UNITED STATES OF AMERICA Before the SECURITIES AND EXCHANGE COMMISSION Securities Act of 1933 Release No. 7663 / March 31, 1999 Securities Exchange Act of 1934 Release No. 41233 / March 31, 1999 Administrative Proceeding Files No. 3-8400 and 3-9860 ______________________________ : : In the Matter of : : JOHN E. THORN, JR. and : ORDER MAKING FINDINGS AND THORN WELCH & CO., INC., : IMPOSING REMEDIAL SANCTIONS FORMERLY KNOWN AS : AND CEASE-AND-DESIST ORDER THORN, ALVIS , WELCH, INC. : : : ORDER INSTITUTING PUBLIC : PROCEEDINGS PURSUANT TO : SECTION 8A OF THE SECURITIES ACT : OF 1933 AND SECTIONS 15(b), 19(h) : AND 21C OF THE SECURITIES : EXCHANGE ACT OF 1934, MAKING : FINDINGS AND IMPOSING REMEDIAL : SANCTIONS AND CEASE-AND-DESIST ORDER : Respondents. : This Order incorporates both an Order Making Findings and Imposing Remedial Sanctions and Cease-and-Desist Order in proceedings currently pending before the Commission and an Order Instituting Public Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b), 19(h) and 21C of the Securities Exchange Act of 1934 Making Findings and Imposing Remedial Sanctions and a Cease-and- Desist Order (Part II, below).[1] The Commission deems it appropriate and in the public interest that public proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b), 19(h) and 21C of the Exchange Act of 1934 ("Exchange Act") be, and they hereby are, institituted against against John E. Thorn, Jr. ("Thorn") and Thorn, Welch & Co., Inc., formerly known as Thorn, Alvis, Welch, Inc. ("TWC") (Collectively "Respondents"). In anticipation of the institution of these proceedings, and in connection with pending proceedings, File No.3-8400, previously instituted against Thorn and TWC pursuant to Section 8A of the Securities Act and Sections 15(b), 19(h) and 21C of the Exchange Act, the Respondents have submitted an Offer of Settlement ("Offer") solely for the purposes of those proceedings or any other proceeding brought by or on behalf of the Commission or in which the Commission is a party. In the Respondents’ Offer, which the Commission has determined to accept, Thorn and TWC, without admitting or denying any of the factual assertions, findings, or conclusions contained herein, except as to the jurisdiction of the Commission over them and over the subject matter of these proceedings and as to the matters contained in findings 1 and 2, below which are admitted, consent to the entry of this Order Instituting Public Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b), 19(h) and 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions and Cease- and-Desist Order and this Order Making Findings and Imposing Remedial Sanctions and Cease-and-Desist Order ( collectively "Order"). I. Pending Proceedings On the basis of this Order, the Order Instituting Public Proceedings Pursuant to Sections 8A of the Securities Act and Sections 15(b), 19(h) and 21C of the Exchange Act, and the Offer, the Commission finds that: 1. TWC. TWC" is a registered broker-dealer located in Jackson, Mississippi. TWC has been registered with the Commission pursuant to Section 15(b) of the Exchange Act since on or about March 10, 1977. On November 22, 1993, the firm changed its name to Thorn, Welch & Co., Inc. TWC's business consisted primarily of underwriting and trading municipal securities. 2. Thorn. Thorn" is a resident of Jackson, Mississippi. During the period relevant to these proceedings, Thorn was the president and a director of TWC and also served as TWC's municipal securities principal since approximately 1975. 3. From August 1992 through October 1993, TWC, as underwriter, raised $19,464,541 from hundreds of investors nationwide through seven offerings of nonrated municipal urban renewal revenue bonds ("the bonds") designed to finance the purchase and rehabilitation of existing low- income housing projects located in and about Jackson and Vicksburg, Mississippi. 4. Thorn, on behalf of TWC, assisted in preparing, reviewed and distributed to potential investors, Official Statements for each of the TWC offerings. The Official Statements were the disclosure documents provided to prospective investors. 5. The bonds were offered and sold to investors as qualified tax exempt private activity bonds. 6. Pursuant to Section 147(g) of the Internal Revenue Code ("IRC"), no more than two percent of the bond proceeds could be used to finance issuance costs, such as bond counsel fees and the underwriter's spread. Pursuant to Section 142(a) of the IRC, at least ninety-five percent of the bond proceeds were required to have been used to provide the financed facility. Failure to comply with either Section 147(g) or Section 142(a) of the IRC could have resulted in interest on the bonds losing its exemption from gross income for federal income tax purposes. The TWC bonds failed to comply with both IRC §§ 147(g) and 142(a). 7. The Official Statements represented that the bond projects were financed by bond proceeds and a cash contribution from the development company. The development company for each project was a limited partnership formed to develop the project. The purported contribution from the development company was disclosed in the Sources of Funds section of the Official Statements of the bond offerings as a "Developer's Contribution." The amount described as a Developer's Contribution was determined by Thorn and others for each of the bond offerings and was based solely on the amount required to cover issuance costs which exceeded two percent of the proceeds of the bond offerings. The purported Developer’s Contributions ranged from approximately $48,000 to approximately $404,000 and with respect to each offering consisted of more than 5% of the offering proceeds. 8. The purported Developer's Contribution was not paid with separate funds from the development company, but was paid exclusively with funds received from the bond proceeds by the contractor which renovated the projects. The compensation to the contractor, in exchange for its services on each project, was artificially inflated in an amount equal to the purported Developer's Contribution. The contractor received bond proceeds, in addition to those required by the contractor for construction in exchange for its services, for the purpose of making what was referred to as the Developer's Contribution. The purported Developer's Contribution was utilized in each of the bond offerings solely to pay issuance costs exceeding two percent of the bond proceeds. The use of offering proceeds to pay the purported Developer's Contribution in each offering was not disclosed to investors or prospective investors. 9. The manner in which proceeds derived from the bond offerings, in amounts equivalent to approximately 7 to 9 percent of the proceeds of each offering, were utilized to make the purported Developer's Contribution, created a substantial risk that the bond offerings failed to comply with the requirements of Sections 147(g) and 142(a) of the IRC and a substantial risk that interest payments on the bonds were not tax exempt as represented in the Official Statements. Thorn, and through him TWC, knew, or was reckless in not knowing, that a substantial risk existed as to the tax exempt status of interest payment on the bonds. The substantial risk to the tax exempt status of interest on the bonds was not disclosed in the Official Statements or otherwise.[2] 10. TWC, through Thorn and others, continued to offer, buy and sell the bonds in the aftermarket as qualified tax exempt, private activity bonds without disclosure of the substantial risk that interest on the bonds may not have been exempt from the federal income tax. 11. During the period from in or about August 1992 through at least February 1994, Thorn and TWC willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by, directly and indirectly, using the means and instrumentalities of interstate commerce and the mails to: (1) employ devices, schemes and artifices to defraud; (2) make untrue statements of material facts and to omit to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) engage in acts, practices, and a course of business which operated or would have operated as a fraud and deceit upon persons, in connection with the purchase and sale of securities, as more particularly described in paragraphs one through ten, above. 12. During the period from in or about August 1992 through at least February 1994, Thorn and TWC willfully violated Section 17(a) of the Securities Act by, directly and indirectly, using the means and instruments of transportation and communication in interstate commerce and the mails to: (1) employ devices, schemes and artifices to defraud purchasers; (2) obtain money and property by means of untrue statements of material facts and omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) engage in acts, practices and a course of business which operated or would have operated as a fraud and deceit upon purchasers, in the offer and sale of securities, as more particularly described in paragraphs one through ten, above. 13. During the period from in or about August 1992 through at least February 1994, TWC willfully violated and Thorn willfully aided and abetted violations of, Section 15B(c)(1) of the Exchange Act and Rule G-17 of the Municipal Securities Rulemaking Board, by, in the conduct of the municipal securities business of TWC, not dealing fairly with other persons and engaging in deceptive, dishonest and unfair practices, as more particularly described in paragraphs one through ten, above. . 14. Respondent Thorn has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay disgorgement plus prejudgment interest. The Commission has reviewed the sworn financial statement and other evidence provided by Respondent Thorn and has determined that Respondent Thorn does not have the financial ability to pay completely disgorgement of $116,432, plus his equity interest in the partnerships which own the projects financed by the bond offerings, or any proceeds from the sale of such interests, plus prejudgment interest. 15. Respondent TWC has submitted a sworn financial statement and other evidence and has asserted its financial inability to pay disgorgement plus prejudgment interest. The Commission has reviewed the sworn financial statement and other evidence provided by Respondent TWC and has determined that Respondent TWC does not have the financial ability to pay completely disgorgement of $234,203 plus prejudgment interest. 16. The Respondents have submitted sworn financial statements and other evidence and have asserted their financial inability to pay a civil penalty. The Commission has reviewed the sworn financial statements and other evidence provided by Respondents and has determined that neither Respondent has the financial ability to pay a civil penalty. II. Proceedings Being Instituted Based on this Order and the Respondents’ Offer, the Commission finds the following. 1.. TWC" Between November 1987 and May 1996, TWC was the underwriter for 74 offerings of urban renewal revenue notes ("notes") issued by 39 Mississippi political subdivisions, including counties, cities and towns ("municipalities"). The offerings raised a total of approximately $287,300,000. 2. In each offering, the notes were sold based upon a representation that bond counsel had concluded that interest on the notes would be excludable from gross income for federal income tax purposes. The disclosure documents used in connection with the note offerings represented that the note proceeds would be utilized within three years on various public projects. In fact, the municipalities had no intention of spending more than a small percentage of the proceeds on public projects. That percentage, generally close to one percent of the proceeds, was received by the municipality as a "premium" or "fee" for issuing the notes. The remaining proceeds were invested in guaranteed investment contracts ("GICs") or certificates of deposit ("CDs") yielding a higher rate of return than the notes. Those instruments provided the cash flows to pay the debt service required by the notes. This financing structure resulted in a significant risk to the tax exempt status of interest on the notes. 3. Internal Revenue Code ("IRC") Section 103(b) provides that gross income includes interest on any state or local bond which is an "arbitrage bond" as that term is defined by IRC Section 148. IRC Section 148 (a) defines an arbitrage bond as "any bond issued as part of an issue any portion of the proceeds of which are reasonably expected (at the time of issuance of the bond) to be used directly or indirectly (1) to acquire higher yielding investments...." 4. IRC Section 148(c)(1) allows the proceeds of certain issues to be invested in higher yielding investments for a reasonable temporary period until such proceeds are needed for the purpose for which the bonds were issued. This provision is known as the "temporary period exception." It provides that the bonds will not be treated as taxable arbitrage bonds if the net sale proceeds and investment proceeds of an issue are reasonably expected to be allocated to expenditures for capital projects within specified time periods. Treas. Reg. Sec. 1.148-2(b)(1) and 2(e)(2)(i)(1993); Treas. Reg. Sec. 1.103-13(a)(2) (1979). When statements regarding reasonable expectations with respect to the amount and use of the proceeds are not made in good faith, the notes are deemed to be taxable arbitrage bonds. Revenue Ruling 85-182, 1985-2 C.B. 39. 5. Although all the note offerings were purportedly structured to comply with the requirements of the temporary period exception, at the time of the offerings, none of the issuers had the resources, intent or expectation to utilize any proceeds from the offerings, other than the premium or fee, for capital projects. Subsequent to the offerings, none of the issuers utilized any of the offering proceeds, other than the premium or fee, for any capital project. The lack of a reasonable expectation to utilize more than a small portion of the proceeds for capital projects would violate the reasonable expectation requirements of IRC Section 148(c)(1) and Treas. Reg. 1.148-2(e)(2). Therefore, a substantial risk exists that the issuers did not satisfy the requirements of the temporary period exception, making the structure of these transactions a prohibited arbitrage scheme that violates IRC Sections 103(b) and 148(a)(1). The violation of these sections created a substantial risk that the IRS would declare interest on the notes includable in gross income for federal income tax purposes. 6. The substantial risk to the tax exempt status of interest on the notes was not disclosed to investors or prospective investors in any of the offerings. The official statements and arbitrage certificates for each offering, among other documents, without exception, represented that the issuers intended to spend the full amount of the offering proceeds within three years on various capital projects, such as roads, parks, a courthouse, and other projects. Each official statement also represented that the issuer was negotiating with a specified firm for "architectural services." These statements were not true. Although the investors were under no duty to independently evaluate the degree of risk to the tax exemption, the false representations dealing with the municipalities' intentions to spend the proceeds and their current negotiations for services in that regard, would have made it difficult for investors, even those with access to tax advice, to ascertain the risk to the tax exemption. 7. TWC, through Thorn and others, sold the notes from each of the offerings using the official statements. Thorn knew, or was reckless in not knowing, that the official statements misrepresented the issuers’ intent to spend the proceeds of the offerings on municipal projects. Thorn also knew, or was reckless in not knowing, that the tax exempt status of the notes was contingent on the issuers having a bona fide intent to utilize the note proceeds on municipal projects within three years from the date of the offering. Thorn, and through him TWC, knew, or was reckless in not knowing, that a substantial risk existed as to the tax exempt status of interest payment on the notes. That risk was not disclosed to purchasers of the notes. 8. During the period from November 1987 through May 1996, Thorn and TWC willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by, directly and indirectly, using the means and instrumentalities of interstate commerce and the mails to: (1) employ devices, schemes and artifices to defraud; (2) make untrue statements of material facts and to omit to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) engage in acts, practices, and a course of business which operated or would have operated as a fraud and deceit upon persons, in connection with the purchase and sale of securities, as more particularly described in paragraphs one through seven, above. 9. During the period from November 1987 through May 1996, Thorn and TWC willfully violated Section 17(a) of the Securities Act by, directly and indirectly, using the means and instruments of transportation and communication in interstate commerce and the mails to: (1) employ devices, schemes and artifices to defraud purchasers; (2) obtain money and property by means of untrue statements of material facts and omissions to state material facts necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading; and (3) engage in acts, practices and a course of business which operated or would have operated as a fraud and deceit upon purchasers, in the offer and sale of securities, as more particularly described in paragraphs one through seven, above. . 10. Respondent Thorn has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay disgorgement plus prejudgment interest. The Commission has reviewed the sworn financial statement and other evidence provided by Respondent Thorn and has determined that Respondent Thorn does not have the financial ability to pay disgorgement of $1,761,770, plus prejudgment interest. 11. Respondent TWC has submitted a sworn financial statement and other evidence and has asserted its financial inability to pay disgorgement plus prejudgment interest. The Commission has reviewed the sworn financial statement and other evidence provided by Respondent TWC and has determined that Respondent TWC does not have the financial ability to pay disgorgement of $1,513,418 plus prejudgment interest. 12. The Respondents have submitted sworn financial statements and other evidence and have asserted their financial inability to pay a civil penalty. The Commission has reviewed the sworn financial statements and other evidence provided by Respondents and has determined that neither Respondent has the financial ability to pay a civil penalty. III. ACCORDINGLY, IT IS HEREBY ORDERED: 1. That the broker-dealer registration of TWC be revoked; 2. That Respondent Thorn be barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company; 3. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, that Thorn cease and desist from committing or causing any violation or any future violation of Section 17(a) of the Securities Act or Sections 10(b) or 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and Rule G-17 of the MSRB; 4. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act that TWC cease and desist from committing or causing any violation or any future violation of Section 17(a) of the Securities Act or Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and Rule G-17 of the MSRB; 5. That Respondent Thorn shall pay disgorgement of $1,878,202 plus any equity interest Thorn owns in the seven limited partnerships which own the projects that were the subject of the bond offerings, plus prejudgment interest, provided that Thorn shall pay $10,000 within sixty (60) days of this order to the United States Treasury. Such payment shall be (a) made by United States postal money order, certified check, bank cashier's check or bank money order; (b) made payable to the Securities and Exchange Commission; (c) hand-delivered or delivered by overnight delivery service to the Comptroller, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (d) submitted under a cover letter which identifies Thorn as a respondent in these proceedings. Thorn is further ordered to comply with his undertaking to forego on any personal income tax return all unused income tax credits which have accrued and to which he may be entitled arising from his interest in the seven limited partnerships which own the projects that were the subject of the bond offerings. Payment of the remainder of the disgorgement is waived based upon Respondent Thorn's demonstrated financial inability to pay; 6. That the Division of Enforcement ("Division") may, at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether Respondent Thorn provided accurate and complete financial information at the time such representations were made; and (2) seek any additional remedies that the Commission would be authorized to impose in this proceeding if Respondent Thorn's offer of settlement had not been accepted. No other issues shall be considered in connection with this petition other than whether the financial information provided by Respondent Thorn was fraudulent, misleading, inaccurate or incomplete in any material respect and whether any additional remedies should be imposed. Respondent Thorn may not, by way of defense to any such petition, contest the findings in this Order or the Commission's authority to impose any additional remedies that were available in the original proceeding; 7. That TWC shall pay disgorgement of $1,747,621 plus prejudgment interest, provided that TWC shall pay $15,000 within thirty (30) days of this order to the United States Treasury. Such payment shall be (a) made by United States postal money order, certified check, bank cashier's check or bank money order; (b) made payable to the Securities and Exchange Commission; (c) hand-delivered or delivered by overnight delivery service to the Comptroller, Stop 0-3, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (d) submitted under a cover letter which identifies TWC as a respondent in these proceedings. Payment of the remaining disgorgement is waived based upon Respondent TWC's demonstrated financial inability to pay; 8. That the Division may, at any time following the entry of this Order, petition the Commission to: (1) reopen this matter to consider whether TWC provided accurate and complete financial information at the time such representations were made; and (2) seek any additional remedies that the Commission would be authorized to impose in this proceeding if TWC's offer of settlement had not been accepted. No other issues shall be considered in connection with this petition other than whether the financial information provided by TWC was fraudulent, misleading, inaccurate or incomplete in any material respect and whether any additional remedies should be imposed. TWC may not, by way of defense to any such petition, contest the findings in this Order or the Commission's authority to impose any additional remedies that were available in the original proceeding. By the Commission. Jonathan G. Katz Secretary **FOOTNOTES** [1]: The findings herein are made pursuant to the Offer of Settlement of Thorn and TWC and are not binding on any other person or entity named as a respondent in this or any other proceeding. [2]: In July 1997 the political subdivisions which issued the bonds announced a settlement with the Internal Revenue Service ("IRS") with respect to the bond offerings. In return for payments of $1.182 million, the IRS agreed not to seek to tax the interest earnings of investors who purchased the bonds. 1