Kevin D. Kunz and Kunz and Cline Investment Mgmt., Inc.
SECURITIES EXCHANGE ACT OF 1934
Rel. No. 45290 / January 16, 2002
Admin. Proc. File No. 3-9960
In the Matter of the Application of KEVIN D. KUNZ
and KUNZ AND CLINE INVESTMENT MGMT., INC.
For Review of Disciplinary Action Taken by the NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. |
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ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION
On the basis of the Commission's opinion issued this day, it is
ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against Kevin D. Kunz and Kunz and Cline Investment Mgmt., Inc., and the Association's assessment of costs, be, and they hereby are, sustained.
By the Commission.
Jonathan G. Katz
Secretary
Footnotes
| 1 | 15 U.S.C. §§ 77a et seq. | |
| 2 | The NASD found that this conduct violated Rule 2110 of the NASD's Conduct Rules. Rule 2110 provides that "a member, in conduct of his business, shall observe high standards of commercial honor and just and equitable principles of trade." This Rule is the successor and virtually identical to Article III, Section 1 of the Rules of Fair Practice, which was in effect in 1994. | |
| 3 | Each of the three investment vehicles allowed the investor to invest for a period of 30, 45, or 60 months. Investors in the Accrual Notes received interest at 12 percent per annum, accrued monthly. Investors in the Monthly Notes received interest at 10 percent per annum, payable monthly.
VesCor used funds from investors in the MLP Interests to originate or acquire mortgages, with the investor secured by the mortgage in proportion to the percentage of the mortgage financing provided by the investor. The investors' rate of return depended on the rate paid on the underlying mortgage. The PPMs for the MLP Interests stated that the target rate of return was 12 percent. VesCor kept the funds from the sales of MLP Interests in money market accounts until they were allocated to a specific mortgage. | |
| 4 | Kunz testified that Val E. Southwick ("Southwick"), the President, Chief Executive Officer, Corporate Secretary, Chairman, and sole member of VesCor's Board of Directors, told him that the Notes and the MLP Interests were simply investments in real estate, not securities. Kunz also testified that, until it distributed the PPMs, VesCor did not provide prospective investors with any financial statements. | |
| 5 | Kunz testified that, from the beginning, one of the purposes for these offerings was to raise additional capital. | |
| 6 | Kunz testified that, when he met Southwick in 1987, Southwick offered him the opportunity to sell VesCor notes that were similar to those at issue. Kunz initiallydeclined because he believed that the notes were "securities" and that such sales would have violated the NASD's selling-away rules because at the time Kunz was working as a general securities representative with a broker-dealer. He discussed the issue with Southwick, who told him that an attorney from Arizona had determined that the notes were not securities. Kunz stated that, although he never reviewed any opinions or any other documents from the Arizona attorney, he decided to accept Southwick's explanation, and sold VesCor securities to one or two clients at that time. | |
| 7 | Kunz testified that the initial intention in forming K&C was that VesCor would control the firm. Kunz and Cline both testified that Southwick expressed the opinion on more than one occasion that, because of the financing provided by VesCor, he expected K&C to be VesCor's captive broker-dealer. | |
| 8 | VesCor did submit "Notice of Sale of Securities Pursuant to Regulation D, Section 4(6), and/or Uniform Limited Offering Exemption" filings with the Commission for the private placement offerings, pursuant to 17 CFR § 230.501 et seq. | |
| 9 | The PPMs stated that Southwick "has effective control of all aspects of the business of the Company," and noted the importance to investors of his background. Although the PPMs issued to Nevada residents contain five paragraphs concerning Southwick's litigation history, none of the PPMs provided to non-Nevada residents contained this information. | |
| 10 | Kunz stated that he relied on VesCor's counsel with respect to the lack of disclosure both of VesCor's financing of K&C and of Southwick's litigation history. With respect to the financing, he stated that, since VesCor's counsel never raised the issue during the drafting of the PPMs, he (Kunz) assumed disclosure was not necessary. Kunz did ask VesCor's counsel whether disclosure of Southwick's litigation history was legally required. He testified that counsel told him inclusion was not required. Kunz did nothing further concerning this issue. | |
| 11 | The purchase was made pursuant to an agreement dated September 26, 1994 ("Agreement"). The Agreement provided that, in addition to issuing stock as payment, VesCor would pay $25,000 in closing costs. | |
| 12 | The terms of the Agreement support Kunz's understanding. The Agreement also granted VesCor call options so that it could repurchase its shares by transferring back the Tennessee Land Grants. These call options cost VesCor $30,000 for the first six month period, with extensions at the rate of $15,000 per calendar quarter for the next 18 months, and then at the rate of $18,000 per quarter thereafter. | |
| 13 | The record also contains copies of the handwritten Land Grants that were issued in the 1820's by which VesCor claimed ownership of the land. An excerpt from a 1977 book entitled, The Fountain Pen Conspiracy, by Jonathan Kwitny, which is a part of the record, provides a description and historical discussion of Tennessee land grant deeds:
The colony of North Carolina issued the grants to induce settlers to cross the mountains and farm the wilderness. A county postal inspector noted: "The grants gave you 5,000 acres and told you to go find it. They didn't tell you the land was in [a particular] county. There [were] no [counties]. If somebody came along and squatted on it and you didn't chase him out, it was his land." . . . . Somebody hasaccounted for virtually every square foot of . . . the . . . counties in eastern Tennessee. . . . So, conflicting land claims stayed on file over the years, all of them with a degree of legitimacy. The whole of a land grant could remain valid as a title even while every part of the grant was gradually occupied by squatters with better title. . . . Confidence men learned years ago that the real gold in them thar' hills lies in the confusing overlay of deeds. . . . The postal inspector noted further: "Some of this land has been registered twenty-five times. In Jamestown, the tax assessor's own house has been registered four times. They get 45,000 or 50,000 acres of registrations a month [the county contains only 305,000 acres]. And if anybody writes and asks if it's registered, they'll say, `Yes, it's registered.'" Jonathan Kwitny, The Fountain Pen Conspiracy, pp. 82-83 (1977). This chapter provides numerous examples of famous judicial cases and instances in the twentieth century in which worthless Tennessee land grant deeds were used to pad the portfolios and balance sheets of "fraudulent banks, insurance companies, and other corporations." | |
| 14 | Rule 506 under Regulation D provides an exemption for the offer and sale of securities that satisfy all the requirements of Rules 501 and 502, if the offering does not involve more than 35 nonaccreditied investors. Rule 501, in pertinent part, defines an "accredited investor" as a "natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his purchase exceeds $1,000,000," or a "person who had an individual income in excess of $200,000 in each of the two most recent years or joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable expectation of reaching the same income level in the current year. . . ." | Under the NASD By-Laws, as an investment company products/variable contract representative, Anderson was limited to soliciting, purchasing, and selling redeemable securities of companies registered pursuant to the Investment Company Act of 1940, securities of registered closed-end companies during the period of original distribution only, and variable contracts and insurance premium funding programs and other contracts issued by an insurance company (except contracts that are exempt securities pursuant to Section 3(a)(8) of the Securities Act). See Schedule C to the NASD By-Laws, Part II, Section 2(d)(i)(a) and Part III, Section 2(b)(i) and (ii) (currently NASD Membership and Registration Rules 1022(d)(1)(A) and 1032 (b)(1) and (2)). Thus, the Series 6 registration was not adequate to permit Anderson's association with K&C. |
| 16 | Kunz paid the "consulting fees" to Anderson pursuant to two "Consulting Agreements" with Anderson, one entered into in December 1994 (back-dated to October 1, 1994), and the other dated January 1, 1995. Kunz stated that he entered into these agreements because Anderson could not be registered. | |
| 17 | Applicants do not separately address the misrepresentation and omission issues in their brief on appeal. Instead, as to those issues, they stated that they would rely on the arguments made in their Brief in Reply before the NASD. | |
| 18 | 426 U.S. 438 (1976). | |
| 19 | Id. at 449. | |
| 20 | The "materiality of information relating to a company's financial condition, solvency and profitablity is not subject to serious challenge." SEC v. Murphy, 626 F.2d 633, 653 (9th Cir. 1980), cited by us in Charles E. French, 52 S.E.C. 858, 863 n.19 (1996). | |
| 21 | VesCor's financial condition, solvency, and profitability cannot be viewed as insignificant factors with respect to the MLP Interests. The probable future success of the MLP Interests depended on VesCor's ability first, to avoid dissipation of investor money during the period after investment in a given MLP and prior to VesCor purchasing the underlying mortgages for that MLP, and also on VesCor's ability to purchase underlying mortgages at attractive rates during the life of each MLP. Therefore, VesCor's business acumen, as reflected by its historical and continued net loss, was material to a reasonableinvestor. See Leandro Emerg. Med. Group Profit Sharing Plan v. Philip Morris Cos., 75 F.3d 801, 809 (2d Cir. 1996) ("[M]aterial facts include . . . those facts which affect the probable future of the company.") (quoting SEC v. Texas Gulf Sulphur Co., 401 P.2d 833, 849 (2d Cir. 1968)). | |
| 22 | 52 S.E.C. 958, 962 (1996), aff'd in pertinent part, Everest Securities, Inc. v. SEC, 116 F.3d 1235 (8th Cir. 1997). | |
| 23 | We stated further in Everest that "the mere fact that a security may allegedly be exempt from the registration requirements of the Securities Act `does not relieve a dealer of these obligations. On the contrary, it may increase his responsibilities, since neither he nor his customers receive the protection which registration under the Securities Act is designed to provide.'" Id. at n.15, quoting Securities Act Rel. No. 4445, 3 Fed. Sec. L. Rpt. (CCH) ¶ 22,759. | |
| 24 | We held in Everest Securities, Inc., 52 S.E.C. at 963, that broker-dealers are required to "exercise a `high degree of care' in investigating and verifying independently [a company's] representations." In Everest we found that a broker-dealer was reckless in allowing a professional investigator it had hired to ignore "red flags" and rely uncritically upon information provided by an issuer's accountant. | |
| 25 | VesCor acquired the Tennessee land asset only four days before the date of the financial statements. | |
| 26 | Kunz admitted that he knew that VesCor had sizeable net operating losses dating back to 1991 and had acquired the Tennessee land asset to enhance its balance sheet for inclusion in the PPMs. Despite this knowledge, Kunz stated that he never really paid attention to the portion of the financial statements that referred to the Tennessee land asset. In fact, he testified that he did not know that VesCor had exchanged 750 shares of stock for it. He did nothing to investigate the validity of VesCor's financial statements, other than questioning VesCor's counsel whether VesCor had proper title to the Tennessee land, and Southwick about VesCor's losses. | |
| 27 | See Everest Securities, 52 S.E.C. at 958. | |
| 28 | See supra, n. 12. | |
| 29 | See Hanly v. SEC, 415 F.2d 589 (2d Cir. 1969), where the court found:
A salesman may not rely blindly upon the issuer for information concerning a company[.] (Id. at 597) Brokers and salesmen are under a duty to investigate. . . . Thus, a salesman cannot deliberately ignore that which he has a duty to know and recklessly state facts about matters of which he is ignorant. (Id. at 595) | |
| 30 | See In re Michael A. Niebuhr, 52 S.E.C. 546, 552 (1995). | |
| 31 | All of the PPMs described Southwick's education and career-related background in real estate lending, including the fact that he began his career in real estate lending with an entity called Summit Systems, Inc. ("Summit"). The non-Nevada PPMs then refer to Southwick's formation of VesCor, and state that, during Southwick's tenure, VesCor's "assets and managed capital base" had increased to more than $18 million and that he had "built associate relations with over 160 institutional and other qualified note buyers which purchase[d] the Company's first trust deeds and notes."
Conspicuously absent in the non-Nevada PPMs is any mention of the fact that, because of his personal guarantees of Summit's obligations, Southwick "had been and continued to be involved in various litigation proceedings, including civil judgments still outstanding in an aggregate original principal amount of $1,830,386.76." | |
| 32 | 426 U.S. at 449. We have found that nondisclosure of information concerning a person responsible for the success or failure of the enterprise is clearly material. See In re Gallagher & Co., 50 S.E.C. 557 (1991). | |
| 33 | See Markowski v. Securities and Exchange Commission, 34 F.3d 99, 104-105 (2d Cir. 1994). | |
| 34 | Id. at 105. See also C.E. Carlson, Inc. v. SEC, 859 F.2d 1429, 1436 (10th Cir. 1988), citing Sorrell v. SEC, 679 F.2d 1323, 1327 (9th Cir. 1982) and Arthur Lipper Corp. v. SEC, 547 F.2d 171, 181-82 (2d Cir. 1976), cert. denied, 434 U.S. 1009 (1978). | |
| 35 | As we noted in Jacob Wonsover, Exchange Act Rel. No. 41123 (Mar. 1, 1999), 69 SEC Docket 694, 706 "it is not sufficient for [a broker-dealer] merely to accept `self-serving statements of his sellers and their counsel without reasonably exploring the possibility of contrary facts.'"(quoting in part Distribution By Broker-Dealers of Unregistered Securities, Securities Act Rel. No. 4445 (February 2, 1962), aff'd, Wonsover v. SEC, 205 F.3d 408 (D.C. Cir. 2000). | |
| 36 | Markowski, 34 F.3d at 105. | |
| 37 | Sections 4 and 5 of the Securities Act, 15 U.S.C §§ 77d and 77e, provide that a registration statement must be in effect for the sale of a security unless the transaction does not involve a public offering or there is a valid exemption from registration. | |
| 38 | See SEC v. Blazon Corp., 609 F.2d 960, 968 (9th Cir. 1979). | |
| 39 | SEC v. Ralston Purina Co., 346 U.S. 119, 126 (1953). | |
| 40 | 17 CFR § 230.506. | |
| 41 | 17 CFR § 230.506(b)(ii). | |
| 42 | Even if the offerings were not integrated, the Accrual Notes and the Monthly Notes had 58 and 45 nonaccredited investors, respectively. Therefore, neither of the Notes offerings would be entitled to a Regulation D exemption. | |
| 43 | See Securities Act Rel. No. 4552 (Nov. 6, 1962), 27 Fed. Reg. 11316. See also Rule 502(a) under Regulation D. | |
| 44 | Each PPM stated:
The Company intends to provide general funding for the operations of the Company's expansion activities with respect to a series of mortgages made or purchased at a discount. The sources of such funds would be the proceeds from the sale of [the subject security] and the sale of [the two other securities] pursuant to simultaneous offering memoranda. Each of the PPMs also stated that VesCor's "principal business objective . . . in offering [the securities was] to invest the proceeds from the sale of such [securities] in loans secured by first Mortgages on real property." | |
| 45 | Applicants' argument ignores the salient fact that the Notes had exactly the same maturity periods. | |
| 46 | Moreover, we note that the Notes each had more than 35 nonaccredited investors. | |
| 47 | See SEC v. Blazon Corp., 609 F.2d 960, 968 (9th Cir. 1979). Although Applicants claim an exemption under Section 4(2), they offer no arguments in support of this claim. The party claiming a private offering exemption from registration has the burden of proving that it is met with respect to each offeree. SEC v. Murphy, 626 F.2d 633, 645 (9th Cir. 1980). Despite Applicants' failure, we address the issue below. | |
| 48 | The United States Supreme Court, in SEC v Ralston Purina Co., 346 U.S. 119 (1953), has provided the framework for private offering analysis for the past 47 years. In Ralston Purina, the Court held that "the applicability of Section 4(2) should turn on whether the particular class of persons affected needs protection of the Act." In SEC v. Murphy, 626 F.2d at 644-45, the 9th Circuit provided the following factors to be considered in determining whether an offering is private: (a) the number of offerees; (b) the sophistication of the offerees; (c) the size and manner of the offering; and (d) the relationship of the offerees to the issuer. See also Mark v. FSC Secs. Corp., 870 F.2d 331 (6th Cir. 1989) for similar factors. | |
| 49 | At least 160 investors invested in the offerings. At least 71 investors purchased the Accrual Notes, 52 investors purchased the Monthly Notes, and 49 investors purchased the MLP Interests. Although Applicants did not present evidence of the exact or approximate number of offerees that were contacted, it is probable that the number of offerees is greater than the listed purchasers. The list of purchasers indicates that they were an unrelated and diverse group who resided in different states. The diversity of the purchasers suggests that the offerees were likewise diverse and unrelated, militating against a "private offering." See Id. at 334 (Failure of a party claiming the exemption tointroduce evidence of the number and type of offerees may be fatal to his or her claim for a Section 4(2) exemption.). | |
| 50 | Each PPM offered up to $6 million worth of securities priced at $5,000 per unit of investment. Such an offering is a significant amount. See, e.g., Murphy, 626 F.2d at 645 (finding a $7.5 million offering to be sizeable and one that should be considered public "absent a showing the investors did not need protection of the Act"). The securities were offered by VesCor, K&C, and, according to Kunz, by at least one other registered broker-dealer. This level of participation seems to be more indicative of a public, rather than a private offering. See Johnston v. Bumba, 764 F. Supp. 1263, 1274 (N.D. Ill. 1991), aff'd, 983 F.2d 1072 (7th Cir. 1992) (Table). | |
| 51 | The Murphy court held that "[a] court may only conclude that the investors do not need the protection of the Act if all the offerees have relationships with the issuer affording them access to or disclosure of the sort of information about the issuer that registration reveals." SEC v. Murphy, 626 F.2d at 647. | |
| 52 | See Eugene T. Ichinose, Jr., 47 S.E.C. 393, 397 n. 14 (1980), citing Management Financial Inc., 46 S.E.C. 226, 234 (1976). | |
| 53 | The NASD dismissed the cause concerning unsuitable recommendations because it could find no clear evidence in the record that Applicants recommended the purchase of the VesCor securities. Applicants argue that we should dismiss the cause on its merits. Under Section 19 of the Securities Exchange Act of 1934, our review of disciplinary actions taken by self-regulatory agencies such as the NASD is limited to review of the disciplinary actions taken, and the findings of fact and application of NASD rules relating to them. Since the NASD dismissed this cause and took no disciplinary action based on it, we have no jurisdiction over this issue. | |
| 54 | 15 U.S.C. § 78s(e). | |
| 55 | We have considered all of the contentions advanced by the parties. We have rejected or sustained them to the extent that they are inconsistent or in accord with the views expressed in this opinion. |