense to Concord.
10 The record does not identify the source of the 2.5% restriction.
11 Concord was reimbursed for about half of the overage payments. It absorbed the loss of the other half so that Fund shareholders could be made whole when the Fund closed down.
12 After May 3, 1994, Borgardt continued to invest in Concord loan participations on behalf of Hardie, and Banhazl invested in Concord participations on behalf of the Fund.
13 15 U.S.C. § 80a-17. Section 17 prohibits certain acts by affiliated persons of registered investment companies. Section 2(a)(3)(D) of the Investment Company Act, 15 U.S.C. § 80a-2(a)(3)(D), defines officers and directors as affiliated persons.
14 Jeffers later concluded that the participations were not prohibited transactions under Section 17 of the Investment Company Act. The validity of that conclusion is not at issue in this proceeding.
15 17 C.F.R. § 200(d)(2).
16 As the law judge noted, while Section 34(b) prohibits material omissions generally, the OIP charged Respondents with the omission of material information from the Fund's prospectus, a specific part of the registration statement. The law judge found that the Division established that the information concerning the Fund's special relationship with Concord should have been included in the prospectus, but did not prove that information regarding the directors' potential conflicts of interest necessarily belonged in the prospectus rather than elsewhere in the registration statements. This finding was not appealed.
17 The motion also sought to exclude any potential testimony from other witnesses "that similarly exceeds the scope of the Order."
18 17 C.F.R.§ 201.200(d)(2). Rule 200(d)(1), by contrast, allows the Commission to amend an order instituting proceedings "to include new matters of fact or law." 17 C.F.R. § 201.200(d)(1).
19 Rules of Practice, 60 Fed. Reg. 32738, 32757 (June 23, 1995) (Rule 200 cmt. (d)) (citing Carl L. Shipley, 45 S.E.C. 589, 595 (1974)) (citations omitted).
20 Compare Carl L. Shipley, 45 S.E.C. at 595-96 (denying motion to amend OIP to add allegations of violations of antifraud provisions of Securities Act and Exchange Act and rules thereunder where OIP had originally charged only breach of fiduciary duty under Investment Company Act).
21 15 U.S.C. §§ 77q(a)(2), (a)(3).
22 SEC v. Monarch Funding Corp., 192 F.3d 295, 308 (2d Cir. 1999); SEC v. First Jersey Sec., Inc., 101 F.3d 1450, 1467 (2d Cir. 1996).
23 15 U.S.C. § 80a-33(b).
24 Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
25 Not all alleged omissions were charged with respect to all six of the registration statements in question. Failure to disclose the special relationship with Concord was charged only with respect to the last five registration statements; the Fund had not yet made any investments when the initial registration statement was filed on October 7, 1992. Failure to disclose the alleged conflicts of interest pertaining to Rutherford and Borgardt was charged only with respect to the first four registration statements; Rutherford and Borgardt resigned from the Fund's board before the fifth and sixth registration statements were filed.
26 The law judge found that the Fund did not start purchasing loan participations until December 1992, at the earliest. Thus, he found, the Fund's exclusive relationship with Concord had not yet become firmly established when its registration initially became effective. Similarly, he found that the extent to which the relationships of Borgardt and Rutherford to Concord and the Fund would present conflicts of interest was not then clear. Additionally, there was no rate differential because the Fund had no portfolio. For these reasons, the law judge found that the charges as they related to the first registration statement were not sustained. This finding was not appealed.
27 As Hicks testified, he identified Concord to broker-dealers because they "want to know exactly who they're dealing with, and what is the relationship between the parties."
28 The record in fact indicates that, despite months of searching, no alternative investments were found. The fact that the Fund did not invest in loans from other providers, even when Concord decided to stop offering participations to the Fund, belies the level of independence from Concord that Respondents assert.

Indeed, Respondents acknowledge that the loss of Concord as a source of loan participations played a role in the decision to liquidate the Fund. Respondents also attribute the Fund's decision to liquidate in part to "a climate of declining interest rates which gradually made it more difficult for the Fund to find alternative loan sources." Since the Fund had never found an alternative loan source it considered worthy of investment, a climate in which such sources were becoming scarcer further emphasizes the importance of Concord to the Fund.
29 As examples of Concord's interest, Respondents citeConcord's repurchase of two defaulted loans from the Fund and Concord's advancement to the Fund of monies to cover organizational expenses and certain operating expenses.
30 Among other things, the registration statements disclosed that the loans in which the Fund invested (1) were typically issued by smaller companies, (2) were unrated, and (3) were not readily marketable.
31 Respondents also argue that it is the norm in the loan participation marketplace for loan originators to charge for their services by in effect taking a portion of the loan interest rate and passing on a lesser yield to all loan participants. Particularly here, given the magnitude of the differential, Rutherford's conflict and the relationship between the Fund and Concord, disclosing the rate differential would have allowed investors to have before them information material to their assessment of the Fund's operation.
32 By arguing that they relied on Jeffers' advice that Concord's roles and the Borgardt conflict did not need to be disclosed, see infra, Respondents implicitly admit that they knew of those roles and that conflict. They could not have sought advice without explaining the factual basis for the advice, nor could they have understood unsolicited advice without knowing the facts to which it related.
33 E.g., Jay Houston Meadows, 52 S.E.C. 778, 785 n.16 (1996), aff'd, 119 F.3d 1219 (5th Cir. 1997); Donald T. Sheldon, 51 S.E.C. 59, 82 n.94 (1992), aff'd, 45 F.3d 1515 (11th Cir. 1995); SEC v. Hughes Capital Corp., 124 F.3d 449, 453-54 (3d Cir. 1997); SEC v. Steadman, 967 F.2d 636, 643 & n.5 (D.C. Cir. 1992). See also Aaron v. SEC, 446 U.S. 680, 695-702 (1980) (Commission need not establish scienter to establish violation of Sections 17(a)(2) and 17(a)(3)).

In light of this established body of law, we reject Respondents' argument that we should instead apply the law of Maryland, the state of the Fund's incorporation. Moreover, because negligence suffices to establish liability, we decline to address the Division's contention that Respondents' conduct amounted to gross negligence.
34 SEC v. Advance Growth Capital Corp., 470 F.2d 40, 52 (7th Cir. 1972).
35 SEC v. Hughes Capital Corp., 124 F.3d at 453; SEC v. Fitzgerald, 135 F. Supp. 2d 992, 1028 (N.D. Cal. 2001).
36 Relying on Gould v. American Hawaiian S.S. Co., 351 F. Supp. 853, 866 (D. Del. 1972), Respondents contend that "where an omission [rather than a false or misleading statement] is at issue, officers and directors should not be liable for negligence unless it can be said that they ought to have known of the 'importance and need for . . . inclusion' of the omitted information."

In Gould, the court stated that requiring a higher level of proof regarding knowledge of materiality could be appropriate where the omissions in question relate to subjects "about which the proxy materials are completely silent and the noninclusion of which does not render misleading an affirmative statement made in the proxy materials." Gould, 351 F. Supp. at 866. The omissions fromthe registration statements in this case were not of this type: instead, their absence rendered statements in the registration statements regarding the Fund's business and management misleading.
37 Marc N. Geman, Securities Exchange Act Rel. No. 43963 (Feb. 14, 2001), 74 SEC Docket 999, 1016 n.38 (citing Savoy Indus., Inc., 665 F.2d 1310, 1314 n.28 (D.C. Cir. 1981)), aff'd, 334 F.3d 1183 (10th Cir. 2003); Louis Feldman, 52 S.E.C. 19, 21 n.9 (1994). Respondents argue that we should depart from this established jurisprudence and apply Maryland law instead. The Geman/Savoy Industries analysis provides a nationwide legal standard that furthers the purposes of the federal securities laws; application of varying state standards would not. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 98 (1991) (use of uniform federal rules to fill interstices of federal remedial schemes is appropriate where scheme in question evidences distinct need for nationwide legal standards).
38 Jeffers admitted that the Fund could have included in the registration statement a disclaimer to the effect that Concord was not a guarantor of the loans.
39 As discussed below, however, we have serious doubts as to whether such reliance would have been justified.
40 E.g., SEC v. Enterprises Solutions, Inc., 142 F. Supp. 2d 561, 576 (S.D.N.Y. 2001) (corporate president and CEO was liable for failure to disclose material information in registration statement; although he supplied the information to counsel preparing registration statement in questionnaire responses, he neither sought specific advice from counsel regarding disclosure of that information nor received specific advice that such disclosure was not required); see also SEC v. Savoy Indus., 665 F.2d at 1314 n.28 (individual who controlled entities that filed various documents with Commission held liable for failure to fulfill disclosure obligations despite assertion that documents were prepared by outside law firm).

Our conclusions as to Respondents' liability are based on their failure to satisfy this duty. While Jeffers was not named as a respondent here and his conduct is thus not before the Commission, it appears from the record before us that the passive role Jeffers played with respect to the key disclosure issue in this matter -- the Fund's relationship to Concord -- does not represent the kind of active counseling that the Commission expects of a securities lawyer engaged to advise a registered investment company.
41 Given Jeffers' authorship of the minutes, the lack of references to such discussion, or proferred advice, suggests that there was none.
42 See Anthony Tricarico, 51 S.E.C. 457, 460 (1993) (credibility determination of initial decision maker is entitled to considerable weight, and can be overcome only when record contains substantial evidence for doing so). See also Jacob Wonsover, Exchange Act Rel. No. 41123 (March 1, 1999), 69 SEC Docket 694, 707-08 (leavingundisturbed law judge's determination not to credit respondent's testimony at administrative hearing when respondent had previously provided "less 'self-serving'" version of events in investigative testimony), petition for review denied, 205 F.3d 408 (D.C. Cir. 2000). Similarly, we leave undisturbed the law judge's decision to accord little weight to Borgardt's testimony that Jeffers gave advice regarding nondisclosure of Concord's role at least four times.
43 Respondents contend that the Division is bound by an "admission" in a related Commission proceeding that Jeffers "reaffirmed [his opinion that Concord's roles need not be disclosed] to at least one Fund director" at some point after "late 1991." See Reid Rutherford, Securities Act Rel. No. 7588 (Sept. 28, 1998), 68 SEC Docket 288, 290. The alleged "admission" by the Division is actually a finding by the Commission. The order in question explicitly disavows the binding impact of findings it contains outside the proceeding settled by the order. Id., 68 SEC Docket at 289 n.1. Moreover, even if the Division were bound by an earlier concession that Jeffers reiterated his advice after late 1991, that would not alter our conclusion that Respondents could not rely on that advice for registration statements filed after December 1992. See infra text accompanying n.45.
44 Respondents contend that the law judge should not have admitted Jeffers' 1996 responses into evidence. They assert that Jeffers was not given an opportunity to explain the responses, which they characterize as "fundamentally ambiguous," and that absent such clarification, the responses do not constitute "reliable, probative, and substantial evidence" within the meaning of Section 556(d) of the Administrative Procedure Act, 5 U.S.C. § 556(d).

Respondents' assertion that Jeffers was not afforded an opportunity to explain his responses lacks record support. In tendering the documents, Division counsel proposed that Jeffers "may be cross-examined at great length on the document." Counsel for Respondents failed to take up the subject and thus passed up the opportunity to clarify any ambiguity.

We find that the responses, and the Division's letter that elicited them, were properly admitted. Jeffers testified that the letter containing his responses was accurate, to the best of his recollection, as of the day he wrote it.
45 Respondents argue that, even if their asserted reliance on Jeffers' advice did not satisfy the Geman/Savoy Industries test, see supra n. 37 and accompanying text, it nonetheless counters the Division's assertion that they were deficient in the exercise of due care. We disagree. Given the central importance of Concord to the Fund, a reasonably careful and competent officer or director would have been well aware that reasonable investors would consider the Fund's dependence on Concord significant, notwithstanding Jeffers' early advice to omit the disclosure.
46 15 U.S.C. § 77h-1.
47 15 U.S.C. § 80a-9(f).
48 See KPMG Peat Marwick LLP, 74 SEC Docket at 429-30, 435-36 (issuing cease-and-desist order pursuant to Section 21C of the Exchange Act, 15 U.S.C. § 78u-3).
49 Id. at 436.
50 Id.
51 We have considered all of the parties' contentions. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed herein.