Municipal Bond Participants: The Underwriter
Report under Section 21(a) of the Exchange Act
SEC, Staff Report on Transactions in the Marine Protein Corporation Industrial Development Revenue Bonds, Exchange Act Release No. 15719 (April 11, 1979). .
See "Obligated Persons" section.
Injunctive Proceedings
Securities and Exchange Commission v. William C. Bethea, Civ. Action No. 3:98CV-457-LAC-MD (N.D. Fl.), Litigation Release No. 15985 (November 23, 1998) (settled final order).
The Securities and Exchange Commission today filed and settled a pay-to-play case against William C. Bethea, the former head of Stephens Inc.'s Public Finance Department, for giving secret payments to certain Florida public officials in exchange for municipal securities business.
The Complaint, filed in the Northern District of Florida, alleges the following: While serving as head of the Public Finance Department of Stephens, Bethea authorized secret payments to one Florida public official (Terry Busbee of the Escambia County Utilities Authority) and facilitated the secret compensation of another (Larry O'Dell of Osceola County), for the purpose of obtaining or retaining municipal securities business for Stephens. Bethea's failure to disclose the arrangements, the payments, and the actual and potential conflicts of interest they created, violated the antifraud provisions as well as fair dealing and gratuities rules of the Municipal Securities Rulemaking Board. Bethea also defrauded the issuer and purchasers of a 1992 Walton County, Florida bond issue by failing to disclose-in the face of a duty to do so-Stephens' compensation of a consultant and an employee of another underwriting firm, in violation of the same provisions. In addition, Bethea: endorsed the conferral of an undisclosed favor upon a third Florida public official; enlisted third parties to serve as conduits for campaign contributions; and created false and misleading books and records at Stephens to cover up the illicit payments, in further violation of fair-dealing rules.
Simultaneous with the filing of the Complaint, and without admitting or denying the allegations contained in the Complaint, Bethea agreed to the entry of a final judgment of permanent injunction barring future violations of Section 17(a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and MSRB rules G-17 and G-20; and ordering him to pay a civil penalty of $30,000. As part of his settlement with the Commission, Bethea has agreed to the entry of a Commission order barring him from the securities business.
The Commission's Complaint against Bethea includes certain conduct alleged in the civil actions styled Securities and Exchange Commission v. Preston C. Bynum and Terry D. Busbee, Civil Action No. 95-30024-RV (N.D. Fla.); Lit. Rel. No. 14387/January 23, 1995; and Securities and Exchange Commission v. Larry K. O'Dell, Civil Action No. 98-948-Civ-Orl-18A (M.D. Fla.); Lit. Rel. No. 15858/August 24, 1998; and in the administrative proceeding styled, In the Matter of Stephens Inc., Exchange Act Rel. No. 40699/Nov. 23, 1998.
Also today, the United States Attorney for the Northern District of Florida ("USAO") announced a civil settlement with Stephens, and the Commission instituted and settled an administrative proceeding against Stephens. Both the USAO's civil settlement, and the Commission's administrative settlement, are based on some of the same conduct alleged in the Commission's Complaint against Bethea. As part of the USAO's civil settlement, Stephens has agreed to forfeit to the Department of Justice $2.25 million in revenues of its Public Finance Department, to make payments to three Florida issuers in the aggregate amount of $886,672.16, to refrain from conducting municipal securities business in Florida for five years; and to refrain indefinitely and throughout the United States from utilizing consultants within the meaning of MSRB rule G-38. The Commission's pay-to play investigation in the Southeastern United States continues.
Securities and Exchange Commission v. First California Capital Markets Group, Inc., H. Michael Richardson and Derrick Dumont, Civ. No. 97-2761-SI (N.D. Cal.), Litigation Release No. 15423 (July 28, 1997) (complaint).
The Securities and Exchange Commission today sued a securities brokerage and two of its executives for defrauding investors who bought $69 million worth of municipal bonds in five municipal bond offerings in California. The Commission's Complaint alleges that Defendants lied to investors and omitted to tell them important information in the offering materials for each bond offering about the risks connected with the bonds.
The Commission filed its lawsuit against First California Capital Markets Group, Inc. ("First California"), a broker-dealer formerly headquartered in San Francisco (now located in San Diego), H. Michael Richardson, a principal of the firm who lives in the Bay Area, and Derrick Dumont, the former manager of the firm's land-based financing department who now lives in Calistoga. The Complaint was filed in the United States District Court for the Northern District of California.
The Complaint alleges that the fraud was committed in connection with the Defendants' underwriting of municipal bonds issued by the County of Nevada ("Nevada County"), the City of Ione ("Ione"), the Avenal Public Financing Authority ("Avenal"), and the Wasco Public Financing Authority ("Wasco"), all located in Central California.
The six-count Complaint asks the court to enjoin permanently the Defendants from violating the law, order them to return all ill-gotten gains plus interest, and impose civil penalties.
Nevada County raised $9 million, and Ione in two offerings raised a total of $14 million, through the sale of "Mello-Roos" municipal bonds. Such bonds are issued to finance real estate development. The Complaint alleges that in the Official Statement for the Nevada County offering, the Defendants overstated the value of the property, misrepresented the developer's ownership interest in the property and overstated the developer's experience and financial condition. The Complaint alleges that in the Official Statement for the Ione offerings, the Defendants misrepresented that all of the listed improvements could be built with the offerings proceeds, overstated the value of the property to be developed, and failed to disclose that the developer had insufficient capital to complete the development. These misrepresentations and omissions were important to investors because they made the projects and the bonds seem less risky than they actually were.
The Avenal and Wasco offerings, which raised $11 million and $35 million respectively, involved the sale of "Marks-Roos" municipal bonds. Such bonds are issued to form pools of money to finance a number of local projects. The Complaint alleges that First California and Richardson lied to investors or omitted to tell them important information in the Official Statements for these offerings about the need for the amount of money raised and the certainty of the intended use of the proceeds. The Complaint alleges that the Defendants failed to disclose that some of the projects listed in the Avenal Official Statement and nearly all of the projects in the Wasco Official Statement were highly contingent, if not speculative. These misrepresentations were important to investors because they falsely created the impression that the pools were fully subscribed. When a bond issue is not fully subscribed, investors could be exposed to the risk that the bonds would not be able to pay principal and interest.
All of this conduct violated the antifraud provisions of the federal securities laws, including Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 (the "Exchange Act") and Rule 10b-5 issued thereunder. Defendants also violated Section 1B(c)(1) of the Exchange Act and Rule G-17 of the Municipal Securities Rulemaking Board ("MSRB"), which require a municipal securities broker to deal fairly with its customers.
The Complaint further alleges that First California and Richardson, when underwriting the Nevada County and Ione offerings, advised Wasco and Avenal to buy large blocks of the Nevada County and Ione bonds, even though they knew that these bonds did not meet certain requirements for Wasco and Avenal which investors had been told would be followed. In addition, First California and Richardson--aware of a representation to Wasco investors that proceeds not invested within a three-year period would be returned to bondholders--advised Wasco to purchase several low quality securities (for one of which First California acted as the underwriter) after the close of the three-year period. All this conduct violated Section 15B(c)(1) of the Exchange Act and MSRB Rule G-19, which require municipal securities brokers to recommend only suitable investments to its clients.
Finally, the Complaint alleges that in February 1994, when Nevada County offered to redeem roughly half of its bonds with its remaining proceeds, First California and Richardson recommended to Wasco and Avenal that they not tender their bonds. This advice allowed First California's other clients holding Nevada County bonds to redeem at par while leaving Wasco and Avenal holding Nevada County's troubled bonds. This conduct violated Section 15B(c)(1) of the Exchange Act and MSRB Rule G-17.
Securities and Exchange Commission v. First California Capital Markets Group, Inc., H. Michael Richardson and Derrick Dumont, Litigation Release No. 16107 (April 7, 1999) (settled final orders).
The Securities and Exchange Commission ("Commission") announced today that the Honorable Charles R. Breyer of the U.S. District Court, Northern District of California, entered judgment by consent against the San Francisco underwriting firm First California Capital Markets Group, Inc. ("First California"), now known as Badger Technologies, Inc., and bankers, H. Michael Richardson ("Richardson"), formerly of Lafayette, California, and Derrick P. Dumont ("Dumont") of Calistoga, California. The Court order permanently enjoins and restrains First California, Richardson and Dumont from violating or committing future violations of the anti-fraud provisions of the federal securities laws and Municipal Securities Rulemaking Board rules requiring fair dealing with investors. Richardson and First California agreed to jointly pay $600,000 in disgorgement and prejudgment interest, and civil penalties totaling $100,000.
In addition, Richardson and Dumont have consented to the entry of administrative orders by the Commission barring them from association with any broker, dealer, investment adviser, investment company or municipal securities dealer, with the right to reapply for registration in three years and two years, respectively. The Commission did not seek to deregister First California because First California had withdrawn its registration as a broker-dealer in 1997 shortly after the Commission filed its district court action.
The Commission's Complaint alleges that First California, Richardson, its CEO, and Dumont, Manager of its Assessment District/Mello-Roos Department, made numerous misrepresentations and omissions in offering material it distributed to investors which undermined the feasibility and security of $69 million in California municipal bonds. Between July 1989 and February 1994, First California underwrote five municipal bond offerings for four California municipalities: the Country of Nevada, City of lone, City of Wasco, and City of Avenal. Two of the bond offerings involved Marks-Roos bonds (pool bonds). The misrepresentations and omissions in those offerings involved oversizing of the pools and failure to disclosed the speculative nature of the intended projects to be funded. The three remaining bond offerings involved Mello-Roos bonds (land development bonds). In these bonds, the background, experience, and financial status of the developers, as well as the valuation of the underlying land and improvements securing the bonds were misrepresented. In addition, Richardson, acting as financial consultant to Wasco and Avenal, advised the cities to invest in the Nevada County and lone bonds, despite the fact that the bonds did not meet Avenal's and Wasco's minimum credit requirements for investment. Richardson also advised Wasco to invest more than half of its pooled funds after the three year limitation period at which time uninvested funds were to be returned to investors. The Commission's Complaint alleged that this conduct violated Sections 17(a) of the Securities Act, Sections 10(b) and 15B(c) of the Exchange Act, Rule 10b-5 promulgated thereunder, and Municipal Securities Rulemaking Board Rules G-17 and G-19.
The Commission previously brought, and settled, administrative proceedings against Nevada County, City of lone, and City of Wasco, as well as numerous other individuals involved with the five bond offerings. An administrative ruling remains pending against Virginia Horler, the financial adviser to Nevada County.
Securities and Exchange Commission v. Robert D. Gersh, Boston Municipal Securities, Inc., and Devonshire Escrow and Transfer Corp., Civ. Action No. 95-12580 (RCL) (D. Mass.), Litigation Release No. 14742 (November 30, 1995) (complaint); Litigation Release No. 15310 (March 31, 1997) (settled final order).
Securities and Exchange Commission v. Robert M. Cochran, Michael B. Garrett and Randall W. Nelson, Civ. Action No. 95-1477T (W.D. Okla.), Litigation Release No. 14644 (September 20, 1995) (complaint) consolidated with Securities and Exchange Commission v. James V. Pannone and Sakura Global Capital, Inc., Civ. Action No. CIV98-146L (W.D. Okla.), Litigation Release No. 15630 (January 29, 1998) (complaint).
The Securities and Exchange Commission ("Commission") announced today that it filed a Complaint in the United States District Court for the Western District of Oklahoma against Robert M. Cochran, Michael B. Garrett and Randall W. Nelson, former employees of Stifel, Nicolaus and Company, Incorporated, ("Stifel") a broker-dealer headquartered in St. Louis. The Complaint alleges that from 1989 through 1993, Stifel received millions of dollars in undisclosed payments from third parties that sold or brokered investments to municipal issuers, and that Stifel undermined the integrity of the bidding process set up for the purchase of certain of those investments. According to the Complaint, the defendants, who worked in Stifel's former Oklahoma Public Finance Office, had a duty to disclose conflicts of interest while advising the issuers about the purchase of the investments. The defendants breached their duty and defrauded the issuers in failing to disclose that Stifel received the payments from the investment providers or investment brokers. The Complaint further alleges that the defendants defrauded investors by failing to disclose the payments to participants in the bond issues, including the issuer, bond counsel and/or special tax counsel, thereby depriving investors of information material to an assessment of the tax exempt status of the bonds.
The Complaint alleges that these actions by the defendants violated Section 17(a) of the Securities Act of 1933, Sections 10(b), and 15B(c)(1) of the Securities Exchange Act of 1934, Rule 10b-5 thereunder and Rule G-17 of the Municipal Securities Rulemaking Board (MSRB). The Complaint seeks relief including final judgments of permanent injunction barring future violations of those provisions, imposition of civil penalties, and against defendant Cochran, disgorgement of bonuses related to the improper payments made to Stifel.
Last month the Commission filed a related action against the defendants' former employer, Stifel. Simultaneously, without admitting or denying the allegations contained in the Complaint, Stifel consented to the entry of a Final Judgment enjoining it from future violations of antifraud and books and records provisions of the federal securities. In addition, Stifel agreed to disgorge $922,741, pay prejudgment interest on that amount of $263,637 and pay a civil money penalty pursuant to Section 20(d) of the Securities Act and Section 21(d) (3) of the Exchange Act of $250,000. See Litigation Release No. 14587 (August 3, 1995).
Also today, the United States Attorney for the Western District of Oklahoma announced that a federal grand jury indicted Cochran and Garrett on charges relating to the conduct alleged in the Complaint.
The Commission's investigation continues as to the conduct of other entities and individuals involved in this matter.
The Securities and Exchange Commission announced that on January 29, 1998, it filed a Complaint in the United States District Court for the Western District of Oklahoma against James Pannone, a former vice president of the Oklahoma Public Finance Office of Stifel, Nicolaus & Company, Inc. ("Stifel"), a broker-dealer registered with the Commission, and Sakura Global Capital, Inc. ("Sakura"), a subsidiary of Sakura Bank that is engaged in the business of selling derivatives. The Complaint alleges that the defendants committed fraud in connection with the sale of municipal securities. The Complaint alleges that in two municipal bond transactions underwritten by Stifel, Pannone engaged in bid-rigging to ensure Sakura's selection as the provider of the forward purchase agreements ("forwards") to the issuers. The Complaint also alleges that in those same securities transactions, Pannone and Sakura made materially misleading statements and/or affirmative misrepresentations to the issuers with respect to undisclosed payments that Sakura made to Stifel. The Complaint alleges that these undisclosed payments jeopardized the tax-exempt status of the bonds.
The Complaint alleges that in a 1992 transaction for the Oklahoma Turnpike Authority, despite bond counsel's requirement that three competitive bids be obtained for the forward, Pannone rigged the bidding to ensure Sakura's selection as the forward provider. The Complaint also alleges that Pannone subsequently negotiated with Steven Strauss, Sakura's then managing director in charge of municipal securities transactions, a $6.593 million undisclosed brokerage fee to be paid by Sakura to Stifel, and that Pannone falsely described to the Turnpike Authority the bidding and negotiation process of the forward. The Complaint further alleges that the forward purchase agreement stated that Sakura did not intend to take any actions which would jeopardize the tax-exempt status of the bonds. The Complaint alleges that at the time Sakura executed the forward it was planning to pay a $6.593 million brokerage fee to Stifel, and that Sakura knew or was reckless in not knowing that such a brokerage fee would jeopardize the tax-exempt status of the bonds.
The Complaint also alleges that in a 1992 transaction for the Sisters of St. Mary's Health Care Obligated Group, despite bond counsel's requirement that three competitive bids be obtained for the forward, Pannone rigged the bidding to ensure Sakura's selection as the forward provider. The Complaint further alleges that at the request of bond counsel, Pannone and Strauss provided certificates stating that Sakura would not make any payments, other than certain payments to the issuer, in connection with the forward. The Complaint alleges that Sakura made a $100,000 payment to Stifel and that Pannone concealed the payment by booking it to a different transaction.
The Complaint alleges that by their conduct, Pannone and Sakura violated Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder, and that Pannone also violated Section 15B(c)(1) of the Exchange Act and Rule G-17 of the Municipal Securities Rulemaking Board. The Complaint seeks relief including a permanent injunction barring Pannone and Sakura from future violations of those provisions and the imposition of civil monetary penalties.
The Commission previously sued Stifel, Robert Cochran, Stifel's former executive vice president in charge of its Oklahoma Public Finance Office, and Steven Strauss in connection with these transactions. The Commission settled its action against Stifel. The Commission's litigation is ongoing with respect to Cochran and Strauss. See Lit. Rel. No. 15569 (Nov. 24, 1997); Lit. Rel. No. 14644 (Sept. 20, 1995); and Lit. Rel. No. 14587 (Aug. 3, 1995).
Securities and Exchange Commission v. Robert M. Cochran, Randall W. Nelson, James V. Pannone, Steven Strauss, and Sakura Global Capital, Inc., (Order granting in part and denying in part motions for summary judgment of defendants) (January 28, 1999).
Securities and Exchange Commission v. Robert Cochran, James Pannone, Sakura Global Capital, Inc. and Steven Strauss, Litigation Release No. 16063 (February 17, 1999) (settled final orders).
The Securities and Exchange Commission announced settlements with Robert Cochran, James Pannone, Sakura Global Capital, Inc. and Steven Strauss with respect to alleged fraud in connection with the sale of municipal securities underwritten by Stifel, Nicolaus & Company, Inc. Cochran was a former executive vice president of Stifel, in charge of its Oklahoma public finance office. Pannone was a former vice president of Stifel. Sakura, a subsidiary of Sakura Bank, was engaged in the business of selling derivatives, including forward purchase agreements ("forwards"). Strauss was a managing director of Sakura. All of the defendants consented to the entry of injunctions prohibiting them from violating the antifraud provisions of the federal securities laws, and collectively they agreed to pay $430,000 in monetary penalties.
The Complaint alleges that in a 1992 transaction for the Oklahoma Turnpike Authority, despite bond counsel's requirement that three competitive bids be obtained for the forward, Cochran and Pannone rigged the bidding to ensure Sakura's selection as the forward provider. The Complaint also alleges that Cochran and Pannone subsequently negotiated with Strauss a $6.593 million undisclosed brokerage fee to be paid by Sakura to Stifel, and that Pannone falsely described to the Turnpike Authority the bidding and negotiation process of the forward. The Complaint further alleges that the forward purchase agreement stated that Sakura did not intend to take any actions which would jeopardize the tax-exempt status of the bonds. The Complaint alleges that at the time Strauss executed the forward on behalf of Sakura, Sakura was planning to pay a $6.593 million brokerage fee to Stifel. The Complaint alleges that Sakura and Strauss knew or were reckless in not knowing that such a brokerage fee would jeopardize the tax-exempt status of the bonds.
The Complaint also alleges that in a 1992 transaction for the Sisters of St. Mary's Health Care Obligated Group, despite bond counsel's requirement that three competitive bids be obtained for the forward, Pannone rigged the bidding to ensure Sakura's selection as the forward provider. The Complaint further alleges that at the request of bond counsel, Pannone, at Cochran's direction, and Strauss provided certificates stating that Sakura would not make any payments, other than certain payments to the issuer, in connection with the forward. The Complaint alleges that Sakura made a $100,000 payment to Stifel and that Cochran and Pannone concealed the payment by booking it to a different transaction. The Complaint alleges that the $100,000 payment from Sakura to Stifel jeopardized the tax-exempt status of the bonds.
Finally, the Complaint alleges that in a 1990 transaction for the Pottawatomie County Development Authority, Cochran recommended that the bond proceeds be invested in a guaranteed investment contract ("GIC"). The Complaint alleges that Cochran did not disclose to the issuer that Stifel received a payment of $87,220 in connection with the GIC. The Complaint alleges that this payment jeopardized the tax-exempt status of the bonds.
Without admitting or denying the allegations in the Complaint, Pannone, Sakura and Strauss consented to the entry of injunctions prohibiting them from future violations of Section 17(a) of the Securities Act of 1933, Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder. Pannone further consented to the entry of injunctions prohibiting them from future violations of Section 15B(c)(1) of the Exchange Act and Rule G-17 of the Municipal Securities Rulemaking Board. Pannone, Sakura and Strauss also consented to the entry of final judgments ordering them to pay monetary penalties of $30,000, $250,000 and $50,000, respectively. In addition, Pannone consented to the entry of an administrative order suspending him from association with any broker, dealer or municipal securities dealer for twelve months.
On January 28, 1999, the Court entered an order dismissing the Commission's securities fraud claims against Cochran with respect to the Oklahoma Turnpike Authority and Pottawatomie County Development Authority transactions. Without admitting or denying the remaining allegations in the Complaint with respect to the Sisters of St. Mary's transaction, Cochran consented to the entry of a final judgment enjoining him from future violations of Section 17(a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and Rule G-17 of the Municipal Securities Rulemaking Board, and ordering him to pay a monetary penalty of $100,000. The settlement with Cochran preserves the Commission's ability to appeal the dismissal of the Oklahoma Turnpike Authority and Pottawatomie County Development Authority transactions.
See also, Lit. Rel. No. 15630 (Jan. 29, 1998); Lit. Rel. No. 15569 (Nov. 24, 1997); Lit. Rel. No. 14644 (Sept. 20, 1995); and Lit. Rel. No. 14587 (Aug. 3, 1995).
Securities and Exchange Commission v. Michael Goodman and Harold Tzinburg, Civ. Action No. 95CV 71563 (E.D. MI.), Litigation Release No. 14471 (April 19, 1995) (settled final order).
The Securities and Exchange Commission announced that on April 14, 1995, a Complaint was filed in the U.S. District Court for the Eastern District of Michigan against Michael Goodman (Goodman) and Harold Tzinberg (Tzinberg) seeking a Permanent Injunction, based on their violations of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act of 1933 (Securities Act), Section 10(b) of the Securities Exchange Act or 1934 (Exchange Act) and Rule 10b-5 promulgated thereunder.
The Commission's Complaint alleges, among other things, that during the years 1984 through 1989, two not-for-profit corporations, First Humanics Corp. (First Humanics) and its successor, International Elderly Care, Inc. (IEC), participated in 26 public offerings of municipal bonds raising over $107 million. The purpose of these offerings was to acquire, renovate and operate nursing homes. In connection with two such offerings, First Humanics' 1987 offering to acquire the Medicos Recovery Care Center nursing home in Detroit, Michigan (Medicos) and IEC's 1988 offering to acquire the Colonial Gardens Convalescent Center in Boonville, Missouri (Colonial Gardens), Goodman served as the representative for the underwriter and Tzinberg served as the underwriter's counsel. During these offerings, however, both Goodman and Tzinberg participated in the preparation of false and misleading offering circulars. Specifically, the Medicos offering circular contained material misrepresentations and omissions concerning: the promoter of the offering, the promoter's control over First Humanics as well as his regulatory history and numerous prior bond and business failures; the prevalent commingling of revenues from existing First Humanics nursing homes and the resulting financial interdependence of all First Humanics nursing homes; and, First Humanics' on-going ponzi scheme. In addition, the Colonial Gardens offering circular contained material misrepresentations and omissions concerning the above promoter's role in the offering and his control over IEC as well as his background; the nexus between IEC and First Humanics; and First Humanics' prior bond defaults.
Simultaneous with the filing of the Commission's Complaint, Goodman and Tzinberg, without admitting or denying the Commission's allegations, consented to the entry of a final judgment enjoining them from violations of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Securities and Exchange Commission v. Nicholas A. Rudi, Joseph C. Salema, Public Capital Advisors, Inc., George L. Tuttle Jr. and Alexander S. Williams, Civ. Action No. 95 Civ. 1282 (S.D.N.Y.), Litigation Release No. 14421 (February 23, 1995) (settled final orders against Tuttle & Williams).
The Commission announced that it filed a Complaint today alleging violations of the federal securities laws and the Municipal Securities Rulemaking Board ("MSRB") Rules arising out from the payment of more than $300,000 in kickbacks in connection with the Camden County Municipal Utilities Authority's ("CCMUA") February 1990 offering of approximately $237,000,000 of debt securities ("Offering").
Named in the Complaint were:
Nicholas A. Rudi, age 46, a resident of Haddon Township, New Jersey. During the period of the conduct alleged in the Complaint, Nicholas A. Rudi was the President and a fifty percent owner of Consolidated Financial Management, Inc., the financial advisor to the CCMUA for the offering Nicholas A. Rudi had been Camden County, New Jersey's ("Camden County") administrator during the early 1980s;
Joseph C. Salema, age 46, a resident of Wenonah, New Jersey. During the period of the conduct alleged in the Complaint, Joseph C. Salema was the Executive Vice President and owned the other fifty percent of Consolidated Financial Management, Inc. In October 1990, Joseph C. Salema sold his interest in Consolidated Financial Management, Inc. to Nicholas A. Rudi;
Public Capital Advisors. Inc., a financial advisory firm that until September 1993, was known as Consolidated Financial Management, Inc.. Consolidated Financial Management, Inc. was incorporated in New Jersey in 1985 and maintains its offices in Clementon, New Jersey. Consolidated Financial Management, Inc. was the CCMUA's financial advisor since February 1985. Nicholas A. Rudi is now the sole owner of Public Capital Advisors, Inc.;
George L. Tuttle. Jr., age 47, who resides in Varnck, New York, and who was a senior vice president at First Fidelity Bank, N.A. ("FFB") during the period of the conduct alleged in the Complaint. In November 1994, George L. Tuttle, Jr. resigned from FFB;
Alexander S. Williams, age 63, resides in Westfield, New Jersey, and who was an executive vice-president at FFB from 1970 until he retired in December 1994. During the period of the conduct alleged in the Complaint1 Alexander S. Williams was also the head of First Fidelity Securities Group ("First Fidelity"), and George L. Tuttle, Jr. reported to Alexander S. Williams.
The Complaint alleges that:
Consolidated Financial Management, Inc. was the financial advisor to the CCMUA on the Offering. Nicholas A. Rudi told George L. Tuttle, Jr. that the CCMUA had reduced Consolidated Financial Management, Inc.'s financial advisory fee on the Offering to a flat fee of $15,000. In prior offerings, Consolidated Financial Management, Inc. had received one dollar per $1,000 face value of bonds ("one dollar per bond"). Nicholas A. Rudi said that he thought Consolidated Financial Management, Inc. should still get paid one dollar per bond for working on the Offering and told George L. Tuttle, Jr. that he wanted First Fidelity to pay Consolidated Financial Management, Inc the difference.
At the time of this conversation, George L. Tuttle, Jr. and Nicholas A. Rudi anticipated that the CCMUA would issue approximately $215 million in debt. George L. Tuttle, Jr. understood that Nicholas A. Rudi wanted to receive $215,000 for Consolidated Financial Management, Inc.'s work on the Offering, $15,000 from the CCMUA and the remaining $200,000 from First Fidelity. Accordingly, George L Tuttle, Jr. and Alexander S. Williams caused their employer, First Fidelity, of pay a kickback of over $200,000 between February and April 1990 to Consolidated Financial Management, Inc. The kickback was shared by Nicholas A. Rudi and Joseph C. Salema.
Joseph C. Salema solicited and received an additional $90,000 kickback from Robert J. Jablonski ("Jablonski"), currently a Commissioner of the New Jersey Highway Authority. In exchange for Joseph C. Salema's assistance in securing for First Fidelity the lead underwriter position on the Offering, Jablonski agreed to pay Joseph C. Salema a portion of the finder's fee that First Fidelity paid to Jablonski in connection with the Offering. Joseph C. Salema and Jablonski agreed that Jablonski's kickback to Salema would be reduced by any political contributions that Jablonski chose to make in the interim.
To conceal the kickback to Consolidated Financial Management, Inc., George L. Tuttle, Jr. and Alexander S. Williams paid the kickback to Consolidated Financial Management, Inc. through Jablonski and disguised these payments on First Fidelity's municipal securities dealer books and records. At Joseph C. Salema's direction, Jablonski in turn paid to Armacon Investment Co., a company owned by Joseph C. Salema, First Fidelity's kickback to Consolidated Financial Management, Inc. and Jablonski's kickback to Joseph C. Salema.
George L. Tuttle, Jr. caused First Fidelity to make an additional $22,000 kickback to Consolidated Financial Management, Inc. in connection with the Offering through a fictitious invoice on another municipal securities transaction and concealed this payment on First Fidelity's municipal securities dealer books and records.
George L. Tuttle, Jr. also caused First Fidelity to pay Armacon Securities, Inc., a broker-dealer jointly owned by Nicholas A. Rudi and Joseph C. Salema, a finder's fee for First Fidelity's role in a 1991 CCMUA Guaranteed Investment Contract. The payment was made in response to a series of false invoices that Nicholas A. Rudi submitted to First Fidelity on unrelated municipal offerings. George L Tuttle, Jr., who knew of the falsity of the invoices, improperly recorded these payments on First Fidelity's municipal securities dealer books and records.
Each of the Defendants violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule l0b-5.
In addition, George L. Tuttle, Jr. and Alexander S. Williams violated Section 15B(c)(1) of the Exchange Act, which prohibits effecting transactions in municipal securities in contravention of any rule of the MSRB, and MSRB Rules G-8 (books and records), G-17 (fair dealing) and G-20 (gifts and gratuities).
In the Complaint, the Commission seeks a final judgment permanently enjoining each of the defendants from violating Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5, and enjoining George L Tuttle, Jr. and Alexander S. Williams from violating Section 15B(c)(1) of the Exchange Act and MSRB Rules G-8, G-17 and G-20. In addition, the Commission seeks disgorgement and prejudgment interest from each of the defendants.
Joseph C. Salema consented, without admitting or denying the allegations of the Complaint, to the entry of a final judgment permanently enjoining him from violating Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule l0b-5. Joseph C. Salema also agreed to pay $324,764.55, representing disgorgement of the money he received as a result of the conduct alleged in the Complaint and prejudgment interest.
George L. Tuttle, Jr. and Alexander S. Williams, without admitting or denying the allegations of the Complaint, have each consented to the entry of a final judgment permanently enjoining them from violating Section 17(a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5, and MSRB Rules G-8, G-17, and G-20. George L. Tuttle, Jr. and Alexander S. Williams have agreed to disgorge $l8,171.48 and $4,684.14, respectively, representing the money each received as a result of the conduct alleged in the Complaint. George L. Tuttle, Jr. has also agreed to cooperate with the Commission.
The Commission's investigation is continuing. The litigation is pending as to defendants Nicholas A. Rudi and Public Capital Advisors, Inc.
The Commission thanks the National Association of Securities Dealers Inc. for its assistance on this investigation.
Securities and Exchange Commission v. Terry D. Busbee and Preston C. Bynum, Civ. Action No. 95-30024 RV (N.D. Fla.), Litigation Release No. 14387 (January 23, 1995); Litigation Release No. 14508 (May 24, 1995) (settled final order).
See "Public Officials" section.
Securities and Exchange Commission v. Matthews & Wright Group, Inc. et al.,Civ. Action No. 89-2877 (S.D.N.Y.), Litigation Release No. 12072 (April 27, 1989) (settled final orders).
The Securities and Exchange Commission ("Commission") today announced the filing of a Complaint for Injunctive Relief in the United States District Court for the Southern District of New York against Matthews & Wright Group, Inc. ("M&W"), Matthews & Wright, Inc. ("M&W Inc."), a wholly owned, registered broker-dealer subsidiary of M&W, M&W's President and Chairman, George W. Benoit ("Benoit"), M&W's Executive Vice President, Arthur Abba Goldberg ("Goldberg") and M&W's Chief Financial Officer, Roger J. Burns ("Burns"), and M&W's outside counsel, Bernard A. Althoff ("Althoff"). M&W is a Delaware corporation with its principal offices at 100 Broadway, New York, New York. During the period covered by the Complaint, M&W engaged in investment banking through its subsidiaries by underwriting, trading, brokering and selling municipal securities.
The Commission's Complaint charges the defendants with numerous violations of the antifraud, reporting, books and records and internal controls provisions of the Securities Act of 1933 (the "Securities Act"), the Securities Exchange Act of 1934 (the "Exchange Act"), the Commission's rules promulgated thereunder, and related rules of the Municipal Securities Rulemaking Board.
In December 1985, the Complaint alleges, at a time when M&W's and M&W Inc.'s capital resources were grossly inadequate to perform the dollar volume of underwriting of new issue, tax exempt municipal securities which M&W and M&W Inc. were attempting to underwrite, M&W, M&W Inc., Benoit, Goldberg and Burns devised and carried out a fraudulent scheme to perform the underwritings through a series of sham closings. The Complaint alleges that the invalid closings were conducted as part of an effort to retain favorable tax treatment for the municipal securities by avoiding the scheduled effective dates of certain provisions in then pending federal tax legislation. Those provisions imposed or expanded certain restrictions applicable to tax-exempt municipal securities.
On December 31, 1985, the Complaint alleges, the last day before the first of the scheduled effective dates in the pertinent tax legislation, defendant Goldberg wrote at least twenty-two checks totaling approximately $768 million on a nonexistent checking account at a credit union he had earlier helped to form and which he controlled. The checks were ostensibly used to purchase approximately $768 million of municipal bonds for M&W and M&W Inc., all with the advance knowledge and approval of defendants Benoit and Burns and the knowledge and assistance of defendant Althoff. M&W and M&W Inc. subsequently sold these twenty-two issues of municipal bonds to the public throughout 1986 using offering materials which affirmatively and falsely represented that the bonds had been "issued" on December 31, 1985, and omitted to disclose that the invalid closings created a special increased risk that interest on such bonds may be taxable.
Throughout 1986, the Complaint alleges, as seventeen of the twenty-two bond issues "closed" on December 31, 1985 were actually issued and sold to the public by M&W and M&W Inc., the proceeds of the offerings were not used for the purposes stated in the bond offering materials. The offering materials for these bonds affirmatively and falsely stated that the bonds were issued to finance the construction of various projects, primarily multi-family housing to be occupied in part by low income families. In fact, the Complaint alleges, substantially all of the proceeds of the offerings were intended to be used, and were actually used, to purchase investment contracts to serve as credit enhancement instruments for the bonds, and not for the projects. The Complaint alleges that M&W and M&W Inc. sold these bonds to the public with the advance knowledge of Benoit and Goldberg that the proceeds were intended to be used for purposes other than those stated in the bond offering materials, and that defendant Althoff also knew about the possible misapplication of proceeds. The use of proceeds for such undisclosed purposes created a further special increased risk that interest on such bonds might not be exempt from federal income taxation because it prevented or impeded the use of the proceeds for the projects as required by the Internal Revenue Code.
The Complaint also charges that in August 1986 M&W sold 1.5 million shares of its common stock to the public through the use of a materially false and misleading Registration Statement and Prospectus filed with the Commission. The Registration Statement and Prospectus were false and misleading because they included a description of M&W's business operations and financial condition which omitted to disclose that M&W, M&W Inc., Benoit, Goldberg and Burns had devised and carried out the foregoing invalid closing and misuse of proceeds schemes, and the consequences thereof. In connection with M&W's sale of its common stock to the public, defendant Althoff supervised the preparation and filing of M&W's false and misleading Registration Statement and Prospectus. Following the public offering, M&W failed to file a required report with the Commission on Form S-R to disclose the use M&W made of the proceeds of the public offering.
The Complaint further alleges that, in August 1986, contemporaneously with the public offering of stock and just before the last of the scheduled effective dates in the pertinent federal tax legislation, M&W, M&W Inc., Benoit, Goldberg and Burns once again conducted additional invalid closings using worthless credit union checks. Specifically, Benoit and Burns signed at least four worthless credit union checks aggregating $554 million to purchase four bond offerings, and M&W and M&W Inc. thereafter sold such bonds to the public through the use of affirmatively false and misleading offering materials which stated that the bonds had been issued before the tax law changes, and which omitted to disclose the special increased risk, caused by the invalid closings, that interest on such bonds might not be exempt from federal income taxation.
In furtherance of the foregoing scheme to defraud, the Complaint alleges that M&W thereafter failed to disclose any of the above-described events in reports filed with Commission and suspended or overrode its internal controls to prevent the accurate recording of these events in M&W's books and records. Benoit, Goldberg and Burns falsified M&W's business records, and Benoit and Burns made, or caused to be made, statements containing material omissions to M&W's outside auditors, all to conceal the scheme.
M&W, M&W Inc., Benoit and Burns have consented, without admitting or denying the allegations of the Commission's Complaint, to the entry of final judgments permanently restraining and enjoining M&W, M&W Inc., Benoit and Burns from future violations of, or aiding and abetting future violations of, (1) the antifraud provisions contained in section 17(a) of the Securities Act and section 10(b) of the Exchange Act and rule 10b-5 thereunder; (2) the periodic reporting provisions contained in section 13(a) of the Exchange Act and rules 12b-20 and 13a-1 thereunder; (3) the provisions relating to books and records and representations to auditors contained in section 13(b) (2) of the Exchange Act and rules 13b2-1 and 13b2-2 thereunder; and (4) the antifraud and reporting provisions applicable to municipal securities broker-dealers contained in sections 15(c)(1) and 15B(c)(1) of the Exchange Act and rule 15c1-2 thereunder and related Rules G-8, G-9, G-14 and G-17 of the Municipal Securities Rulemaking Board.
M&W Inc. has also consented, based upon and following the entry of the final judgment, to the institution by the Commission of administrative proceedings revoking M&W Inc.'s broker-dealer license. Benoit and Burns have also consented, based upon and following the entry of the final judgments, to the institution by the Commission of administrative proceedings barring Benoit and Burns from association with any broker, dealer, government securities broker or dealer, investment adviser or municipal securities dealer with the provisos that Benoit may make application to become reassociated with any such entity after four years, and Burns may make application to become reassociated with any such entity after two years.
The Commission's litigation with Goldberg and Althoff of the allegations in the Complaint is pending. The Commission's investigation of related municipal securities matters is continuing.
SEC v. William H. Crossman, et al., Civ. Action No. 79C-2550 (N.D. lll.), Litigation Release No. 8809 (July 2, 1979) (complaint).
William D. Goldsberry, Administrator of the Chicago Regional Office of Securities and Exchange Commission, announced that on June 20, 1979, the Commission filed a complaint in the United States District Court for the Northern District of Illinois, Eastern Division, seeking injunctive relief against William H. Crossman (Crossman) of Crystal Lake, Illinois, William H. Crossman and Associates (Crossman and Associates) of Crystal Lake, Illinois, a sole proprietorship, and Norman M. McDougall, Jr., of Wayne, Illinois, alleging violations of the anti-fraud provisions and municipal broker-dealer registration provisions of the Federal securities laws.
The Commission's complaint alleges that the defendants made misrepresentations and omitted to state material facts in connection with the offer and sale of three separate offerings of bonds of the Hanover Park Park District (Park District) of Hanover Park, Illinois. The complaint alleges that the defendants falsely represented that a new recreational complex would be built by the Park District from the funds obtained in the sale of its bonds which complex would contain ice skating and ice hockey facilities; that earnings and revenue and debt service coverage would come from the ice skating and ice hockey facilities.
The complaint further alleges that the defendants omitted to disclose that the construction of the ice skating facility had been completely abandoned; that the construction of the ice hockey facility would be constructed sometime after the completion of the recreational complex.
The complaint further alleges that in the offer and sale of one of the three bond issues, the defendants failed to disclose that the bonds were issued and sold in a two-step process to circumvent an Illinois statute limiting the interest which a municipal issuer could pay on its bonds.
Finally, the complaint alleges that after December, 1975, Crossman and Crossman and Associates failed to register as municipal broker-dealers, in violation of the Securities Exchange Act of 1934.
SEC v. William H. Crossman, et al., Litigation Release No. 8956 (December 18, 1979) (settled final orders).
William D. Goldsberry, Administrator of the Chicago Regional Office of the Securities and Exchange Commission announced that on November 29, 1979, the Honorable Marvin Aspen, Judge of the United States District Court for the Northern District of Illinois, Eastern Division, entered a final judgment of permanent injunction against Norman McDougall, Jr. (McDougall), of Kildeer, Illinois, enjoining him from violating the anti-fraud provisions in the offer and sale of municipal securities. The final judgment was entered with the consent of the defendant, who neither admitted nor denied the allegations of the complaint.
In addition, final judgments of permanent injunction were entered against William H. Crossman (Crossman) and William H. Crossman and Associates (Crossman and Associates) of West Dundee, Illinois on October 23, 1979. These final judgments enjoined the defendants from violating the anti-fraud provisions of the federal securities laws in the offer and sale of any securities and from violating the municipal broker-dealer registration provisions of the Securities Act of 1934. These final judgments were entered by default as these defendants failed to answer the complaint or appear.
The Commission commenced this action on June 20, 1979, by filing a complaint which alleged, among other things, that Crossman, Crossman and Associates and McDougall violated the anti-fraud provisions of the federal securities laws in the offer and sale of revenue bonds, refunding revenue bonds and junior lien bonds of the Hanover Park District (Park District) concerning, among other things, the construction of ice skating facilities in a recreation complex to be built by the Park District, the projected revenues from the facility and the bond amortization schedule for repayment of bond principal and interest. In addition, the complaint alleged violations by Crossman and Crossman and Associates of the municipal broker-dealer registration requirement of the Securities Exchange Act of 1934. For further information, see Litigation Release No. 8809.
SEC v. Shelby Bond Service Corp., et al., Civ. Action No. C-77-2236 (W.D. Tenn.), Litigation Release No. 7888 (April 27, 1977) (complaint).
Jule B. Greene, Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, announced that on April 18, 1977, a civil injunctive complaint was filed in United States District Court for the Western District of Tennessee, Memphis Division, naming Shelby Bond Service Corporation (Shelby Bond), a municipal securities dealer, Precision Optical Laboratory, Inc. (Precision Optical), both Tennessee corporations, Max J. Baer, Robert E. Hawks, Charles M. West, Donald E. Helms, Richard C. Flick, Edward J. Blumenfeld, and Patrick Lawyer, all of Memphis, and Charles M. Beale of Cardova, Tennessee, Manuel W. Yopp of Germantown, Tennessee, and Richard Lutz of Southaven, Mississippi.
The complaint alleges that Shelby Bond, Beale, Baer, West, Helms, Yopp, Flick, Lutz, Blumenfeld, and Lawyer violated the anti-fraud provisions of the federal securities laws in connection with the offer, purchase and sale of municipal securities by making numerous misrepresentations and omissions of material facts to prospective investors. The complaint also alleges that these defendants omitted to state to investors that they were being charged prices for their securities which were not reasonably related to the then current market price for the securities. Undisclosed mark-ups as high as 166 percent over the contemporaneous cost to Shelby Bond are alleged.
The complaint further alleges that Shelby Bond, Precision Optical, Baer, Beale and Hawks violated the anti-fraud provision of federal securities laws by making numerous misrepresentations and omissions of material facts in connection with the offer and sale of municipal securities, namely industrial development revenue bonds issued by the Gallaway Industrial Development Board of Gallaway, Tennessee, underwritten by Shelby Bond, in which Precision Optical is the lessee. The misrepresentations alleged relate to the safety and merits of investment in these bonds and the financial status of Precision Optical.
SEC v. Shelby Bond Service Corp., et al., Litigation Release No. 7965 (June 9, 1977) (settled final orders).
Jule B. Greene, Administrator of the Atlanta Regional Office, announced that on May 20, 1977, the Honorable Robert M. McRae, Jr., United States District Judge for the Western District of Tennessee, Memphis Division, issued orders of permanent injunction from further violations of the anti-fraud provisions of Section 17(a) of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder against Shelby Bond Service Corporation ("Shelby Bond"), a now defunct Memphis, Tennessee, municipal securities broker-dealer, Precision Optical Laboratory, Inc. ("Precision Optical") of Gallaway, Tennessee, a Tennessee corporation, Max J. Baer, Charles M. West, Richard C. Flick, Patrick Lawyer, Donald E. Helms, all of Memphis, Tennessee, Manual W. Yopp of Germantown, Tennessee, and Richard Lutz of Southaven, Mississippi. Precision Optical, West, Flick, Lawyer, Helms, and Yopp consented to the entry of the orders of injunction. The judgments against Shelby Bond, Baer, and Lutz were by default.
In addition, on May 27, 1977, Judge McRae issued orders of preliminary injunction from further violations of the anti-fraud provisions of the federal securities laws against Charles M. Beale of Cardova, Tennessee, and Robert E. Hawks and Edward J. Blumenfeld, both of Memphis, Tennessee, based upon findings set out in a memorandum opinion filed on that date.
In addition, on May 27, 1977, Judge McRae issued orders of preliminary injunction from further violations of the anti-fraud provisions of the federal securities laws against Charles M. Beale of Cardova, Tennessee, and Robert E. Hawks and Edward J. Blumenfeld, both of Memphis, Tennessee, based upon findings set out in a memorandum opinion filed on that date.
The first two counts of the complaint alleged fraud in the offer, purchase, and sale of municipal securities by Shelby Bond, its principals, and its salesmen by making misrepresentations and omitting to state material facts concerning the nature and merits of the securities, charging prices for securities which were unrelated to the market price of the securities, selling securities without regard to the investment objectives or financial status of investors, recommending securities without an adequate basis upon which to make the recommendation, and using sales techniques which amounted to a course of conduct which operated as a fraud upon purchasers of securities. Hawks was chairman of the board of directors of Shelby Bond, Beale was president and a director of Shelby Bond, and Baer was vice-president and a director of Shelby Bond.
The third and fourth counts of the complaint alleged fraud in the offer and sale of municipal securities issued to finance Precision Optical (first mortgage industrial development revenue bonds of the Gallaway Industrial Development Board of Gallaway, Tenn., issued November 29, 1974) which were underwritten by Shelby Bond, unconditionally guaranteed by Shelby Bond, Precision Optical, Hawks, Baer and Beale, sold through Shelby Bond using the alleged fraudulent methods outlined in the first two counts of the complaint, and which defaulted in payments of interest and principal on November 1, 1976. (For further information see Litigation Release No. 7888.)
SEC v. Shelby Bond Service Corp., et al.., Litigation Release No. 8578 (October 27, 1978) (settled final order).
Jule B. Greene, Administrator of the Atlanta Regional Office of the Securities and Exchange Commission, announced that on October 2, 1978, Honorable Robert M. McRae, Jr., Judge of the United States District Court for the Western District of Tennessee, at Memphis, entered an order permanently enjoining Charles M. Beale of Memphis from further violations of the anti-fraud provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. Beale consented to the entry of the order without admitting or denying the allegations of the complaint. Beale has been subject to a preliminary injunction since May 27, 1977. The complaint charged that Beale, while president and a director of Shelby Bond Service Corp., offered and sold municipal securities at excessive mark-ups, engaged in adjusted trades, and misrepresented the financial condition of issuers of securities and the speculative nature of an investment in such securities. (For additional information see Litigation Release No. 7965.)
SEC v. Washington County Utility District, et al., Civ. Action No. CA-2-77-15 (E.D. Tenn.), Litigation Release No. 7782 (Feb. 15, 1977) (complaint).
SEC v. Washington County Utility District, et al., Litigation Release No. 8466 (July 17, 1978) (settled final orders).
Jule B. Greene, Administrator of the Atlanta Regional Office, announced that on June 29, 1978, the Honorable C. G. Neese, Judge of the U.S. District Court in Greenville, Tennessee, entered an order permanently enjoining Thomas R. Alcock of Hingham, Mass., and Diversified Securities, Inc., a New York corporation, from further violations of the anti-fraud provisions of the federal securities laws in connection with the offer, purchase, and sale of municipal bonds by the Washington County Utility District. Alcock and Diversified consented to the entry of the order, without admitting or denying the allegations in the Commission's complaint. For further information see Litigation Release Nos. 7782, 7868, 7983, 7984, and 8410.
SEC v. Astro Products of Kansas, Inc., et al., Civ. Action No. CA-76-359-L6 (D.C. Kan.), Litigation Release No. 7557 (September 13, 1976) (complaint); Litigation Release No. 7774 (February 10, 1977) (settled final orders); Litigation Release No. 8613 (December 8, 1978) (defaults entered).
See "Obligated Persons" section.
SEC v. Reclamation District No. 2090, et al., Civ. Action No. C76-1231-SAW (N.D. Cal.), Litigation Release No. 7460 (June 22, 1976) (complaint).
SEC v. Reclamation District No. 2090, et al., Litigation Release No. 7688 (December 7, 1976) (settled final orders).
Gerald E. Boltz, Regional Administrator of the Los Angeles Regional Office, and Leonard H. Rossen, Associate Regional Administrator of the San Francisco Branch Office, announced that on November 11, 1976, the Honorable Robert H. Schnacke, United States District Judge for the Northern District of California, entered a Final Judgment of Permanent Injunction against MFAL Associates, a registered broker-dealer, and Lawrence A. Luebbe, its president, both of Los Angeles, California. The injunction proscribes violations of the anti-fraud provisions of the federal securities issued by Reclamation District No. 2090 ("the District") and any other security of any other issuer. MFAL and Luebbe consented to the entry of the Permanent Injunctions without admitting or denying the allegations of the Commission's Complaint.
The Commission's Complaint alleged that the defendants' conduct resulted in the fraudulent sales of approximately $55,000 of bond anticipation notes issued by the District of eight purchasers. For further information see Litigation Release No. 7460.
SEC v. The Senex Corporation, et, al., Civ. Action No. 74-53 (E.D. Ky.), Litigation Release No. 6451 (July 24, 1974) (complaint), Litigation Release No. 6769 (March 5, 1975) (settled final order); Litigation Release No. 8651 (January 23, 1979) (settled final order).
See "Obligated Persons" section.
Administrative Proceedings - Commission Decisions
In re Boettcher and Company, Exchange Act Release No. 8393, A.P. File No. 3-544 (August 30, 1968).
Text: Findings, Opinion and Order Censuring Broker-Dealer
In these proceedings pursuant to Sections 15(b), 15A and 19(a) (3) of the Securities Exchange Act of 1934 ("Exchange Act"), we granted petitions for review of the hearing examiner's initial decision in which he concluded that Boettcher and Company ("registrant"), a registered broker and dealer, should be censured, and that David F. Lawrence and Alfred A. Wiesner, general partners of registrant, and Bruce C. Newman, an employee of registrant, should each be suspended from association with any broker or dealer for 15 days. Briefs were filed, and we heard oral argument. On the basis of our review of the record and for the reasons set forth herein and in the initial decision, we make the following findings.
Markups on Government Bonds in Connection with "Advance Refunding" Transactions
Registrant acted as manager of an underwriting syndicate in connection with the "advance refunding" in 1963 of bonds of two Colorado school districts, Jefferson County District No. R-1 ("Jeffco") and Adams County District No. 50 ("Adams"). The "advance refunding" technique entails the issuance by a school district of new bonds for the purpose of "refunding" existing bonds which may not be due or callable. Under such technique, as here relevant, the proceeds of the new bonds issued by the school district are invested in United States Government obligations ("Governments") maturing at such times and in such amounts as to insure prompt payments of the "refunded" bonds. The Governments are then placed in escrow, and the "refunded" bonds are no longer deemed outstanding. The objective of these steps is to secure savings to the school district by enabling it to issue its "refunding" bonds at a lower interest rate than it receives on the Governments; and it may also be able to reduce the principal amount of its debt by purchasing Governments at a discount. In negotiated sales of refunding bonds, as here, the form of the underwriter's compensation may include a markup on the new bonds issued by, or on the Governments sold to, the school district, or cash paid by the district. In this case the syndicate purchased the refunding bonds from and sold the Governments to Jeffco and Adams, charging Jeffco a markup on the Governments over the syndicate's cost. The Governments involved in both transactions were acquired by the syndicate from registrant's wholly-owned subsidiary which, pursuant to syndicate authorization, had purchased such securities and charged the syndicate a markup of $1.25 per bond. The hearing examiner found that registrant failed to make adequate disclosure to Jeffco and Adams of the markups taken on the Governments, and respondents controvert this finding.
1. Jeffco Transaction
Registrant reached an agreement with Jeffco on July 30, 1963, giving it the right to form a selling group to buy Jeffco refunding bonds for resale to the general public, the proceeds of which Jeffco would use to buy Governments from the underwriters at the prices paid by the latter, who undertook to acquire the Governments at the "best possible" price. The objective by Jeffco was to achieve net savings estimated at approximately $2,500,000. The option given registrant was not exercised by its extended expiration date of September 30, but negotiations with Jeffco continued. Registrant concluded that because of changed market conditions the gross profit it had anticipated could not be realized under the terms of the July 30 proposal, and determined to make up the deficiency in part by taking a markup on the Governments. It entered into a new agreement with Jeffco as of October 10, under which the syndicate formed by registrant would purchase $38,873,000 of Jeffco refunding bonds in exchange for which the underwriters would supply Jeffco with specified Governments sufficient to refund $39,757,000 of outstanding Jeffco bonds. The transaction was consummated on November 1, 1963. The prices paid the syndicate by Jeffco for the Governments, however, included a markup of $394,469 over the prices paid for such securities by registrant's subsidiary. Following a 1964 audit Jeffco instituted legal action against registrant to recover that amount, and the case was thereafter settled by the parties by a payment to Jeffco of $200,000.
At the outset we note that no finding was made by the hearing examiner that registrant's underwriting compensation was in fact excessive or improper per se, and that Jeffco attained substantially the estimated savings of about $2,500,000. Our inquiry here relates solely to the question of the disclosure of the underwriting compensation. Respondents assert that in 1963 Jeffco was concerned only with the over-all compensation involved, and that in any event Jeffco was informed by registrant, but unreasonably failed to understand, that part of such compensation under the October 10 contract consisted of a markup on the Governments. It is certainly incumbent upon an underwriter to exercise care to make full and clear disclosure to issuers, both public and private, with respect to the nature and amount of the underwriting expense and profit involved. We are unable to find, however, that registrant failed in this duty in the Jeffco situation.
Jeffco was experienced and knowledgeable in financial matters and was advised by counsel in connection with the transaction in question. The October 10 agreement, pursuant to which the transaction was consummated, repeated provisions of the July 30 proposal but did not include the earlier provision barring a markup on the Governments. In addition, an exhibit attached to the October 10 agreement prepared by registrant, which summarized the estimated underwriting costs and expenses per $100 bond issued, listed "U.S. Government bond underwriting" at $.893 (on which basis the markup on Governments would aggregate around $350,000) as well as "refunding bond underwriting" at $1.376. Moreover, a letter signed by Wiesner addressed to bond counsel, dated November 1, stated that the costs of the Governments included at least $394,469 for "underwriting, obtaining and maintaining physical availability" of such securities. Not only are these items inconsistent with an intent on registrant's part to conceal the markup on the Governments but at least the exhibit should have alerted Jeffco to the possibility of such a markup. In view of the integrated nature of a refunding transaction, it would have been reasonable to evaluate its fairness on the basis of overall results. The markup on the Governments of $394,469 was one aspect of a transaction involving the issuance of $38,873,000 of refunding bonds in which Jeffco achieved its estimated savings of around $2,500,000. The record as a whole indicates, as recognized by the parties in settling the civil action based on the issues now before us, a "mutual misunderstanding" with respect to registrant's compensation engendered by the "complicated nature" of the negotiations and transactions.
2. Adams Transaction
Registrant entered into an agreement in August 1963 with Adams for an advance refunding of $7,735,000 of Adams bonds. That agreement, which was modeled after the July 30 Jeffco proposal, provided that registrant and its associates would purchase the necessary Governments at the "best possible" price and resell them to Adams at their purchase price. The transaction was consummated on September 30, 1963, around which time registrant's subsidiary acquired the Governments. The syndicate purchased the Governments from the subsidiary for $7,760,100, and sold them to Adams for the same price. However, unknown to Adams that price included a markup of $1.25 per $1,000 bond or a total of $9,031 taken by the subsidiary in the sale of the Governments to the syndicate.
Newman, registrant's employee who prepared the Adams contract, contemplated that the markup would not be passed on to Adams but would be absorbed by the syndicate. However, he turned over the transaction to another employee without advising him of that intention, and the latter interpreted the contract to mean that Adams would purchase the Governments at the syndicate's cost (which included the markup charged by registrant's subsidiary). Upon discovering the markup after the closing date Adams claimed it was an improper charge, and around April 1966 registrant repaid the full amount.
Respondents assert, and we find, that the markup was charged Adams through inadvertence. However, neither the inadvertence of the undisclosed markup nor the restitution following complaint can absolve registrant of the failure to carry out its responsibility to review transactions, particularly of the size here involved, and make certain that no unauthorized or undisclosed charges are imposed. It cannot by its own carelessness shift such burden to its customer. Under the circumstances we conclude that registrant failed to exercise reasonable supervision to prevent overcharging its customer in violation of the securities acts.n1
Registrant effected some of its over-the-counter transactions with customers on a principal basis, disclosing its principal capacity but not always disclosing the markups included in the prices. The hearing examiner held that under the circumstances registrant should have made clear what procedures and pricing policies it followed when it filled orders from inventory, and that the failure to do so made the advertisements false and misleading. The record does not show that the prices charged in the principal transactions referred to were not in fact the best possible prices, it being stipulated merely that the undisclosed markups in some instances exceeded the minimum commissions that would have been charged on transactions executed on the New York Stock Exchange. On the record before us we are unable to find that registrant violated the anti-fraud provisions. We also note that registrant discontinued the use of the advertisements after being alerted to the problems they created.
Public Interest
In determining what remedial action is appropriate in the public interest, we have taken into account the facts that registrant has been in business for over 50 years without any prior disciplinary action; that it has settled the claims of both Jeffco and Adams; and that it has made changes in its operations and forms designed to prevent a repetition of the problems respecting refundings that arose in this case. Nevertheless we consider that registrant should be censured for the failure to exercise proper supervision in the Adams situation.
Since we have made no adverse findings with respect to the individual respondents, we shall enter an order dismissing the proceedings as to them.
Accordingly, IT IS ORDERED that Boettcher and Company be, and it hereby is, censured;
IT IS FURTHER ORDERED that the proceedings herein as to David F. Lawrence, Alfred A. Wiesner and Bruce C. Newman be, and they hereby are, dismissed.
By the Commission (Chairman Cohen and Commissioners Owens, Budge, Wheat and Smith).
Footnotes
-[n1]- During 1966 registrant used certain newspaper and radio advertisements containing statements which conveyed the impression that in every over-the-counter transaction registrant's traders try to get for the customer "the best possible price. "Although they also indicated that registrant maintained an inventory of some securities, nothing was said specifically about pricing in sales from inventory. Prior to the use of the advertisements registrant in accordance with the requirements of the New York Stock Exchange, of which it is a member, had submitted them to that Exchange for approval of their manner and form of presentation and the Exchange had raised no questions as to their use.
Commission Orders - Settled Administrative Proceedings
In re John E. Thorn, Jr., and Thorn Welch & Co., Inc., Securities Act Release No. 7663; A.P. No. 3-8400 (March 31, 1999).
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, instituted 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 complete 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 complete 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 his Order and the Respondents' Offer, the Commission finds the following.
1. TWC, between November 1987 and May 1996, 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.
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.
In re Eugene J. Yelverton, Jr., Securities Act Release No. 7662, Exchange Act of Release No. 41232, A.P. No. 3-9859 (March 31, 1999).
I. 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 Securities Exchange Act of 1934 ("Exchange Act") be, and they hereby are, instituted against Eugene J. Yelverton, Jr. ("Yelverton" or "Respondent").
II. In anticipation of the institution of these proceedings, the Respondent has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, the Respondent, without admitting or denying the findings set forth herein, except as contained in Section III 1 and 2, below, and as to the jurisdiction of the Commission over the Respondent and over the subject matter of these proceedings, which are admitted, consents 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 Exchange Act of 1934, Making Findings, and Imposing Remedial Sanctions and Cease-and-Desist Order ("Order").
III. Based on this Order and the Respondent's Offer, the Commission finds the following.1
1. Thorn, Welch & Co., Inc., ("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. Yelverton. Yelverton is a resident of Jackson, Mississippi. From 1987 through 1990, Yelverton was a consultant to TWC. From 1990 through the present, Yelverton has been a shareholder of TWC. Yelverton was a municipal securities principal of TWC from January 1991 through 1996.
3. 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.
4. 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.
5. 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...."
6. 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.
7. 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.
8. 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.
9. TWC, through Yelverton and others, sold the notes from each of the offerings using the official statements. Yelverton 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. Yelverton 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. Yelverton 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.
10. During the period from November 1987 through May 1996, Yelverton 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 nine, above.
11. During the period from November 1987 through May 1996, Yelverton 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 nine, above.
12. Respondent Yelverton 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 Yelverton and has determined that Respondent Yelverton does not have the financial ability to pay completely disgorgement of $877,350, plus prejudgment interest.
13. Yelverton has submitted sworn financial statements and other evidence and has asserted his financial inability to pay a civil penalty. The Commission has reviewed the sworn financial statements and other evidence provided by Yelverton and has determined that Yelverton does not have the financial ability to pay a civil penalty.
ACCORDINGLY, IT IS HEREBY ORDERED:
1. That Respondent Yelverton be barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company;
2. That Respondent Yelverton cease and desist from committing or causing any violation or any future violation of Section 17(a) of the Securities Act or Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
3. That Respondent Yelverton shall pay disgorgement of $877,350, plus prejudgment interest, provided that Yelverton shall pay $3,000 within thirty (30) days of this order and shall pay an additional $27,000 within 270 days 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, 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 Yelverton as a respondent in these proceedings. Yelverton 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 as of the date of this Order arising from his interest in the seven limited partnerships which own low-income housing projects financed by urban renewal revenue bonds underwritten by TWC between August 1992 and October 1993. Payment of the remainder of the disgorgement is waived based upon Respondent Yelverton's demonstrated financial inability to pay;
4. 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 Yelverton 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 Yelverton'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 Yelverton was fraudulent, misleading, inaccurate or incomplete in any material respect and whether any additional remedies should be imposed. Respondent Yelverton 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;
Footnotes
-[1]- The findings herein are made pursuant to the Offer of Settlement of the Respondent and are not binding on any other person or entity named as a respondent in this or any other proceeding.
In re James V. Pannone, Exchange Act Release No. 41065, A.P. File No. 3-9830 (February 17, 1999).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public administrative proceedings be, and hereby are, instituted pursuant to Sections 15(b) (6), 15B(c) (4) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act"), against James V. Pannone ("Pannone").
II. In anticipation of the institution of these proceedings, Pannone has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, Pannone, without admitting or denying the findings contained in this Order Instituting Public Administrative Proceedings Pursuant to Section 15(b) (6), 15B(c) (4) and 19(h) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions ("Order"), except that Pannone admits: (i) that the Commission has jurisdiction over him and over the subject matter of these proceedings, and (ii) the entry of the injunction set forth in paragraph III.D below, consents to the entry of the findings and the imposition of the remedial sanctions set forth herein.
III. FINDINGS
On the basis of this Order and the Offer, the Commission finds that:1
A. At all times relevant, Pannone was associated with Stifel, Nicolaus & Company, Inc. ("Stifel"), a broker-dealer and municipal securities dealer registered with the Commission.
B. On September 21, 1998, the Commission filed its Second Amended Complaint ("Complaint") against Pannone [Securities and Exchange Commission v. Robert Cochran, et al., Case No. CIV-95-1477-A (W.D. Okla.)], alleging that Pannone violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and Rule G-17 of the Municipal Securities Rulemaking Board ("MSRB").
C. The Complaint alleged that Pannone, in conjunction with others, defrauded two municipal bond issuers and the respective municipal bond purchasers by failing to disclose and/or making false statements concerning: (i) the rigging of the bidding process to ensure the selection of a certain entity as the investment agreement provider; and (ii) the resulting payments Stifel received from the investment agreement provider.
D. On February 17, 1999, pursuant to a consent agreement in which Pannone neither admitted nor denied any of the allegations contained in the Complaint, the federal district court in the Western District of Oklahoma entered a Final Judgment of Permanent Injunction and Other Relief as to Defendant James Pannone, permanently enjoining Pannone from violations of Section 17(a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5 thereunder, and Rule G-17 of the MSRB.
IV. ORDER
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer and impose the sanctions specified therein.
ACCORDINGLY, IT IS HEREBY ORDERED that:
A. Pannone be, and hereby is, suspended from association with any broker or dealer or municipal securities dealer for twelve months, effective on the second Monday following the entry of this Order; and
B. Pannone shall provide to the Commission, within three days after the end of the twelve-month suspension period described above, an affidavit that he has complied fully with the sanctions described in Section IV A above.
Footnotes
-[1]- The findings in this Order are made pursuant to Pannone's Offer and are not binding on any other person or entity in this or any other proceeding.
In re Randall W. Nelson, Securities Act Release No. 7635, Exchange Act Release No. 40984, A.P. File No. 3-9819 (January 27, 1999).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative proceeding be, and hereby is, instituted pursuant to 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"), against Randall W. Nelson ("Nelson").
II. In anticipation of the institution of this proceeding, Nelson has submitted an Offer of Settlement ("Offer"), which the Commission has determined to accept. Solely for the purpose of this proceeding, and any other proceedings brought by or on behalf of the Commission, or to which the Commission is a party, Nelson, without admitting or denying the findings contained in this Order Instituting Public Administrative Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b) (6) and 19(h) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order ("Order"), except that Nelson admits that the Commission has jurisdiction over him and over the subject matter of this proceeding, consents to the entry of the findings and the imposition of the remedial sanctions set forth herein.
III. On the basis of this Order and the Offer, the Commission finds that:1
A. RESPONDENT
Nelson is a resident of Tulsa, Oklahoma. From April 1991 until April 1993, Nelson was associated with Stifel, Nicolaus & Company, Inc. ("Stifel"), employed in its Oklahoma Public Finance Office in Oklahoma City.
B. OTHER RELEVANT ENTITIES
1. Stifel is a broker-dealer and municipal securities dealer registered with the Commission and headquartered in St. Louis, Missouri. On August 3, 1995, the Commission filed a settled civil injunctive action against Stifel. The Commission's complaint against Stifel included allegations concerning Stifel's restructuring of the Grand River Dam Authority's debt service fund, as described below. Without admitting or denying the allegations in the complaint, Stifel consented to the entry of a final judgment which enjoined Stifel from violating certain provisions of the federal securities laws, and ordered Stifel to disgorge certain unjust gains plus prejudgment interest thereon, and to pay a civil monetary penalty. See SEC v. Stifel, Nicolaus & Co., Inc., Lit. Rel. No. 14587 (Aug. 3, 1995).
2. The Grand River Dam Authority ("GRDA") is a conservation and reclamation district and an agency of the state of Oklahoma. The directors of the GRDA are appointed by the Governor of Oklahoma, with the advice and consent of the Oklahoma Senate. The GRDA provides electrical service to a defined area in Oklahoma. The GRDA has a limited staff, and relies substantially on outside professionals in issuing municipal securities and related financial matters.
C. THE GRDA RETAINS STIFEL AND NELSON TO RESTRUCTURE THE DEBT SERVICE FUND
For several years prior to joining Stifel, Nelson was a trust department officer at an Oklahoma commercial bank which served as the trustee for certain GRDA bond issues. As a result, Nelson developed a relationship of trust and confidence with the GRDA and its staff.
After joining Stifel's Oklahoma Public Finance Office in April 1991, Nelson approached the GRDA and proposed that the GRDA restructure a debt service fund associated with a previous bond issue. Nelson told the GRDA that he believed that Stifel could obtain for the GRDA a higher yield on the moneys in its debt service fund than it was then receiving, plus a one time, up-front cash payment of at least $1 million.
In June 1991, based upon Nelson's proposal, the GRDA hired Stifel to act as its financial adviser in restructuring the debt service fund for a total fee of $75,000. Acting as financial adviser, Nelson proposed an investment contract for the GRDA's debt service fund. The investment contract, as proposed by Nelson, provided for an interest rate of seven percent. The winning bidder would be the bidder willing to make the largest up-front payment to the GRDA in excess of $1 million, in addition to paying the requested rate of interest.
D. STIFEL RECEIVES A BROKERAGE FEE THAT IS NOT DISCLOSED TO THE GRDA
Nelson and James Pannone ("Pannone"), another member of Stifel's Oklahoma Public Finance Office, contacted a then vice president (the "Vice President") at Pacific Matrix Financial Group, Inc. ("Pacific Matrix"), an investment contract broker, and requested that he solicit bids for the investment contract. Nelson and Pannone demanded, and the Vice President agreed, that Stifel would receive ninety percent of whatever brokerage fee was paid by the winning provider.
Steven Strauss ("Strauss"), a then managing director of Sakura Global Capital, Inc. ("Sakura"), told Nelson, Pannone and the Vice President that Sakura was willing to pay the seven percent interest rate requested in the bid solicitation, plus an up-front payment in the amount of $1.4 million, which was the largest up-front payment offered by any of the bidders. Nelson, Pannone, the Vice President and Strauss agreed that Sakura would pay, from the amount of its gross bid, the sum of $283,500 directly to Stifel, as well as the sum of $31,500 to Pacific Matrix. After discussions within the Oklahoma Public Finance Office, Nelson told the GRDA that Sakura's bid included an up-front payment in the amount of $1.085 million and failed to disclose that the figure was net of the $283,500 Sakura paid to Stifel and the $31,500 Sakura paid to Pacific Matrix.
About one week after the closing of the GRDA transaction, a member of Stifel's compliance department asked Nelson if Stifel's payment from Sakura had been disclosed to the GRDA. Because Nelson had not disclosed to the GRDA the payment from Sakura, Nelson wrote a letter to the GRDA advising the GRDA that Stifel would receive a payment from Sakura. Nelson gave the letter to his supervisor who acknowledged that the payment had not been disclosed. Nelson's supervisor told Nelson he would take care of the matter. Nelson's supervisor never sent the letter to the GRDA.
E. NELSON CAUSED STIFEL'S VIOLATIONS OF SECTION 17(a)(2) AND (3) OF THE SECURITIES ACT
As the financial adviser to the GRDA, Stifel had a duty to disclose conflicts of interest. Receiving a payment from Sakura was a conflict of interest which should have been disclosed to the GRDA at the time the potential conflict arose. Stifel violated Section 17(a)(2) and (3) of the Securities Act by not disclosing to the GRDA the payment it received from Sakura. By failing to disclose the conflict of interest to the GRDA, Nelson willfully aided and abetted and caused Stifel's violations of Section 17(a)(2) and (3) of the Securities Act.
IV. FINDINGS
From April 1991 until April 1993, Nelson was associated with Stifel, Nicolaus & Company, Inc., a broker-dealer and municipal securities dealer registered with the Commission.
Based on the foregoing, the Commission finds that Nelson willfully aided and abetted and caused Stifel's violations of Section 17(a)(2) and (3) of the Securities Act.
V. ORDER
In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer and impose the sanctions specified therein.
ACCORDINGLY, IT IS HEREBY ORDERED that:
A. Nelson, pursuant to Section 8A of the Securities Act, cease and desist from committing or causing any violation and any future violation of Section 17(a)(2) and (3) of the Securities Act;
B. Nelson pay a civil monetary penalty in the amount of $20,000, pursuant to Section 21B of the Exchange Act, to the United States Department of Treasury, within ten days after the entry of this Order. Payment shall be: (i) made by United States postal money order, certified check, bank cashier's check or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (iv) submitted under cover letter which identifies Nelson as the Respondent in this proceeding and the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to Kevin J. Harnisch, Senior Counsel, Division of Enforcement, Securities and Exchange Commission, 450 Fifth Street, N.W., Stop 7-2, Washington, D.C. 20549;
C. Nelson be, and hereby is, suspended from association with any broker or dealer for one month, effective on the third day following the entry of this Order; and
D. Nelson provide to the Commission, within three days after the end of the one-month suspension period described above, an affidavit that he has complied fully with the sanctions described in Section V.C above.
Footnotes
-[1]- The findings in this Order are made pursuant to Nelson's Offer and are not binding on any other person or entity in this or any other proceeding.
In re Stephens Inc., Securities Act Release No. 7612, Exchange Act Release No. 40699, A.P. File No. 3-9781 (November 23, 1998).
The Commission deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") [15 U.S.C. 77h-1] and Sections 15(b) (4), 15B(c) (2) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. 78o(b) (4), 78o-4(c) (2), 78s(h) and 78u-3] against Stephens Inc. ("Stephens" or "Respondent").
In anticipation of the institution of these proceedings, Stephens has submitted an Offer of Settlement ("Offer") to the Commission, which the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, Stephens, without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over Respondent and over the subject matter of these proceedings, which is admitted, consents to the entry of the findings, and the imposition of the remedial sanctions set forth below.
The Commission finds1 that:
FACTS
Respondent
Stephens Inc. Stephens is an Arkansas corporation with its principal place of business in Little Rock, Arkansas. At all relevant times, Stephens was a broker-dealer and municipal securities dealer, and was registered with the Commission pursuant to Sections 15(b) and 15B(a) of the Exchange Act.
Summary
This matter involves undisclosed payments to three Florida public officials, and other improper practices in connection with Stephens' pursuit of municipal securities business between 1989 and 1995, including the failure to disclose to a Georgia issuer Stephens' receipt of a brokerage commission on a Guaranteed Investment Contract ("GIC") in 1993.
William C. Bethea--a former senior vice-president of Stephens who served as head of its Public Finance Department from June 1991 until March 1994--authorized secret payments to one Florida public official, facilitated secret payments to another, and endorsed the conferral of an undisclosed favor on a third, all for the purpose of obtaining or retaining municipal securities business for Stephens.2 In addition, Bethea, who from 1987 until 1991 served as a member of Stephens' Political Action Committee ("PAC") with authority to sign PAC checks: (1) enlisted third parties to serve as conduits for approximately $10,000 in Stephens campaign contributions between 1989 and 1992; and (2) created materially false and misleading books and records. In much of the aforementioned activity, Bethea was assisted by Preston C. Bynum, a former Stephens banker from its Little Rock office. In connection with the conferral of the undisclosed favor referenced above, Bethea was also assisted by a former Stephens vice-president from its Atlanta office who had supervisory responsibility over the Public Finance Department bankers in that office (the "Atlanta Supervisor"). Following Bethea's tenure as department head, the Atlanta Supervisor also took part in the secret compensation of a Florida state official as an inducement and reward for that official's support of Stephens' selection for certain state securities business.
As a result of the misconduct of these former members of its Public Finance Department, Stephens is responsible for (1) defrauding three different issuers in six different offerings of municipal securities; (2) defrauding investors in those offerings; and (3) violating books and records provisions and the gifts and fair-dealing rules of the Municipal Securities Rulemaking Board ("MSRB").
Payments to Escambia County Utilities Authority ("ECUA")3 Official Terry D. Busbee
During 1992 and 1993, Bethea authorized, and assisted Bynum with, the payment of at least $18,000 to Terry D. Busbee, an elected public official of the ECUA, for the purpose of securing underwriting business for Stephens in two ECUA bond issuances: a $16 million offering used to finance the upgrade of a sewage treatment plant, that closed on October 29, 1992 ("Plant Upgrade issue"); and a $20 million offering used to acquire and upgrade the existing sanitation system, that closed on February 11, 1993 ("Sanitation issue").
On Thursday, July 30, 1992, after casting the deciding vote to select Stephens as senior managing underwriter for the ECUA's Plant Upgrade issue, Busbee demanded of Bynum that Stephens pay an associate in excess of $15,000 to (1) prevent the rescinding of Stephens' selection for the Plant Upgrade underwriting; and (2) ensure Stephens' selection as lead underwriter for the upcoming Sanitation issue. When informed by Bynum of this demand, Bethea agreed to it, despite knowing, having reason to know, or recklessly disregarding the fact that the payments to Busbee's associate were meant for Busbee. Shortly thereafter, Bethea learned from Bynum that the payments would, in fact, be funneled to Busbee.
On September 29, 1992, Busbee again cast the deciding vote for Stephens' selection as lead underwriter, this time for the Sanitation issue. Thereafter, in November 1992 and September 1993, respectively, Bethea and Bynum caused Stephens to issue checks of $10,000 and $7,500 payable to an entity owned by Busbee's associate, in accordance with the payment arrangement Bethea had approved. Bethea caused the mischaracterization of these payments on Stephens' books and records as payments to Busbee's associate for consulting services; they, in fact, were payments to Busbee. Moreover, no such consulting services had been rendered by Busbee's associate.
In order to conceal the payment scheme, Bethea caused the delay in the issuance of the second ($7,500) check until after the completion of a state grand jury investigation into the ECUA's underwriter selections. A further payment of $6,000 was disbursed in October 1993, at Bynum's request. In addition, Bynum gave Busbee $8,935.84 more in December 1993, by paying off certain loans on Busbee's behalf.
At no time during the selection or offering process for the Plant Upgrade or Sanitation bonds was the payment arrangement with Busbee and the resulting conflicts of interest created thereby disclosed.
Payments to Osceola County4 Official Larry K. O'Dell
By the Summer of 1992, a municipal securities business development consultant to Stephens (the "Consultant") had entered into a secret agreement with Larry K. O'Dell, then Director of Public Works for Osceola County, Florida, that if O'Dell would help Stephens obtain a selling group position for an upcoming bond issue of Osceola County, the Consultant would share his compensation from Stephens with O'Dell. The bond issue in question was the $150 million Osceola County, Florida, Transportation Improvement Bonds (Osceola Parkway Project), dated July 15, 1992 ("Parkway Bonds").
Also by the Summer of 1992, Bethea had agreed with the Consultant that, if Stephens were selected as a selling group member for the Parkway Bonds, Stephens would pay the Consultant one-half the Public Finance Department's net profits on that bond issue. Although Bethea lacked actual knowledge of the payment arrangement between the Consultant and O'Dell, he ignored indications that the Consultant would (and did) share his compensation with O'Dell in the approximate amount of $1,700.
By July 1992, with O'Dell's help, Stephens was named a selling group member for the Parkway Bonds. The bond issue closed on August 6, 1992. By December 1992, Stephens' Public Finance Department had recorded net profits of $35,739.54 for the Parkway Bonds. At that time, in accordance with his agreement with the Consultant, Bethea caused Stephens to issue a check to the Consultant for $17,869.77--exactly half of $35,739.54--ostensibly for "special compensation" relating to "Florida transactions." In fact, this check was solely for the Parkway Bonds.
Shortly thereafter, concerned that the arithmetical relationship between the $17,869.77 check and the amount of his department's profits from the Parkway Bonds might cause the uncovering of its connection to that bond issue, Bethea directed the voiding of the $17,869.77 check, and its replacement by another check, in a different amount, with different supporting documentation. The replacement check, for $17,800, was mischaracterized on Stephens' books and records at Bethea's direction as a "bonus" pursuant to the Consultant's contract with Stephens.
At no time during the selling-group selection or offering process for the Parkway bonds was the payment arrangement with O'Dell and the resulting conflicts of interest created thereby disclosed.
Conferral of Undisclosed Favor on Florida Housing Finance Agency ("FHFA")5 Official W. Jay Ramsey
In or about early March 1993, the Consultant assisted W. Jay Ramsey, an FHFA official, in obtaining a $90,000-per-year post with an architecture firm the Consultant represented, by giving Ramsey a favorable recommendation. Bethea learned of the Consultant's help with Ramsey's employment at the time it occurred. Shortly thereafter, the Atlanta Supervisor enlisted the Consultant to assist Stephens with its effort to be named remarketing agent for a $6 million remarketing issue of the FHFA that closed on August 19, 1993 ("Remarketing issue"), by advocating Stephens' selection to Ramsey. Bethea approved the hiring of the Consultant for this purpose. The Consultant then persuaded Ramsey to drop his prior opposition to Stephens' selection. In June 1993, Stephens was selected as remarketing agent for the Remarketing issue, with Ramsey's support.
Following closing of the Remarketing issue, Bethea caused Stephens to issue a $10,000 check to the Consultant for his assistance in that issue. At Bethea's direction, however, false books and records were created at Stephens concerning the $10,000 payment, including an invoice mischaracterizing the payment as relating to other matters.
Payments to FHFA Official W. Jay Ramsey
In April 1994, the FHFA invited interested underwriting firms to seek positions on its Approved List of Senior Managing Underwriters (the "Senior Manager Rotation") by issuing a Request for Proposals (the "Rotation RFP"). The Senior Manager Rotation was a list specifying which firms were approved as lead (i.e., "senior managing") underwriters for FHFA bond issues; once the Senior Manager Rotation was established, underwriters for particular FHFA bond issues were selected from it. Stephens submitted a proposal in response to the Rotation RFP. At the time, it had been nearly three years since Stephens held a spot in the FHFA's Senior Manager Rotation. By June 1994, the selection process pursuant to the Rotation RFP was completed. Stephens was not among the sixteen firms ultimately selected; nor did Stephens make the FHFA's short list of firms invited for interviews.
By November 1994, one of the sixteen firms indicated it would resign, causing an opening in the rotation. Also by November 1994, Ramsey, who served not only on the FHFA's board but also on its Professional Services Selection Committee, asked the Consultant for supplemental income of $1,500 per month.
On November 21, 1994, in Tampa, Ramsey, the Consultant, and two Stephens bankers (one of whom was the Atlanta Supervisor), met. At that meeting, the three Stephens representatives asked Ramsey to help Stephens fill the opening in the FHFA's Senior Manager Rotation. Ramsey agreed to help. At or about the same time, the Consultant agreed to arrange for the $1,500 in supplemental monthly income.
By December 5, 1994, the Atlanta Supervisor had enlisted the Consultant to assist with Stephens' naming as remarketing agent for certain FHFA securities offerings. The Consultant did so by, among other things, advocating Stephens' selection to Ramsey.
On December 9, 1994--less than three weeks after the Tampa meeting--the FHFA's Professional Selection Committee and full board both met. Ramsey was present at the meetings. One item of business taken up at both meetings was Stephens' addition to the FHFA's Senior Manager Rotation. Both the Professional Selection Committee and the full board, including Ramsey, voted unanimously to take this action.
By early January 1995, less than a month after Stephens' addition to the Senior Manager Rotation, the Consultant arranged to furnish Ramsey with his first $1,500 payment. This payment was made through a conduit, under cover of documentation falsely characterizing it as for consulting work. On February 3, 1995, just one week after Ramsey deposited the $1,500, the full board, including Ramsey, voted unanimously to select Stephens as remarketing agent for a $32 million FHFA remarketing issue--the same issue for which the Consultant had previously advocated Stephens' selection to Ramsey. Because the Consultant and Ramsey became aware of the Commission's investigation regarding this matter, no additional monthly payments were made to Ramsey.
By mid-February 1995, the Consultant, with the assistance of the Atlanta Supervisor, entered into a contract with Stephens for consulting services. Although this contract purported to be for future services outside the municipal securities arena, the contract and all payments thereunder were in fact exclusively for the Consultant's assistance with FHFA matters, and principally for Stephens' addition to the Senior Manager Rotation.
On October 13, 1995, the full board, including Ramsey, voted unanimously to select Stephens as remarketing agent for another FHFA issue: A $23 million remarketing that closed in December 1995. Subsequently, solely as a result of its inclusion in the Senior Manager Rotation, Stephens was named a co-manager for a $13.5 million FHFA bond issue dated March 1996.
Neither during the selection of Stephens for any of the FHFA issues identified above, nor during the offering process, were the payment arrangement with Ramsey and the resulting conflicts of interest created thereby disclosed.
Non-disclosure of GIC Commission to Cherokee County (Georgia) Water and Sewerage Authority ("Cherokee WSA")6 In December 1993, Stephens served as sole underwriter for a $46 million refunding bond issue of the Cherokee WSA ("Cherokee WSA Refunding Bonds"). Contemporaneously with the closing of the bonds, and on the advice of Stephens, the Cherokee WSA entered into a GIC. The Cherokee WSA reasonably believed and understood at the time that Stephens' underwriting fees and sales commissions on the bonds were all the compensation Stephens would receive. It was never disclosed to the Cherokee WSA that Stephens received $75,482.28, which was a portion of the GIC broker's commission paid by the GIC provider.
Books and Records Violations
The payments to public officials and the consulting payments referenced above were accompanied and facilitated by false and misleading entries in the books and records of Stephens. The payments to the officials and payments to the Consultant were mischaracterized in check request forms and accounting records, and never designated as relating to the items of business for which they were paid. Numerous other instances of misbookings of payments and disbursements occurred at Stephens as well; these are described below.
1. Invoicing the ECUA for a Fishing Trip
In 1992, Stephens invoiced the ECUA for "communications and regulatory expenses." Although never paid by ECUA, included within this invoice as a "regulatory" expense was $2,130.75 that Stephens paid toward a Stephens-sponsored golf and fishing outing for Busbee and others. By so characterizing this expense, the invoice was false and misleading.
2. Misbookings of Consultant Compensation relating to a Walton County, Florida Bond Issue
In connection with a $17 million Florida Community Services Corporation of Walton County ("FCS-Walton")7 bond issue closing in February 1992, for which Stephens served as sole underwriter (the "South Walton Bonds"), Stephens' books and records contained false and misleading entries. In particular, the Consultant's invoice for $35,000 in fees relating to the South Walton Bonds included an itemization of expenses that was fictional and that was created at Bethea's direction to make the invoice appear legitimate. In fact, the Consultant had incurred no such expenses. In addition, following closing of the South Walton Bonds, Bethea and the Consultant executed a misleading "contract" between Stephens and the Consultant. This contract was purportedly for consulting services to be performed over the ensuing nine months throughout the state of Florida, and provided for compensation of $9,500 per month plus $7,000 in "start-up expenses." In fact, the contract and all payments thereunder were exclusively for the Consultant's activities in connection with the South Walton Bonds.
3. Misbookings of Campaign Contribution Reimbursements
Finally, in 1992, by or at the direction of Bethea, false books and records were created at Stephens concerning the reimbursement of campaign contributions. In particular, during the Summer of 1992, the Consultant, at Bethea's request, acted as a conduit for $700 in Stephens campaign contributions to ECUA candidates. At Bethea's direction, the Consultant invoiced Stephens for these contributions, as "expenses" relating to the Consultant's contract with Stephens. Bethea also directed the creation of materially misleading accounting records at Stephens mischaracterizing the true nature of these payments.
Between 1989 and 1992, inclusive of the $700 in reimbursed ECUA campaign contributions referenced above, Bethea and Bynum enlisted Stephens employees and outside vendors to make approximately $10,000 in campaign contributions to state and local candidates in connection with Stephens' efforts to obtain municipal securities business. With respect to these contributions, Bethea and Bynum caused the reimbursement of the employees and outside vendors, and in some cases, the advancing of funds to them, for the contributions. Again, in some instances Stephens' books and records failed to accurately reflect the true nature of these payments.
LEGAL ANALYSIS
Violations of the Antifraud Provisions
By virtue of the above-described conduct of Bethea, Bynum, the Atlanta Supervisor and the Consultant, Stephens is responsible for violating Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Nondisclosure to Issuers
The failure to disclose the arrangements with and payments to Busbee, O'Dell and Ramsey constituted and operated as a scheme to defraud the issuers of the ECUA, Osceola County, and FHFA bonds. See First Fidelity Securities Group, Exchange Act Rel. No. 36694, 61 S.E.C. Docket 68 (Jan. 9, 1996) (underwriter defrauded issuers by paying undisclosed kickbacks to fiduciary for underwriting business).
Moreover, as an underwriter of ECUA and FHFA securities, and as a selling group member for Osceola County securities, Stephens was a purchaser of securities from those issuers. Bethea, Bynum and the Atlanta Supervisor, knew and understood that Stephens, as a broker-dealer, had an obligation to deal fairly with the issuers. See Charles Hughes & Co. v. SEC, 139 F.2d 434, 437 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944); see also MSRB rule G-17.8 The undisclosed arrangements with and payments to Busbee, O'Dell and Ramsey breached that duty. See, e.g., SEC v. Feminella, 947 F. Supp. 722, 732 (S.D.N.Y 1996) (kickback paid to agent of broker-dealer's customer should have been received by the customer, and not the agent). The ECUA, Osceola County and the FHFA were entitled to impartial advice from their respective officials, and in evaluating that advice were entitled "to judge for themselves what significance to attribute" to the payments their officials received. See Wilson v. Great American Industries, Inc., 855 F.2d 987, 994 (2d Cir. 1988). This is "not because such [arrangements] are always corrupt but because they are always corrupting." Mosser v. Darrow, 341 U.S. 267, 271 (1951).9
Nondisclosure to Investors
As underwriter on the ECUA and FHFA offerings, Stephens delivered the Official Statements for the offerings to investors, and had a duty to review the key representations in those Official Statements.10 The Official Statements for the ECUA and FHFA offerings failed to disclose the payments to Busbee and Ramsey. Because the existence of these payments cast doubt on the integrity of the offering process for the respective bond issues, they were material to investors. In the Matter of Lazard Freres & Co. LLC., Exchange Act Rel. No. 39388/Dec. 3, 1997.
Scienter
Bethea, Bynum and the Atlanta Supervisor, acted with the requisite scienter.11 This is evidenced by their efforts to keep hidden the arrangements with and payments to Busbee, O'Dell and Ramsey, including by making the payments through an indirect channel, and under the guise of false and misleading documentation. By virtue of their positions with Stephens, the mental states of Bethea, Bynum and the Atlanta Supervisor may be imputed to Stephens.
Jurisdiction
The arrangements for, and payments of the monies to public officials, violated the antifraud provisions because they "touch[ed]" on the ECUA's, Osceola County's and the FHFA's sale of the securities. Superintendent of Insurance of New York v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13 (1971). The information withheld was material to the issuers' decision to select Stephens as underwriter and as selling group member, and the selection of underwriters and selling group members had a direct nexus with the issuers' sale, and in turn, the public's purchase of the issuers' securities.
Violations of Section 15B(c)(1) of the Exchange Act and MSRB rules G-17 and G-20
As associated persons of a broker-dealer, Bethea, Bynum and the Atlanta Supervisor were bound by the MSRB rules.12 By virtue of their above-described conduct in connection with the ECUA, Osceola County, and FHFA transactions, and by virtue of the failure to disclose the GIC commission in the Cherokee WSA transaction, Stephens is responsible for violating Section 15B(c)(1) of the Exchange Act and MSRB rules G-17 and G-20.
MSRB rule G-17
The failure to disclose financial and other relationships between Stephens and fiduciaries of its issuer clients, and its issuer-client's GIC broker, created potential or actual conflicts of interest and violated MSRB rule G-17, a fair-dealing rule. See Lazard Freres & Co. LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Rel. No. 36419 (Oct. 26, 1995); SEC v. Ferber, Lit. Rel. No. 15193 (December 19, 1996); First Fidelity Securities Group, supra; SEC v. Busbee, Lit. Rel. Nos. 14387 (January 23, 1995) and 14508 (May 24, 1995)); SEC v. Rudi, Lit. Rel. Nos. 14421 (February 23, 1996) and 15202 (December 30, 1996). In addition, the use of third parties as conduits for campaign contributions made in connection with municipal securities business development efforts likewise violated rule G-17. See In the Matter of FAIC Securities, Inc., Exchange Act Rel. No. 36937 (March 7, 1996) (imposing liability under Rule G-17 where broker dealer, among other things, failed to disclose its non-compliance with state law regarding campaign contributions made in furtherance of municipal securities business development efforts).
Footnotes
-[1]- The findings herein are made pursuant to Respondent's Offer and are not binding on any other person or entity in these or any other proceedings.
-[2]- The Commission has filed separate enforcement actions related to some of the matters discussed herein. SEC v. Bynum, Civil Action No. 95-30024-RV (N.D. Fla.); Lit. Rel. No. 14387/January 23, 1995; SEC v. O'Dell, Civil Action No. 98-948-Civ-Orl-18A (M.D. Fla.); Lit. Rel. No. 15858/August 24, 1998.
-[3]- The ECUA is a local government body that was established by the Florida legislature in 1981, for the purpose of managing, financing and improving the water and sewer systems of Escambia County, Florida. At all relevant times, the ECUA was empowered to issue revenue bonds to finance the acquisition, construction and improvement of water, sewer, sanitation and (with certain limitations) natural gas systems within Escambia County and some adjacent areas. The ECUA had an elected board comprised of five members who served staggered four-year terms.
-[4]- Osceola County is a political subdivision of the State of Florida. Its governing body is the Osceola County Board of Commissioners. At all relevant times, the Osceola County Board of Commissioners consisted of five elected members, and was empowered to issue bonds and to select underwriters and selling group members in connection with such bond issuances. The authority to select selling group members was delegated to the Osceola County Manager.
-[5]- At all relevant times, the FHFA was a public body, established under Florida law, empowered, among other things, to issue revenue bonds to provide financing for mortgage loans to assist in alleviating the shortage in safe, sanitary, affordable housing for low-, middle- and moderate-income persons or families. The FHFA was headed by a nine-member board of directors. Eight of the nine members were appointed by the Governor and confirmed by the state senate; the ninth member, the Secretary of the Department of Community Affairs, was an ex-officio, voting member of the board.
-[6]- Cherokee WSA was at all relevant times a public body established under Georgia law and empowered, among other things, to operate, expand and improve sources of water supply, water utility and sewage treatment facilities both within and without the territorial boundaries of Cherokee County, Georgia. The Cherokee WSA was headed by a seven-member board, appointed by the grand jury of Cherokee County. The Cherokee WSA was empowered to issue bonds to finance the construction, operation, maintenance, expansion and improvement of facilities within its system, and to refinance prior bonds issued for such purposes.
-[7]- FCS-Walton was at all relevant times a non-profit corporation which provided central wastewater and water service through a regional utilities system for South Walton County,
-[8]- MSRB rule G-17 provides: In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.
-[9]- Cf. United States v. Waymer, 55 F.3d 564, 572 (11th Cir. 1995), cert. denied, 517 U.S.1119(1996) (nondisclosure of kickback prevented renegotiations of contracts at better price); United States v. Rudi, 902 F. Supp. 452, 456-57 (S.D.N.Y. 1995); and First Fidelity Securities Group, supra, 61 S.E.C. Docket at 78.
-[10]- See Exchange Act Rule 15c2-12. As the Commission stated in proposing the Rule: By participating in an offering, an underwriter makes an implied recommendation about the securities . . . [T]his recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings. Exchange Act Release No. 26100, 41 S.E.C. Docket 1402, 1411 (Sept. 22, 1988).
-[11]- ]: See Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982); Rochez Bros.,Inc. v. Rhoades, 527 F.2d 880, 884 (3d Cir. 1975). See also American Soc'y of Mech. Eng'rs, Inc. v. Hydrolevel Corp., 456 U.S. 556, 565-566 (1982).
-[12]- Section 15B(b) of the Exchange Act established the Municipal Securities Rulemaking Board ("MSRB") and empowered it to propose and adopt rules with respect to transactions in municipal securities by brokers, dealers and municipal securities dealers. Pursuant to Section 15B(c)(1), a broker dealer or municipal securities dealer is prohibited from using the mails or any instrumentality in interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any municipal security in violation of any rule of the MSRB. As a municipal securities dealer, Stephens is subject to Section 15B(c)(1)of the Exchange Act and the MSRB rules.
In re Merrill Lynch, Pierce, Fenner & Smith Inc., Securities Act Release No. 7566, Exchange Act Release No. 40352, A.P. File No. 3-9683 (August 24, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative and cease-and-desist proceeding be and hereby is instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch").
II. In anticipation of the institution of this proceeding, Merrill Lynch has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except that Merrill Lynch admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, Merrill Lynch, by its Offer of Settlement, consents to the entry of this Order Instituting a Public Administrative and Cease-And-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b) and 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing Sanctions and Cease-and-Desist Order ("Order") and to the entry of the findings, sanctions, and cease-and-desist order set forth below.
Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act and Sections 15(b) and 21C of the Exchange Act be, and hereby is, instituted.
III. On the basis of this Order and the Offer of Settlement submitted by Merrill Lynch, the Commission finds that:1
A. RESPONDENT
Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch") is a broker-dealer registered with the Commission pursuant to Section 15(b) of the Exchange Act [15 U.S.C. 78o(b)] and is headquartered in New York, New York. Merrill Lynch was the underwriter or co-manager of $875 million in notes (the "Notes") issued through four offerings (the "Note Offerings") by the County of Orange, California ("Orange County" or the "County") and the Orange County Flood Control District (the "Flood Control District") in July and August 1994.
B. FACTS
1. Introduction
Merrill Lynch was the underwriter or co-manager of the Note Offerings conducted by Orange County and the Flood Control District in July and August 1994.2 Merrill Lynch sold the Notes to institutional investors through Official Statements that omitted material facts about the Orange County Investment Pools' (the "Pools") investment strategy, the risks of that strategy, and the Pools' investment losses. Accurate and complete disclosure about the Pools was material to investors because, in all four offerings, the funds pledged to repay the notes were invested in the Pools and, in two of the offerings, the Pools guaranteed repayment of the notes in that the Orange County Treasurer-Tax Collector ("Treasurer"), on behalf of the Pools, agreed that, if the funds pledged to repay the notes were insufficient, the Treasurer would purchase the notes at maturity at face value plus interest.
The Official Statements for three of the Note Offerings also omitted to disclose that the variable interest rate paid on the Notes was statutorily capped at 12%. This information was material to investors that had adopted policies against investing in securities with an interest rate cap.
As a result of a business relationship with the County, certain Merrill Lynch personnel knew substantial information about the Pools. The firm, however, unreasonably failed to assure that such information was conveyed to the Merrill Lynch employees who were responsible for reviewing and approving the Official Statements. The Merrill Lynch employees who were responsible for reviewing the Official Statements also knew or should have known material information about the Pools and the interest rate cap. These employees, from a reasonable review of the Official Statements, knew or should have known that the Official Statements omitted such information.
2. The Orange County Investment Pools
The Pools operated as an investment fund managed by the Treasurer, in which the County and various local governments or districts ("Participants") deposited public funds. As of December 6, 1994, the Pools held approximately $7.6 billion in Participant deposits, which the County had leveraged to an investment portfolio with a book value of over $20.6 billion.
a. The Pools' Investment Strategy
From at least April 1992 until December 1994, the Treasurer's investment strategy for the Pools involved: (1) using a high degree of leverage by obtaining funds through reverse repurchase agreements on a short-term basis (less than 180 days); and (2) investing the Participants' deposits and funds obtained through reverse repurchase agreements in debt securities (issued by the United States Treasury, United States government sponsored enterprises, and highly-rated banks and corporations) with a maturity of two to five years, many of which were derivative securities. The Pools' investment return was to result principally from the interest received on the securities in the Pools. Leverage enabled the Pools to purchase more securities with the anticipation of increasing interest income. This strategy was profitable as long as the Pools were able to maintain a positive spread between the long-term interest rate received on the securities and the short-term interest rate paid on the funds obtained through reverse repurchase agreements.
b. The Pools' Portfolio
During 1993 and 1994, the Treasurer, using reverse repurchase agreements, leveraged the Participants' deposits to amounts ranging from 158% to over 292%. As of the end of June 1994, the Pools held $19.8 billion in securities, with approximately $7.2 billion in Participant deposits and about $12.6 billion in reverse repurchase agreements, resulting in leverage of about 274%. During 1993 and 1994, the amount of derivatives in the Pools' portfolio ranged from 27.6% to 42.2% of the portfolio. As of the end of June 1994, 38.2% of the Pools' securities were derivatives. Most of the Pools' derivative securities were inverse floaters, which paid interest rates inversely related to the prevailing interest rate. From January 1993 through November 1994, 24.89% to 39.84% of the Pools' portfolio consisted of inverse floaters. As of the end of June 1994, 35% of the Pools' portfolio was invested in inverse floaters. From January 1993 through November 1994, only 1.84% to 5.59% of the Pools' portfolio consisted of securities that paid interest rates directly related to the prevailing interest rate (variable rate securities) or securities that paid interest rates that rose at certain stated intervals to certain stated rates (step-up securities). As of the end of June 1994, about 3.17% of the Pools' portfolio was invested in variable and step-up securities.
c. The Pools' Sensitivity To Interest Rate Changes And The Rise In Interest Rates During 1994
The composition of the Pools' portfolio made it sensitive to interest rate changes. As interest rates rose, the market value of the Pools' securities fell, and the interest received on the Pools' inverse floaters also declined. Thus, the Treasurer's investment strategy was profitable so long as interest rates, including the cost of obtaining funds through reverse repurchase agreements, remained low, the market value of the Pools' securities did not decline, and the Pools had the ability to hold securities to maturity.
From April 1992 through 1993, U.S. interest rates remained low and relatively stable. Due to the low interest rates and the Pools' investment strategy, the Pools earned a relatively high yield of approximately 8%. Beginning in February 1994, interest rates began to rise. This rise in interest rates resulted in: (1) an increase in the cost of obtaining funds under reverse repurchase agreements; (2) a decrease in the interest income on inverse floaters; (3) a decrease in the market value of the Pools' debt securities; (4) collateral calls and reductions in amounts obtained under reverse repurchase agreements; and (5) a decrease in the Pools' yield.
d. Orange County's Bankruptcy
By early December 1994, the Pools had an unrealized decline in market value of about $1.5 billion. Shortly thereafter, on December 6, 1994, Orange County filed Chapter 9 bankruptcy petitions on behalf of itself and the Pools (the petition filed on behalf of the Pools was later dismissed). Between early December 1994 and January 20, 1995, the Pools' securities portfolio was liquidated, incurring a loss of almost $1.7 billion on the Participants' deposits of $7.6 billion, a 22.3% loss.
3. The Note Offerings
a. The Taxable Note Offerings
In July and August 1994, Merrill Lynch underwrote or co-managed the underwriting of municipal securities offerings for Orange County and the Flood Control District. The issuers conducted these offerings (the "Taxable Note Offerings") for the purpose of generating an anticipated profit by reinvesting the proceeds (together with funds equal to the estimated interest on the notes) in the Pools to earn an investment return that would be higher than the rate of interest payable to the Taxable Note investors. The issuers pledged these invested funds to secure repayment of the Taxable Notes, and, if the pledged funds were insufficient to pay principal and interest, the issuers would satisfy any deficiency with other moneys lawfully available to repay the notes in the respective issuer's general fund attributable to the fiscal year in which the notes were issued.
The County issued $600 million in notes (the "$600 Million Taxable Notes") on July 8, 1994, described in an Official Statement dated July 1, 1994. These notes earned a variable interest rate reset monthly at the one-month London Interbank Offered Rate ("LIBOR") not to exceed 12% per annum. The $600 Million Taxable Notes were originally due on July 10, 1995. On June 27, 1995, the County and the noteholders entered into Rollover Agreements under which the maturity of the notes was extended from July 10, 1995, to June 30, 1996, and the interest rate paid on the notes was increased. On June 12, 1996, as part of its emergence from bankruptcy, the County repaid the notes with a portion of the proceeds from another County municipal securities offering.
On August 2, 1994, the Flood Control District issued $100 million in notes (the "$100 Million Taxable Notes") described in an Official Statement dated July 27, 1994. These notes earned a variable interest rate reset monthly at the one-month LIBOR plus .03% not to exceed 12% per annum. The notes matured, and were repaid, on August 1, 1995.
b. The Teeter Note Offerings
In July and August 1994, Merrill Lynch underwrote two Orange County offerings of Teeter Notes (the "Teeter Note Offerings"). The purpose of the Teeter Note Offerings was to fund the County's Teeter Plan, an alternate method of property tax distribution whereby the County pays local taxing entities (such as school districts) their share of property taxes upon levy rather than actual collection and the County then retains all property taxes, and the penalties and interest thereon, upon collection.
The first Teeter Note Offering was conducted on July 20, 1994, for $111 million (the "$111 Million Teeter Notes"). These notes were described in an Official Statement dated July 13, 1994. These notes earned a variable interest rate reset monthly at one-month LIBOR not to exceed 12% per annum. The second Teeter Note Offering was conducted on August 18, 1994, for $64 million (the "$64 Million Teeter Notes"). These notes were described in an Official Statement dated August 12, 1994. These notes earned a variable interest rate reset monthly at 70% of one-month LIBOR not to exceed 12% per annum. The $111 Million and $64 Million Teeter Notes matured, and were repaid, in part with proceeds from a June 30, 1995 Teeter bond offering.
The Official Statements for the Teeter Note Offerings represented that the County planned to deposit certain delinquent tax payments, penalties, and interest collections in accounts pledged to repay the Teeter Notes and to then invest those funds in the Pools. The Official Statements for the Teeter Note Offerings represented that the County anticipated that the funds in the repayment account would not be sufficient to pay the principal and interest on the Teeter Notes at maturity and that the County estimated that, at maturity of the Teeter Notes, approximately $70 million would be available in the repayment account to pay the principal and interest on the $175 million in Teeter Notes. The Official Statements further represented that this anticipated deficiency in the repayment account would be satisfied from moneys received under Standby Note Purchase Agreements, which agreements obligated the Treasurer (as "fund manager" of the Pools) to purchase the Teeter Notes, and from other moneys lawfully available to the County for repayment from revenues received or attributable to the fiscal year in which the notes were issued.
4. Omissions Of Material Facts In The Official Statements
Merrill Lynch offered and sold the Notes through Official Statements that omitted material facts regarding the Pools. The Official Statements for three of the Note Offerings also omitted to disclose the statutory 12% cap on the interest rate payable to noteholders.
a. Omissions Of Material Facts Regarding The Pools
i. The Pools' Investment Strategy
The disclosure in the Official Statements for the Note Offerings regarding the Pools' investment strategy was misleading because it failed to disclose material information, including:
(1) the Pools' investment strategy was predicated upon the assumption that prevailing interest rates would remain at relatively low levels; (2) the Pools' use of leverage through reverse repurchase agreements was constant, high, and a major part of the Pools' investment strategy; and (3) the Pools had a substantial investment in derivative securities, particularly inverse floaters.
ii. The Risks Of The Pools' Investment Strategy
The disclosure in the Official Statements regarding the risks of the Pools' investment strategy was misleading because it omitted material information about the Pools' sensitivity to rises in interest rates. Specifically, the Official Statements failed to disclose that because of the Pools' high degree of leverage and substantial investment in inverse floaters, rising interest rates would have a negative effect on the Pools, including: (1) the Pools' cost of obtaining funds under reverse purchase agreements would increase; (2) the Pools' interest income on the inverse floaters would decrease; (3) the Pools' securities would decline in market value; (4) as the value of the securities fell, the Pools would be subject to collateral calls and reductions in amounts obtained under reverse repurchase agreements; (5) the Pools' earnings would decrease; (6) the Pools would suffer losses of principal at certain interest rate levels; and (7) if the Pools' began to suffer lower earnings or losses of principal, certain Participants may withdraw their invested funds, leaving the County and other Participants such as the Flood Control District who were required to deposit their funds with the Treasurer to absorb any losses.
iii. The Pools' Investment Results
The disclosure in the Official Statements regarding the Pools' historic investment results was misleading because it omitted material information regarding the Pools' investment results during the first half of 1994 when interest rates were rising. Specifically, the Official Statements omitted to disclose that as a result of rising interest rates in 1994, the market value of the Pools' securities was declining, the Pools were subject to collateral calls and reductions in amounts obtained under reverse repurchase agreements, and the Pools' costs of obtaining funds under reverse repurchase agreements were increasing.
b. Omission Of The Interest Rate Cap
The Official Statements for the Taxable Notes and the $111 Million Teeter Notes each represented that the notes paid a variable interest rate connected to one-month LIBOR. These Official Statements were misleading because they omitted to disclose the material information that the notes contained a statutory 12% cap on the maximum variable interest rate.
5. Merrill Lynch's Knowledge About The Pools
a. Merrill Lynch's Securities Business With Orange County
Merrill Lynch engaged in significant securities business with Orange County in the years prior to the Note Offerings. From 1992 to December 1994, Orange County was one of Merrill Lynch's largest accounts. As of June 1994, just prior to the Note Offerings, approximately two-thirds of the securities in the Pools' portfolio, including inverse floaters, had been purchased from Merrill Lynch and almost one-fifth of the Pools' reverse repurchase agreements were entered into with Merrill Lynch. Merrill Lynch conducted this securities business with Orange County through trading and sales personnel, who as a result knew substantial information about the Pools.
b. Merrill Lynch's Receipt Of Information Concerning The Pools From Orange County
Merrill Lynch, through trading and sales personnel, received from the County several documents that provided detailed information about the Pools, including the Pools' Annual Financial Statements (the "Annual Reports") for fiscal years 1991-1992 and 1992-1993.
The 1991-1992 Annual Report stated that: the Pools' investment strategy was to obtain funds through reverse repurchase agreements and reinvest the proceeds in securities that paid an interest rate higher than the interest paid on those funds; the Pools would "vigorously continue" this reverse investment policy; the Pools invested in derivative securities; and the Treasurer "expected interest rates to stay in or near these [low] levels for at least the next two or three years."
The 1992-1993 Annual Report stated that: the Pools' investment strategy utilized leverage through reverse repurchase agreements and derivative securities, particularly inverse floaters; the Pools' leverage ratio was approximately 2 to 1; the Pools' leverage strategy had "been predicated on interest earning rates to continue to remain low for a minimum of the next three years"; and if interest rates were to rise materially, it would be "reasonable to expect that the overall performance of the portfolio would decline."
c. Merrill Lynch's Derivatives Pricing Reports
From 1992 to late 1994, Merrill Lynch, through trading and sales personnel, provided Orange County with a monthly report, called the Derivatives Pricing Report, that marked to market the derivatives that Merrill Lynch had sold to Orange County. The Derivatives Pricing Reports for March through June 1994 priced about $3.7 billion to $4.2 billion in derivative securities, which constituted 17% to 21% of the Pools' total portfolio and 47% to 56% of the Pools' derivative securities. During March through July 1994, a period of rising interest rates, the Derivatives Pricing Reports showed that these derivative securities, marked to market, had declined by between 7.59% and 8.36%.
d. Merrill Lynch's Mid-1992 Review Of The Pools
In mid-1992, Merrill Lynch conducted a review of the Pools' securities, leverage position, and sensitivity to interest rate changes. The review showed that as of mid-1992, the Pools had a $6.15 billion portfolio, including $4 billion in derivative securities, which was purchased with $3.5 billion in deposits and $2.5 billion in funds borrowed under reverse repurchase agreements (indicating leverage of 175%) and that, for each 1% increase (or decrease) in the interest rate, the equity in the Pools would decrease (or increase) by 7%. The review noted that the duration of the Pools' portfolio was relatively long and was more typical of a portfolio with a maturity of ten to twenty years. The review suggested that the account representative responsible for the Orange County account ("account representative") ensure that the County was aware of how sensitive the portfolio was to changes in interest rates and explore with the County ways of reducing its overall leverage by limiting its amount of reverse repurchase agreements.
In an October 1992 letter, Merrill Lynch advised the Treasurer of the results of its mid-1992 review. This letter stated that the Pools' duration indicated more price volatility than would be expected from a portfolio with such a short average maturity of 1.4 years and that the Pools' use of leverage through reverse repurchase agreements and investment in inverse floaters made maturity of the portfolio a less reliable indicator of the price sensitivity of the portfolio. Merrill Lynch trading and sales personnel knew the results of this review and participated in communicating the results to the Treasurer.
e. Merrill Lynch Discussions In November 1992 Regarding The Risks Of The Pools
In November 1992, the Merrill Lynch account representative reported to the Treasurer that a number of Merrill Lynch trading and sales personnel and other officials had met to discuss the Pools. The account representative reported to the Treasurer that these officials had discussed: (1) the fact that the Pools already owned about $3 billion in inverse floaters and was planning on investing another $1 billion in these derivatives; (2) the belief of these Merrill Lynch officials that the Treasurer was too concentrated in inverse floaters and that a significant rise in interest rates would have a negative effect on the Pools' investment performance; and (3) that Merrill Lynch intended to review the derivative structures that Merrill Lynch could offer to Orange County that might serve as a hedge against changes in interest rates. In late 1992, Merrill Lynch established a mechanism by which a separate department would consult with trading personnel regarding the purchase of certain derivatives by the County.
f. Merrill Lynch Urges The Treasurer To Provide The County Board Of Supervisors With Additional Disclosure About The Pools
Also in November 1992, Merrill Lynch urged the Treasurer to make greater disclosure to the County Board of Supervisors regarding the Pools' investment strategy and the risks of that strategy. Subsequently, in an April 1993 letter, Merrill Lynch provided to the Treasurer bullet points to include in the Treasurer's next Annual Report regarding the Pools. These bullet points included: the Pools' investment strategy used leverage; the Pools' use of reverse repurchase agreements and purchase of derivative securities resulted in a leverage ratio of 2 to 1; if interest rates were to rise, it was reasonable to expect that the overall performance of the portfolio would decline; and if a sudden rise in interest rates were to recur, there could be an erosion of principal. Merrill Lynch trading and sales personnel knew that Merrill Lynch was urging the Treasurer to make such greater disclosure and participated in communicating the bullet points to the Treasurer.
g. Merrill Lynch's January 1993 Meeting With The Treasurer Regarding The Pools
In January 1993, Merrill Lynch trading and sales personnel discussed the Pools with the Treasurer. At this meeting, the Merrill Lynch trading and sales personnel discussed with the Treasurer: the Pools' "distinct" investment strategy; the amount of leverage in the Pools; the risks associated with the strategy; and that, at certain interest rate levels, the Pools would lose principal because the Pools' financing costs would exceed the yield. The Merrill Lynch trading and sales personnel also suggested at this meeting that the Treasurer should report to the County Board of Supervisors about these matters and that the Pools should reduce the leverage ratio to no more than 2 to 1 and should not invest in derivatives in excess of the Pools' long-term deposits.
h. The February 1993 Memorandum Regarding Certain Risks Of The Pools
In February 1993, a Merrill Lynch trader distributed to certain other Merrill Lynch trading personnel a memorandum in which he expressed certain concerns about the Pools' risks and made specific recommendations concerning Merrill Lynch's ongoing relationship with the Orange County account. The memorandum explained that a substantial amount in the Pools had been voluntarily deposited by Participants seeking the Pools' higher return and stated the trader's views that these voluntary Participants could withdraw their funds at par with little restriction and were, therefore, not bearing any of the risks accompanying the high yields and that the County and other long term investors were bearing that risk associated with higher yields. The memorandum then stated that if interest rates rose and the Pools' yield decreased, these voluntary Participants would withdraw their funds, causing adverse consequences for Orange County.
i. Merrill Lynch's Offer To Repurchase Derivatives Sold To The Pools
In March 1993, Merrill Lynch made an offer to the Treasurer to repurchase certain securities that it had sold to the Pools. These securities had a book value of $4.09 billion (36% of the portfolio) and were comprised of $3.8 billion in inverse floaters (34% of the portfolio), $175 million in floating rate securities (2% of the portfolio), and $100 million in fixed rate securities (1% of the portfolio).
In March 1993, Merrill Lynch told the Treasurer that it was making the offer to assist the Treasurer in reducing the Pools' risk profile in the event of changes in interest rates. In a June 1993 letter, Merrill Lynch reiterated its position, stating that it had made the offer to allow the County the opportunity to lower its risk profile in derivative securities and to reduce leverage so that the Pools would be better positioned to perform in the event of interest rate changes.
In April 1993, the Treasurer refused Merrill Lynch's offer, stating that he believed that because of future low interest rates, the securities may be even more valuable in the future. Merrill Lynch trading and sales personnel knew of this offer and the Treasurer's rejection of the offer and participated in these communications with the Treasurer.
j. Merrill Lynch's February 1994 Review Of The Pools
In February 1994, Merrill Lynch trading and sales personnel presented to the Treasurer their review of certain of the Pools' securities as of late 1993-early 1994. This review presented information showing that the Pools held $5 billion in inverse floaters and $6.8 billion in fixed rate securities, and found that the Pools' aggregate derivative portfolio had declined in value to a price of 99.50. The review further specifically discussed the sensitivity of the portfolio to changes in interest rates, noting that: (1) the Pools' performance was dependent upon continued low interest rates; (2) each basis point (.01%) change in the interest rates would result in a change in the market value of the derivatives in the portfolio of $2.7 million; (3) the portfolio held approximately $5.3 billion in derivative securities with an average duration of about five years; (4) if interest rates were to rise, the inverse floaters would pay lower coupons; (5) rising interest rates would result in significant movements in the market value of the portfolio due to the Pools' investment in inverse floaters; and (6) continued rising rates could have a severe impact on the market value of the Pools' securities.
The review also discussed future interest rates, stating that it was difficult to predict future interest rates but that historically initial increases by the Federal Reserve Bank of interest rates led to further increases. Finally, the review presented certain recommendations that the Treasurer could implement in light of the interest rate environment.
6. Merrill Lynch's Underwriting Of The Notes
Merrill Lynch trading personnel were principally responsible for Merrill Lynch's obtaining the underwriting of the first Note Offering, the $600 Million Taxable Note Offering. The Merrill Lynch trading personnel referred the underwriting to Merrill Lynch investment bankers. The account representative knew that Merrill Lynch obtained the underwriting. These Merrill Lynch trading and sales personnel knew much of the information about the Pools stated above, but Merrill Lynch failed to assure that such information was conveyed to the investment bankers.
Merrill Lynch participated in the review and approval of the Official Statements for the Note Offerings through the investment bankers. As stated below, the investment bankers knew or reasonably should have known information about the Pools and/or about the interest rate cap and that such information was omitted from the Official Statements.
a. The Investment Bankers' Knowledge
As stated below, the investment bankers knew or reasonably should have known information about the Pools from media coverage in the first half of 1994 and from Merrill Lynch's business relationship with Orange County. As a result of participating in Merrill Lynch's underwriting of a large taxable note offering conducted in 1993 by another local government located in Southern California (the "Prior Offering"), one of the investment bankers also knew or reasonably should have known of disclosure issues relating to the Pools. One of the investment bankers also knew or reasonably should have known of the interest rate cap on the Taxable Notes and the $111 Million Teeter Notes.
i. Media Coverage Regarding The Pools
From January 31 through June 30, 1994, articles appeared in the media regarding the Pools. The articles reported that the Treasurer stated that: he used reverse repurchase agreements to leverage the Pools' $7.5 billion in deposits to $19.5 billion in investments; 20% of the $19.5 billion portfolio was invested in derivative securities; his strategy was to obtain funds through short-term reverse repurchase agreements and invest in medium-term securities; the value of the Pools' portfolio had "been hit by rising interest rates"; and as a result of rising interest rates and the declining market value of the Pools' securities, the County had recently experienced up to $300 million in collateral calls under reverse repurchase agreements. These articles also reported that the County's portfolio had incurred a decline in market value of "an estimated $1.2 billion" and that many believed that the investment strategy was too risky for public funds and exposed the Pools to the risk of very large losses.
The investment bankers knew that there were a number of articles published in the first half of 1994 regarding the Pools and read at least some of these articles. In addition, in late April 1994, one of the investment bankers received a memorandum from Merrill Lynch municipal research personnel about recent municipal securities offerings by issuers located in Southern California. The memorandum attached an article about the Pools that was published on April 15, 1994. In referring to the article, the memorandum stated that, although the research personnel had no additional information about the Pools and the article was perhaps one-sided, it implied there may be a great potential for losses in the fund due to recent market trends. The memorandum further stated this development may have implications for how Merrill Lynch addressed future note underwritings, in particular during the upcoming California note season.
ii. Merrill Lynch's Business Relationship With Orange County
The investment bankers knew that Orange County was a client of Merrill Lynch and, therefore, should have known that the firm had information about Orange County. The investment bankers further knew the account representative was responsible for the Orange County account and that the account representative had information regarding the Pools. In the Spring of 1994, even though Merrill Lynch did not have an underwriting relationship with the County at that time, one of the investment bankers contacted the account representative to ascertain the validity of the concerns about the Pools raised in the media reports. The account representative told the investment banker that the Pools were okay and taking a more defensive posture and that the County was selling securities to increase the cash position.
iii. The Prior Offering
The Merrill Lynch investment bankers also knew of the Prior Offering; one of the investment bankers had even participated in the underwriting. The preliminary official statement for the offering stated that the proceeds would be invested in the issuer's investment pool (the "Prior Pool") and contained disclosure about the Prior Pool that was similar to portions of the disclosure regarding the Orange County Pools in the Official Statements for the Note Offerings. Because of certain market rumors about the Prior Pool, Merrill Lynch requested additional information and disclosure about the Prior Pool's derivative investments before pricing the offering. A detailed comparison of the Prior Offering and the Note Offerings and their related disclosure would have shown at least two differences. First, with respect to reverse repurchase agreements, both offerings stated that "[f]rom time to time" the pools engaged in reverse repurchase transactions. The Prior Offering, however, disclosed that the Prior Pool had engaged in no reverse repurchase agreements as of the end of the prior quarter and that the maximum amount of the Prior Pool's portfolio that could be pledged under reverse repurchase agreements was 25%. In contrast, the Note Offerings only disclosed that "a significant portion" of the Pools' securities was pledged under reverse repurchase agreements but did not disclose that the Pools were leveraged by about 274% and that the Pools' investment strategy was based on such leverage. Second, with respect to derivative investments, the Prior Offering specifically disclosed the dollar amount of derivative securities held by the pool and the structure of the derivatives. In contrast, the Note Offering only disclosed the Pools' investment in fixed and floating rate securities but did not disclose the Pools' dollar investment in inverse floaters.
iv. The Interest Rate Cap
The existence of the interest rate cap on the Taxable Notes and the $111 Million Teeter Notes was stated in three documents relating to the issuance of those Notes: the resolutions of the Boards of Supervisors of Orange County and the Flood Control District authorizing the issuance of the notes; the issuers' certificates stating that the offering amounts complied with state law; and the sample notes. These documents were included in the official transcript of the Taxable Note and $111 Million Teeter Note Offerings, which were provided to all professionals participating in the offering, including one of the Merrill Lynch investment bankers.
b. Merrill Lynch's Review Of The Official Statements
Merrill Lynch's review of the Official Statements was conducted through the investment bankers. One of the investment bankers reviewed and approved the disclosure for all of the Note Offerings. The only change that this investment banker made to the disclosure related to the interest reset language. Another investment banker also read, and did not object to, the Pool disclosure and directed a third investment banker who was not otherwise assigned to the underwriting to review the Pool disclosure.
The investment bankers took no further action to determine whether the disclosure was accurate and complete. At the time of the Note Offerings, Merrill Lynch had a written policy stating that the underwriter cannot ignore the underwriter's "`independent reservoir' of knowledge" about the issuer. After Merrill Lynch obtained the underwriting, the investment bankers did not discuss the Pool disclosure with anyone at Merrill Lynch other than with each other, even though the investment bankers knew that Orange County was a Merrill Lynch client and other Merrill Lynch personnel had been involved in obtaining the underwriting for the firm.
The investment bankers also did not make inquiries into the media coverage about the Pools, even though the investment bankers knew of the reports and one of the investment bankers had received a memorandum stating that the Pools' reported losses could have implications for Merrill Lynch's future underwriting of municipal note offerings in California. The investment banker who had previously spoken to the account representative about the media coverage regarding the Pools did not question whether the Treasurer had taken a more defensive position. The investment bankers also did not conduct a detailed comparison between the disclosure in the Note Offerings and the disclosure in the Prior Offering, which would have shown that the Prior Offering had additional disclosure regarding derivatives and leverage.
C. LEGAL DISCUSSION
1. Merrill Lynch Violated Sections 17(a)(2) And (3) Of The Securities Act In The Offer and Sale of the Notes
Sections 17(a)(2) and (3) of the Securities Act make it unlawful for any person, through the means or instruments of interstate commerce or the mails, in the offer or sale of any security:
(2) to obtain money or property 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; or
(3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
Scienter is not required to prove violations of Sections 17(a)(2) or (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980). Violations of these sections may be established by showing negligence. 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).
Accordingly, Merrill Lynch, through negligent conduct, violated Sections 17(a)(2) and (3) of the Securities Act in the offer and sale of the Notes.
a. The Omissions Were Material
Information about the Pools' investment strategy, the risks of that strategy, and the Pools' declining investment results and about the cap on the Notes' variable interest rates was material to the Note investors. Information is material if there is a substantial likelihood that a reasonable investor in making an investment decision would consider it as having significantly altered the total mix of information made available. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976).
Accurate and complete disclosure about the Pools was material to investors because it affected the sources of repayment for the Notes. In particular, in all of the Note Offerings, the funds pledged to repay the securities were invested in the Pools, and, in the two Teeter Note Offerings, the Pools guaranteed repayment of the securities. Disclosure of the interest rate cap was material to investors that had adopted policies against investing in securities with an interest rate cap.
b. Merrill Lynch Should Have Known That The Official Statements Were Materially Misleading
Merrill Lynch, as underwriter of the Note Offerings, had a duty to conduct a professional review of the Official Statements, including an assessment of the information in its possession or reasonably accessible to it, sufficient to form a reasonable basis for believing in the accuracy and completeness of the key representations in the Official Statements. Merrill Lynch, through its trading and sales personnel, knew substantial material information about the Pools. Merrill Lynch, however, unreasonably failed to assure that such information was conveyed to the investment bankers responsible for reviewing and approving the Official Statements for the Note Offerings.
In addition, Merrill Lynch, through its investment bankers responsible for reviewing and/or approving the Official Statements for the Note Offerings, also knew or reasonably should have known material information about the Pools and/or the Notes' interest rate. From such a professional review of the Official Statements, Merrill Lynch, through its investment bankers, knew or reasonably should have known that the Official Statements omitted to disclose material information that was in its possession or reasonably accessible to it about the Pools and the Notes' interest rates.3
2. Merrill Lynch Violated Section 15B(c)(1) Of The Exchange Act And MSRB Rule G-17
Under Section 15B(c)(1) of the Exchange Act, a broker, dealer, or municipal securities dealer is prohibited from using the mails or any instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any municipal security in violation of any rule of the Municipal Securities Rulemaking Board ("MSRB"). As a broker-dealer conducting a municipal securities business, Merrill Lynch was subject to Section 15B(c)(1) of the Exchange Act and the MSRB rules.
MSRB Rule G-17 provides that: "In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice." For the reasons set forth above in Section E.1. with respect to the violations of Sections 17(a)(2) and (3) of the Securities Act, Merrill Lynch violated MSRB Rule G-17.
3. Conclusion
Accordingly, based on the foregoing, the Commission finds that Merrill Lynch willfully violated Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1)of the Exchange Act, and MSRB Rule G-17.
IV. Merrill Lynch has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it consents to the Commission's entry of this Order, which: (1) makes findings, as set forth above; (2) orders Merrill Lynch to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17; and (3) orders Merrill Lynch to pay a civil penalty in the amount of $2,000,000.
V. Prior to the date of this Order, Merrill Lynch revised its policies and procedures relating to municipal securities underwriting.
VI. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by Merrill Lynch.
Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act and Sections 15(b) and 21C of the Exchange Act:
1. Merrill Lynch shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17.
2. Merrill Lynch shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $2,000,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the United States Securities and Exchange Commission; (3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312; and (4) submitted under cover letter that identifies Merrill Lynch as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Kelly Bowers, Assistant Regional Director, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.
3. Merrill Lynch shall comply with the undertakings specified in its Offer as follows: Merrill Lynch undertakes to maintain the policies and procedures referred to in Section V above; provided, however, that Merrill Lynch may modify such policies and procedures with alternative policies and procedures designed to achieve the same purposes.
Footnotes
-[1]- The findings herein are made pursuant to the Offer of Settlement of Merrill Lynch and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[2]- Orange County and the Flood Control District were charged with disclosure violations concerning these offerings in a settled cease-and-desist proceeding. See In re County of Orange, California, Securities Act Release No. 7260 (Jan. 24, 1996).
-[3]- For purposes of Merrill Lynch's violations, the conduct of the Merrill Lynch officials and employees may be imputed to the firm. See SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972).
In re Meridian Securities, Inc., and Corestates Capital Markets, Securities Act Release No. 7525, Exchange Act Release No. 39905, A.P. File No. 3-9582 (April 23, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that administrative proceedings be instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b), 15B and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Meridian Securities, Inc. ("Meridian Securities"), a broker-dealer registered with the Commission, CoreStates Capital Markets ("CoreStates Capital"), a municipal securities dealer registered with the Commission, and Martin J. Stallone ("Stallone").
In anticipation of the institution of these proceedings, Meridian Securities, CoreStates Capital and Stallone have submitted Offers of Settlement which the Commission has determined to accept. Solely for purposes of these proceedings and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, without admitting or denying the findings contained herein, except that Meridian Securities, CoreStates Capital and Stallone admit that the Commission has jurisdiction over them and over the subject matter of these proceedings, Meridian Securities, CoreStates Capital and Stallone consent to the entry of an Order Instituting Public Proceedings, Making Findings and Imposing Remedial Sanctions and Cease-and-Desist Order ("Order") as set forth below.
Accordingly, IT IS ORDERED that proceedings against Meridian Securities, CoreStates Capital and Stallone be, and hereby are, instituted.
II. On the basis of this Order, and the Offers of Settlement submitted by Meridian Securities, CoreStates Capital and Stallone, the Commission finds that:1
A. At all times relevant to this proceeding, Meridian Securities, headquartered in Reading, Pennsylvania, was registered with the Commission as a broker-dealer. It is the successor, in form, to the municipal securities dealer registration of Meridian Capital Markets, Inc. ("Meridian Capital").2
B. At all times relevant to this proceeding, CoreStates Capital, a division of CoreStates Bank, N.A. ("CoreStates Bank"), was registered with the Commission as a municipal securities dealer pursuant to Section 15B(a) (2) of the Exchange Act.3 CoreStates Capital is the de facto successor to Meridian Capital and is named as a Respondent solely on that basis. It has continued the operations of Meridian Capital, including advance refunding transactions. Meridian Capital's customer accounts have been transferred to CoreStates Capital. Although certain key personnel, formerly associated with Meridian Capital, are now employed by CoreStates Capital, the senior management of Meridian Capital and the senior officers of Meridian Capital's Public Finance Department with primary responsibility for the transactions described herein were not employed by CoreStates Capital or any of its affiliates following the merger between CoreStates Bank and Meridian Bank.
C. At all times relevant to this proceeding, Stallone was registered as a municipal securities representative with Meridian Capital. Stallone joined Meridian Capital in 1989 at age 24 and became a vice-president of Meridian Capital's Public Finance Department in 1993. Despite his title, Stallone did not have a managerial position at any time during his employment at Meridian Capital, and he voluntarily resigned from Meridian Capital prior to the merger between CoreStates Bank and Meridian Bank.
D. From at least March 1993 through December 1995, Meridian Capital, Stallone and another employee of Meridian Capital willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, in the offer and sale and in connection with the purchase and sale, of securities in that they, directly and indirectly, by the use of the means or instruments of transportation or communication in interstate commerce, or the means and instrumentalities of interstate commerce, or of the mails, employed devices, schemes, or artifices to defraud obtained money and property by means of, or otherwise made, untrue statements of material fact or omitted to state material facts necessary to make the statements made, in the light of the circumstances under which they were made, not misleading; or engaged in acts, transactions, practices or courses of business which would and did operate as a fraud or deceit upon the purchasers of such securities and on other persons, such as the issuers of municipal securities.
E. Meridian Capital, Stallone and another employee of Meridian Capital engaged in a scheme to generate substantial profits by charging various Pennsylvania and West Virginia municipalities excessive, undisclosed mark-ups on U.S. Treasury securities ("Treasury securities") sold in connection with various tax-exempt advance refunding transactions and in two other cases involving another type of refinancing. They increased the prices of Treasury securities in order to reduce the yield, thereby purporting to comply with the federal tax laws governing tax-exempt advance refunding transactions. This practice is commonly known as "yield burning." Meridian Capital, Stallone and another employee of Meridian Capital calculated mark-ups on a portfolio basis and, as a result, charged excessive mark-ups on individual Treasury securities ranging as high as 13.78 percent in connection with various advance refunding transactions and as high as 46.29 percent in two other cases involving another type of refinancing. The mark-ups were excessive based upon all of the relevant facts and circumstances surrounding the sales of the particular Treasury securities. On five occasions, Meridian Capital, Stallone and/or another employee of Meridian Capital also falsely certified in writing that the prices charged for the Treasury securities were in essence fair market prices, as defined by federal tax regulations. In addition, Meridian Capital and others engaged in an undisclosed payment arrangement in order to secure Meridian Capital's selection as escrow provider in certain transactions. As a result of this pattern of conduct, Meridian Capital earned substantial profits and Stallone and another employee of Meridian Capital earned substantial commissions.
F. Excessive Mark-ups
1. Beginning in 1988, Meridian Capital solicited various municipalities to undertake various financing transactions, including advance funding transactions. In an advance refunding transaction, a municipality issues tax-exempt municipal securities (the "refunding bonds") in order to defease a pre-existing issue of bonds usually bearing higher interest rates. Because the pre-existing bonds cannot be paid off immediately, the proceeds of the refunding bonds are invested in Treasury securities, which are deposited into an escrow account established on behalf of the municipality and irrevocably pledged to pay the principal and interest on the old bonds as they become due. Advance refunding transactions generally enable municipalities to realize savings, in part because the refunding bonds are issued at lower interest rates.
2. Meridian Capital's Public Finance Department ("Public Finance"), in which Stallone and others were employed, handled many advance refunding transactions in addition to other types of municipal financings. In connection with these advance refunding transactions, Meridian Capital often acted as the underwriter for the municipal issuer as well as the escrow provider. As the underwriter, Meridian Capital sold the bonds that were issued by the municipalities. As the escrow provider, the firm selected the Treasury securities for the escrow account and sold them to the municipalities.
3. The Pennsylvania Public Finance Group ("Pennsylvania Group"), which primarily conducted business in Pennsylvania, New Jersey and Delaware, was a part of Public Finance. The employees of the Pennsylvania Group, which included Stallone, were compensated through commissions based upon a percentage of the profits earned by Public Finance, including mark-ups on Treasury securities sold in connection with advance refunding transactions.
4. Stallone and another employee of Meridian Capital were primarily responsible for selecting and pricing the Treasury securities that Meridian Capital sold to the municipalities. Specifically, they identified the Treasury securities needed for the escrow accounts and set the prices at which Meridian Capital sold these securities. Although an entire portfolio of securities selected for an escrow account was sold to the municipality, Meridian Capital generated a separate confirmation slip for each individual Treasury security.
5. In accordance with the Internal Revenue Code and Internal Revenue Service ("IRS") regulations in effect during the relevant time period, where a municipality issued tax-exempt advance refunding bonds, the overall yield on the investments held in the escrow account could not materially exceed (which under the tax regulations essentially meant that it could not be more than one-thousandth of one percentage point higher than) the yield on the refunding bonds. If the overall yield on the escrow securities materially exceeded the yield on the bonds, the bonds would be deemed "arbitrage bonds" and the tax-exempt status of the refunding bonds would be jeopardized. If the yield on the open market escrow securities, purchased at fair market value, were to materially exceed the yield on the refunding bonds (a "positive arbitrage" situation), the IRS regulations effectively required that the excess yield (known as "arbitrage profit") be reduced by investing a portion of the escrow account in State and Local Government Series ("SLGS") - customized securities issued by the U.S. Treasury at below market interest rates specifically for the purpose of allowing municipal issuers to comply with the IRS yield restrictions. A mix of Treasury securities and SLGS in the escrow account can be used to ensure that the yield on the escrow account will not be higher than the yield on the refunding bonds.
6. One way to circumvent these yield limitations is through a practice commonly known as "yield burning" - that is, lowering the yield earned on escrow securities by excessively increasing the price an issuer pays for those securities. Such an increase in the price paid by the issuer has no direct economic impact on the issuer in a positive arbitrage situation, because any increased markup paid by the issuer would otherwise have to be transferred to the U.S. Treasury through the purchase of SLGS. Thus, this practice enriches the seller of the escrow securities at the expense of the U.S. Treasury, which otherwise would receive the arbitrage profit. It also exposes the issuer and its investors to the risk of losing the bonds' tax-exempt status. In a negative arbitrage situation (i.e., when the yield of the open market escrow securities, when purchased at fair market value, would not exceed the yield on the refunding bonds), any increase in the price paid for the escrow securities directly harms the issuer, but does not have federal tax implications.
7. Applicable provisions of the IRS regulations in effect at the time of the transactions at issue here generally required that the escrow investments be purchased at fair market value. In particular, the Treasury securities had to be valued at the price at which a willing buyer would purchase the investment from a willing seller in a bona fide, arm's-length transaction. 26 C.F.R. 1.148-5(d) (6), T.D. 8476, 58 F.R. 33510 (June 18, 1993).
8. Pursuant to the IRS regulations, municipalities issuing tax-exempt bonds were required to certify, based on their reasonable expectations, that the bonds were not arbitrage bonds. In various advance refundings handled by Meridian Capital during the relevant time period, the municipalities made such certifications.
9. Meridian Capital, Stallone and another employee of Meridian Capital improperly retained the arbitrage profits generated from the sale of Treasury securities without the knowledge or consent of the municipalities. The conduct entailed inflating the prices for certain individual Treasury securities in order to reduce the overall yield earned on the portfolio of Treasury securities, thereby meeting the yield restrictions. The undisclosed mark-ups charged on the individual Treasury securities (which reached as high as 13.78 percent) in the various advance refundings were excessive based upon all of the relevant facts and circumstances surrounding the sales of the particular Treasury securities.
10. In two instances, Meridian Capital, Stallone and another employee of Meridian Capital charged municipalities excessive, undisclosed mark-ups in advance refunding transactions which, notwithstanding the size of the mark-ups, did not exceed applicable yield restrictions and, therefore, did not raise any issue of compliance with IRS regulations. The mark-ups charged on these securities transactions were excessive based upon all of the relevant facts and circumstances, and, as a result, the municipalities involved in these two transactions (the Reading School Authority and the Borough of Ambler) were financially harmed.
G. Misrepresentations and Omissions
1. In connection with the sale of Treasury securities to the municipalities, Meridian Capital, Stallone and/or another employee of Meridian Capital also made certain material misrepresentations and omissions. In 5 instances, they provided documents in the form of certifications that in essence represented that the prices on the Treasury securities were at fair market value and established without an intent to reduce yield. In fact, the prices on the Treasury securities in those transactions exceeded their fair market value by reason of the mark-ups that were charged, and were established with an intent to reduce the yield on the Treasury securities. The municipalities relied upon these representations in making their certifications that the bonds were not arbitrage bonds.
2. In certain advance refunding transactions, Meridian Capital served as both underwriter and escrow provider. In such transactions, Stallone and others advised municipalities with respect to how the transactions should be structured, including, but not limited to, the investment of the refunding bond proceeds. The municipalities relied upon Meridian Capital, Stallone and others to provide Treasury securities that were suitable for retiring the pre-existing issue of municipal bonds in accordance with IRS yield restriction requirements.
3. Meridian Capital, Stallone and another employee of Meridian Capital failed to disclose to the municipalities that they had sold the Treasury securities to the municipalities for more than their fair market value by reason of the mark-ups that were charged and, thereby, jeopardized the tax-exempt status of the refunding bonds.
4. As underwriter of various advance refunding bonds, Meridian Capital had an obligation to have a reasonable basis for belief in the truthfulness and completeness of the key representations made in the disclosure documents used in the securities offerings. Exch. Act Rel. No. 26100 (Sept. 22, 1988). In addition, employees of Meridian Capital participated in the preparation of those offering documents, and were responsible for various representations contained in those documents. The offering documents did not disclose to potential bond purchasers that Meridian Capital, Stallone and another employee of Meridian Capital had sold the Treasury securities to the municipalities for more than their fair market value by reason of the mark-ups that were charged. Nor did the documents disclose that they did so in order to receive arbitrage profits in those advance refundings and had, thereby, placed the tax-exempt status of the refunding bonds in jeopardy. Therefore, Meridian Capital, Stallone and another employee of Meridian Capital also failed to disclose material facts in the offering documents which were distributed to the bond purchasers in those advance refunding transactions.
H. Undisclosed Payments
1. Meridian Capital and others also engaged in an undisclosed financial arrangement involving three advance refundings with municipalities in West Virginia. In these advance refundings, Meridian Capital was responsible for providing the Treasury securities sold to the municipalities, but was not the underwriter. Meridian Capital secured its role as the escrow provider by paying undisclosed fees to two financial consultants.
2. One of the financial consultants, an independent contractor, provided services to the underwriter on the three West Virginia advance refunding transactions. Among other things, he was responsible for selecting a broker or a dealer to provide the Treasury securities needed for the escrow accounts.
3. During the fall of 1993, before Meridian Capital became involved in the West Virginia advance refunding transactions, the two financial consultants contacted an employee of Meridian Capital about Meridian Capital becoming the escrow provider in the first of the three advance refundings. In order to ensure Meridian Capital's selection, an employee of Meridian Capital entered into an undisclosed arrangement with the two financial consultants whereby it was agreed that Meridian Capital would pay them a pre-determined percentage of the profits generated from Meridian Capital's sale of Treasury securities to the West Virginia municipality. In addition to securing Meridian Capital's selection in the first advance refunding, the arrangement ensured Meridian Capital's selection as the escrow provider in future advance refundings in which the two financial consultants were involved.
4. In the same manner as they had done in the other advance refundings, Meridian Capital, Stallone and another employee of Meridian Capital charged excessive mark-ups on the Treasury securities sold to the West Virginia municipalities in order to retain the arbitrage profits.
5. After the Treasury securities were sold to the municipalities, Meridian Capital made payments to the two financial consultants, as previously agreed. In addition, an employee of Meridian Capital directed the two financial consultants to generate invoices, which falsely reflected that they had provided services to Meridian Capital in exchange for the payments. Neither of the consultants performed any services in exchange for the payments, other than securing Meridian Capital's selection as escrow provider.
6. In each of the three West Virginia advance refundings, Meridian Capital, Stallone and another employee of Meridian Capital provided certificates directly to the municipalities in which they made affirmative misrepresentations concerning the suitability of the Treasury securities and compliance with the IRS yield restriction requirements. The West Virginia municipalities were unaware of the financial arrangement.
I. Other Excessive Mark-ups
1. In June 1994 and May 1995, Meridian Capital, Stallone and another employee of Meridian Capital handled two refinancings that involved the establishment of sinking funds on behalf of two Pennsylvania municipalities. In these refinancings, the municipalities sought to defease prior offerings of tax-exempt municipal bonds. However, rather than using proceeds from the issuance of refunding bonds, the municipalities used other sources of funds to defease the old bonds.
2. Meridian Capital, Stallone and another employee of Meridian Capital were responsible for providing the Treasury securities that were deposited into escrow accounts established on behalf of the municipalities in these two transactions. As with advance refunding transactions, the Treasury securities in the escrow account were subject to yield restriction requirements under the federal tax laws.
3. With respect to these two refinancings, Meridian Capital, Stallone and another employee of Meridian Capital calculated mark-ups on a portfolio basis and, as a result, charged excessive mark-ups on individual Treasury securities that reached as high as 46.29 percent. Neither the mark-ups nor the fact that Meridian Capital had earned arbitrage profits in these refinancings, was ever disclosed to the municipalities. The mark-ups were excessive based upon all of the relevant facts and circumstances.
III. On the basis of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in the Offers of Settlement submitted by Meridian Securities, CoreStates Capital, and Stallone:
Accordingly, IT IS ORDERED that:
A. Meridian Securities' registration as a broker-dealer is revoked;
B. Stallone be, and hereby is, censured;
C. CoreStates Capital and Stallone shall cease and desist from committing or causing any violations and any future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder;
D. CoreStates Capital and Stallone are directed to comply with their undertakings to pay an aggregate of $3,820,884, to be apportioned as follows: $3,720,884 shall be paid by CoreStates Capital, and $100,000 shall be paid by Stallone;
1. Of the aggregate amount, $414,070 shall be paid to the Reading School Authority and $6,814 shall be paid to the Borough of Ambler within ten days of the date of entry of this Order;
2. The remaining $3.4 million shall be paid to the United States Treasury pursuant to an agreement simultaneously entered into between Meridian Securities, CoreStates Financial Corp., the Internal Revenue Service and the United States Attorney for the Southern District of New York;
3. CoreStates Capital and Stallone shall provide written confirmation to Ronald C. Long, District Administrator, Securities and Exchange Commission, Philadelphia District Office, 601 Walnut Street, Suite 1120E., Philadelphia, PA 19106, that the payments specified in sub-paragraphs D.1. and D.2. above, have been duly made;
E. Stallone shall pay a civil penalty of $15,000 to the United States Treasury. Such payment shall be: (1) paid within thirty days of the date of the entry of this Order; (2)made by United States postal money order, certified check, bank cashier's check, or bank money order; (3) made payable to the Securities and Exchange Commission; (4) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Mail Stop 0-3, 450 Fifth Street, N.W., Washington, D.C. 20549; and (5) submitted under cover letter which identifies Stallone as a Respondent in this proceeding and the file number of this proceeding. A copy of the cover letter and money order or check shall be simultaneously sent to Ronald C. Long, District Administrator, Securities and Exchange Commission, Philadelphia District Office, 601 Walnut Street, Suite 1120E., Philadelphia, Pa 19106;
F. Stallone be, and hereby is, suspended from association with any broker, dealer, municipal securities dealer, investment adviser, or investment company, for a period of twelve months, effective on the second Monday following the entry of this Order; and G. Stallone shall provide to the Commission, within thirty days after the end of the twelve month suspension period described in paragraph F. above, an affidavit that he has complied fully with the suspension.
Footnotes
-[1]- The findings herein are made pursuant to the Offers of Settlement of Meridian Securities, CoreStates Capital, and Stallone and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[2]- Meridian Capital was a municipal securities dealer registered with the Commission pursuant to Section 15B(a) (2) of the Exchange Act from February 1987 through November 1996, when the entity officially ceased operations.
-[3]- On April 9, 1996, CoreStates Financial Corp., the holding company for CoreStates Bank, N.A. merged with Meridian Bancorp, Inc., the holding company for Meridian Bank. By operation of the merger, on June 27, 1996, Meridian Bank, together with its division Meridian Capital, was dissolved, and its operations and personnel became part of CoreStates Bank and CoreStates Capital.
In re CS First Boston Corp., Jerry L. Nowlin and Douglas J. Montague, Securities Act Release No. 7498, Exchange Act Release No. 39595, A.P. File No. 3-9535 (January 29, 1998).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that a public administrative and cease-and-desist proceeding be and hereby is instituted pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Credit Suisse First Boston Corporation ("First Boston"), Jerry L. Nowlin ("Nowlin"), and Douglas S. Montague ("Montague").
II. In anticipation of the institution of this proceeding, First Boston, Nowlin, and Montague each has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except that First Boston, Nowlin, and Montague each admit the jurisdiction of the Commission over them and over the subject matter of this proceeding, First Boston, Nowlin, and Montague, by their Offers of Settlement, consent to the entry of this Order Instituting a Public Administrative And Cease-And-Desist Proceeding Pursuant to Section 8A of the Securities Act of 1933 and Sections 15(b) and 21C of the Securities Exchange Act of 1934, Making Findings, and Imposing Sanctions and Cease-and-Desist Order ("Order") and to the entry of the findings, sanctions, and cease-and-desist order set forth below.
Accordingly, IT IS HEREBY ORDERED that a proceeding pursuant to Section 8A of the Securities Act and Sections 15(b) and 21C of the Exchange Act be, and hereby is, instituted.
III. On the basis of this Order and the Offers of Settlement submitted by First Boston, Nowlin, and Montague the Commission finds that:1
A. RESPONDENTS
1. Credit Suisse First Boston Corporation ("First Boston") is registered with the Commission as a broker-dealer (File No. 8-00422) and is based in New York, New York. First Boston was the senior underwriter for the County of Orange, California's ("Orange County") 1994 $320,040,000 offering of Pension Obligation Bonds (the "Pension Bonds"). First Boston ceased participating as an underwriter in municipal securities offerings in early 1995.
2. Jerry L. Nowlin ("Nowlin") is a resident of Park City, Utah, and was employed by First Boston from 1990 to February 1995. In 1994, Nowlin was a Vice President in the Public Finance Department of the Municipal Securities Division in First Boston's San Francisco office and was an investment banker assigned to the Pension Bond underwriting.
3. Douglas S. Montague ("Montague") is a resident of La Canada, California, and was employed by First Boston from 1993 to March 1995. In 1994, he was a Vice President in the Public Finance Department of the Municipal Securities Division in First Boston's Los Angeles office and was an investment banker assigned to the Pension Bond underwriting.
B. FACTS
1. Introduction
First Boston was the underwriter of Orange County's 1994 Pension Bonds.2 The Official Statement for the Pension Bond offering misrepresented and omitted material facts regarding the Orange County Investment Pools (the "Pools"). Accurate and complete disclosure regarding the Pools was material to investors in a $110,200,000 portion of the offering (the "Series B Bonds"), because the Pools provided liquidity for these bonds.
2. The Orange County Investment Pools
The Pools operated as an investment fund managed by the County Treasurer-Tax Collector (the "Treasurer") in which the County and various local governments or districts (the "Pool Participants" or the "Participants") deposited public funds. As of December 6, 1994 (the date the County and the Pools filed bankruptcy petitions), the Pools held approximately $7.6 billion in Participant deposits, which the County had leveraged to an investment portfolio with a book value of over $20.6 billion.
a. The Pools' Investment Strategy
The Pools' investment policy as stated by the Treasurer to the Pool Participants was, in order of importance: (1) preservation of investment capital; (2) liquidity; and (3) investment yield. Contrary to that policy, the Treasurer caused the Pools to engage in a risky investment strategy. This strategy involved using a high degree of leverage by obtaining funds through reverse repurchase agreements on a short-term basis (less than 180 days), and investing in securities with a longer maturity (generally two to five years), many of which were derivative securities known as inverse floaters. At the time of the Pension Bond Offering, First Boston had $1.58 billion in reverse repurchase agreements outstanding with the County. During 1993 and 1994, First Boston sold securities to the County. Neither Nowlin nor Montague was aware of or inquired into First Boston's reverse repurchase agreements with the County or sale of securities to the County.
The Pools' investment return was to result principally from the interest received on the securities in the Pools. Leverage enabled the Pools to purchase more securities to generate increased interest income. This strategy was profitable as long as the Pools were able to maintain a positive spread between the long-term interest rate received on the securities and the short-term interest rate paid on the funds obtained through reverse repurchase agreements.
b. The Pools' Portfolio
During 1993 and 1994, the Treasurer, using reverse repurchase agreements, leveraged the Participants' deposits to amounts ranging from 158% to over 292%. The Treasurer then typically invested the Participants' deposits and the funds obtained through reverse repurchase agreements in debt securities issued by the United States Treasury or United States government sponsored enterprises.
Many of the Pools' securities were derivative securities, comprising from 27.6% to 42.2% of the portfolio. In particular, the Pools were heavily invested in derivative instruments known as inverse floaters which paid interest rates inversely related to the prevailing market interest rate. Inverse floaters are negatively affected by a rise in interest rates.
c. The Rise in Interest Rates During 1994 and its Effect on the Pools
The composition of the Pools' portfolio made it highly sensitive to interest rate changes. As interest rates rose, the market value of the Pools' securities fell, and the interest received on the Pools' inverse floaters also dropped. Thus, the Treasurer's investment strategy was profitable so long as interest rates, including the cost of borrowing through reverse repurchase agreements, remained low and the market value of the Pools' securities remained stable. Indeed, the Treasurer's 1992-93 Financial Statement for the Pools stated that the investment strategy was "predicated on interest rates to continue to remain low for a minimum of the next three years."
During 1993, interest rates remained low and relatively stable. Due to the low interest rates and the Pools' investment strategy, the Pools earned a relatively high yield of approximately 8% during 1993. Beginning in February 1994, interest rates began to rise. This rise in interest rates caused the Pools' yield to decrease, the reverse repurchase costs to increase, the Pools' interest income on inverse floaters to decrease, and the market value of the Pools' debt securities to decline. Month-end reports generated by the Treasurer reflected that the Pools' securities that were marked-to-market (up to 43% of the entire portfolio) experienced a sharp drop in value, ranging from over $26 million in January 1994 (or .45% loss in value), to over $565 million in September 1994 (or 6.27% loss in value). From January through August 1994, the rising interest rates and the declining value of the Pools' securities caused the Pools to suffer collateral calls and reductions in loan amounts totalling over $1 billion.
3. The Pension Bond Offering
On September 28, 1994, First Boston underwrote Orange County's offering of $320,040,000 in Pension Bonds. The proceeds of this offering were used to fund the County's accrued, but unfunded, pension liability to the Orange County Employees Retirement System. Nowlin and Montague were First Boston's lead investment bankers assigned to this offering. During the underwriting, First Boston, through Nowlin and Montague, participated in drafting the Official Statement. First Boston then offered and sold the Pension Bonds through that Official Statement. The Official Statement was the document that should have provided investors with accurate and complete disclosure of material facts regarding the Pension Bonds upon which they could rely to make an informed investment decision.
The Series B Bonds, issued in the amount of $110,200,000, were to pay interest at a rate that was to be reset periodically by First Boston as the remarketing agent. Under the terms of the Series B Bonds, the investors had the right to liquidate their investment on seven days' notice. To exercise this right, the investors were to tender their bonds for repurchase to First Boston as the remarketing agent. If First Boston could not resell the tendered bonds within seven days, the Pools were obligated to purchase the tendered securities in an amount up to the County's unrestricted funds in the Pools. Thus, the Pools acted as the standby liquidity provider.
4. Misleading Disclosure in the Official Statement
a. The Pools' Investment Strategy and the Risks of that Strategy
The Official Statement represented that the Pools' "investment policy focuses on retaining the safety of investment principal while earning satisfactory yields." The Official Statement further represented that it was the Pools' "practice to select quality investments . . . and not to take any risks which, in the judgment of the Treasurer's Office, would be unreasonable."
The Official Statement further represented that the Pools:
[I]nvested primarily in United States Government Securities, including, but not limited to, United States Treasury Notes, Treasury Bills, Treasury Bonds, and obligations of United States Government Agencies. When circumstances warrant, the [Pools'] investments may also include bankers acceptances, negotiable certificates of deposit of national or state-chartered banks and state or federal thrift, commercial paper, repurchase agreements, reverse repurchase agreements, medium term corporate notes and collateralized time deposits.
These statements were misleading because they omitted to disclose material information about the Pools' investment strategy. Specifically, the Official Statement omitted to disclose the material information that the Pools' investment strategy: (1) was premised on the assumption that interest rates would remain relatively low for at least three years; (2) involved an extremely high degree of leverage, which at the time of the Pension Bond offering was 258.55%; and (3) involved a substantial investment in inverse floaters, which comprised 33.6% of the Pool's holdings at the time of the Pension Bond offering.
The Official Statement also omitted to disclose material information regarding the risks of that strategy if interest rates were to rise, including: (1) the Pools' cost of borrowing on the substantial reverse repurchase position would increase; (2) the Pools' interest income on the substantial investment in inverse floaters would decrease; (3) the Pools' securities would decline in market value; (4) as the value of the securities fell, the Pools would suffer collateral calls and reductions in loan amounts on the reverse repurchase agreements; (5) the Pools' earnings would decrease; and (6) the Pools would suffer losses of principal at certain interest rate levels.
The Official Statement also represented that: "To maintain the liquidity of its investments, the [Pools] invest in securities that are actively traded in the securities markets." In fact, many of the Pools' securities, including certain derivatives, were not actively traded.
b. The Pools' Investment Results
Regarding the Pools' investment performance, the Official Statement stated that the County had earned a net yield of 7.67% on its investment in the Pools in the fiscal year ended June 30, 1994, that the Pools had earned an average yield of 7.74% during the fiscal year ended June 30, 1994, and the Pools had an annualized yield of 7.45% during July 1994. In addition, in a footnote to the County's financial statements, the chart listing the Pools' securities indicated that, as of June 30, 1993, the market value of the investments was above the purchase price, indicating that the Pools had a market profit.
The inclusion of this market profit without the additional disclosure of certain material information concerning the Pools' declining investment results in 1994 was misleading. The Pools had suffered substantial declines during 1994 in the overall market value of the portfolio. Contrary to the market profit indicated in the County's 1993 financial statements, the Treasurer's records indicated that a substantial portion of the Pools' securities, when marked-to-market as of the end of August 1994, had declined in value by at least $565 million. These market declines were not disclosed in the Official Statement. The Pools had also experienced over $1 billion in collateral calls and reductions in loan amounts under reverse repurchase agreements. These collateral calls and reductions in loan amounts were also not disclosed in the Official Statement.
5. The Knowledge of First Boston, Nowlin, and Montague
At the time of the Pension Bond offering, First Boston, Nowlin, and Montague knew or should have known certain material information regarding the Pools from: (1) media reports concerning the Pools that were published in the first half of 1994; and/or (2) information at the County, including the Treasurer's 1992-93 Financial Statement received by First Boston.3 This information included:
The Pools' investment strategy was premised on the assumption that interest rates would remain low for a minimum of three years; The County used reverse repurchase agreements to leverage the Pools' $7.5 billion of Participant deposits into an investment portfolio of $19.5 billion;
The Pools invested in derivative securities, including inverse floaters;
The Pools had suffered market declines as a result of the rise in interest rates;
The Pools had suffered collateral calls in early 1994; and Critics of the Treasurer had charged that the Pools' investment strategy was too risky for public funds.
6. Review of the Disclosure for the Pension Bond Offering
The County provided the underwriting team with disclosure regarding the Pools for inclusion in the Official Statement. This disclosure came from an offering earlier in 1994 in which the Pools had acted as liquidity provider. Nowlin and Montague adopted the disclosure for incorporation in the Official Statement with revisions relating to the historical liquidity of the Pools. Despite the importance of the Pools in the offering and the media articles voicing concerns about the Pools investment strategy, Nowlin and Montague did not make any inquiry within First Boston for information related to the Pools. Given the information known or readily available to them, First Boston, Nowlin, and Montague made insufficient inquiry into the Pools' investment strategy and the risks of that strategy, use of reverse repurchase agreements, investment in derivatives, or decline in investment results caused by the rise in interest rates.
Nowlin and Montague knew at the time of the Pension Bond offering that Orange County had conducted other securities offerings relating to the Pools. Despite this knowledge, they did not review the official statements for these prior offerings (except for the disclosure provided by the County) to determine whether the disclosure in the Pension Bond Official Statement regarding the Pools was consistent with disclosure in the prior offerings. In fact, the disclosure in the Official Statement for the Pension Bonds was different from the disclosure in the prior Orange County offerings.
7. First Boston's Supervision of Its Investment Bankers
First Boston failed reasonably to supervise Nowlin and Montague by not establishing adequate policies and procedures relating to disclosure in municipal securities transactions. In 1994, First Boston allowed its investment bankers, such as Nowlin and Montague, to approve official statements on behalf of the firm. Despite this grant of authority, First Boston did not have adequate policies or procedures concerning the review of official statements to guide investment bankers in their review of disclosure.
8. Orange County's Bankruptcy and Default on the Pension Bonds
As a result of the risks of the Pools' investment strategy, by December 1994, the Pools had suffered market declines of about $1.5 billion. In response to these declines, Orange County and the Pools filed Chapter 9 bankruptcy on December 6, 1994. Between mid-December 1994 and January 20, 1995, Orange County liquidated the Pools' securities portfolio, suffering a loss of almost $1.7 billion on the Participants' deposits of $7.6 billion, a 22.3% loss. The Pools also defaulted on their obligation to repurchase the tendered Series B Bonds. Thus, the investors were unable to liquidate their bonds, and the Pension Bonds' credit rating was downgraded to default status.
C. LEGAL DISCUSSION
1. First Boston, Nowlin, and Montague Violated Sections 17(a)(2) and (3) of the Securities Act in the Offer and Sale of the Pension Bonds
Sections 17(a)(2) and (3) of the Securities Act make it unlawful for any person, through the means or instruments of interstate commerce or the mails, in the offer or sale of any security:
(2) to obtain money or property 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; or (3) to engage in any transaction, practice, or course of business which operates or would operate as a fraud or deceit upon the purchaser.
Scienter is not required to prove violations of Sections 17(a)(2) or (3) of the Securities Act. Aaron v. SEC, 446 U.S. 680, 697 (1980). Violations of these sections may be established by showing negligence. 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). Accordingly, First Boston, Nowlin, and Montague, through their negligent conduct, violated Sections 17(a)(2) and (3) of the Securities Act in the offer and sale of the Series B Bonds.
a. The Misstatements and Omissions Were Material
The Pools' investment strategy, the risks of that strategy, and the Pools' declining investment results were material to the Series B Bond investors. Information is material if there is a substantial likelihood that a reasonable investor in making an investment decision would consider it as having significantly altered the total mix of information made available. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus. v. Northway, Inc., 426 U.S. 438, 449 (1976). As previously discussed, the Pools were the standby liquidity provider on the Series B Bonds. The Pools' investment strategy, the risks of that strategy, and the Pools' declining investment results affected the Pools' ability to fulfill their obligations to repurchase the Series B Bonds. The safety of the investment and the Pools' ability to repurchase the Series B Bonds was material to reasonable investors.
b. First Boston, Nowlin, and Montague Should Have Known that the Official Statement was Materially Misleading
At the time First Boston, Nowlin and Montague participated in drafting the Official Statement, they knew or should have known certain information about the Pools' investment strategy, the risks of that strategy, and the Pools' declining investment results, which matters affected the Pools' ability to provide liquidity for the Series B Bonds. From a reasonable review of the Official Statement, First Boston, Nowlin, and Montague should have known that the Official Statement was materially misleading because the disclosure misrepresented or omitted to disclose such material information about the Pools. For purposes of First Boston's violations, the conduct of the First Boston bankers may be imputed to the firm. See SEC v. Manor Nursing Centers, Inc., 458 F.2d 1082, 1089 n.3 (2d Cir. 1972).
2. First Boston, Nowlin, and Montague Violated Section 15B(c)(1) of the Exchange Act and MSRB Rule G-17
Under Section 15B(c)(1) of the Exchange Act, a broker, dealer, or municipal securities dealer is prohibited from using the mails or any instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any municipal security in violation of any rule of the Municipal Securities Rulemaking Board ("MSRB").
As a broker-dealer conducting a municipal securities business, First Boston was subject to Section 15B(c)(1) of the Exchange Act and the MSRB rules, as were its associated persons, Nowlin and Montague. See MSRB Rule D-11.
MSRB Rule G-17 provides that: "In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice." For the reasons set forth above in Section C.1. with respect to the violations of Sections 17(a)(2) and (3) of the Securities Act, First Boston, Nowlin, and Montague violated MSRB Rule G-17.
3. First Boston Failed Reasonably to Supervise Its Investment Bankers
Under Section 15(b) (4) (E) of the Exchange Act, the Commission may sanction broker-dealers for failing reasonably to supervise a person under its supervision. Supervision is an essential function of broker-dealers. The Commission has "made it clear that it is critical for investor protection that a broker-dealer establish and enforce procedures to supervise its employees." In re Sheldon, Exchange Act Release No. 31475, 52 SEC Docket 3826 (Nov. 18, 1992). See also In re Dean Witter Reynolds, Inc., Exchange Act Release No. 26144, 41 SEC Docket 1680, 1684 (Sept. 30, 1988). In large organizations in particular, it is "imperative that the system of internal control be adequate and effective." In re Prudential Sec., Inc., Exchange Act Release No. 33082 (Oct. 21, 1993). See also In re Shearson, Hammill & Co., Exchange Act Release No. 7743, 42 S.E.C. 811, 843 (Nov. 12, 1965). A firm's failure to establish such guidelines is symptomatic of a failure to supervise reasonably. See In re G.K. Scott & Co., Exchange Act Release No. 33485 (Jan. 14, 1994).
First Boston failed reasonably to supervise Nowlin and Montague with a view towards preventing their violations of the federal securities laws within the meaning of Section 15(b) (4) (E) of the Exchange Act. First Boston allowed Nowlin and Montague to approve the Official Statement on behalf of the firm. The firm, however, failed to have adequate policies and procedures to guide the investment bankers in the review of the disclosure and to detect and prevent violations in connection with municipal securities offerings.
4. Conclusion
Accordingly, based on the foregoing, the Commission finds that First Boston, Nowlin, and Montague willfully violated Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17.4 The Commission further finds that pursuant to Section 15(b) (4) (E) of the Exchange Act, First Boston failed reasonably to supervise Nowlin and Montague with a view towards preventing their violations of the federal securities laws.
IV. First Boston has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it consents to the Commission's entry of this Order, which: (1) makes findings, as set forth above; (2) orders First Boston to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17; and (3) orders First Boston to pay a civil penalty in the amount of $800,000. As set forth in its Offer of Settlement, First Boston undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transaction that is the subject of this Order. Furthermore, First Boston has agreed to certain specific undertakings in the event that it reenters the business of underwriting municipal securities.
V. Nowlin has submitted an Offer of Settlement in which, without admitting or denying the findings herein, he consents to the Commission's entry of this Order, which: (1) makes findings, as set forth above; (2) orders Nowlin to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17; and (3) orders Nowlin to pay a civil penalty in the amount of $35,000. As set forth in his Offer of Settlement, Nowlin undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transaction that is the subject of this Order.
VI. Montague has submitted an Offer of Settlement in which, without admitting or denying the findings herein, he consents to the Commission's entry of this Order, which: (1) makes findings, as set forth above; (2) orders Montague to cease and desist from committing or causing any violations and any future violations of Sections 17(a)(2) and (3) of the Securities Act and Section 15B(c)(1) of the Exchange Act and MSRB Rule G-17; and (3) orders Montague to pay a civil penalty in the amount of $35,000. As set forth in his Offer of Settlement, Montague undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceedings concerning the transaction that is the subject of this Order.
VII. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers of Settlement submitted by First Boston, Nowlin, and Montague.
Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 8A of the Securities Act and Sections 15(b) and 21C of the Exchange Act:
1. First Boston shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17.
2. First Boston shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $800,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the United States Securities and Exchange Commission; (3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter that identifies First Boston as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to William E. White, Senior Trial Counsel, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.
3. First Boston shall comply with the undertakings specified in its Offer as follows:
a. Should First Boston reenter the business of underwriting municipal securities, First Boston undertakes to implement policies and procedures relating to its review of preliminary official statements and supervisory procedures concerning such underwritings prior to reentering such business.
b. Within thirty (30) days of First Boston's reentry into the business of underwriting municipal securities, First Boston shall engage an Independent Consultant who is not unacceptable to the Commission staff. Such Independent Consultant shall have his or her compensation and expenses borne exclusively by First Boston. The Independent Consultant may retain such consultants as he or she shall deem reasonably necessary and appropriate for the task.
c. The Independent Consultant shall review First Boston's policies and procedures to determine the adequacy of such policies and procedures to reasonably detect and prevent the violations of the federal securities laws that gave rise to this proceeding, and with respect to such policies and procedures, the Independent Consultant shall: (1) recommend the adoption and implementation of any new and/or revised procedures deemed necessary or appropriate; and (2) recommend the adoption and implementation of new and/or revised training program deemed necessary or appropriate.
d. The Independent Consultant's recommendation shall be made in the form of an Initial Report submitted to the Chief Executive Officer and Board of Directors of First Boston and the Commission's staff within sixty (60) days of the appointment of the Independent Consultant.
e. Within thirty (30) days of receipt of the draft report submitted by the Independent Consultant, the Chief Executive Officer and Board of Directors of First Boston shall, in writing, advise the Independent Consultant of those recommendations that First Boston has determined not to accept because they are unduly burdensome. Regarding any recommendation First Boston believes is unduly burdensome, First Boston shall undertake to propose an alternative policy or procedure designed to achieve the same result. First Boston and the Independent Consultant shall then attempt in good faith to reach agreement on any policy and procedure as to which there is a dispute.
f. If there is a dispute over a policy or procedure recommended by the Independent Consultant then the Independent Consultant shall evaluate First Boston's alternative policy or procedure. First Boston will, however, abide by the determination of the Independent Consultant with regard thereto and adopt those recommendations deemed appropriate by the Independent Consultant.
g. The Independent Consultant shall complete the aforementioned review and submit a written Final Report thereon to First Boston and the Commission's staff within sixty (60) days following the date of the Initial Report.
h. First Boston shall cooperate fully with the Independent Consultant and shall provide such person with access to its files, books, records, and personnel as reasonably requested for the review by the Independent Consultant.
i. First Boston shall take all necessary and appropriate steps to adopt and implement the recommendations contained in the report.
j. Within sixty (60) days of receipt of the Final Report, First Boston shall file an affidavit with the Commission's staff stating that it has put in place a system of policies and procedures reasonably designed to prevent and/or detect the violations of the securities laws which gave rise to this proceeding or is in the process of so doing, providing a reasonable estimate not to exceed sixty (60) additional days without the approval of the Commission's staff, as to when implementation shall be completed.
k. For the period of engagement and for a period of two years from completion of the engagement, the Independent Consultant shall not enter into any employment, consultant, attorney-client, auditing or other professional relationship with First Boston, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. Any firm with which the Independent Consultant is affiliated or of which he/she is a member, and any person engaged to assist the Independent Consultant in performance of his/her duties under this Order shall not, without prior written consent of the staff of the Commission's Pacific Regional Office, enter into any employment, consultant, attorney-client, auditing or other professional relationship with First Boston, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such for the period of the engagement and for a period of two years after the engagement.
4. Nowlin shall, effective immediately, cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17.
5. Nowlin shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $35,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the United States Securities and Exchange Commission; (3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter that identifies Nowlin as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to William E. White, Senior Trial Counsel, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.
6. Nowlin shall comply with his undertakings described in Section V above.
7. Montague shall cease and desist from committing or causing any violation and any future violation of Sections 17(a)(2) and (3) of the Securities Act, Section 15B(c)(1) of the Exchange Act, and MSRB Rule G-17.
8. Montague shall, within thirty (30) days of the date of this Order, pay a civil money penalty in the amount of $35,000 to the United States Treasury. Such payment shall be: (1) made by United States postal money order, certified check, bank cashier's check or bank money order; (2) made payable to the United States Securities and Exchange Commission; (3) hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6432 General Green Way, Stop 0-3, Alexandria, VA 22312; and (4) submitted under cover letter that identifies Montague as a Respondent in these proceedings, and states the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to William E. White, Senior Trial Counsel, Pacific Regional Office, Securities and Exchange Commission, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036.
9. Montague shall comply with his undertakings described in Section VI above.
Footnotes
-[1]- The findings herein are made pursuant to the Offers of Settlement of First Boston, Nowlin, and Montague and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[2]- The County of Orange, California, was charged with disclosure violations concerning this offering in a settled cease-and-desist proceeding instituted on January 24, 1996. See In re County of Orange, California, Securities Act Release No. 33-7260 (Jan. 24, 1996).
-[3]- Neither Nowlin nor Montague received or requested this Financial Statement.
-[4]- In applying the term "willful" in Commission administrative proceedings instituted pursuant to Sections 15(b),15B,15C,17A,19(h),and 21B of the Exchange Act, Section 9 of the Investment Company Act of 1940,and Section 203 of the Investment Advisers Act of 1940, the Commission evaluates on a case-by-case basis whether the respondent knew or reasonably should have known under the particular facts and circumstances that his conduct was improper. In this case as in all Commission administrative proceedings charging a willful violation under these statutory provisions, the Commission applies this standard to persons -- specifically, securities industry professionals -- who are directly subject to Commission jurisdiction and who have a responsibility to understand their duties to the investing public and to comply with the applicable rules and regulations which govern their behavior.
In re Lazard Freres & Co. LLC, Securities Act Release No. 7480, Exchange Act Release No. 39388, A.P. File No. 3-9495 (December 3, 1997).
I. The Commission deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") [15 U.S.C. 77h-1] and Sections 15B(c) (2) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") [15 U.S.C. 78o-4(c) (2) and 78u-3] against Lazard Freres & Co. LLC ("Lazard Freres" or "Respondent").
In anticipation of the institution of these proceedings, Lazard Freres has submitted an Offer of Settlement ("Offer") to the Commission. Solely for the purpose of these proceedings, and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and prior to a hearing pursuant to the Commission's Rules of Practice, Lazard Freres, without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over Respondent and over the subject matter of these proceedings, which is admitted, by its Offer, consents to the issuance of this Order Instituting Public Administrative Proceedings Pursuant to Section 8A of the Securities Act of 1933 and Sections 15B(c) (2) and 21C of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions (the "Order") and to the entry of the findings and the imposition of the remedial sanctions set forth below.
The Commission has determined that it is appropriate and in the public interest to accept the Offer and is issuing this Order.
II. FACTS
The Commission finds1 that:
A. Respondent
Lazard Freres & Co. LLC. Lazard Freres is a New York limited liability company with its principal place of business in New York, New York. It is the successor to Lazard Freres & Co., a New York limited partnership with its principal place of business in New York, New York. At all relevant times, both Lazard Freres and its predecessor were a broker-dealer and municipal securities dealer, and were registered with the Commission pursuant to Sections 15(b) and 15B(a) (2) of the Exchange Act.
B. Relevant Entities
1. Fulton County, Georgia. The most populous county in the State of Georgia, Fulton County's largest city and county seat is Atlanta. Fulton County's governing body is the Board of Commissioners, which, at all times relevant, consisted of seven members, elected to four-year terms. Four members were elected from territorial districts and three, including the Chairman, were elected from the County at-large. At all times relevant, the Fulton County Commission was empowered to issue bonds and to select underwriters in connection with such bond issuances.
2. Fulton-DeKalb Hospital Authority. The Fulton-DeKalb Hospital Authority ("FDHA") was at all times relevant a public body created pursuant to Georgia law and resolutions adopted by Fulton and DeKalb Counties, Georgia. The FDHA was responsible for providing public health facilities, including the Grady Memorial Hospital in Atlanta. At all times relevant, the FDHA was also authorized to issue revenue anticipation certificates for the purpose of carrying out its duties, to issue such certificates to refund or refinance indebtedness, and to select underwriters for the foregoing. At all times relevant, the FDHA was managed by its Board of Trustees, which was composed of ten members: Seven were residents of Fulton County and were appointed by the Fulton County Board of Commissioners, and three were residents of DeKalb County and were appointed by the DeKalb County Board of Commissioners.
3. Duval County, Florida, School Board. A public body existing under the laws of the State of Florida, the Duval County School Board ("DCSB") was at all times relevant the governing body of the Duval County School District, which included the public schools of the City of Jacksonville. A participant in the "consolidated government" structure in place between the City of Jacksonville and Duval County, the DCSB was empowered to issue bonds, and to select underwriters and other professionals in connection with such bond issuances. The DCSB was composed of seven elected members.
C. Summary
This matter involves an undisclosed payment to a financial advisor and other improper practices to obtain municipal securities underwriting business. A former partner of Lazard Freres who was an investment banker in its Municipal Finance Department (the "Former Partner") and a former Vice-President resident in Florida who was also an investment banker in Respondent's Municipal Finance Department (the "Former Vice-President"), arranged for an outside consultant used by the Former Partner and Former Vice-President in connection with their efforts to obtain municipal securities business for Lazard Freres (the "OutsideConsultant"), to make a $41,936 payment to a former Vice-President of a co-financial advisor to Fulton County and the FDHA (the "Financial Advisor"). In addition, the Former Partner and Former Vice-President used and compensated the Outside Consultant on an undisclosed basis to assist in their efforts to secure a role for Lazard Freres in a 1992 municipal securities offering by the DCSB, in violation of certain representations contained in a contract with the DCSB. As a result of this misconduct of the Former Partner and Former Vice-President, Lazard Freres is responsible for defrauding the issuers in three offerings of municipal securities. Furthermore, the Former Partner also used third parties to act as conduits for political contributions in certain jurisdictions, under cover of false and misleading invoices for consulting and other services which were submitted to Lazard Freres in order to obtain funds from Lazard Freres to reimburse such third parties, thereby causing Lazard Freres to violate books and records provisions and the Municipal Securities Rulemaking Board's ("MSRB") fair dealing rule.2
D. Payment to Financial Advisor
On June 3, 1992, the Fulton County Commission voted to select a two-firm team to provide financial advisory services in connection with, among other things, future municipal underwritings by Fulton County. The Financial Advisor was the senior investment banker for one of the firms selected and was resident in Atlanta for his firm. The Financial Advisor was the person at his firm responsible for the Fulton County financial advisory assignment. Among the responsibilities of Fulton County's financial advisors was assistance with underwriter selection for future Fulton County bond issues.
By July 16, 1992, the Former Partner, the Former Vice President, the Outside Consultant and the Financial Advisor agreed that, in exchange for the promise of compensation, the Financial Advisor would assist the Former Partner and Former Vice-President in their efforts to obtain for Lazard Freres the senior managing underwriter position on a large upcoming bond issue of Fulton County, i.e., the $163,375,000 Fulton County, Georgia, Water and Sewage Revenue Bonds, Refunding Series 1992 (dated October 1992) ("Fulton Water & Sewer Refunding"). Thereafter, the Financial Advisor assisted the Former Partner and Former Vice-President in their ultimately successful effort to obtain that position for Lazard Freres by, among other things, manipulating the results of the financial advisors' ranking of the 32 underwriting proposals received to ensure that Lazard Freres received the top score, and joining in the recommendation submitted to the Fulton County Commission that Lazard Freres be named senior managing underwriter.
In December 1992, following closing of the Fulton Water & Sewer Refunding, the Former Partner arranged for the Outside Consultant to submit a false and misleading invoice to Lazard Freres requesting payment of $83,872 for "Governmental Consulting-Business Development/Marketing Services" and caused Lazard Freres to issue an $83,872 check to the Outside Consultant in payment of the invoice. The Outside Consultant then paid the Financial Advisor $41,936, exactly half of this amount. The $41,936 payment to the Financial Advisor was not disclosed to the issuer or to investors in the Fulton Water & Sewer Refunding.
In conduct that began shortly before he received the $41,936 from the Outside Consultant and that continued thereafter, the Financial Advisor also assisted the Former Partner and Former Vice-President in their efforts to obtain municipal underwriting business from a neighboring issuer, the FDHA, for which the Financial Advisor also came to serve as co-financial advisor by virtue of his position as financial advisor to Fulton County. The bond issue was the $336 million Fulton-DeKalb Hospital Authority (Georgia) Revenue Refunding Certificates, Series 1993 (dated May 1993) ("Grady Hospital Refunding"). The Financial Advisor assisted the Former Partner and Former Vice-President in their efforts to obtain a role for Lazard Freres in the Grady Hospital Refunding by, among other things, providing the Former Partner and Former Vice-President with a copy of a competitor's unsolicited refunding proposal, and joining in the recommendation to the FDHA that Lazard Freres be named as one of three co-senior managing underwriters. The Financial Advisor took these actions, again, without disclosing to the issuer or to investors in the Grady Hospital Refunding the financial arrangement he reached with the Former Partner and Former Vice-President or the $41,936 payment he received from the Outside Consultant. Nor was any such disclosure made by the Former Partner and Former Vice-President.
E. Undisclosed Use of Consultant and Improper Contacts
In connection with the underwriter selection process for the $184,500,000 School District of Duval County, Florida, General Obligation Refunding Bonds, Series 1992 (dated April 1992) ("Duval School Refunding") the terms of the DCSB's Request for Proposals ("RFP") for underwriting services prohibited prospective underwriters from using and paying non-full-time employees as consultants to assist in obtaining business for any such underwriter on the Duval School Refunding. The terms of the Investment Banking Services Agreement ultimately entered into by DCSB and the underwriters expressly empowered the DCSB to recover the amount of any such consultant payments from the underwriters, either as part of the purchase price for the bonds or otherwise.3 In addition, the RFP limited contacts by prospective underwriters and their agents to two individuals: the financial advisor for the transaction and a DCSB staff member.
Notwithstanding these prohibitions, the Former Partner and Former Vice-President arranged to use the Outside Consultant, who was not a Lazard Freres employee, on an undisclosed basis to assist in their efforts to obtain the senior managing underwriter position on the Duval School Refunding for Lazard Freres and promised the Outside Consultant compensation for doing so. Pursuant to such arrangement, the Outside Consultant assisted the Former Partner's and Former Vice-President's efforts to obtain the senior managing underwriter position on the Duval School Refunding for Lazard Freres by, among other things, making prohibited pre-selection contacts with an elected member of the DCSB. Following Lazard Freres' selection as senior managing underwriter for the Duval School Refunding, the Former Partner was responsible for the making of a materially false and misleading representation in the Investment Banking Services Agreement he caused to be executed with the issuer on behalf of Lazard Freres by (1) warranting that Lazard Freres "has not employed or retained any company or person, other than a bona fide employee working solely for Lazard Freres, to solicit or secure this Agreement, and that it has not paid or agreed to pay any person, company, corporation, individual or firm, other than a bona fide employee working solely for Lazard Freres any fee, commission, percentage, gift or other consideration, contingent upon or resulting from the award or making of this Agreement," and (2) failing to disclose the involvement of or compensation to be paid to the Outside Consultant.
F. Use of Consultant and Other Payments for Campaign Contributions
In September and October 1992 and February 1993, the Former Partner arranged for the reimbursement of at least $62,500 in political contributions to gubernatorial campaigns in two jurisdictions. In particular, the Former Partner arranged for third parties -- including certain Florida lawyers and consulting firms -- to make the political contributions. The Former Partner then had the third parties submit false and misleading invoices to Lazard Freres requesting payment for purportedly legitimate municipal-related legal, consulting or other services rendered to Lazard Freres in order to obtain funds from Lazard Freres to reimburse the third parties for the political contributions. The Former Partner then saw to it that these invoices were paid by Lazard Freres. All of the foregoing contributions were made in furtherance of the Former Partner's municipal securities underwriting business development efforts.
III. OPINION
A. Violations of the Antifraud Provisions
By virtue of the above-described conduct of the Former Partner and the Former Vice-President, Lazard Freres is responsible for violations of (1) Section 10(b) of the Exchange Act and Rule 10b-5 thereunder with respect to the sales of bonds from the issuers to Lazard Freres on the three refunding issues, and (2) Sections 17(a)(2) and 17(a)(3) of the Securities Act with respect to the sales of bonds to investors in the three refunding issues.
1. Fraud on the Issuers
The failure to disclose the arrangement with and payment to the Financial Advisor constituted and operated as a scheme to defraud the issuers on the Fulton Water & Sewer and Grady Hospital Refundings. See First Fidelity Securities Group, Exchange Act Rel. No. 36694, 61 S.E.C. Docket 68 (Jan. 9, 1996) (underwriter defrauded issuers by paying undisclosed kickbacks to financial advisor for underwriting business). Similarly, the failure to disclose the use of and the payment of a success fee to the Outside Consultant constituted and operated as a scheme to defraud the DCSB on the Duval School Refunding.
Moreover, as an underwriter of Fulton County, FDHA and DCSB securities, Lazard Freres was a purchaser of securities from those issuers. The Former Partner and Former Vice-President knew and understood that Lazard Freres, as a broker-dealer, had an obligation to deal fairly with the issuers. See MSRB rule G-17;4 see also Charles Hughes & Co. v. SEC, 139 F.2d 434, 437 (2d Cir. 1943), cert. denied, 321 U.S. 786 (1944). The undisclosed arrangement with and payment to the Financial Advisor breached that duty. See, e.g., SEC v. Feminella, 947 F. Supp. 722, 732 (S.D.N.Y 1996) (kickback paid to agent of broker-dealer's customer should have been received by the customer, and not the agent). Fulton County and the FDHA were entitled to impartial advice from the Financial Advisor and in evaluating that advice were entitled "to judge for themselves what significance to attribute" to the payment received by the Financial Advisor. See Wilson v. Great American Industries, Inc., 855 F.2d 987, 994 (2d Cir. 1988). This is "not because such [arrangements] are always corrupt but because they are always corrupting." Mosser v. Darrow, 341 U.S. 267, 271 (1951).5 With respect to the DCSB and the Duval School Refunding, the Former Partner caused a false and misleading representation to be made to the issuer concerning the use and compensation of the Outside Consultant. That misrepresentation went to the terms of the sale of the bonds, and was therefore material to the issuer.
2. Nondisclosure to Investors
As underwriter on the three transactions, Lazard Freres delivered the Official Statements for the offerings to investors, and had a duty to review the key representations in those Official Statements.6 The Official Statements for the Fulton Water and Sewer Refunding and the Grady Hospital Refunding failed to disclose the payment to the Financial Advisor. The Official Statement for the Duval School Refunding failed to disclose the success fee paid to the Outside Consultant. Because the existence of these payments cast doubt on the integrity of the offering process for the respective bond issues, they were material to investors. As the Commission has said, "information concerning financial and business relationships and arrangements among the parties involved in the issuance of municipal securities may be critical to an evaluation of an offering." Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Exchange Act Release No. 33741, 56 S.E.C. Docket 596, 599 (Mar. 9, 1994).
3. Scienter
Both the Former Partner and the Former Vice-President acted with the requisite scienter, see Shivangi v. Dean Witter Reynolds, Inc., 825 F.2d 885, 889 (5th Cir. 1987) (defining scienter as a mental state embracing "intent to deceive, manipulate, or defraud . . . or severe recklessness" (citations omitted)). This is evidenced by their efforts to keep hidden the arrangement with and payment to the Financial Advisor and their use and compensation of the Outside Consultant, including by making the payment to the Financial Advisor through an indirect channel, and also using false and misleading documentation submitted to Lazard Freres in connection with the payment to the Financial Advisor and the payment of the Duval success fee to the Outside Consultant. By virtue of their positions with Lazard Freres, the mental states of the Former Partner and Former Vice-President may be imputed to Lazard Freres.7
4. Jurisdiction
In order for there to be a violation of the antifraud provisions it would be necessary to find that the nondisclosures of the arrangement with and payment to the Financial Advisor and the use and compensation of the Outside Consultant were in connection with the purchase or sale of securities.8 The nondisclosures satisfied this requirement, because they "touch[ed]" on DCSB's, Fulton County's and the FDHA's sale of the securities. Superintendent of Insurance of New York v. Bankers Life & Cas. Co., 404 U.S. 6, 12-13 (1971). The information withheld was material to the issuers' decision to select Lazard Freres as underwriter, and selection of underwriters had a direct nexus with the issuers' sale, and in turn, the public's purchase of the issuers' securities.
B. Violations of Section 15B(c)(1) of the Exchange Act and MSRB rules G-17 and G-20 Section
15B(b) of the Exchange Act established the Municipal Securities Rulemaking Board ("MSRB") and empowered it to propose and adopt rules with respect to transactions in municipal securities by brokers, dealers and municipal securities dealers. As associated persons of broker-dealers, the Financial Advisor, the Former Partner and the Former Vice-President were bound by the MSRB rules. Pursuant to Section 15B(c)(1), a broker-dealer or municipal securities dealer is prohibited from using the mails or any instrumentality in interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any municipal security in violation of any rule of the MSRB. As a municipal securities dealer, Lazard Freres is subject to Section 15B(c)(1) of the Exchange Act and the MSRB rules. By virtue of the above-described conduct of the Former Partner and the Former Vice-President in connection with the Fulton Water and Sewer, Grady Hospital and Duval School Refundings, Lazard Freres is responsible for violating Section 15B(c)(1) of the Exchange Act and MSRB rules G-17 and G-20.
1. MSRB rule G-17
MSRB rule G-17 is a fair dealing rule. The failure to disclose financial and other relationships between a fiduciary of an issuer and an underwriter that create potential or actual conflicts of interest violates MSRB rule G-17. See Lazard Freres & Co. LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Rel. No. 36419 (Oct. 26, 1995); SEC v. Ferber, Lit. Rel. No. 15193 (December 19, 1996); First Fidelity Securities Group, supra; SEC v. Busbee, Lit. Rel. Nos. 14387 (January 23, 1995) and 14508 (May 24, 1995)); SEC v. Rudi, Lit. Rel. Nos. 14421 (February 23, 1996) and 15202 (December 30, 1996).
2. MSRB rule G-20
This rule, "Gifts and Gratuities," prohibits municipal securities dealers from (1) giving any thing or service of value worth more than $100 per year; (2) directly or indirectly; (3) to a person other than an employee or partner of such dealer; (4) if such payment or service is in relation to the municipal securities activities of the employer of the recipient of the payment or service. MSRB Rule G-20(a). The rule specifically provides that "employer" includes the principal for whom the recipient of the payment or service is acting as agent or representative. The rule is intended to prohibit commercial bribery and covers payments to issuer officials and fiduciaries.
By using the Outside Consultant as a conduit for the $41,936 payment to the Financial Advisor, knowing that the Outside Consultant would pass on money to the Financial Advisor at a time when the Former Partner and the Former Vice-President were soliciting underwriting business for Lazard Freres from the Financial Advisor's principal, Fulton County, the Former Partner and the Former Vice-President "indirectly" gave the Financial Advisor "a thing or service of value . . . in excess of $100."
C. Books and Records Violations
Section 17(a)(1) of the Exchange Act requires brokerage firms to create and maintain books and records reflecting their operations and dealings as required by rules promulgated by the Commission. Rule 17a-3 specifies the books and records that brokerage firms must create pursuant to Section 17(a). The MSRB's books and records provisions parallel the Commission's. MSRB rule G-8 is the provision requiring municipal securities dealers to make certain books and records concerning their municipal securities business. The rule requires that the information be recorded "clearly and accurately." MSRB rule G-8(b). The Commission has described the records maintained by broker-dealers as "the basic source documents and transaction records of a broker-dealer," and the "keystone of the surveillance of brokers and dealers by our staff and by the securities industry's self-regulatory bodies." Edward J. Mawod & Co., 46 S.E.C. 865, 873 n. 39 (1977) aff'd sub nom. Edward J. Mawod & Co. v. SEC, 591 F.2d 588, 594 (10th Cir. 1979).
The conduct of the Former Partner and the Former Vice-President caused the books and records of Lazard Freres to be inaccurate with respect to the payment to the Outside Consultant on the Duval School Refunding, the payment to the Financial Advisor (via the Outside Consultant) on the Fulton Water & Sewer Refunding, and the reimbursement of political contributions. With respect to each of these transactions, Lazard Freres' books and records failed to accurately record the true nature of the payments, and characterized them in a misleading manner.
IV. FINDINGS
On the basis of this Order and the Offer, the Commission finds that Lazard Freres willfully violated Sections 10(b), 15B(c)(1) and 17(a) of the Exchange Act and Rules 10b-5 and 17a-3 thereunder, Sections 17(a)(2) and 17(a)(3) of the Securities Act and MSRB rules G-8, G-17 and G-20.
V. OFFER OF SETTLEMENT
Lazard Freres has submitted an Offer of Settlement that the Commission has determined to accept.9 In determining to accept the Offer, the Commission considered the remedial efforts promptly undertaken by Lazard Freres and the cooperation Lazard Freres afforded the Commission staff. In its Offer, Lazard Freres consents, without admitting or denying, to the entry of this Order making findings as set forth above, and ordering Lazard Freres to cease and desist from committing or causing any violation of and committing or causing any future violation of Sections 10(b), 15B(c)(1) and 17(a) of the Exchange Act and Rules 10b-5 and 17a-3 thereunder, Sections 17(a)(2) and 17(a)(3) of the Securities Act and MSRB rules G-8, G-17 and G-20.
VI. ORDER
Accordingly, IT IS HEREBY ORDERED, pursuant to Section 8A of the Securities Act and Sections 15B(c) (2) and 21C of the Exchange Act:
A. That Lazard Freres cease and desist from committing or causing any violation of and committing or causing any future violation of Sections 10(b), 15B(c)(1) and 17(a) of the Exchange Act and Rules 10b-5 and 17a-3 thereunder, Sections 17(a)(2) and 17(a)(3) of the Securities Act and MSRB rules G-8, G-17 and G-20;
B. That Lazard Freres pay a civil penalty in the amount of $1 million pursuant to Section 21B of the Exchange Act. Payment shall be made within ten (10) days of the date of this order. Payment shall be made by wire transfer, to the United States Treasury. Documentation confirming the wire transfer shall be hand-delivered or mailed to the Comptroller, Securities and Exchange Commission, Operations Center, 6342 General Green Way, Stop 0-3, Alexandria, VA 22312, under cover of letter identifying the name and number of this administrative proceeding and the Respondent. A copy of the cover letter and wire transfer documentation shall be simultaneously transmitted to J. Lee Buck, II, Senior Counsel, Division of Enforcement, Securities and Exchange Commission, Stop 7-5, Washington, DC 20549.
Footnotes
-[1]- The findings herein are made pursuant to Respondent's Offer solely for these proceedings and are not binding on any other person or entity in these or any other proceedings.
-[2]- The misconduct described herein for which Lazard Freres is responsible was limited to the Former Partner and Former Vice-President who worked in Lazard Freres' Municipal Finance Department. Moreover, the Former Partner and Former Vice-President caused numerous false and misleading invoices requesting payment for municipal legal, consulting and other services to be submitted to Lazard Freres for payment, in order to facilitate their activities as described in this Order. Notwithstanding the above, Lazard Freres is responsible for the improper conduct of the Former Partner and Former Vice-President by virtue of their prior positions with Respondent. At the end of 1995, Lazard Freres closed its Municipal Finance and Municipal Bond Departments and is no longer engaged in the municipal underwriting business.
-[3]- Both the RFP and later, the "Investment Banking Services Agreement" for the Duval School Refunding provided that, in the event any underwriter paid any compensation to a non-full-time employee engaged to assist an underwriter in obtaining underwriting business in connection with the Duval School Refunding, the DCSB "shall have the right to terminate this agreement without liability and, at its discretion, to deduct from the contract price, or otherwise recover, the full amount" of any such compensation.
-[4]- MSRB rule G-17 provides: In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.
-[5]- Cf. United States v. Waymer, 55 F.3d 564, 572 (11th Cir. 1995), cert. denied, 116 S. Ct. 1350 (1996) (nondisclosure of kickback prevented renegotiation of contracts at better price); United States v. Rudi, 902 F. Supp. 452, 456-57 (S.D.N.Y. 1995); and First Fidelity Securities Group, supra, 61 S.E.C. Docket at 78.
-[6]- See Exchange Act Rule 15c2-12. As the Commission stated in proposing the Rule: By participating in an offering, an underwriter makes an implied recommendation about the securities . . . [T]his recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings. Exchange Act Release No. 26100, 41 S.E.C. Docket 1402, 1411 (Sept. 22, 1988).
-[7]- See Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982); Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 884 (3d Cir. 1975). See also American Soc'y of Mech. Eng'rs, Inc. v. Hydrolevel Corp., 456 U.S. 556, 565-566 (1982). The Commission need not show scienter to establish a violation of Sections 17(a)(2) and 17(a)(3) of the Securities Act.
-[8]- The Commission need not show any financial loss in order to satisfy this element. SEC v. Blavin, 760 F.2d 706, 711 (6th Cir. 1985).
-[9]- In conjunction with the resolution of this matter, Lazard Freres has entered into a separate civil settlement with the Department of Justice. As part of that settlement, Lazard Freres has agreed to make restitutionary payments to Fulton County and the FDHA, and to make a civil settlement payment in the amount of $10 million.
In re Michael Lissack, Exchange Act Release No. 39119, A.P. File No. 3-9427 (September 23, 1997).
On September 23, 1997, the Commission instituted administrative and cease-and-desist proceedings against Michael Lissack ("Lissack"), pursuant to Sections 15(b), 15B(c) (4), 19(h) and 21C of the Securities Exchange Act of 1934 (Exchange Act). The Order Instituting Proceedings ("Order") alleges that beginning in 1990, Lissack worked within the derivative group of a nationally known broker-dealer ("the National Firm") in its public finance department and that through its public finance department, the National Firm, among other things, underwrote offerings by municipalities for a variety of bonds.
The Order further alleges that in June 1993, Dade County, Florida (the "County") issued a request for proposals ("RFP") in connection with a proposed bond offering to finance the refunding of existing water and sewer bonds and, in addition, to finance certain construction projects for its water and sewer system. The County initially planned to raise approximately $800 million through such an offering. After issuance of the RFP, the County determined to proceed with separate offerings: a new money offering of approximately $431 million (the "WASA transaction") and a refunding offering. The National Firm, along with a Miami-based underwriter ("Local Firm"), submitted a joint proposal in response to the RFP, whereby each would serve as co-senior managing underwriter. The response to the RFP discussed the National Firm's background, experience and capabilities, including its experience in structuring interest rate swaps. The RFP also included a discussion of alternative plans of finance that the County could consider should market conditions change prior to marketing the bonds. In September 1993, the County selected the National Firm and the Local Firm to serve as co-senior managing underwriters for the WASA transaction.
According to the Order, the County originally had planned for the WASA transaction to consist of traditional, fixed-rate bonds, whereby the County would be obliged to pay a fixed interest rate to bondholders over the life of the bonds. However, over the next several months, the National Firm raised with the County a different financing structure as an alternative to fixed-rate bonds (the "Alternative Financing Structure"). The Alternative Financing Structure provided for the County to issue variable-rate bonds, and thereafter enter into a contract with a third-party (the "Swap Provider"), whereby the County would exchange its obligation to make variable-rate payments for an obligation to make fixed-rate payments. The National Firm assigned substantial responsibility for structuring the Alternative Financing Structure and calculating its benefits to Lissack, a senior professional within the National Firm's municipal derivative products group who, at the time of the WASA transaction, was a managing director of the firm. Also, according to the Order, the County informed the National Firm that it required a certain minimum threshold in present value savings in order to proceed with the Alternative Financing Structure. Lissack knew about the County's minimum savings requirement.
The Order alleges that Lissack, the banker assigned to the WASA transaction for purposes of structuring and assessing the economic benefits of the Alternative Financing Structure occupied a unique role within the National Firm's public finance department. Lissack was involved in many deals and was permitted latitude in creating and structuring concepts for the various clients of the National Firm. Lissack was also responsible for assessing the relative costs associated with the two possible financing scenarios in the WASA transaction, fixed-rate versus the Alternative Financing Structure. The National Firm's financing team made numerous presentations to the County concerning the proposed financing. Lissack was responsible for that portion of the presentations relating to the benefits of the Alternative Financing Structure as opposed to a fixed rate structure. The savings evaluations performed by Lissack were the centerpiece of such presentations.
The Order alleges that from late October 1993 through January 25, 1994, the presentations to the County showed present value savings that the County would realize if it selected the Alternative Financing Structure over a fixed-rate structure. Those presentations were based substantially on assumptions made and calculations performed by Lissack. In addition, the Order alleges that certain savings presentations to the County in 1993 showed that the County would indeed realize savings in excess of its minimum savings threshold if it implemented the Alternative Financing Structure. However, in late December 1993 or early January 1994, because of a change in interest rates, calculations of the potential savings associated with the Alternative Financing Structure revealed such savings fell below the County's minimum savings threshold, as compared to a traditional fixed-rate model. Thereafter, the staff alleges Lissack manipulated certain of the variables used in the traditional fixed rate and Alternative Financing Structure models in order to create the false impression that the selection of the Alternative Financing Structure would still result in savings to the County in excess of its stated threshold. Those presentations ultimately persuaded the County to implement the Alternative Financing Structure.
The Order alleges that the presentations to the County showing present value savings were based on intentional manipulations by Lissack and that the use of these faulty and inaccurate assumptions resulted, under conservative estimates, in an overstatement of the hypothetical savings associated with the Alternative Financing Structure by at least $5 million. Moreover, the Order alleges that on January 25, 1994, the County decided to implement the Alternative Financing Structure based upon the representation, as calculated by Lissack, that the County would realize present value savings of more than $8 million if it selected the Alternative Financing Structure. On January 25, 1994, the County entered into a thirty-year variable-to-fixed rate forward swap. On February 2, 1994, the County issued $431,700,000 in variable-rate bonds. The Order alleges that Lissack committed or caused violations of the antifraud provisions of the federal securities laws and MSRB Rule G-17 by intentionally manipulating the assumptions included within presentations to the County.
A hearing will be held to determine whether the staff's allegations are true and, if so, what remedial action, if any, is appropriate.
I. As a result of an investigation, the Division of Enforcement alleges that:
A. At all relevant times, Michael Lissack ("Lissack" or "Respondent") was employed by a nationally known broker-dealer (the "National Firm"). Lissack was promoted to the position of Managing Director in the National Firm's public finance department in April 1, 1987. Beginning in 1990, Lissack worked within the derivative group of the National Firm's public finance department. Lissack was terminated by the National Firm in February 1995.
B. The National Firm that employed Lissack is a member of the New York Stock Exchange ("NYSE") and the National Association of Securities Dealers, Inc. ("NASD"). At all times relevant, the National Firm maintained a public finance department that was engaged in the business of structuring and implementing transactions with municipal issuers. Through its public finance department, the National Firm, among other things, underwrote offerings by municipalities for a variety of bonds.
C. In the course of conducting this business, it was the general practice of the National Firm to assemble a team of bankers, each of whom had specific responsibilities relating to a purported offering. This team would typically respond to an issuer's request for proposals ("RFP") and, if selected, generally would continue to deal with the issuer throughout the offering process.
D. At all times relevant, the public finance department of the National Firm maintained a municipal derivatives product group that specialized in offering municipalities certain derivative products and in structuring interest rate swaps. In those instances in which the National Firm intended to propose an interest rate swap to a municipality or where a municipality inquired about the potential use of an interest rate swap, a member of the municipal derivatives product group generally was assigned responsibility for addressing those issues and was assigned to the banking team.
E. In June 1993, Dade County, Florida (the "County") issued an RFP in connection with a proposed bond offering to finance the refunding of existing water and sewer bonds and, in addition, to finance certain construction projects for its water and sewer system. The County initially planned to raise approximately $800 million through such an offering. After issuance of the RFP, the County determined to proceed with separate offerings: a new money offering of approximately $431 million (the "WASA transaction") and a refunding offering.
F. The National Firm, along with a Miami-based underwriter ("Local Firm"), submitted a joint proposal in response to the RFP, whereby each would serve as co-senior managing underwriter. The response to the RFP discussed the National Firm's background, experience and capabilities, including its experience in structuring interest rate swaps. The RFP also included a discussion of alternative plans of finance that the County could consider should market conditions change prior to marketing the bonds. In September 1993, the County selected the National Firm and the Local Firm to serve as co-senior managing underwriters for the WASA transaction.
G. The County originally had planned for the WASA transaction to consist of traditional, fixed-rate bonds, whereby the County would be obliged to pay a fixed interest rate to bondholders over the life of the bonds. However, over the next several months, the National Firm raised with the County a different financing structure as an alternative to fixed-rate bonds (the "Alternative Financing Structure"). The Alternative Financing Structure provided for the County to issue variable-rate bonds, and thereafter enter into a contract with a third-party (the "Swap Provider"), whereby the County would exchange its obligation to make variable-rate payments for an obligation to make fixed-rate payments.1
H. The National Firm assigned substantial responsibility for structuring the Alternative Financing Structure and calculating its benefits to Lissack, a senior professional within the National Firm's municipal derivative products group who, at the time of the WASA transaction, was a managing director of the firm.
I. The County understood that there were certain additional costs and risks associated with the Alternative Financing Structure that were not present in a fixed-rate financing. Accordingly, to offset these additional costs and risks, the County required a certain economic benefit in the form of present value savings before it would select the Alternative Financing Structure. The County informed the National Firm that it required a certain minimum threshold in present value savings in order to proceed with the Alternative Financing Structure. Lissack knew about the County's minimum savings requirement.
ROLE OF LISSACK
J. At all times relevant, Lissack, the banker assigned to the WASA transaction for purposes of structuring and assessing the economic benefits of the Alternative Financing Structure occupied a unique role within the National Firm's public finance department. Lissack was involved in many deals and was permitted latitude in creating and structuring concepts for the various clients of the National Firm. Lissack was also responsible for assessing the relative costs associated with the two possible financing scenarios in the WASA transaction, fixed-rate versus the Alternative Financing Structure. The National Firm's financing team made numerous presentations to the County concerning the proposed financing. Lissack was responsible for that portion of the presentations relating to the benefits of the Alternative Financing Structure as opposed to a fixed rate structure. The savings evaluations performed by Lissack were the centerpiece of such presentations.
K. From late October 1993 through January 25, 1994, the presentations to the County showed present value savings that the County would realize if it selected the Alternative Financing Structure over a fixed-rate structure. Those presentations were based substantially on assumptions made and calculations performed by Lissack.
L. Certain savings presentations to the County in 1993 showed that the County would indeed realize savings in excess of its minimum savings threshold if it implemented the Alternative Financing Structure. However, in late December 1993 or early January 1994, because of a change in interest rates, calculations of the potential savings associated with the Alternative Financing Structure revealed such savings fell below the County's minimum savings threshold, as compared to a traditional fixed-rate model.
M. Thereafter, Lissack manipulated certain of the variables used in the traditional fixed rate and Alternative Financing Structure models in order to create the false impression that the selection of the Alternative Financing Structure would still result in savings to the County in excess of its stated threshold. Those presentations ultimately persuaded the County to implement the Alternative Financing Structure.
TREATMENT OF THE DEBT SERVICE RESERVE FUND
N. The County Bond Ordinance, which authorized the issuance of the bonds, required that a certain amount of the bond proceeds be placed in a Debt Service Reserve Fund ("DSR"). In comparisons run prior to late December 1993, the National Firm's calculation of the costs associated with the Alternative Financing Structure and the fixed-rate Structure accrued no interest on the DSR. In late December 1993 or early January 1994, Lissack changed the savings calculations to include accrued interest on the bond proceeds earmarked for the DSR in the Alternative Financing Structure. Lissack did not include accrued interest on the DSR for the fixed-rate financing model.
O. This treatment of the DSR resulted in an overstatement of the purported present value savings of the Alternative Financing Structure by at least $4 million. This analysis was incorporated into the savings presentations made to the County.
TREATMENT OF THE CONSTRUCTION FUND
P. Lissack also skewed the anticipated interest earnings on monies in the Construction Fund in favor of the Alternative Financing Structure. Lissack used an unreasonably low interest rate for calculating interest earnings on the Construction Fund in the traditional fixed-rate analysis. This resulted in an overstatement of the Alternative Financing Structure by at least $1 million. This disparity was also included in the presentations to the County which further inflated the purported savings associated with the Alternative Financing Structure.
Q. Accordingly, the presentations to the County showing present value savings were based on intentional manipulations by Lissack of the underlying calculations and assumptions as to the fixed-rate model and the Alternative Financing Structure, undertaken to fraudulently present the Alternative Financing Structure in an artificially favorable light. The use of these faulty and inaccurate assumptions resulted, under conservative estimates, in an overstatement of the hypothetical savings associated with the Alternative Financing Structure by at least $5 million.
R. On January 25, 1994, the County decided to implement the Alternative Financing Structure based upon the representation, as calculated by Lissack, that the County would realize present value savings of more than $8 million if it selected the Alternative Financing Structure. On January 25, 1994, the County entered into a thirty-year variable-to-fixed rate forward swap. On February 2, 1994, the County issued $431,700,000 in variable-rate bonds.
PRIMARY VIOLATIONS OF THE FEDERAL SECURITIES LAWS
As a result of the conduct described above, Lissack willfully committed or caused violations of Sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5, thereunder, and MSRB Rule G-17.
II. In view of the allegations made by the Division of Enforcement, the Commission deems it necessary and appropriate in the public interest and for the protection of investors that public proceedings be instituted to determine:
A. whether the allegations set forth in Section I hereof are true and, in connection therewith, to afford Lissack an opportunity to establish any defense to such allegations;
B. whether, pursuant to Section 21C of the Exchange Act, Lissack should be ordered to cease and desist from committing or causing a violation or any future violation of any or all of the Sections or Rules specified in Section I above;
C. what, if any, remedial sanctions are appropriate in the public interest against Lissack;
D. whether, Lissack should be required make an accounting and pay disgorgement plus prejudgement interest; and
E. whether, pursuant to Section 21B of the Exchange Act, a civil money penalty should be imposed against Lissack.
III. IT IS ORDERED that a public hearing for the purpose of taking evidence on the questions set forth in Section II hereof shall be convened not earlier than 30 days and not later than 60 days from service of this Order at a time and place to be fixed and before an Administrative Law Judge to be designated by further order as provided by Rule 200 of the Commission's Rules of Practice, 17 C.F.R. § 201.200.
IT IS FURTHER ORDERED that Lissack file an answer to the allegations contained in this Order Instituting Administrative and Cease-And-Desist Proceedings Pursuant to Sections 15(b), 15B(c) (4), 19(h) and 21C of the Exchange Act ("Order") within twenty (20) days after service upon him of this Order, as provided by Rule 220 of the Commission's Rules of Practice, 17 C.F.R. § 201.220.
If Lissack fails to file an answer, or fails to appear at a hearing after being duly notified, he may be deemed in default and the proceedings may be determined against him upon consideration of this Order, the allegations of which may be deemed to be true as provided by Rules 310 and 220 of the Commission's Rules of Practice, 17 C.F.R. § 201.310 and § 201.220.
This Order shall be served upon Lissack personally or by certified mail, forthwith.
In the absence of an appropriate waiver, no officer or employee of the Commission engaged in the performance of investigative or prosecuting functions in this or any factually related proceedings will be permitted to participate or advise in the decision upon this matter, except as witnesses or counsel in proceedings held pursuant to notice.
Because this proceeding is not "rule-making" within the meaning of Section 4(c) of the Administrative Procedure Act, it is not deemed subject to the provisions of that Section delaying the effective date of any final Commission action.
Footnotes
-[1]- Mechanically, the proposed Alternative Financing Structure involved three steps. First, the County was to issue $431,700,000 in variable rate bonds, whereby the County would be obliged to make interest payments at a rate that would fluctuate over the life of the offering. Second, the proceeds from such an offering allocated for the Construction Fund and for the Debt Service Reserve Fund ("DSR") were to be placed in guaranteed investment contracts ("GIC"). The GIC provider for the construction fund guaranteed interest payments to the County at a rate higher than the amount the County was obliged to pay variable-rate bondholders. Third, the County was to enter into a forward, variable-to-fixed interest rate swap with the Swap Provider, pursuant to which the County would "swap" its variable-rate interest payments for the certainty of a fixed rate payment with the Swap Provider. The Swap Provider paid a fee to The National Firm in connection with this transaction.
In re Michael Lissack, Exchange Act Release No. 39687 (February 20, 1998).
I. The Securities and Exchange Commission ("Commission") instituted public administrative and cease-and-desist proceedings pursuant to Sections 15(b), 15B(c) (4), 19(h) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Respondent Michael Lissack ("Lissack") on September 23, 1997.
II. Respondent Lissack has submitted an Offer of Settlement ("Offer") to the Commission, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over the Respondent and over the subject matter of this proceeding, which is admitted, Respondent Lissack by its Offer consents to the entry of findings and remedial sanctions set forth below.
III. On the basis of the Order Making Findings And Imposing Sanctions And A Cease-And-Desist Order ("Order") and the Offer submitted by Respondent Lissack, the Commission finds that.1
BACKGROUND
At all relevant times, Lissack was employed by a nationally known broker-dealer (the "National Firm"). Lissack was promoted to the position of Managing Director in the National Firm's public finance department on April 1, 1987. From 1990 to February 1995, Lissack worked within the derivative group of the National Firm's public finance department. The National Firm employing Lissack is a member of the New York Stock Exchange ("NYSE") and the National Association of Securities Dealers, Inc. ("NASD"). At all times relevant, the National Firm maintained a public finance department that was engaged in the business of structuring and implementing transactions with municipal issuers. Through its public finance department, the National Firm, among other things, underwrote offerings by municipalities for a variety of bonds. In the course of conducting this business, it was the general practice of the National Firm to assemble a team of bankers, each of whom had specific responsibilities relating to a purported offering. This team would typically respond to an issuer's request for proposals ("RFP") and, if selected, generally would continue to deal with the issuer throughout the offering process.
At all times relevant, the public finance department of the National Firm maintained a municipal derivatives product group that specialized in offering municipalities certain derivative products and in structuring interest rate swaps. In those instances in which the National Firm intended to propose an interest rate swap to a municipality or where a municipality inquired about the potential use of an interest rate swap, a member of the municipal derivatives product group was generally assigned to the banking team.
In June 1993, Dade County, Florida (the "County") issued an RFP in connection with a proposed bond offering to finance the refunding of existing water and sewer bonds and, in addition, to finance certain construction projects for its water and sewer system. The County initially planned to raise approximately $800 million through such an offering. After issuance of the RFP, the County determined to proceed with separate offerings: a new money offering of approximately $431 million (the "WASA transaction") and a refunding offering.
The National Firm submitted a joint proposal in response to the RFP, whereby it would serve as co-senior managing underwriter. The response to the RFP discussed the National Firm's background, experience and capabilities, including its experience in structuring interest rate swaps. The RFP also included a discussion of alternative plans of finance that the County could consider should market conditions change prior to marketing the bonds. In September 1993, the County selected the National Firm to serve as a co-senior managing underwriter for the WASA transaction.
The County originally had planned for the WASA transaction to consist of traditional, fixed-rate bonds, whereby the County would be obliged to pay a fixed interest rate to bondholders over the life of the bonds. However, over the next several months, the National Firm raised with the County a different financing structure as an alternative to fixed-rate bonds (the "Alternative Financing Structure"). The Alternative Financing Structure provided for the County to issue variable-rate bonds, and thereafter enter into a contract with a third-party (the "Swap Provider"), whereby the County would exchange its obligation to make variable-rate payments for an obligation to make fixed-rate payments.2
The National Firm assigned substantial responsibility for structuring the Alternative Financing Structure and calculating its benefits to Lissack, a senior professional within the National Firm's municipal derivative products group who, at the time of the WASA transaction, was a managing director of the firm. The National Firm's team assigned to the WASA transaction included bankers from the National Firm's Tampa, West Palm Beach, and Miami offices, as well as other bankers from its New York City Office.
The County understood that there were certain additional costs and risks associated with the Alternative Financing Structure that were not present in a fixed-rate financing. Accordingly, to offset these additional costs and risks, the County required a certain economic benefit in the form of present value savings before it would select the Alternative Financing Structure. The County informed the National Firm that it required a certain minimum threshold in present value savings in order to proceed with the Alternative Financing Structure. Lissack knew about the County's minimum savings requirement.
ROLE OF LISSACK
At all times relevant, Lissack was responsible for the National Firm's assessment of the relative costs associated with the two possible financing scenarios in the WASA transaction, fixed-rate versus the Alternative Financing Structure. The National Firm's financing team made numerous presentations to the County concerning the proposed financing. Lissack was responsible for that portion of the presentations relating to the benefits of the Alternative Financing Structure as opposed to a fixed rate structure. The savings evaluations were the centerpiece of such presentations.
From late October 1993 through January 25, 1994, the presentations to the County showed present value savings that the County would realize if it selected the Alternative Financing Structure over a fixed-rate structure. Those presentations were based substantially on assumptions provided by Lissack and calculations carried out pursuant thereto.
Certain savings presentations to the County in 1993 showed that the County would indeed realize savings in excess of its minimum savings threshold if it implemented the Alternative Financing Structure. However, in late December 1993 or early January 1994, because of a change in interest rates, calculations of the potential savings associated with the Alternative Financing Structure revealed such savings fell below the County's minimum savings threshold, as compared to a traditional fixed-rate model.
Thereafter, Lissack manipulated the use of certain variables in the traditional fixed rate and Alternative Financing Structure models in the presentations made to the County in order to create the false impression that the selection of the Alternative Financing Structure would still result in savings to the County in excess of its stated threshold. Those presentations ultimately persuaded the County to implement the Alternative Financing Structure.
TREATMENT OF THE DEBT SERVICE RESERVE FUND
The County Bond Ordinance, which authorized the issuance of the bonds, required that a certain amount of the bond proceeds be placed in a DSR. In comparisons run prior to late December 1993, the National Firm calculation of the costs associated with the Alternative Financing Structure and the fixed-rate Structure accrued no interest on the DSR. In late December 1993 or early January 1994, Lissack's savings calculations were changed to include accrued interest on the bond proceeds earmarked for the DSR in the Alternative Financing Structure. Lissack's changes did not include accrued interest on the DSR for the fixed-rate financing model.
This treatment of the DSR resulted in an overstatement of the purported present value savings of the Alternative Financing Structure by at least $4 million. This analysis was incorporated into the savings presentations made to the County.
TREATMENT OF THE CONSTRUCTION FUND
Lissack also skewed the anticipated interest earnings on monies in the Construction Fund in favor of the Alternative Financing Structure. Lissack decided to use an unreasonably low interest rate for calculating interest earnings on the Construction Fund in the traditional fixed-rate analysis. This resulted in an overstatement of the Alternative Financing Structure by at least $1 million. This disparity was also included in the presentations to the County which further inflated the purported savings associated with the Alternative Financing Structure.
Accordingly, the presentations to the County showing present value savings were based on intentional manipulations by Lissack of the underlying calculations and assumptions as to the fixed-rate model and the Alternative Financing Structure, undertaken to fraudulently present the Alternative Financing Structure in an artificially favorable light. The use of these faulty and inaccurate assumptions resulted, under conservative estimates, in an overstatement of the hypothetical savings associated with the Alternative Financing Structure by at least $5 million.
SUBSEQUENT EVENTS
On January 25, 1994, the County decided to implement the Alternative Financing Structure based upon the representation that the County would realize present value savings of more than $8 million if it selected the Alternative Financing Structure. That representation was based on Lissack's faulty methodology, as described above. On January 25, 1994, the County entered into a thirty-year variable-to-fixed rate forward swap. On February 2, 1994, the County issued $431,700,000 in variable-rate bonds.
PRIMARY VIOLATIONS OF THE FEDERAL SECURITIES LAWS
Based on his role in the false presentations to the County, Lissack willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The amount of present value savings associated with the Alternative Financing Structure was material to the County's decision as to which structure to utilize in issuing securities. See Basic, Inc. v. Levinson, 485 U.S. 224 (1988). Lissack's intentional manipulation of the assumptions included within the savings presentations, as described more fully above, demonstrates that he undertook such conduct with an intent to deceive. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976). Municipal securities brokers, dealers and municipal finance professionals, such as Lissack, also must comply with the Municipal Securities Rulemaking Board ("MSRB") rules. Section 15B(c) (4) of the Exchange Act makes it unlawful to use the mails or other means or instrumentalities of interstate commerce to effect transactions in or induce the purchase or sale of any municipal security in contravention of the MSRB Rules. MSRB Rule G-17 requires that each broker, dealer, and municipal securities dealer deal fairly with all persons and refrain from engaging in any deceptive, dishonest, or unfair practice. Based on his previously described conduct, Lissack also willfully violated Section 15B(c) (4) of the Exchange Act and MSRB Rule G-17.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Lissack and impose the sanctions specified therein.
Accordingly, IT IS ORDERED that:
A. Pursuant to Section 21C of the Exchange Act, Lissack is ordered to cease-and-desist from committing or causing any violation or any future violation of Sections 10(b), and 15B(c) (4) of the Exchange Act, and Rule 10b-5, thereunder, and MSRB Rule G-17.
B. IT IS FURTHER ORDERED that Lissack be, and hereby is, barred from association with any broker, dealer, municipal securities dealer, investment advisor or investment company with the right to reapply for association after five years to the appropriate self-regulatory organization, or if there is none, to the Commission.
C. IT IS FURTHER ORDERED that Lissack shall, within thirty (30) business days after the entry of the Order, pay a civil money penalty in the amount of $30,000 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) mailed to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, Mail Stop O-3; and (d) submitted under cover letter which identifies Lissack as a respondent in these proceedings, the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to David Nelson, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, FL 33131.
Footnotes
-[1]- The findings contained herein are not binding on anyone other than Lissack.
-[2]- Mechanically, the proposed Alternative Financing Structure involved three steps. First, the County was to issue $431,700,000 in variable rate bonds, whereby the County would be obliged to make interest payments at a rate that would fluctuate over the life of the offering. Second, the proceeds from such an offering allocated for the Construction Fund and for the Debt Service Reserve Fund ("DSR") were to be placed in guaranteed investment contracts ("GIC"). The GIC provider for the construction fund guaranteed interest payments to the County at a rate higher than the amount the County was obliged to pay variable-rate bondholders. Third, the County was to enter into a forward, variable-to-fixed interest rate swap with the Swap Provider, pursuant to which the County would "swap" its variable-rate interest payments for the certainty of a fixed rate payment with the Swap Provider. The Swap Provider paid a fee to The National Firm in connection with this transaction.
In re Smith Barney, Inc, Exchange Act Release No. 39118, A.P. File No. 3-9426 (September 23, 1997).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") against Respondent Smith Barney, Inc. ("Smith Barney" or "Respondent").
II. In anticipation of the institution of these proceedings, Respondent Smith Barney has submitted an Offer of Settlement ("Offer") to the Commission, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over the Respondent and over the subject matter of this proceeding, which is admitted, Respondent Smith Barney by its Offer consents to the entry of findings and remedial sanctions set forth below.
Accordingly, IT IS ORDERED that proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act be, and, they hereby are, instituted.
III. On the basis of this Order and the Offer submitted by Respondent Smith Barney, the Commission finds1 that:
Background
Smith Barney is a member of the New York Stock Exchange ("NYSE") and the National Association of Securities Dealers, Inc. ("NASD"). At all times relevant, Smith Barney maintained a public finance department that was engaged in the business of structuring and implementing transactions with municipal issuers. Through its public finance department, Smith Barney, among other things, underwrote offerings by municipalities for a variety of bonds. In the course of conducting this business, it was the general practice of Smith Barney to assemble a team of bankers, each of whom had specific responsibilities relating to a purported offering. This team would typically respond to an issuer's request for proposals ("RFP") and, if selected, generally would continue to deal with the issuer throughout the offering process.
At all times relevant, the public finance department of Smith Barney maintained a municipal derivatives product group that specialized in offering municipalities certain derivative products and in structuring interest rate swaps. In those instances in which Smith Barney intended to propose an interest rate swap to a municipality or where a municipality inquired about the potential use of an interest rate swap, a member of the municipal derivatives product group generally was assigned responsibility for addressing those issues and was assigned to the banking team.
In June 1993, Dade County, Florida (the "County") issued an RFP in connection with a proposed bond offering to finance the refunding of existing water and sewer bonds and, in addition, to finance certain construction projects for its water and sewer system. The County initially planned to raise approximately $800 million through such an offering. After issuance of the RFP, the County determined to proceed with separate offerings: a new money offering of approximately $431 million (the "WASA transaction") and a refunding offering.
Smith Barney, along with a Miami-based underwriter (hereinafter, the "Local Firm"), submitted a joint proposal in response to the RFP, whereby each would serve as co-senior managing underwriter. The response to the RFP discussed Smith Barney's background, experience and capabilities, including its experience in structuring interest rate swaps. The RFP also included a discussion of alternative plans of finance that the County could consider should market conditions change prior to marketing the bonds. In September 1993, the County selected Smith Barney and the Local Firm to serve as co-senior managing underwriters for the WASA transaction.
The County originally had planned for the WASA transaction to consist of traditional, fixed-rate bonds, whereby the County would be obliged to pay a fixed interest rate to bondholders over the life of the bonds. However, over the next several months, Smith Barney raised with the County a different financing structure as an alternative to fixed-rate bonds (the "Alternative Financing Structure"). The Alternative Financing Structure provided for the County to issue variable-rate bonds, and thereafter enter into a contract with a third-party (the "Swap Provider"), whereby the County would exchange its obligation to make variable-rate payments for an obligation to make fixed-rate payments.2
Smith Barney assigned substantial responsibility for structuring the Alternative Financing Structure and calculating its benefits to a senior professional within Smith Barney's municipal derivative products group, who left Smith Barney in early 1995 but who, at the time of the WASA transaction, was a managing director of the firm (hereinafter, the "SB Municipal Derivatives Banker").
The County understood that there were certain additional costs and risks associated with the Alternative Financing Structure that were not present in a fixed-rate financing. Accordingly, to offset these additional costs and risks, the County required a certain economic benefit in the form of present value savings before it would select the Alternative Financing Structure. The County informed Smith Barney that it required a certain minimum threshold in present value savings in order to proceed with the Alternative Financing Structure. The SB Municipal Derivatives Banker knew about the County's minimum savings requirement.
ROLE OF THE SB MUNICIPAL DERIVATIVES BANKER
At all times relevant, the SB Municipal Derivatives Banker assigned to the WASA transaction for purposes of structuring and assessing the economic benefits of the Alternative Financing Structure occupied a unique role within Smith Barney's public finance department. The SB Municipal Derivatives Banker was involved in many deals and was permitted latitude in creating and structuring concepts for the various clients of Smith Barney. The SB Municipal Derivatives Banker was also responsible for assessing the relative costs associated with the two possible financing scenarios in the WASA transaction, fixed-rate versus the Alternative Financing Structure. Smith Barney's financing team made numerous presentations to the County concerning the proposed financing. The SB Municipal Derivatives Banker was responsible for that portion of the presentations relating to the benefits of the Alternative Financing Structure as opposed to a fixed rate structure. The savings evaluations performed by the SB Municipal Derivatives Banker were the centerpiece of such presentations.
From late October 1993 through January 25, 1994, the presentations to the County showed present value savings that the County would realize if it selected the Alternative Financing Structure over a fixed-rate structure. Those presentations were based substantially on assumptions made and calculations performed by the SB Municipal Derivatives Banker.
Certain savings presentations to the County in 1993 showed that the County would indeed realize savings in excess of its minimum savings threshold if it implemented the Alternative Financing Structure. However, in late December 1993 or early January 1994, because of a change in interest rates, calculations of the potential savings associated with the Alternative Financing Structure revealed such savings fell below the County's minimum savings threshold, as compared to a traditional fixed-rate model.
Thereafter, the SB Municipal Derivatives Banker, without informing his supervisors, manipulated certain of the variables used in the traditional fixed rate and Alternative Financing Structure models in order to create the false impression that the selection of the Alternative Financing Structure would still result in savings to the County in excess of its stated threshold. Those presentations ultimately persuaded the County to implement the Alternative Financing Structure.
TREATMENT OF THE DEBT SERVICE RESERVE FUND
The County Bond Ordinance, which authorized the issuance of the bonds, required that a certain amount of the bond proceeds be placed in a Debt Service Reserve Fund ("DSR"). In comparisons run prior to late December 1993, the Smith Barney calculation of the costs associated with the Alternative Financing Structure and the fixed-rate Structure accrued no interest on the DSR. In late December 1993 or early January 1994, the SB Municipal Derivatives Banker changed the savings calculations to include accrued interest on the bond proceeds earmarked for the DSR in the Alternative Financing Structure. The SB Municipal Derivatives Banker did not include accrued interest on the DSR for the fixed-rate financing model.
This treatment of the DSR resulted in an overstatement of the purported present value savings of the Alternative Financing Structure by at least $4 million. This analysis was incorporated into the savings presentations made to the County.
TREATMENT OF THE CONSTRUCTION FUND
The SB Municipal Derivatives Banker also skewed the anticipated interest earnings on monies in the Construction Fund in favor of the Alternative Financing Structure. The SB Municipal Derivatives Banker used an unreasonably low interest rate for calculating interest earnings on the Construction Fund in the traditional fixed-rate analysis. This resulted in an overstatement of the Alternative Financing Structure by approximately $1 million. This disparity was also included in the presentations to the County which further inflated the purported savings associated with the Alternative Financing Structure.
Accordingly, the presentations to the County showing present value savings were based on intentional manipulations by the SB Municipal Derivatives Banker of the underlying calculations and assumptions as to the fixed-rate model and the Alternative Financing Structure, undertaken to fraudulently present the Alternative Financing Structure in an artificially favorable light. The use of these faulty and inaccurate assumptions resulted, under conservative estimates, in an overstatement of the hypothetical savings associated with the Alternative Financing Structure by at least $5 million.
RELIANCE BY THE COUNTY
On January 25, 1994, the County decided to implement the Alternative Financing Structure based upon the representation, as calculated by the SB Municipal Derivatives Banker, that the County would realize present value savings of more than $8 million if it selected the Alternative Financing Structure. On January 25, 1994, the County entered into a thirty-year variable-to-fixed rate forward swap. On February 2, 1994, the County issued $431,700,000 in variable-rate bonds.
BENEFITS TO SMITH BARNEY
Smith Barney's up-front fees from the WASA transaction were derived primarily from its share, after splitting with the Local Firm, of the swap fee, management and underwriting fees, and a fee paid in connection with the GIC. Smith Barney's up-front compensation amounted to approximately $2.2 million before expenses.
Smith Barney has also earned and stands to earn additional fees pursuant to a remarketing agreement with the County dated February 4, 1994 (the "Remarketing Agreement"), whereby Smith Barney is obliged to perform certain duties in connection with bonds presented for sale over the 30-year life of the deal. Pursuant to the Remarketing Agreement, Smith Barney is entitled to earn a potential total of approximately $5 million over the life of the variable-rate debt. As of the date of this Order, Smith Barney has received approximately $709,668 pursuant to the Remarketing Agreement. Smith Barney's potential outstanding share of future fees due from the County for remarketing services is approximately $3,125,634, after expenses.
Had the County undertaken a traditional, fixed-rate financing, Smith Barney would have earned only approximately $700,000 before expenses and would not have entered into or received fees from a remarketing agreement. Smith Barney earned significantly more money on the WASA transaction as a result of the County's decision to implement the Alternative Financing Structure. After a credit for certain otherwise unreimbursed expenses, the economic benefit to Smith Barney for implementing the Alternative Financing Structure as opposed to a fixed rate financing, exclusive of remarketing fees, was over $1.5 million.
PRIMARY VIOLATIONS OF THE FEDERAL SECURITIES LAWS
In preparing the false presentations to the County, the SB Municipal Derivatives Banker violated Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The amount of present value savings associated with the Alternative Financing Structure was material to the County's decision as to which structure to utilize in issuing securities. See Basic. Inc. v. Levinson, 485 U.S. 224 (1988). The SB Municipal Derivatives Banker's intentional manipulation of the assumptions included within the savings presentations as described more fully above, demonstrates that he undertook such conduct with an intent to deceive. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 (1976). Municipal securities brokers, dealers and municipal finance professionals, such as the SB Municipal Derivatives Banker, also must comply with the Municipal Securities Rulemaking Board ("MSRB") rules. Section 15B(c)(1) of the Exchange Act makes it unlawful to use the mails or other means or instrumentalities of interstate commerce to effect transactions in or induce the purchase or sale of any municipal security in contravention of the MSRB Rules. MSRB Rule G-17 requires that each broker, dealer, and municipal securities dealer deal fairly with all persons and refrain from engaging in any deceptive, dishonest, or unfair practice. Based on his previously described conduct, the SB Municipal Derivatives Banker also violated MSRB Rule G-17.
SMITH BARNEY'S FAILURE TO SUPERVISE
"The responsibility of broker dealers to supervise their employees by means of effective, established procedures is a critical component in the federal investor protection scheme regulating the securities market." In the Matter of Lehman Brothers. Inc., Exchange Act Release No. 37673 (Sept. 12, 1996) (citing In re Smith Barney, Harris Upham & Co., Exchange Act Release No. 21813 (Mar. 5, 1985)).
At all relevant times, Smith Barney had no express written supervisory procedures providing for any meaningful review of the calculations performed by the SB Municipal Derivatives Banker, or the assumptions and methodology underlying such calculations, or disclosures made to the County. As a result of the absence of any such written procedures or other institutionally-recognized practice, the SB Municipal Derivatives Banker's disparate treatment in the two models went undetected, and the savings associated with a financing transaction proposed by Smith Barney to Dade County were overstated by at least $5 million.
Accordingly, in light of the conduct described above, Smith Barney failed reasonably to supervise an individual subject to its supervision within the meaning of Section 15(b) (4) (E) of the Exchange Act with a view to preventing violations of Sections 10(b) and 15B(c)(1) of the Exchange Act, Rule 10b-5 thereunder, and MSRB Rule G-17.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Smith Barney and impose the sanctions specified therein.
Accordingly, IT IS ORDERED that:
A. Smith Barney shall be, and hereby is, censured;
B. Smith Barney shall comply with the undertakings described below:
1. Smith Barney represents that, since the conduct described above, it has modified its compliance and supervisory policies in the following respects: (i) it has implemented a Quality Control Checklist procedure for all negotiated transactions senior managed by Smith Barney, and (ii) it has established a Transaction Review Committee that reviews, among other things, interest rate swaps over $25 million executed in conjunction with senior managed new issues. Smith Barney undertakes that, within twenty (20) days of the entry of the Order, it will further supplement, if it deems appropriate, its compliance and supervisory policies and procedures to address those deficiencies raised in this order. Smith Barney undertakes to maintain any modified supervisory and compliance policies and procedures, as well as existing supervisory and compliance policies and procedures, except as they may be inconsistent with, or superseded by, any new policies or procedures adopted in accordance with Paragraphs B.2. through B.7. below.
2. Smith Barney undertakes to retain within twenty (20) days of the date of the Order, at Smith Barney's expense, an Independent Consultant ("Consultant"), not unacceptable to the Commission's staff, to conduct a review of, and to report and make recommendations as to Smith Barney's supervisory and compliance policies and procedures applicable to the public finance department, related to the types of conduct which gave rise to this proceeding and which are described in this Order.
3. The Consultant shall conduct a review of Smith Barney's supervisory and compliance policies and procedures applicable to the public finance department, related to the types of conduct which gave rise to this proceeding and which are described in this Order.
4. Smith Barney shall cooperate fully with the Consultant in this review, including making such non-privileged information and documents available, as the Consultant may reasonably request, and by permitting and requiring Smith Barney's employees and agents to supply such non-privileged information and documents as the Consultant may reasonably request.
5. The Consultant shall provide a written report to Smith Barney and the Staff of the Commission within three (3) months of the date of this Order setting forth the Consultant's recommendations. The Consultant shall have the option to seek an extension of time by making a written request to the Commission staff.
6. Smith Barney shall adopt all recommendations contained in the written report of the Consultant; provided, however, that as to any recommendation that Smith Barney believes is unduly burdensome or impractical, Smith Barney may suggest an alternative policy or procedure designed to achieve the same objective, submitted in writing to the Consultant and the Commissions staff. Smith Barney and the Consultant shall then attempt in good faith to reach agreement as to any policy or procedure as to which there is any dispute and the Consultant shall reasonably evaluate any alternative policy or procedure proposed by Smith Barney. Smith Barney will abide by the Consultant's determinations with regard thereto and adopt those recommendations deemed appropriate by the Consultant.
7. Within thirty (30) days of the receipt of the Consultant's written report, Smith Barney shall submit an affidavit to the Commission's staff stating that it has implemented the recommendations of the Consultant.
8. To ensure the independence of the Consultant, Smith Barney: (i) shall not have the authority to terminate the Consultant without the prior written approval of the staff of the Southeast Regional Office of the Commission ("SERO"); and (ii) shall compensate the Consultant, and persons engaged to assist the Consultant, for services rendered pursuant to this Order at their reasonable and customary rates.
9. For the period of the engagement and for a period of two years from the completion of the engagement, the Consultant shall not enter into any employment, consulting, attorney-client or auditing relationship with Smith Barney, or any of its present or former affiliates, directors, officers, employees, or agents acting in their capacity as such. Any firm with which the Consultant is affiliated or of which he/she is a member, and any person engaged to assist the Consultant in performance of his/her duties under this Order shall not, without prior written consent of the SERO, enter into any employment, consulting or other professional relationship with Smith Barney, or any of its present or former directors, officers, employees, or agents in their capacity as such for the period of the engagement and for a period of two years after the engagement.
10. Smith Barney shall agree to forego, in connection with the Remarketing Agreement, 46.6% of its prospective quarterly billings to the County under the remarketing agreement, to a maximum of $3,125,634 for the full term of the agreement, representing the outstanding amount of its share of such fee that exceeds certain anticipated expenses. Smith Barney's obligations under this Remarketing Agreement shall otherwise remain unchanged by this Order.
C. IT IS FURTHER ORDERED that Smith Barney shall, within thirty (30) business days after the entry of the Order, pay disgorgement in the amount of $1,584,671 and prejudgment interest in the amount of $452,365 to Dade County, Florida.
D. IT IS FURTHER ORDERED that Smith Barney shall also, within thirty (30) business days after the entry of the Order, pay a civil money penalty in the amount of $250,000 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 to the Comptroller, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, Mail Stop 0-3; and (d) submitted under cover letter which identifies Smith Barney as a respondent in these proceedings, the file number of this proceeding, a copy of which cover letter and money order or check shall be sent to David Nelson, Southeast Regional Office, Securities and Exchange Commission, 1401 Brickell Avenue, Suite 200, Miami, FL 33131.
Footnotes
-[1]- The findings contained herein are made pursuant to Respondent's Offer of Settlement and are not binding on any other person or entity in this or any other proceeding.
-[2]- Mechanically, the proposed Alternative Financing Structure involved three steps. First, the County was to issue $431,700,000 in variable rate bonds, whereby the County would be obliged to make interest payments at a rate that would fluctuate over the life of the offering. Second, the proceeds from such an offering allocated for the Construction Fund and for the Debt Service Reserve Fund ("DSR") were to be placed in guaranteed investment contracts ("GIC"). The GIC provider for the construction fund guaranteed interest payments to the County at a rate higher than the amount the County was obliged to pay variable-rate bondholders. Third, the County was to enter into a forward, variable-to-fixed interest rate swap with the Swap Provider, pursuant to which the County would "swap" its variable-rate interest payments for the certainty of a fixed rate payment with the Swap Provider. The Swap Provider paid a fee to Smith Barney in connection with this transaction.
In re Derek Washington, Securities Act Release No. 7442, Exchange Act Release No. 38978 (August 27, 1997).
On August 27, 1997, the Commission instituted public administrative and cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 ( Securities Act ) and Sections 15(b), 15B(c) (4), 19(h) and 21C of the Securities Exchange Act of 1934 (Exchange Act ), against Derek Washington(Washington ) of Brooklyn, New York. The Order Instituting Proceedings (Order ) alleges that Washington was a registered vice-president of a certain broker-dealer (the broker-dealer") from August 1991 to August 1993. Although not registered with the broker-dealer since August 1993, Washington, at all relevant times, maintained his office within the New York headquarters of the broker-dealer and was responsible for the broker-dealer's trading and back office operations. The Order further alleges that from May 10, 1995 through April 18, 1996, while unregistered, the broker-dealer purchased and sold over $13 million in municipal bonds and received over $200,000 in proceeds as a result of participating in municipal underwritings. According to the Order, Washington was aware of his role in the broker-dealer s scheme to conduct unregistered underwriting business and rendered substantial assistance by, among other things, executing underwriting agreements, submitting solicitations for underwritings, executing transactions and placing orders. In addition, the Order alleges that Washington made material misrepresentations regarding the broker-dealer to various municipal issuers and other underwriting firms.
The Order alleges that as a result of the foregoing conduct, Washington committed and/or caused violations of Section 17(a) of the Securities Act and Sections 15(a) (1), 15B(a) (1), 15(c)(1) and 15B(c)(1) and 10(b) of the Exchange Act, and Rules 10b-5 and 15c1-2, thereunder, and Rule G-17 of the Municipal Securities Rulemaking Board ( MSRB ). The Order further alleges Washington willfully aided and abetted violations of Sections 15(a) (1), 15B(a) (1), 15(c)(1) and 15B(c)(1) of the Exchange Act, and Rule 15c1-2 thereunder, and MSRB Rule G-17. A hearing will be conducted to determine, among other things, whether remedial sanctions and a cease-and-desist order should be entered against Washington.
In re Derek Washington , Securities Act Release No. 7504, Exchange Act Release No. 39650 (February 12, 1998).
I. The Securities and Exchange Commission ("Commission") instituted public administrative and cease-and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 ("Securities Act") and Sections 15(b), 15B(c) (4), 19(h) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Respondent Derek Washington ("Washington") on August 27, 1997.
II. Respondent Washington has submitted an Offer of Settlement ("Offer") to the Commission, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over the Respondent and over the subject matter of this proceeding and as to Sections III.A. and B. below, which are admitted, Respondent Washington by his Offer consents to the entry of findings, remedial sanctions and cease-and-desist order set forth below.
III. On the basis of this Order Making Findings and Imposing Remedial Sanctions and a Cease-and-Desist Order ("Order") and the Offer submitted by Respondent Washington, the Commission finds that.1
A. Derek Washington was a registered vice-president of a certain municipal securities broker-dealer (the "broker-dealer") from August 1991 to August 1993. Although not registered with the broker-dealer since August 1993, Washington, at all relevant times, maintained his office within the New York headquarters of the broker-dealer and was responsible for the broker-dealer's trading and back office operations.2
B. The broker-dealer, at all relevant times, operated as a municipal securities broker-dealer within the meaning of Sections 3(a) (30) and 3(a) (31) of the Exchange Act. Until March 1995, the broker-dealer was headquartered in New York City and maintained eight offices throughout the United States. The broker-dealer was founded and registered with the Commission in 1984.
C. In 1984, the broker-dealer was founded and registered with the Commission by a principal officer of the broker-dealer. Since its inception, the broker-dealer's primary source of business had been underwriting state and local municipal debt.
D. In 1994, the broker-dealer was financially distressed. In approximately February 1995, the broker-dealer's principal officer decided to close the firm. The principal officer, on behalf of the broker-dealer, filed the withdrawal of registration as a broker-dealer on March 31, 1995. The broker-dealer's withdrawal became effective with the National Association of Securities Dealers, Inc. ("NASD") and the Commission on April 27, 1995 and on June 9, 1995, respectively. At the time, Washington, who was no longer an employee of the broker-dealer but who worked out of the broker-dealer's New York office, was also informed of the pending closure by the firm's principal officer. The principal officer proceeded to wind down the broker-dealer's affairs, including the liquidation of the firm's equipment and furniture. Washington assumed the broker-dealer's lease after its closure.
E. By May 1995, the broker-dealer had effectively withdrawn its NASD registration as a broker-dealer. The principal officer failed to inform the various municipalities with which the broker-dealer had been registered in underwriting pools that it no longer could do business as a broker-dealer. As a result, the broker-dealer continued to be selected as an underwriter for municipal underwritings from various municipal underwriting pools.
F. After being advised of the broker-dealer's selection to these underwritings, the broker-dealer, the principal officer and Washington executed underwriting agreements with senior underwriters. These agreements contained material misrepresentations to the effect that the broker-dealer was then currently registered with the NASD and the Commission and that it was in regulatory compliance with the entity or agency.
G. The broker-dealer, through the principal officer and Washington, also prepared and submitted solicitations for additional business to various other municipalities after the broker-dealer had withdrawn its registration as a broker-dealer. The broker-dealer solicited underwriting business from at least five municipal bond issuers. These solicitations, prepared by Washington, contained misrepresentations and material omissions concerning the broker-dealer and its employees. For example, in the broker-dealer's September 6, 1995 response to an issuer's request for proposals for underwriters, the broker-dealer omitted to inform the issuer that it was not currently registered as a broker-dealer and misrepresented, among other things, the number of salespeople capable of distributing the upcoming transaction and the amount of secondary trading in which the firm was engaged.
H. During the period of May 10, 1995 through April 18, 1996, while unregistered, the broker-dealer, through Washington, purchased and sold $14,800,000 worth of bonds in at least fifteen different underwritings. The broker-dealer received over $200,000 in compensation as a result of its participation in these transactions.
I. Washington was aware of his role in the broker-dealer's scheme to conduct underwriting business and rendered substantial assistance to that scheme by, among other things, executing underwriting agreements and by submitting solicitations for underwritings.
J. Washington has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay disgorgement plus prejudgment interest or a civil money penalty. The Commission has reviewed the sworn financial statement and other evidence provided by Washington and has determined that Washington does not have the financial ability to pay disgorgement of $10,000 plus prejudgment interest or a civil money penalty.
Violations
K. As a result of the conduct described above, Washington willfully aided and abetted violations of Sections 15(a) (1), 15(c)(1), 15B(a) (1) and 15B(c)(1) of the Exchange Act and Rule 15c1-2, thereunder, and Municipal Securities Rulemaking Board ("MSRB") Rule G-17, by effecting, inducing and attempting to induce the purchase and sale of municipal securities while the broker-dealer was not registered with the Commission as a broker-dealer or municipal securities dealer, and by misrepresenting the registration status and qualifications of the broker-dealer.
L. As a result of the conduct described above, Washington committed or caused violations of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act. Sections 10(b), 15(a) (1), 15(c)(1), 15B(a) (1), and 15B(c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2, thereunder, and MSRB Rule G-17 by effecting, inducing and attempting to induce the purchase and sale of municipal securities while the broker-dealer was not registered with the commission as a broker-dealer or municipal securities dealer, and by misrepresenting the registration status and qualifications of the broker-dealer.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Washington and impose the remedial sanctions and cease-and-desist order specified therein.
Accordingly, IT IS ORDERED that:
A. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Washington is ordered to cease and desist from committing or causing any violation or any future violation of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act, Sections 10(b), 15(a) (1), 15(c)(1), 15B(a) (1) and 15(B) (c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder, and MSRB Rule G-17.
B. Washington be, and hereby is, suspended from association with any broker, dealer, municipal securities dealer, investment adviser or investment company, for a period of one year, effective on the second Monday following the entry of this order.
C. Washington shall be liable for, and pay disgorgement of $10,000.00 plus prejudgment interest, but that the payment of such amount shall be waived and a civil money penalty will not be imposed based upon Washington's demonstrated financial inability to pay.
D. 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 Washington provided accurate and incomplete financial information at the time such representations were made; (2) order disgorgement of $10,000, plus prejudgement interest; (3) determine the amount of civil penalty to be imposed; and (4) seek any additional remedies that the Commission would be authorized to impose in this proceeding if Respondent'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 the Respondent was fraudulent, misleading, inaccurate or incomplete in any material respect, the amount of civil penalty to be imposed and whether any additional remedies should be imposed. Respondent 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.
Footnotes
-[1]- The findings contained herein are not binding on anyone other than Washington.
-[2]- From March 1995 to October 1996, Washington was associated with at least one, and at times as many as three, other broker-dealers.
In re Willie Daniels, Securities Act Release No. 7441, Exchange Act Release No. 38977, A.P. File No. 3-9375 (August 27, 1997).
I. The Securities and Exchange Commission ( Commission ) deems it appropriate and in the public interest to institute public administrative and cease- and-desist proceedings pursuant to Section 8A of the Securities Act of 1933 ( Securities Act ) and Sections 15(b), 15B(c) (4), 19(h) and 21C of the Securities Exchange Act of 1934 ( Exchange Act ) against Respondent Willie Daniels ( Daniels ).
II. In anticipation of the institution of these proceedings, Respondent Daniels has submitted an Offer of Settlement ( Offer ) to the Commission, which the Commission has determined to accept. Solely for the purpose of this proceeding and any other proceeding brought by or on behalf of the Commission, or in which the Commission is a party, and without admitting or denying the findings contained herein, except as to the jurisdiction of the Commission over the Respondent and over the subject matter of this proceeding and as to Sections III.A. and B. below, which are admitted, Respondent Daniel by his Offer consents to the entry of findings, remedial sanctions and cease-and-desist order set forth below.
Accordingly, IT IS ORDERED that proceedings pursuant to Section 8A of the Securities Act and Sections 15(b), 15B(c) (4), 19(h) and 21C of the Exchange Act be, and, they hereby are, instituted.
III. On the basis of this Order and the Offer submitted by Respondent Daniels, the Commission finds1 that:
A. Daniels, at all relevant times, operated as a non-registered principal of a municipal securities broker-dealer ( the broker-dealer ). Daniels was the founder of the broker-dealer, and remains its president and sole owner. Daniels was registered with the National Association of Securities Dealers, Inc. ( NASD ) as a municipal securities principal of the broker-dealer until April 1995.
B. The broker-dealer, at all relevant times, operated as a municipal securities broker-dealer within the meaning of Sections 3(a) (30) and 3(a) (31) of the Exchange Act. Until March 1995, the broker-dealer was headquartered in New York City and maintained eight offices throughout the United States. The broker-dealer was founded and registered by Daniels with the Commission in 1984.
C. Since its inception, the broker-dealer s primary source of business had been underwriting state and local municipal debt.
D. In 1994, Daniels and the broker-dealer were financially distressed. In approximately February 1995, Daniels decided to close the firm. Daniels, on behalf of the broker-dealer, filed the withdrawal of its registration as a broker-dealer on March 31, 1995. The broker-dealer's withdrawal became effective with the NASD and the Commission on April 27, 1995 and on June 9, 1995, respectively. As a result of this action, Daniels also surrendered his Municipal Securities Principal registration. Thereafter, Daniels proceeded to wind down the broker-dealer s affairs, including the liquidation of the firm s equipment and furniture.
E. By May 1995, the broker-dealer had effectively withdrawn its NASD registration as a broker-dealer. Daniels failed to inform the various municipalities with which the broker-dealer had been registered in underwriting pools that it no longer could do business as a broker-dealer. As a result, the broker-dealer continued to be selected as an underwriter for municipal underwritings from various municipal underwriting pools.
F. After being advised of the broker-dealer's selection to these underwritings, the broker-dealer, through Daniels and another individual acting on behalf of the broker-dealer, executed underwriting agreements with senior underwriters. Certain of these agreements contained affirmative material misrepresentations to the effect that the broker-dealer was then currently registered with the NASD and the
Commission and that it was in regulatory compliance with those entities.
G. The broker-dealer, through Daniels and another individual acting at his direction, also prepared and submitted solicitations for additional business to various other municipalities after the broker-dealer had withdrawn its registration. The broker-dealer solicited underwriting business from at least five municipal bond issuers. These solicitations also contained misrepresentations and material omissions concerning the broker-dealer and its employees. For example, in a September 6, 1995 response by the broker-dealer to a request for proposals for underwriters from an issuer, the broker-dealer omitted to inform the issuer that the broker-dealer was not currently registered as a broker-dealer and misrepresented, among other things, the number of salespeople capable of distributing the upcoming transaction and the amount of secondary trading in which the firm was engaged.
H. During the period of May 10, 1995 through April 18, 1996, while unregistered, the broker-dealer purchased and sold $14,800,000 bonds in at least fifteen different underwritings. The broker-dealer received over $200,000 in compensation as a result of its participation in these transactions.
I. Daniels was aware of his role in the broker-dealer's scheme to conduct unregistered underwriting business and rendered substantial assistance to that scheme by arranging for the offices of the broker-dealer to be maintained, by executing underwriting agreements, by submitting solicitations for underwritings, and by paying employees and otherwise meeting the costs of conducting the illicit business.
J. Respondent Daniels has submitted a sworn financial statement and other evidence and has asserted his financial inability to pay disgorgement plus prejudgement interest or a civil money penalty. The Commission has reviewed the sworn financial statement and other evidence provided by Daniels and has determined that Daniels does not have the financial ability to pay disgorgement of $218,419.54 plus prejudgement interest or a civil money penalty.
Violations
K. As a result of the conduct described above, Daniels willfully aided and abetted the broker-dealer s violations of Sections 15(a) (1), 15(c)(1), 15B(a) (1) and 15B(c)(1) of the Exchange Act, and Rule 15c1-2 thereunder, and Municipal Securities Rulemaking Board ( MSRB ) Rule G-17, by effecting and inducing and attempting to induce the purchase and sale of municipal securities while the broker-dealer was not registered with the Commission as a broker-dealer or municipal securities dealer, and by misrepresenting the registration status and qualifications of the broker-dealer.
L. As a result of the conduct described above, Daniels committed or caused violations of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act, Sections 10(b), 15(a) (1), 15(c)(1), 15B(a) (1) and 15B(c)(1) of the Exchange Act, and Rules 10b-5 and 15c1-2 thereunder, and MSRB Rule G-17 by effecting and inducing and attempting to induce the purchase and sale of municipal securities while the broker-dealer was not registered with the Commission as a broker dealer or municipal securities dealer, and by misrepresenting the registration status and qualifications of the broker-dealer. Daniels, acting through the broker-dealer, also willfully violated MSRB Rule G-2 by engaging in municipal securities business while not registered as a municipal securities principal and failing to requalify in accordance with MSRB Rule G-3.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer submitted by Daniels and impose the remedial sanctions and cease-and-desist order specified therein.
Accordingly, IT IS ORDERED that:
A. Pursuant to Section 8A of the Securities Act and Section 21C of the Exchange Act, Daniels is ordered to cease-and-desist from committing or causing any violation or any future violation of Sections 17(a)(1), 17(a)(2) and 17(a)(3) of the Securities Act, Sections 10(b), 15(a) (1), 15(c)(1), 15B(a) (1) and 15(B) (c)(1) of the Exchange Act and Rules 10b-5 and 15c1-2 thereunder, and MSRB Rules G-2 and G-17.
B. Daniels be, and hereby is, barred from association with any broker, dealer, municipal securities dealer, investment advisor or investment company.
C. Daniels shall be liable for, and pay disgorgement of $218,419.54 plus prejudgement interest, but the payment of such amount shall be waived and a civil money penalty will not be imposed based upon Daniels demonstrated financial inability to pay.
D. 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 Daniels provided accurate and incomplete financial information at the time such representations were made; (2) determine the amount disgorgement and prejudgement interest to order; (3) determine the amount of civil penalty to be imposed; and (4) seek any additional remedies that the Commission would be authorized to impose in this proceeding if Respondent 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 the Respondent was fraudulent, misleading, inaccurate or incomplete in any material respect, the amount of disgorgement and prejudgement interest to order, the amount of civil penalty to be imposed and whether any additional remedies should be imposed. Respondent 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.
Footnotes
-[1]- The findings contained herein are not binding on anyone other than Daniels.
In re Robert D. Gersh, Exchange Act Release No. 38459, Advisers Act Release No. 1626, A.P. File No. 3-9284 (April 1, 1997).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that an administrative proceeding be instituted pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") and Section 203(f) of the Investment Advisers Act of 1940 ("Advisers Act") against Robert D. Gersh ("Gersh").
II. In anticipation of the institution of this administrative proceeding, Gersh has submitted an Offer of Settlement ("Offer") that the Commission has determined to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission, or to which the Commission is a party, Gersh, by his Offer, and without admitting or denying the findings contained herein except that he admits the jurisdiction of the Commission over him and over the subject matter of this proceeding and the entry of the injunction set forth in paragraph 7 in Section III hereunder, consents to the entry of the findings and the imposition of the remedial sanctions set forth below.
Accordingly, IT IS ORDERED that proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act and Section 203(f) of the Advisers Act be, and hereby are, instituted.
III. On the basis of this Order Instituting Proceedings Pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 and Section 203(f) of the Investment Advisers Act of 1940, Making Findings and Imposing Remedial Sanctions, and the Offer submitted by Gersh, the Commission finds that:
Background
1. From April 19, 1990 to November 20, 1991, Gersh, a resident of Burlington, Massachusetts, was an associated person of Boston Municipal Securities, Inc. ("BMS"), an investment adviser registered with the Commission during that time period.
2. From June 1990 to July 1995, Gersh was an associated person of Burlington Securities Corp. ("Burlington"), a broker-dealer registered with the Commission.
3. Gersh and two corporations that he controlled, BMS and Devonshire Escrow and Transfer Corp. ("Devonshire"), packaged, offered, sold and administered securities in the form of Certificates of Participation ("COPs") that were issued in 1990. Since early 1990, Devonshire has served as the trustee for several COPs offerings.
Injunction for Securities Law Violations
4. On November 29, 1995, the Commission filed a Complaint for Injunctive and Other Relief (the "Complaint") against Gersh, BMS and Devonshire, and against several relief defendants, in the United States District Court for the District of Massachusetts.1 The Complaint alleged that Gersh violated Section 10(b) of the Exchange Act, Rule 10b-5 promulgated thereunder and Section 17(a) of the Securities Act of 1933 ("Securities Act").
5. The Complaint alleged, among other things, that, from early 1990 to the date of the Complaint, Gersh, BMS and Devonshire engaged in continuing fraudulent acts in connection with the offer and sale of $14 million in securities in the form of COPs. According to the Complaint, Gersh misappropriated at least $7,000,000 in investor funds. The Complaint alleged that, as a result of this misappropriation, two COPs issues, with an aggregate principal amount of $3,400,000, defaulted and six additional COPs issues, with an aggregate principal amount of $3,840,000, would also default.
6. The Complaint alleged that, to induce public investors to invest in these COPs, Gersh, BMS and Devonshire marketed the offerings as tax-exempt municipal securities, collateralized by equipment leases entered into by state and local governments. Gersh, BMS and Devonshire allegedly made multiple false statements and omissions of material fact. These included falsely promising that investments were fully-secured by state and municipal obligations, that the defendants would merely pass-through the collateral payments to investors and that a trustee would protect the interests of investors. The Complaint also alleged that the defendants failed to disclose that Gersh exercised control over the trustee, and that they falsely represented that the COPs were issued pursuant to the authority of state or local government agencies. According to the Complaint, Gersh commingled the proceeds of the investments and misappropriated the monies to invest in a variety of personal business ventures. The complaint further alleged that Gersh's failure to use the investor proceeds as represented deprived investors of information material to an assessment of the tax-exempt status of the COPs.
7. On November 18, 1996, without admitting or denying any of the allegations contained in the Complaint, except as to jurisdiction which he admitted, Gersh consented to the entry of a final judgment of permanent injunction and other relief. The Final Judgment was entered by the United States District Court for the District of Massachusetts on March 20, 1997. Pursuant thereto, Gersh is permanently enjoined from violating Section 10(b) of the Exchange Act, Rule 10b-5 thereunder and Section 17(a) of the Securities Act.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offer of Settlement submitted by Gersh and impose the sanction specified in the Offer.
Accordingly, IT IS HEREBY ORDERED that Robert D. Gersh be, and hereby is, barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company.
Footnotes
-[1]- Securities and Exchange Commission v. Robert D. Gresh, Boston Municipal Securities, Inc. and Devonshire Escrow and Transfer Corp., Defendants, and MA'AYAN Book Company, Inc., Charles River Landing, Ltd., CRL Group, Inc., Culinary Classics of Chestnut Hill, Inc, Culinary Classics of Burlington, Inc., The Kitchen Shelf, Inc., and The Compu-Bill Co., Inc., Relief Defendants, Civil Action No. 95-12580 (RCL) (D. Massachusetts, filed November 29, 1995). See Litigation Release No. 14742 (November 30, 1995), 60 SEC Docket 2345, 2543.
In the Matter of First Fidelity Securities Group, Exchange Act Release No. 36694, A.P. File No. 3-8917 (January 9, 1996).
I. The Commission deems it appropriate and in the public interest that public administrative proceedings be instituted pursuant to Section 15B(c)(2) of the Securities Exchange Act of 1934 ("Exchange Act") against First Fidelity Securities Group ("FFSG").
Accordingly, IT IS ORDERED that a public administrative proceeding pursuant to Section 15B(c)(2) of the Exchange Act be, and hereby is, instituted.
II. In anticipation of the institution of this administrative proceeding, FFSG has submitted an Offer of Settlement ("Offer"), which the Commission has determined is in the public interest to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except that FFSG admits the jurisdiction of the Commission over it and over the subject matter of this proceeding, FFSG, by its Offer, consents to the issuance of this Order and to the entry of the findings and the imposition of the sanctions set forth below.
III. On the basis of this Order and the Offer, the Commission finds1 that:
FACTS
1. Respondent
First Fidelity Securities Group is a municipal securities dealer, as defined in Section 3(a)(30)(B) of the Exchange Act, and is registered with the Commission pursuant to Section 15B(a)(2) of the Exchange Act. It was separately identifiable department of the treasury division of First Fidelity Bank N.A. (the "Bank"), which in turn was a wholly-owned subsidiary of First Fidelity Bancorporation ("FFB"), a bank holding company. On June 18, 1995, FFB entered into an agreement with First Union Corporation ("First Union") which provided, among other things, for the merger of FFB with and into a wholly-owned subsidiary of First Union. This merger closed on January 1, 1996. As a result of the merger, FFSG's municipal securities business will be conducted in First Union's registered broker-dealer subsidiary. Prior to the merger, FFB's common stock was registered with the Commission pursuant to Section 12(b) of the Exchange Act, and was traded on the New York Stock Exchange.
2. Relevant Persons and Entities
A. George L. Tuttle, Jr. ("Tuttle"), was an investment banker associated with FFSG and a senior vice president of the Bank, until his employment was terminated in November 1994.
B. Alexander S. Williams ("Williams"), was the head of FFSG and an executive vice president of the Bank, until his employment was terminated in November 1994.
C. Nicholas A. Rudi ("Rudi"), was the president and a fifty percent owner of Consolidated Financial Management, Inc. ("CFM") in late 1989 and early 1990, among other times. Rudi had been Camden County, New Jersey's ("Camden County") administrator during the early 1980s.
D. Essex County is a county in the State of New Jersey comprised of 22 municipalities. Essex County's executive branch is headed by a county executive that, among other things, signs contracts, bonds and other instruments requiring the county's consent. The legislative branch is comprised of the Essex County Board of Chosen Freeholders ("Freeholders"), which has the power to adopt ordinances and resolutions, including those concerning bond issues.
E. Irvington, New Jersey is a township located in Essex County. Irvington's executive branch is headed by a mayor. The legislative branch is comprised of the Municipal Council, which has the power to adopt ordinances and resolutions, including those concerning bond issues. The Municipal Council also selects underwriters, at times upon the recommendation of the mayor.
F. The Camden County Municipal Utilities Authority ("CCMUA") was organized on March 15, 1972, for the purpose of acquiring, constructing, maintaining, and operating sewerage facilities for Camden County.
G. The Payee was a financial consultant to the Freeholders from 1982 until June 1987. The Payee was Treasurer of Essex County from June 1987 until mid-1989, when the Payee became the financial consultant to the Essex County administration. The Payee was the budget consultant to the Irvington Municipal Council from at least 1984 until 1992. The Payee was also the financial consultant to the Municipal Council on Irvington's fiscal year adjustment financings.
3. FFSG Agrees to Pay Kickbacks to Secure Underwriting Business
Sometime prior to 1986, the Payee solicited a kickback arrangement from Tuttle in return for securing underwriting business in Essex County for FFSG, which Tuttle took under advisement. Then in 1986, FFSG began to analyze Essex County's outstanding debt to determine whether a refunding would be beneficial to Essex County. Although FFSG had been the lead underwriter of the debt offering that was to be refunded, Tuttle learned that Essex County's administration was planning to support another underwriting firm for the lead underwriter position on the refunding.
To secure for FFSG the lead underwriter position on this planned refunding and other Essex County bond offerings, Tuttle, on behalf of FFSG, agreed to the kickback arrangement previously proposed by the Payee, under which the Payee would obtain underwriting business in Essex County for FFSG in return for FFSG paying the Payee a kickback based upon the amount of bonds issued by Essex County that FFSG underwrote. Tuttle and the Payee also agreed that the payments would be made in connection with bond issues outside of Essex County. This kickback agreement was not disclosed. At the time of the agreement, the Payee was an employee of Essex County, namely the budget and financial consultant to the Freeholders. As budget and financial consultant to the Freeholders, the Payee's duties included reviewing any financial information presented by the executive branch on bond issues.
Later, in or about January 1987, the Payee informed Tuttle that FFSG had been selected as the lead underwriter for the bond refunding which was to take place in March 1987 (the "March 1987 Offering"). Furthermore, the Payee was Tuttle's main contact at Essex County on the March 1987 Offering. In fact, Tuttle negotiated the underwriters' discount with the Payee.2 Tuttle considered the kickback owing to the Payee in determining the amount of the proposed underwriters' discount that Tuttle submitted to the Payee as the agent of Essex County. The Payee accepted the proposed underwriters' discount with outchange. The fee schedule that Tuttle submitted to Essex County on FFSG's behalf for the March 1987 Offering failed to disclose that the underwriters' discount included a kickback to the Payee.
FFSG paid $31,331.50 to the Payee as a kickback on the March 1987 Offering. As Tuttle and the Payee had agreed, the Payee submitted sham invoices to FFSG for services allegedly rendered on bond transactions outside of Essex County. FFSG then paid the invoices from its profits on the other transactions. The Payee performed no bona fide services on any of those transactions for which he submitted invoices. As a result of Tuttle's actions, FFSG improperly recorded these payments on its municipal securities dealer books and records as relating to these other transactions.
4. The Payee Continues to Receive Kickbacks From FFSG After Being Appointed Essex County Treasurer.
In mid-1987, the Payee was appointed Essex County Treasurer. As part of his duties as Treasurer, the Payee was primarily responsible for overseeing Essex County bond issues. In accordance with their agreement, the Payee continued to receive kickbacks from Tuttle, and again this agreement was not disclosed. In January 1989, Essex County conducted a refunding of approximately $49 million in order to complete the funding of Essex County's pension fund (the "January 1989 Offering"). On June 15, 1989, Essex County issued approximately $103 million in bonds in a general obligation refunding (the "June 1989 Offering"). FFSG was selected as lead underwriter on both of these transactions.
As in the March 1987 Offering, Tuttle submitted the proposed underwriters' discount to the Payee in connection with both of these transactions. Tuttle took into consideration the kickback to the Payee when proposing the underwriters' discount. The Payee made no change to the proposed underwriters' discount. The fee schedules that Tuttle submitted to Essex County on FFSG's behalf for the January 1989 Offering and the June 1989 Offering failed to disclose that the underwriters' discount included a kickback to the Payee.
Between March 1990 and February 1991, the Payee received, directly or indirectly from FFSG, at least $119,964.66 in kickbacks for his assistance in securing for FFSG the lead underwriter role on the January 1989 Offering and the June 1989 Offering. As had been agreed, the Payee submitted fictitious invoices either to FFSG or to a third party that owed money to FFSG. The Payee provided no bona fide services on any of those transactions for which he submitted invoices. As a result of Tuttle's actions, FFSG improperly recorded these payments on its municipal securities dealer books and records.
5. FFSG Pays Kickbacks to the Payee On the Irvington Offerings
In 1991, Tuttle informed the Payee, who was also budget consultant to the Municipal Council of Irvington, that FFSG was interested in being the lead underwriter for Irvington's fiscal year bond anticipation notes (the "Irvington BANs") and Irvington's fiscal year adjustment bonds (the "Irvington FYABs") (collectively, the "Irvington Offerings"). Tuttle and the Payee agreed that FFSG would pay the Payee if he helped FFSG obtain the lead underwriter role on the Irvington Offerings. Again, the agreement to pay the kickback was not disclosed.
The Payee brought FFSG's interest in lead underwriting the Irvington Offerings to the attention of the Municipal Council and spoke to its members on FFSG's behalf. At or about the same time that the Municipal Council approved FFSG as the lead underwriter, the Municipal Council also entered into a contract with the Payee under which he was retained as the financial consultant to the Municipal Council in connection with the Irvington Offerings. FFSG was selected as the lead underwriter for the Irvington BANs, which were issued on December 17, 1991. When the Irvington FYABs were issued two months later, FFSG was again the lead underwriter on the offering. Tuttle considered the kickback to the Payeewhen he set the underwriters' discount on the Irvington BANs. The fee schedule that Tuttle submitted to Irvington on FFSG's behalf for the Irvington BANs failed to disclose that the underwriters' discount included a kickback to the Payee.
As with the kickbacks on the Essex County March 1987 Offering, January 1989 Offering and June 1989 Offering (collectively, the "Essex County Offerings"), FFSG paid the Payee on a fictitious invoice the Payee submitted to a third party for work allegedly done relating to another municipal securities offering. The Payee provided no bona fide services on the offering for which he submitted an invoice. On Tuttle'sinstructions, in August 1992, the third party paid the Payee $25,000 using FFSG's profits on a guaranteed investment contract ("GIC")3 on this other offering.
6. FFSG Agrees to Pay a Kickback to CFM
On behalf of FFSG, Tuttle also agreed to pay, and paid, kickbacks to CFM in connection with a February 1990 offering by the CCMUA (the "CCMUA Offering") in return for FFSG securing thelead underwriting position.
In late 1988, FFSG and Butcher & Singer, Inc. ("Butcher & Singer"), a broker-dealer registered with the Commission, began to analyze whether the outstanding CCMUA debt could be refunded. Over approximately the next year and a half, FFSG and Butcher & Singer analyzed the CCMUA's debt and discussed their analyses with various individuals and entities, including CFM.
In or about December 1989, Rudi told Tuttle that the CCMUA had reduced CFM's financial advisory fee on the CCMUA Offering to a flat fee of $15,000 because the amount of past fees had been subject to criticism by the press. In prior offerings, CFM had received one dollar per $1,000 face value of bonds ("one dollar per bond"). Rudi said that CFM should still receive one dollar per bond for working on the CCMUA Offering and told Tuttle that he wanted FFSG to pay CFM the difference, which at the time wasexpected to be $200,000.
On behalf of FFSG, Tuttle agreed to pay CFM one dollar per bond. This agreement was not disclosed. Tuttle had intended to include a structuring fee in the underwriters' discount, representing the work that First Fidelity and Butcher & Singer had done in putting the CCMUA Offering together. Tuttle decidedto increase the structuring fee to include the one dollar per bond kickback.
Not only did Tuttle increase the structuring fee by one dollar per bond, but he also padded the other components of the underwriters' discount in anticipation of negotiating these fees downward with Rudi. Tuttle submitted the inflated fee schedule to Rudi for approval. Tuttle explained to Rudi that the structuring fee was to compensate FFSG and Butcher & Singer for the work they had done and that the third underwriter would not share in that fee. In further justification of the size of the structuring fee, Tuttle emphasized to Rudi that FFSG had some extra expenses, referring to the kickback on the CCMUA Offering. Contrary to his usual practice, Rudi did not negotiate the underwriters' discount and accepted the figure presented by Tuttle. The fee schedule that Tuttle submitted to the CCMUA on FFSG's behalf for the CCMUA Offering failed to disclose that the underwriters' discount included a kickback to CFM.
In or about January 1990, Tuttle told Williams about FFSG's kickback to CFM. When pressed about the need for the kickback, Tuttle told Williams that they had no choice but to pay the money. Williams was concerned about the payment of a kickback and wanted to hide it from the Bank's internal auditors. He did so by arranging for FFSG's finder on the CCMUA Offering, Robert Jablonski ("Jablonski"), to pay CFM the kickback on FFSG's behalf. Williams so informed Tuttle, who told Rudi.
7. FFSG Makes Kickbacks to CFM
The CCMUA ultimately issued approximately $237 million in bonds. At one dollar per bond, the kickback due CFM from FFSG was $222,000 ($237,000 less the $15,000 advisory fee paid directly to CFM by the CCMUA), rather than the $200,000 originally anticipated. In a series of payments ending December 3, 1990, FFSG paid $595,000 to Meadowlands Securities, Inc. ( "Meadowlands"), Jablonski's company, which included Jablonski's finder's fee and FFSG's one dollar per bond kickback to CFM.
Jablonski, in turn, paid $335,500 to Armacon Investment Company ("Armacon Investment") between February 27, 1990 and April 17, 1990. 4 Included in this $335,500 was FFSG's one dollar per bond kickback to CFM. Between March 9, 1990 and April 25, 1990, Armacon Investment disbursed $240,000 to CFM. Between March 7, 1990 and April 25, 1990, Armacon Investment distributed an additional $93,000 to Salema.
As a result of Tuttle's actions, FFSG falsely recorded all payments to Jablonski, including both Meadowlands' finder's fee and the CFM kickback, as cash disbursements to Meadowlands. Nowhere in FFSG's municipal securities dealer books and records is there any record of any payment to CFM in connection with the CCMUA Offering. FFSG's municipal securities dealer books and records were also false because they overstated the finder's fee due Jablonski and Meadowlands.
Tuttle then began to make arrangements to pay CFM the remaining $22,000 of the kickback. Tuttle decided to pay CFM the $22,000 from FFSG's profits on The Town of West New York Municipal Utilities Authority's March 1990 debt offering ("WNYMUA Offering"), for which FFSG and Butcher & Singer were also underwriters.
Tuttle called Rudi and told Rudi to send FFSG a CFM invoice for $22,000 purportedly for CFM's work on the WNYMUA Offering, even though Rudi and Tuttle both knew that CFM had performed no work on the WNYMUA Offering. Rudi agreed and sent FFSG the requested invoice. FFSG paid CFM $22,000 from FFSG's and Butcher & Singer's profits on the WNYMUA Offering. Tuttle falsely recorded this payment to CFM on FFSG's municipal securities dealer books and records as a "consulting fee" on the WNYMUA Offering.
8. FFSG Makes Further Payments to CFM from a Variety of Bond Issues for CFM's Help on a Guaranteed Investment Contract for the CCMUA.
In late 1990, Tuttle and an investment banker at Butcher & Singer approached Rudi with the idea of reinvesting $20 million of the CCMUA's funds more efficiently by using a GIC. In or about January or February 1991, the CCMUA entered into the GIC. The GIC provider paid fees to FFSG and Butcher & Singer. By that time, Tuttle and the Butcher & Singer investment banker had decided to pay CFM a share of their firms' fees on the GIC. Specifically, they agreed that FFSG and Butcher & Singer wouldpay CFM $45,000 and $30,000, respectively.
Tuttle arranged with Rudi to pay FFSG's share out of FFSG's profits on various municipal bond offerings for which FFSG was the lead underwriter. On each such bond offering, Tuttle told Rudi to send Tuttle an invoice for a certain amount of money for services relating to the particular offering. Rudi complied and submitted invoices to FFSG requesting payment to his and Salema's then registered broker-dealer, Armacon Securities, Inc. ("Armacon"). Each time Armacon sent FFSG an invoice, FFSG paidArmacon the specified amount from FFSG's profits on the invoiced offering even though Rudi and Tuttle both knew that CFM had performed no work on that offering. Tuttle then falsely recorded the payments on FFSG's municipal securities dealer books and records as an expense of the bond transaction referenced on the invoice.
B. LEGAL DISCUSSION
1. FFSG Willfully Violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5.
FFSG, through Tuttle and Williams, willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5, which prohibit fraud in the offer or sale, or in connection with the purchase or sale, of securities. Specifically, as a result of Tuttle's and Williams's undisclosed kickback schemes, FFSG defrauded Essex County, Irvington, and the CCMUA (collectively, the "Issuers") as well as investors.
a. The Fraud on the Issuers
FFSG, through Tuttle and Williams, engaged in schemes to defraud the Issuers by agreeing to pay kickbacks to the Payee and to CFM, agents of the Issuers, in exchange for underwriting business. Tuttle not only agreed to pay the kickbacks to the Payee and CFM, but also ensured that the Issuers' money, in whole or in part, would be used to fund the kickbacks, thus inflating the Issuers' underwriters' discounts or costs of issuance. For example, Tuttle factored in the kickbacks to the Payee when calculating the underwriters' discounts that he submitted to Essex County through the Payee on the Essex County Offerings, while on the CCMUA Offering, Tuttle directly charged most of the kickback to the CCMUA by including it as part of the structuring fee. Tuttle, on FFSG's behalf, submitted fee schedules on theEssex County Offerings, the Irvington BANs and the CCMUA Offering which failed to disclose that the underwriters' discounts or costs of issuance included kickbacks to the Payee or to CFM.
The undisclosed kickback scheme was material to the Issuers. The fact that an issuer's agent was to receive kickbacks from an underwriter in exchange for the underwriting assignment is information that a reasonable issuer would likely consider important in deciding to sell its securities to the underwriter, especially when, as here, the kickbacks had a direct financial effect on the Issuers because the payments increased the underwriters' discounts or the costs of issuance. 5 A reasonable issuer would want to know that its underwriter had agreed to make secret payments to the issuer's financial consultant, treasurer or financial advisor because such arrangements and payments could compromise the independence and judgment of these agents and distort the underwriter selection process.
b. The Fraud On Investors
FFSG delivered the official statements on the Essex County Offerings, Irvington BANs and the CCMUA Offering to investors. These official statements were materially false and misleading because they misrepresented the underwriters' discounts or costs of issuance, and do not disclose the kickback scheme6. The omitted information concerning FFSG's kickbacks to Essex County's financial consultant and Treasurer, the Irvington Municipal Council's financial consultant and the CCMUA's financial advisor was material to investors because it increased the underwriters' discounts or costs of issuance at Essex County's, Irvington's and the CCMUA's expense. The existence of the kickbacks also casts doubt on the integrity of the offering process, including the honesty of the underwriter. 7 As the Commission has said: "[I]nformation concerning financial and business relationships and arrangements among the parties involved in the issuance of municipal securities may be critical to an evaluation of an offering." Statement of the Commission Regarding Disclosure Obligations of Municipal Securities Issuers and Others, Exchange Act Release No. 33741, 7 Fed. Sec. L. Rep. 72,442 at 62,198 (Mar. 9, 1994) 8
c. Scienter
FFSG acted with scienter. Tuttle, a senior investment banker with FFSG, agreed to make secret payments to the Payee and to CFM to secure underwriting business and factored these kickbacks into the fees he charged Essex County, Irvington, and the CCMUA. Williams, the head of FFSG, approved the payments to CFM. Tuttle and Williams each took steps to conceal the payments from the Bank's internal auditors and others. Specifically, Tuttle concealed the kickbacks to the Payee by disguising them on FFSG's municipal securities dealer books and records as expenses on the transactions for which the Payee submitted false invoices. On the CCMUA Offering, Tuttle and Williams concealed the kickbacks by directing the payments to CFM through Jablonski's company, Meadowlands, and by recording the payments on FFSG's municipal securities dealer books and records as "cash disbursements to Meadowlands," or as "consulting fees" to CFM on other municipal transactions. Such concealment is evidence of scienter. Tuttle knew that the kickback, agreements were not disclosed to either the Issuers of to investors. Tuttle also knew that, because of the undisclosed kickback agreements, the official statements for the Essex County Offerings, the Irvington BAN's, and the CCMUA Offering misrepresented the underwriters' discounts and cost of issuance. The actions of Tuttle and Williams are imputed to FFSG. 9
d. Nexus
The frauds were in the offer or sale and in connection with the purchase or sale of securities (the "nexus requirements"). The fraud here concerns the manner in which FFSG -- which was awarded contracts to purchase securities from Essex County, Irvington, and the CCMUA -- obtained this role and the manner in which the Payee and Rudi advised the Issuers. Moreover, the kickbacks on the Essex County Offerings, Irvington BANs and CCMUA Offering were charged, in part, to the Issuers, thus increasing the underwriters' discount or costs of issuance and decreasing the consideration received by the Issuers for their securities. Last, the bonds were sold to the public by means of official statements that omitted material facts. The kickbacks, therefore, satisfy the nexus requirements. 10
2. FFSG Willfully Violated Section 15B(c)(1) of the Exchange Act and MSRB Rules G-8, G-17 and G-20
Section 15B(b) of the Exchange Act established the MSRB and empowers it to propose and adopt rules with respect to transactions in municipal securities by brokers, dealers and municipal securities dealers. Pursuant to Section 15B(c)(1), a broker, dealer or municipal securities dealer is prohibited from using the mails or any instrumentality of interstate commerce to effect any transaction in, or to induce or attempt to induce the purchase or sale of, any municipal security in violation of any rule of the MSRB. As a municipal securities dealer, FFSG is subject to Section 15B(c)(1) of the Exchange Act and the MSRBrules. In connection with the Essex County Offerings and the CCMUA Offering, FFSG, through Tuttle and Williams, willfully violated Section 15B(c)(1) of the Exchange Act and MSRB rules G- 8, G-17 and G-20.
a. MSRB Rule G-8
MSRB rule G-8 requires municipal securities dealers to make certain books and records concerning their municipal securities business. Among the required books and records are blotters or other records of original entry containing: (1) all receipts and disbursements of cash with respect to transactions in municipal securities; and (2) all other debits and credits pertaining to transactions in municipal securities. MSRB rule G-8(a)(i). The rule requires that the information be recorded "clearly and accurately." MSRB rule G-8(b).
FFSG failed to make accurate municipal securities dealer books and records. As a result of Tuttle's actions, FFSG created false municipal securities dealer books and records by recording the kickbacks to the Payee on transactions other than the Essex County Offerings. Similarly, as a result of Tuttle's and Williams's actions, FFSG also created false municipal securities dealer books and records by recording the kickbacks to CFM as payments to Jablonski. Thus, FFSG willfully violated Section 15B(c)(1) of the Exchange Act and MSRB rule G-8.
b. MSRB Rule G-17
MSRB rule G-17 provides:
In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice.
MSRB rule G-17 is a fair dealing rule. The failure to disclose financial and other relationships between a fiduciary of an issuer and an underwriter that create potential or actual conflicts of interest violates MSRB rule G-17. See In the Matter of Lazard Freres & Co. LLC and Merrill Lynch, Pierce, Fenner & Smith Incorporated, Exchange Act Release No. 36419, 1995 SEC LEXIS 2818 (Oct. 26, 1995) (settled case).
FFSG, through Tuttle and Williams, by paying kickbacks to the Payee and CFM, dealt unfairly with Essex County, Irvington and the CCMUA, and thus willfully violated Section 15B(c)(1) of the Exchange Act and MSRB rule G-17.
c. MSRB Rule G-20
This rule, "Gifts and Gratuities," prohibits municipal securities dealers from: (1) giving any thing or service worth more than $100 per year; (2) to a person other than an employee or partner of such dealer; (3) if such payment or service is in relation to the municipal securities activities of the employer of the recipient of the payment or service. MSRB rule G-20(a). The rule specifically provides that "employer" includes the principal for whom the recipient of the payment or service is acting as agent or representative. The rule is intended to prohibit commercial bribery and covers payments to issuer officials. Order Approving a Proposed Rule Change by the Municipal Securities Rulemaking Board Relating to Recordkeeping and Record Retention Requirements Concerning Gifts and Gratuities, Exchange Act Release No. 34372, 1994 SEC LEXIS 2112 at [*4-*5] (July 13, 1994); Comments Requested Concerning Recordkeeping and Record Retention Relating to Gifts and Gratuities; Rules G-20, G-8 and G-9, MSRB Manual (CCH) 10,623 at 11,250 (Jan. 12, 1994).
By paying kickbacks of over $175,000 to the Payee and in excess of $220,000 to CFM, FFSG, through Tuttle and Williams, gave to them each "a thing or service of value . . . in excess of $100." The Payee and CFM were neither an employee nor partner of FFSG; instead, they were agents or representatives of theIssuers. The kickbacks were directly related to the Essex County Offerings, the Irvington Offerings, and the CCMUA Offering. FFSG, therefore, willfully violated Section 15B(c)(1) of the Exchange Act and MSRB rule G-20.
IV. FFSG has submitted an Offer which the Commission has determined is in the public interest to accept. Under the Offer, FFSG, without admitting or denying the findings herein, consents to the Commission's issuance of this Order, and agrees to pay disgorgement plus prejudgment interest in the amount of $1,793,309.43 and a civil penalty in the amount of $500,000.00. In determining that it is in the public interest that the Offer be accepted, the Commission has relied upon FFSG's undertaking set forth in its Offer that, within twenty-one (21) days of the date of this Order, FFSG will file a Form MSDW.
Accordingly, IT IS HEREBY ORDERED that, pursuant to Section 21B(e) of the Exchange Act, FFSG shall, within twenty-one (21) days of the date of this Order, pay $1,793,309.43, representing disgorgement of $1,044,441.00 and prejudgment interest of $748,868.43. Payment shall be made by postal money order,certified check, bank cashier's check or bank money order, payable to the order of the "United States Securities and Exchange Commission." The payment shall be transmitted to the Comptroller, Securities and Exchange Commission ("Comptroller"), 450 Fifth Street, N.W., Washington, D.C. 20549, under cover of letter identifying the name and number of this administrative proceeding and the Respondent, and specifying that the payment is disgorgement and prejudgment interest. A copy of the cover letter and payment shall be simultaneously transmitted to Teri A. Brotbacker, Senior Attorney, Securities and Exchange Commission, 7 World Trade Center, New York, New York 10048.
IT IS FURTHER ORDERED that, the disgorgement and prejudgment interest paid by FFSG shall be held by the Comptroller, to be utilized for payment to persons eligible to receive such funds pursuant to a plan of distribution, which shall be submitted by FFSG (or its successor) or the Division of Enforcement within 60 days from the date of the payment by FFSG. In the event that all or any portion of these funds remain after adjudication of any claims and disbursement of any funds, the remainder shall be disbursed to the United States Treasury in the manner described below in this Paragraph IV. In no event shall any portion of these funds be returned to FFSG or its agents, successors or assigns, or to any other defendant or respondent in this action or in any other action or proceeding brought or instituted by the Commission concerning the transactions, acts, practices and courses of business that are the subject of this Order.
IT IS FURTHER ORDERED that FFSG shall comply with its undertaking to file a Form MSDW within twenty-one (21) days of the date of this Order.
IT IS FURTHER ORDERED that, pursuant to Section 21B(a) of the Exchange Act, FFSG shall, within twenty-one (21) days of the date of this Order, pay a penalty to the United States Treasury in the amount of $500,000. Payment shall be made by postal money order, certified check, bank cashier's check or bank money order, payable to the order of the "United States Securities and Exchange Commission." The payment shall be transmitted to the Comptroller, under cover of letter identifying the name andnumber of this administrative proceeding and the Respondent, and specifying that the payment is a penalty pursuant to Section 21B(a) of the Exchange Act. A copy of the cover letter and payment shall be simultaneously transmitted to Teri A. Brotbacker, Senior Attorney, Securities and Exchange Commission, 7 World Trade Center, New York, New York 10048.
By the Commission.
Jonathan G. Katz
Secretary
Footnotes
-[1]- The findings herein are made pursuant to Respondent's Offer of Settlement and shall not be binding on any other person or entity named as a respondent or otherwise in this or any other proceeding.
-[2]- The underwriters' discount is the difference between the purchase price that the underwriter pays to the issuer to buy the bonds and the offering price at which the underwriter sells the bonds to the public.
-[3]- A GIC is a contract that guarantees the interest, income or yield on the use of funds for a specified period of time in exchange for a fee.
-[4]- Armacon Investment was owned by Joseph C. Salema ("Salema"), who was a fifty percent owner of CFM at the time.
-[5]- See SEC v. Washington County Utility District, 676 F.2d 218 (6th Cir. 1982) (undisclosed kickback scheme between underwriter and official of municipal securities issuer violated antifraud provisions); United States v. Rudi, 902 F. Supp. 452 (S.D.N.Y. 1995) (holding that securities fraud claim adequately pleaded when financial advisor allegedly caused the issuer to sell its bonds to an underwriter for less than the bonds would have brought but for the fraud).
-[6]- As the Commission has repeatedly recognized in discussing the responsibilities of municipal underwriters to investors:
By participating in an offering, an underwriter makes an implied recommendation about the securities. Because the underwriter holds itself out as a securities professional, and especially in light of its position vis-a-vis the issuer, this recommendation itself implies that the underwriter has a reasonable basis for belief in the truthfulness and completeness of the key representations made in any disclosure documents used in the offerings.
Exchange Act Release No. 26100 (Sept. 22, 1988) (proposing adoption of Rule 15c2-12), 4 Fed. Sec. L. Rep. (CCH) 25,097, at 18,175, 18,183. This interpretation was clarified and modified by Exchange Act Release No. 26985, 4 Fed. Sec. L. Rep. (CCH) 25,098, at 18,199-10 to 18,200 (Jun. 28, 1989), and reaffirmed by the Commission in Exchange Act Release No. 33741, 7 Fed. Sec. L. Rep. (CCH) 72,442 at 62,193 (Mar. 9, 1994). See also Exchange Act Release No. 34961, [1994-95 Transfer Binder] Fed. Sec. L. Rep. 85,456 at 85,950 (Nov. 10, 1994) (making certain amendments to Rule 15c2-12).
Disclosures in an official statement about the underwriters' discount and costs of issuance are key representations. See MSRB rule G-32(a)(ii)(A).
-[7]- See Washington County, 676 F.2d at 224-25 & n.15 (kickback scheme between official of a municipal securities issuer and the underwriter was material because it increased the costs of issuance and "an investor, had he known of the payments, could have reasonably concluded . . . that the District's bonds were a poor investment because the quality of the District's management was suspect.").
-[8]- There, the Commission noted:
[S]uch information could indicate the existence of actual or potential conflicts of interest, breaches of duty or less than arm's length transactions . . . . Failure to disclose material information concerning such relationships, arrangements or practices may render misleading statements made in connection with the process . . . . In addition, investors reasonably expect participants in municipal securities offerings to follow standards and procedures established by such participants, or other governing authorities, to safeguard the integrity of the offering process; accordingly, material deviations from those procedures warrant disclosure.
. . .
Beyond existing specific disclosure requirements and guidelines, the range of financial and business relationships, arrangements and practices that need to be disclosed depends on the particular facts and circumstances of each case. If, for example, the issuer (or any person acting on its behalf) selects an underwriter, syndicate or selling group member, expert, counsel or other party who has a direct or indirect (for example, through a consultant) financial or business relationship or arrangement with persons connected with the offering process, that relationship or arrangement may be material. Areas of particular concern are undisclosed payments to obtain underwriting assignments and undisclosed agreements or arrangements, including fee splitting, between financial advisers and underwriters. If the adviser is hired to assist the issuer, sure relationship, financial or otherwise, may be divide loyalties.
Id. At 62,199 (footnotes omitted).
-[9]- See Sharp v. Coopers & Lybrand, 649 F. 2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938 (1982); Rochez Bros., Inc. v. Rhoades, 527 F.2d 880, 884 (3d Cir. 1975). See also American Soc'y of Mechanical Eng'rs., Inc, v. Hydrolevel Corp., 456 U.S. 556, 565-66 (1982).
-[10]- See Washington County, 676 F.2d at 226 n.17; Rudi, 902 F. Supp. at 456-57.
In re FAIC Securities, Exchange Act Release No. 36937, A.P. File No. 3-8970 (March 7, 1996).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest to institute public administrative proceedings pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against FAIC Securities, Inc. ("FAIC").
II. In anticipation of the institution of these proceedings, the Respondent has submitted an Offer of Settlement which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission, or in which the Commission is a party, prior to a hearing pursuant to the Commission's Rules of Practice [17 C.F.R. _ 201.1 et seq.], without admitting or denying the findings contained herein, except that Respondent admits the jurisdiction of the Commission over it and over the subject matter of these proceedings and the findings contained in paragraph III.A. (below), Respondent consents to the entry of this Order Instituting Public Administrative Proceedings, Making Findings and Imposing Remedial Sanctions ("Order") as set forth below.1
Accordingly, IT IS ORDERED that administrative proceedings pursuant to Sections 15(b) and 21C of the Exchange Act, be, and hereby are, instituted.
III. On the basis of this Order and Respondent's Offer of Settlement, the Commission finds that:
Background
A. At all times relevant to this proceeding, FAIC Securities, Inc. ("FAIC") was a broker-dealer registered with the Commission pursuant to Section 15 of the Securities Exchange Act of 1934 ("Exchange Act") and was a municipal securities dealer within the meaning of Section 3(a) (30) of the Exchange Act. Between August 21, 1995, and January 8, 1996, FAIC twice filed with the Commission a Form BDW, whereby it sought to withdraw its registration as a broker-dealer. In each instance, after discussions with the staff, FAIC withdrew the pending Form BDW before it went effective. The most recent Form BDW was withdrawn pending resolution of this matter.
B. At all times relevant to this proceeding, the Chairman of FAIC's Executive Committee and the Chairman of FAIC's Board of Directors were "municipal finance professionals" (hereinafter "FAIC's municipal finance professionals") subject to rules and regulations promulgated by the Municipal Securities Rulemaking Board ("MSRB"), as further described in paragraph H, below.
C. At all times relevant to this proceeding, FAIC's municipal finance professionals had financial stakes and controlling interests in a variety of corporate entities (hereinafter, collectively, the "FAIC-Affiliated Companies").
D. Prior to 1993, FAIC's business consisted of, primarily, brokering Certificates of Deposit (CDs) and acting as a finder for customers wanting to purchase CDs with the highest rate of
return. During 1993, the market for brokered CDs declined. At about that time, FAIC entered the municipal securities underwriting business.
Applicability of MSRB Rules
E. In April of 1994, MSRB rule G-37 became effective, and FAIC became subject to its provisions.
F. Rule G-37, and several companion recordkeeping provisions, including amendments to rules G-8 and G-9, were enacted to ensure that the high standards and integrity of the municipal securities industry are maintained, to prevent fraudulent and manipulative acts and practices, to promote just and equitable principles of trade, to perfect a free and open market and to protect investors and the public interest. The rules were also designed to remove any possibility of an appearance that decisions by municipalities in awarding negotiated underwriting business might have been influenced by political contributions. Rule G-37 was therefore drafted and is applied as a broad prophylactic measure, and a violation does not require a particularized showing of an actual "quid pro quo."
G. Subsection (b) of rule G-37 provides that no broker, dealer or municipal securities dealer shall engage in municipal securities business with an issuer within two years after any contribution to an official of such issuer made by (i) the broker, dealer or municipal securities dealer; (ii) any municipal finance professional associated with such broker, dealer or municipal securities dealer; or (iii) any political action committee controlled by the broker, dealer or municipal securities dealer or by any municipal finance professional, unless the contribution is exempted by the rule. For purposes of rule G-37, a contribution triggers the two-year prohibition if it is made to any person (or election committee for that person) who was at the time of the contribution, an incumbent, candidate, or successful candidate for elective office of the issuer if the office is directly or indirectly responsible for, or can influence the outcome of, the hiring of a broker, dealer or municipal securities dealer for the issuer's municipal securities business or for any elective office of a state or political subdivision which office has authority to appoint an official to an office of an issuer if the office is directly or indirectly responsible for, or can influence the outcome of, hiring a broker, dealer or municipal securities dealer for the issuer's municipal securities business.
H. Rule G-37 defines a municipal finance professional to include, among other things, any associated person who is a member of the broker, dealer, municipal securities dealer, executive or management committee or similarly situated officials, if any. Thus, under rule G-37, political contributions by either FAIC, as a municipal securities dealer, or by FAIC's municipal finance professionals, would trigger the two-year prohibition on FAIC engaging in, or seeking to engage in, certain municipal securities business.
I. At all times relevant, FAIC was subject to rule G-37(c), which provides that no broker, dealer or municipal securities dealer, or any municipal finance professional, shall solicit or coordinate contributions to an official of an issuer with which the broker, dealer, or municipal securities dealer is engaging or is seeking to engage in municipal securities business.
J. Rule G-37(d) states that no broker, dealer, or municipal securities dealer or any municipal finance professional shall, directly or indirectly, through or by any other person or means, do any act which would otherwise result in a violation of rule G-37. Thus, pursuant to operation of subsection (d) of rule G-37, "indirect" contributions by FAIC or any of FAIC's municipal finance professionals would also invoke the two-year prohibition on FAIC engaging in, or seeking to engage in, certain municipal securities business.
K. FAIC also became subject to MSRB rules requiring periodic reports to the MSRB of political contributions (MSRB rule G-37(e)), and to certain MSRB rules requiring the maintenance of internal recordkeeping of such contributions, as well as an identification of the municipalities with which the municipal securities dealer was engaged in, or sought to engage in, business (MSRB rules G-8 and G-9). The requirements of rules G-8 and G-9 were, among other purposes, designed to keep certain relevant information readily available in order to facilitate compliance examinations of municipal securities dealers by the staff of the Commission, with the goal of promoting investor confidence in the integrity of the municipal securities market.
Violative Conduct
L. At all times relevant to this proceeding, FAIC's municipal finance professionals controlled, directed, and were ultimately responsible for, political contributions of the FAIC-Affiliated Companies to candidates for office who could influence the awarding of municipal securities business by the State of Florida and by Dade County, Florida. Indeed, the FAIC-Affiliated Companies were not authorized to make any political contributions without the approval of FAIC's municipal finance professionals.
M. After the effective date of MSRB rule G-37, until in or about November 1994, FAIC's municipal finance professionals continued, through the FAIC-Affiliated Companies, to make political contributions to various candidates for elected office in Dade County and the State of Florida who could influence the awarding of municipal securities business. All told, FAIC's municipal finance professionals coordinated and directed the payment of thousands of dollars of contributions to candidates for elected office in those jurisdictions.
N. Nonetheless, well within the two-year prohibited period following political contributions to persons who could influence the awarding of municipal securities business by the State of Florida and by Dade County, Florida, FAIC sought, and was selected to participate in, three negotiated underwritings of certain municipal securities by both Dade County, Florida, and a state agency, the Florida Housing Finance Authority ("FHFA") (hereinafter, collectively, the "underwritings").
O. The underwritings included (i) a $240 million offering of Metropolitan Dade County Aviation Revenue Bonds, Series 1995 B and C, which went effective in or about March 1995; (ii) an $84.2 million offering of FHFA Single Family Mortgage Revenue Refunding Bonds, Series 1995 A, which went effective in or about February 1995; and (iii) a $54.9 million offering of FHFA Multi-Family Revenue Bonds, which went effective in or about January 1995.
P. In total, the underwritings represented sales to the public of approximately $379 million in securities issued by Dade County, Florida and the FHFA. For its roles in the underwritings, FAIC received $224,205.00 in fees.
Q. FAIC willfully violated MSRB rule G-37(b) in that FAIC, as a municipal securities dealer, engaged in municipal securities business with issuers within two years after FAIC's municipal finance professionals directed political contributions to an elected official (or candidate for office) who could influence the awarding of municipal securities business by such issuers.
R. FAIC willfully violated MSRB rule G-37(c), in that FAIC, as a municipal securities dealer directly, or indirectly through the FAIC-Affiliated Companies, solicited and coordinated political contributions for elected officials (or candidates for such offices) of issuers, who could influence the awarding of municipal securities business, while FAIC was engaging or seeking to engage in municipal securities business.
S. FAIC willfully violated MSRB rule G-37(e), in that FAIC, as a municipal securities dealer, failed to file, on a quarterly basis, a Form G-37, setting out for the reporting period (i) all political contributions, whether direct or indirect, to elected officials (or candidates for such offices) of issuers by FAIC, and its municipal finance professionals, and (ii) an identification of all issuers with which FAIC engaged in municipal securities business.
T. FAIC willfully violated MSRB rule G-8 in that FAIC, as a municipal securities dealer, failed to keep current and accurate records which show, among other things: (i) the states in which it was engaging, or was seeking to engage, in underwriting business, and (ii) for the current and two prior years, all political contributions, whether direct or indirect, to elected officials or candidates for office by FAIC, and its associated municipal finance professionals.
U. FAIC willfully violated MSRB rule G-9, in that FAIC, as a municipal securities dealer, failed to preserve, records described in paragraph T, above, for a period of not less than six years.
V. FAIC willfully violated MSRB rule G-17 in that FAIC, as a municipal securities dealer, failed to deal fairly with all persons and failed to refrain from engaging in any deceptive, dishonest, or unfair practice, in that in certain of its conduct with respect to political contributions and subsequent attempts to engage in municipal securities business, FAIC misled municipalities, the investing public, and possibly others, by failing to disclose its non-compliance with, and by affirmatively misrepresenting its compliance with, certain state regulations.
W. FAIC willfully violated Section 15B(c)(1) of the Exchange Act, in that it made use of the mails or other means or instrumentalities of interstate commerce to effect transactions in, or to induce or attempt to induce the purchase or sale of, any municipal security in contravention of MSRB rules G-37, G-8, G-9, and/or G-17.
Summary of Violations
X. As a result of the foregoing described conduct, FAIC willfully violated Section 15B(c)(1) of the Exchange Act and MSRB rules G-37, G-8, G-9, and G-17.
IV. In view of the foregoing, the Commission deems it appropriate and in the public interest to impose the sanctions specified in FAIC's Offer of Settlement.
Accordingly, IT IS HEREBY ORDERED that:
A. Pursuant to Section 21C of the Exchange Act, FAIC is ordered to cease and desist from committing any violation or future violation of Section 15B(c)(1) of the Exchange Act and MSRB rules G-37, G-8, G-9, and/or G-17.
B. FAIC's registration under Section 15 of the Exchange Act as a broker-dealer is hereby revoked.
C. FAIC shall pay disgorgement in the amount of $224,205.00, plus $15,754.74 in prejudgment interest, to the United States Treasury within sixty days from the date of this Order. Such payment shall be: (i) made by United States postal money order, certified check, bank cashier's check or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) transmitted to the Comptroller, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and (iv) submitted under cover of a letter which identifies FAIC as the Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Charles V. Senatore, Esq., Regional Director, Securities and Exchange Commission, Southeast Regional Office, 1401 Brickell Avenue, Suite 200, Miami, Florida 33131.
D. Pursuant to Section 21B of the Exchange Act, FAIC shall pay a civil money penalty in the amount of $200,000 to the United States Treasury within sixty days from the date of this Order. Such payment shall be: (i) made by United States postal money order, certified check, bank cashier's check or bank money order; (ii) made payable to the Securities and Exchange Commission; (iii) transmitted to the Comptroller, U.S. Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549; and (iv) submitted under cover of a letter which identifies FAIC as the Respondent in these proceedings, the file number of these proceedings, a copy of which cover letter and money order or check shall be sent to Charles V. Senatore, Esq., Regional Director, Securities and Exchange Commission, Southeast Regional Office, 1401 Brickell Avenue, Suite 200, Miami, Florida 33131.
Footnotes
-[1]- The findings herein are made pursuant to FAIC's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.
In re Lazard Freres & Co., LLC, and Merrill Lynch, Pierce, Fenner & Smith Incorporated , Exchange Act Release No. 36419, A.P. File No. 3-8872 (October 26, 1995).
I. The Securities and Exchange Commission ("Commission") deems it appropriate and in the public interest that public cease-and-desist proceedings and administrative proceedings be and hereby are instituted pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934 ("Exchange Act") against Lazard Freres & Co. LLC ("Lazard") and Merrill Lynch, Pierce, Fenner & Smith Incorporated ("Merrill Lynch").
II. In anticipation of the institution of these proceedings, Lazard and Merrill Lynch have each submitted an Offer of Settlement, each of which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except that Lazard and Merrill Lynch each admits the jurisdiction of the Commission over each of them and over the subject matter of these proceedings, Lazard and Merrill Lynch, by their Offers, consent to the issuance of this Order Instituting Proceedings Pursuant to Sections 15(b) and 21C of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions ("Order") and to the imposition of the remedial sanctions set forth in Section VII below.
Accordingly, IT IS ORDERED that proceedings pursuant to Sections 15(b) and 21C of the Exchange Act be, and hereby are, instituted.
III. On the basis of this Order and the Offers submitted by Lazard and Merrill Lynch, the Commission finds that:1
A. RESPONDENTS
Lazard is a New York Limited Liability Company with its principal place of business at Thirty Rockefeller Plaza, New York, New York. Lazard is registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act (File No. 8-2595). At all times relevant to these proceedings, Lazard was a New York Limited Partnership.
Merrill Lynch is a Delaware corporation with its principal place of business at 250 Vesey Street, New York, New York. Merrill Lynch is registered with the Commission as a broker-dealer pursuant to Section 15(b) of the Exchange Act (File No. 8-2592).
B. FACTS
1. Background
Among other things, Lazard conducts a municipal securities business through its Municipal Department, which principally (I) serves as financial advisor to certain municipal issuers with respect to the development of financial plans and strategies, and (ii) acts as underwriter with respect to the issuance of municipal securities by various state and local governments and their agencies and instrumentalities. Beginning in April 1988, Lazard maintained a Municipal Department branch office in Boston, Massachusetts, which was established and managed by a former partner of Lazard (the "Former Partner"). When the Former Partner resigned from Lazard at the end of January 1993, Lazard closed its Boston office.
At times relevant to these proceedings, Lazard was a financial advisor to the Massachusetts Water Resources Authority ("MWRA") and the District of Columbia ("D.C."). Lazard's financial advisory services to those municipal issuers were provided primarily by the Former Partner and others under his supervision.
Merrill Lynch, in addition to acting as a broker-dealer, is an underwriter of tax-exempt securities by state and local governments and their agencies. In the mid-1980s, Merrill Lynch began to develop and market interest rate swaps for municipalities and other tax-exempt issuers. By 1989, Merrill Lynch had become the largest provider of interest rate swaps to municipalities and other tax-exempt issuers.2 Interest rate swaps are transactions by which an entity may exchange (i.e., swap) its obligation to make periodic payments based on a particular interest rate or index for the right to receive periodic payments based on a different rate or index (e.g., one may swap its obligation to make variable rate payments for the right to receive fixed rate payments). In the late 1980's, Merrill Lynch, whose swap business had in the past been done primarily with its own clients, sought to expand its swap business.
2. Events Leading Up To The June 1990 Contract
In the late 1980's, the MWRA, which had been given responsibility for cleaning up the Boston Harbor and for providing water and sewerage services to over 40 Boston area cities and towns, determined to issue several billion dollars in revenue bonds in the coming years. To assist it in executing its bond transactions, in January 1989, the MWRA issued a request for proposals for the purpose of selecting an underwriting team. In his position as financial advisor to the MWRA, during early 1989, the Former Partner advised the MWRA throughout the selection process concerning, among other things, the strengths and weaknesses of the potential underwriters.
Beginning in 1988 and continuing through 1989, Merrill Lynch representatives met and discussed with the Former Partner MWRA business and potential business involving non-financial advisory clients of Lazard. During the course of such discussions, the Former Partner solicited business from Merrill Lynch. The Former Partner did not advise anyone at Lazard's New York headquarters of these discussions.
In March of 1989, the Board of Directors of the MWRA, which was being advised by the Former Partner, chose Merrill Lynch as one of three senior managing underwriters. The MWRA decided to rotate the senior managing underwriters. Merrill Lynch was chosen from this group of three to act as the senior managing underwriter for the MWRA's first bond offering, which ultimately was executed in January 1990.
Beginning in the fall of 1989, Merrill Lynch attempted to market to the MWRA an interest rate swap in conjunction with the early 1990 underwriting. During this process, in late September 1989, Merrill Lynch initially raised the swap idea with the Former Partner as financial advisor to the MWRA. After being introduced to the swap concept by Merrill Lynch, the Former Partner expressed an immediate interest in the business potential of swaps. Merrill Lynch and the Former Partner discussed the prospect of Merrill Lynch and Lazard engaging in a joint swap marketing agreement.
In the fall of 1989, while working on an interest rate swap with the Indian Trace Community Development District in Broward County, Florida (the "Florida Transaction"), Merrill Lynch invited the Former Partner to learn about the mechanics of structuring and documenting interest rate swaps. Ultimately, although neither the Former Partner nor any other Lazard personnel worked on the Florida Transaction, Merrill Lynch paid Lazard $90,000 in connection with this transaction, which represented approximately 10% of Merrill Lynch's overall compensation on the swap. The Former Partner did not advise his partners that Lazard personnel did not work on the swap.
Following further discussions between representatives of Merrill Lynch and the Former Partner, Merrill Lynch and Lazard entered into a written contract dated December 5, 1989 (the "December 1989 Contract"). The December 1989 Contract, which was prepared by a national law firm at the request of the then head of Merrill Lynch's municipal swaps department, provided that Merrill Lynch and Lazard would split fees generated from any successful jointly marketed swaps.
In January 1990, Merrill Lynch attempted to persuade the MWRA and the Former Partner that the MWRA should enter into an interest rate swap in conjunction with the 1990 MWRA underwriting. In connection with the MWRA's consideration of a possible swap transaction, the Former Partner told a representative of the MWRA that Lazard had been involved with Merrill Lynch in an out-of-state interest rate swap transaction in late 1989. The Former Partner did not fully disclose, and Merrill Lynch did not ensure full and complete disclosure of, the facts and circumstances of the Florida Transaction, including Merrill Lynch's payment of $90,000 to Lazard. The Former Partner advised his partners that the December 1989 Contract applied only to the Florida Transaction. The Former Partner did not advise his partners at Lazard's New York headquarters that Merrill Lynch was attempting to market to the MWRA an interest rate swap in connection with the MWRA's early 1990 underwriting.
3. The June 1990 Contract
On June 26, 1990, Merrill Lynch entered into a successor contract with Lazard (the "June 1990 Contract"). The Contract, which was negotiated principally by the Former Partner and the then head of Merrill Lynch's municipal swaps department, provided that Merrill Lynch and Lazard would participate together in originating, negotiating and arranging interest rate swaps to be entered into between Merrill Lynch and municipal issuers. Like the December 1989 Contract, the June 1990 Contract was drafted by the same national law firm at the request of the then head of Merrill Lynch's municipal swaps department, and provided for fee-splitting between Merrill Lynch and Lazard on successful jointly marketed interest rate swaps. Unlike the December 1989 Contract, however, the June 1990 Contract further provided that: (1) Lazard would consult generally with Merrill Lynch with respect to the presentation, marketing and sales of municipal interest rate swaps; and (2) Merrill Lynch would pay Lazard an annual fee in the amount of $800,000 for the period June 26, 1990 through December 31, 1990.
The June 1990 Contract initially covered only calendar year 1990. But in December 1990, prior to its expiration, the June 1990 Contract was renewed in writing to cover calendar year 1991.
Later, Merrill Lynch and Lazard, acting through the Former Partner, orally extended the June 1990 Contract to cover the year 1992. During 1991 and 1992, the annual fee that Merrill Lynch paid Lazard was increased from $800,000 to $1,000,000. The June 1990 Contract effectively remained in place until it was terminated in January 1993.3
The Former Partner and others under his direct supervision primarily provided Lazard's services to Merrill Lynch under the June 1990 Contract. Pursuant to the June 1990 Contract, Merrill Lynch paid Lazard a total of $5,766,878 between September 1990 and November 1992, which consisted of $2,550,000 in annual fees and $3,216,878 in payments under the fee-splitting provision. Since the Former Partner was compensated based on the overall production of the Boston branch office, the Former Partner received a substantial financial benefit from the June 1990 Contract.
The June 1990 Contract established an ongoing, continuing relationship between Lazard and Merrill Lynch that resulted in a substantial financial benefit to the Former Partner who was providing financial advisory services to certain clients that were considering the selection of Merrill Lynch. Consequently, the June 1990 Contract created at least a potential conflict of interest for Lazard that should have been disclosed to its financial advisory clients that were serviced by the Former Partner and were considering the selection of Merrill Lynch to provide certain financial services in the conduct of Lazard's and Merrill Lynch's municipal securities business.
4. Inadequate Disclosure of the June 1990 Contract and the Florida Transaction
The MWRA and D.C. were not fully informed of the facts relating to the relationship between Lazard and Merrill Lynch at the time they evaluated the advice of the Former Partner concerning the selection of Merrill Lynch to provide certain financial services. Specifically, the June 1990 Contract and the facts and circumstances of the Florida Transaction, including Merrill Lynch's payment of $90,000 to Lazard, were not adequately disclosed to the MWRA and D.C. when the Former Partner provided financial advisory services relating to the following actions taken by those municipal issuers. The MWRA, with advice from the Former Partner as its financial advisor, (1) selected Merrill Lynch to execute interest rate swaps in May 1990 (notional amount: $90 million) and June 1990 (notional amount: $78 million)4 and to serve as Book-Running Manager on a $717 million bond issue in March 1992, and (2) negotiated with Merrill Lynch with respect to bond prices, underwriting fees and swap fees for those transactions. D.C., with advice from the Former Partner as its financial advisor and in connection with related municipal securities offerings, (1) selected Merrill Lynch to execute an interest rate swap in September 1991 (notional amount: $230 million) and March 1992 (notional amount: $299.8 million), and (2) negotiated with Merrill Lynch with respect to swap fees for those transactions.5
Senior personnel in Lazard's New York office instructed the Former Partner to make disclosure and later asked the Former Partner whether he had made disclosure to the MWRA and D.C. In response, the Former Partner informed them that he had disclosed Lazard's relationship with Merrill Lynch to the MWRA and D.C. In addition, the Former Partner informed Merrill Lynch that he had disclosed Lazard's relationship with Merrill Lynch to the MWRA and D.C. In fact, however, the Former Partner had not fully disclosed the relationship; specifically, that Lazard and Merrill Lynch had entered into a contract, and that pursuant to the contract, Lazard and Merrill Lynch had an ongoing, continuing relationship pursuant to which Merrill Lynch was paying Lazard an annual fee of between $800,000 and $1 million for consulting generally concerning the marketing of interest rate swaps, as well as a share of Merrill Lynch's income earned on successful joint swap proposals. Moreover, not only did the Former Partner fail to fully disclose the June 1990 Contract, but he expressly represented to the MWRA that no conflicts of interest existed with respect to Lazard's services to that municipal issuer.
Lazard did not take adequate steps to ensure that the Former Partner had fully disclosed the June 1990 Contract to Lazard's financial advisory clients serviced by the Former Partner that were considering the selection of Merrill Lynch to provide certain financial services. Lazard did not have adequate procedures in place to ensure that the Former Partner made full disclosure of the June 1990 Contract to those municipal financial advisory clients. Lazard did not have a procedure to require the Former Partner to make disclosures to Lazard's municipal financial advisory clients in writing. Moreover, when informed by the Former Partner that he had made disclosure, senior personnel in Lazard's New York office did not ask the Former Partner whether he had specifically disclosed the consulting relationship and the annual fee.
In addition, Merrill Lynch did not take adequate steps to ensure that the June 1990 Contract and the facts and circumstances of the Florida Transaction, including Merrill Lynch's payment of $90,000 to Lazard, were fully disclosed to Lazard's financial advisory clients serviced by the Former Partner. These clients were considering the selection of Merrill Lynch to provide certain financial services. Although the Former Partner advised Merrill Lynch that he had disclosed the relationship, Merrill Lynch did not ask the Former Partner whether he had specifically disclosed the Florida Transaction, the consulting relationship and the annual fee.
C. LEGAL DISCUSSION
1. Rule G-17
Rule G-17 of the Municipal Securities Rulemaking Board ("MSRB") provides that:
In the conduct of its municipal securities business, each broker, dealer, and municipal securities dealer shall deal fairly with all persons and shall not engage in any deceptive, dishonest, or unfair practice. As broker-dealers conducting municipal securities businesses, Lazard and Merrill Lynch are subject to the MSRB Rules.
2. Violations of Rule G-17
a. Lazard
The Former Partner did not fully disclose the June 1990 Contract to the MWRA and D.C., and Lazard did not have adequate procedures in place to ensure that the Former Partner made full disclosure of the June 1990 Contract to those financial advisory clients. Senior personnel in Lazard's New York office asked the Former Partner whether he had disclosed Lazard's relationship with Merrill Lynch to the MWRA and D.C. When told by the Former Partner that he had disclosed the relationship with Merrill Lynch to those municipal financial advisory clients, Lazard took no further steps to determine what was disclosed. For example, Lazard did not have a procedure to determine whether the Former Partner had specifically disclosed the consulting relationship and the annual fee. In addition, Lazard did not have a procedure to ensure that the Former Partner made disclosures to Lazard's municipal financial advisory clients in writing.
Lazard, as the financial advisor to the MWRA and D.C., was required to disclose the potential conflict of interest created by the June 1990 Contract. As a result of the Former Partner's failure to fully disclose the June 1990 Contract to the MWRA and D.C., Lazard's failure to take adequate steps to ensure that the Former Partner made full disclosure of the June 1990 Contract, and the Former Partner's representations to the MWRA that no conflicts of interest existed, Lazard engaged in a willful violation of MSRB Rule G-17.6
b. Merrill Lynch
While providing certain financial services for the MWRA and D.C., Merrill Lynch failed to take adequate steps to ensure that the June 1990 Contract and the facts and circumstances of the Florida Transaction, including Merrill Lynch's payment of $90,000 to Lazard, were fully disclosed to the MWRA and D.C. As a result, Merrill Lynch engaged in a willful violation of MSRB Rule G-17.
IV. Lazard has submitted an Offer of Settlement in which, without admitting or denying the findings herein, it consents to the Commission's issuance of this Order, which makes findings, as set forth above, and orders Lazard to cease and desist from committing or causing any violation or future violation of MSRB Rule G-17; to pay, as also required by Settlement Agreements among each of the Respondents, the United States Attorney's Office for the District of Massachusetts and the Attorney General's Office for the Commonwealth of Massachusetts, a civil money penalty of $2.5 million and restitution to the MWRA and D.C. in the amounts of $2.12 million and $1.8 million, respectively; to maintain the undertakings described in Section VI below, implemented prior to the date of this Order; and to a censure of Lazard pursuant to Section 15(b) of the Exchange Act. As set forth in Lazard's Offer of Settlement, Lazard undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceeding concerning the transactions that are the subject of this Order.
V. Merrill Lynch has submitted an Offer in which, without admitting or denying the findings herein, it consents to the Commission's issuance of this Order, which makes findings, as set forth above, and orders Merrill Lynch to cease and desist from committing or causing any violation or future violation of MSRB Rule G-17; to pay, as also required by Settlement Agreements among each of the Respondents, the United States Attorney's Office for the District of Massachusetts and the Attorney General's Office for the Commonwealth of Massachusetts, a civil money penalty of $2.5 million and restitution to the MWRA and D.C. in the amounts of $2.0 million and $1.8 million, respectively; to maintain the undertakings described in Section VI below, implemented prior to the date of this Order; and to a censure of Merrill Lynch pursuant to Section 15(b) of the Exchange Act. As set forth in Merrill Lynch's Offer, Merrill Lynch undertakes to cooperate with Commission staff in preparing for and presenting any civil litigation or administrative proceeding concerning the transactions that are the subject of this Order.
VI. Prior to the date of this Order, Lazard and Merrill Lynch revised their policies and procedures. Lazard and Merrill Lynch undertake to maintain such policies and procedures.
The policies and procedures adopted and implemented by Lazard are as follows:
(a) In October 1993, Lazard adopted comprehensive compliance policies and procedures for its Municipal Department that address, among other things, the proper documentation and disclosure of joint business relationships, has distributed those policies to all Municipal Department personnel, and has continued to revise and update them;
(b) Lazard's Municipal Department compliance policies and procedures include a requirement that personnel working on financial advisory assignments make written disclosure to its municipal financial advisory clients of the existence and terms of all agreements and arrangements with actual or potential underwriters, financial advisors, consultants and/or swap counterparties that might create a potential conflict with the interests of Lazard's municipal financial advisory clients;
(c) Lazard has held periodic compliance training sessions that are mandatory for all Municipal Department personnel; and
(d) Lazard established a Municipal Task Force, of which a number of senior partners including the General Counsel are members, to ensure that the Municipal Department and its personnel are guided by all appropriate legal and ethical standards. This Task Force modified Lazard's training and compliance systems, its hiring procedures, its use of outside consultants and joint marketing efforts with other firms, its documentation and disclosure practices and its accounting policies.
The policies and procedures adopted and implemented by Merrill Lynch are as follows:
(a) On August 16, 1993, Merrill Lynch issued a new, comprehensive and detailed set of procedures governing interaction between Merrill Lynch's Municipal Markets employees and third parties such as consultants and broker-dealers. On June 6, 1994, Merrill Lynch supplemented those procedures.7 The Procedures provide that Merrill Lynch will use the assistance of consultants to obtain or retain public finance business only in limited circumstances and only under specific guidelines, including the following:
(b) Whenever Merrill Lynch decides to use a consultant to assist in obtaining or retaining public finance business, it will now as a matter of course disclose in writing its retention of the consultant to the governing body of all existing or prospective potentially affected public finance clients. The basic terms of the consulting agreement, including the compensation to be paid to the consultant, either must be included in the written disclosure or made available to the public finance clients upon request;
(c) Whenever a Municipal Markets employee wishes to retain a consultant, the employee must prepare a memorandum for internal supervisory review and approval explaining the services sought from the consultant and indicating the compensation to be paid. When supervisory approval is granted, Merrill Lynch in-house counsel must review and approve all public finance consulting agreements before they are executed. As to specific payments under a consulting agreement, the Municipal Markets employee responsible for the agreement now must prepare a billing memorandum indicating the services performed and the amount of compensation to be paid. Management level review and written approval of the payments are required before payment will be made;
(d) In cases in which the consultant also may act as a financial advisor to other issuers of municipal securities, Merrill Lynch is to obtain a list of the consultant's municipal financial advisory clients, which, by contract, the consultant is required to update quarterly. The Merrill Lynch Municipal Markets Consultant Relationship Manager responsible for the consultant's retention is required to promptly notify, in writing, the governing body of each of the consultant's financial advisory clients of the consultant arrangement. The written notification must include a general description of the arrangement, including the compensation;
(e) Merrill Lynch Municipal Markets will not pay, directly or indirectly, or split a fee with any consultant in connection with an assignment for which the consultant is the financial advisor to the municipal issuer;
(f) All agreements with Merrill Lynch public finance consultants are to be in writing. Consultants who may act as financial advisors to public entities during the pendency of the consulting agreement must acknowledge in the written agreement that they are not at the time of the agreement, and will not during the term of the agreement, be retained as financial advisors or financial consultants to any municipal issuers for whom Merrill Lynch is seeking to be retained as a result of the consultants' activities under the consulting agreement. Consultants who act as financial advisors to public entities must further acknowledge in the written agreement that no payment under the agreement will be made in connection with an assignment for which the consultants are the financial advisor to the public entity; and
(g) During 1993, 1994 and 1995, Merrill Lynch has conducted in-house compliance meetings for its Municipal Markets employees throughout the United States during which the employees have been instructed as to various compliance issues including Merrill Lynch's procedures governing interaction with third parties such as consultants.
VII. In view of the foregoing, the Commission deems it appropriate and in the public interest to accept the Offers submitted by Lazard and Merrill Lynch and impose the sanctions specified in the Offers. In determining to accept these Offers, the Commission considered the policies and procedures adopted and implemented by Lazard and Merrill Lynch and cooperation afforded the Commission staff.
Accordingly, IT IS HEREBY ORDERED that:
1. Lazard shall cease and desist from committing or causing any violation or future violation of MSRB Rule G-17;
2. Lazard shall be, and hereby is, censured;
3. Lazard shall, within ten business days of the issuance of this Order, pay a civil money penalty in the amount of $2.5 million to the United States Treasury and shall make restitution to the MWRA and D.C. in the amounts of $2.12 million and $1.8 million, respectively;
4. Lazard shall comply with its undertaking to maintain the policies and procedures described in Section VI above, implemented prior to the date of this Order; provided, however, that Lazard may modify such policies and procedures with alternative policies and procedures designed to achieve the same purposes;
5. Merrill Lynch shall cease and desist from committing or causing any violation or future violation of MSRB Rule G-17;
6. Merrill Lynch shall be, and hereby is, censured;
7. Merrill Lynch shall, within ten business days of the issuance of this Order, pay a civil money penalty in the amount of $2.5 million to the United States Treasury and shall make restitution to the MWRA and D.C. in the amounts of $2.0 million and $1.8 million, respectively;
8. Merrill Lynch shall comply with its undertaking to maintain the policies and procedures described in Section VI above, implemented prior to the date of this Order; provided, however, that Merrill Lynch may modify such policies and procedures with alternative policies and procedures designed to achieve the same purposes;
9. The Respondents have each entered into Settlement Agreements with the United States Attorney's Office for the District of Massachusetts and the Attorney General's Office for the Commonwealth of Massachusetts. The Respondents' respective obligations to pay penalties and restitution under the terms of this Order will be satisfied by the payment of penalties and restitution under the terms of such Settlement Agreements; and
10. Lazard and Merrill Lynch shall within 30 days of entry of this Order, send to Juan Marcel Marcelino, District Administrator, Securities and Exchange Commission, Boston District Office, 73 Tremont Street, Boston, Massachusetts, 02108, via certified mail, evidence, including copies of checks, of the payments of the civil penalties and restitution, as ordered herein. Such evidence shall be submitted under cover letter which identifies the respondent as the respondent in these proceedings, the file number, and the Commission case number.
Footnotes
-[1]- The findings herein are made pursuant to Lazard's and Merrill Lynch's Offers of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.
-[2]- Unlike Merrill Lynch, Lazard did not serve as a counter party in municipal interest rate swap transactions during the relevant time period.
-[3]- The Former Partner advised his partners at Lazard's New York headquarters that Lazard would be helping Merrill Lynch to obtain swap business only with Lazard's municipal underwriting clients. Payments under the fee-splitting provision of the June 1990 Contract were received only for swaps with entities that were underwriting clients, not financial advisory clients, of Lazard.
-[4]- The MWRA decided to execute swaps with Merrill Lynch, as opposed to any other entity, without issuing a request for proposals. The MWRA's decisions were based, at least in part, upon the initial recommendation of the Former Partner in January 1990, and subsequent input and advice from the Former Partner throughout the spring of 1990.
-[5]- The related municipal offerings were a $331 million General Fund Recovery Bond issue in September 1991 and a $229.8 million General Obligation Bond refunding in March 1992. The swap transactions were executed contemporaneously with the two bond offerings for the purpose of converting variable-rate interest rate obligations arising from the bond offerings into fixed-rate obligations.
-[6]- As used in this Order, "willful" means the intentional commission of an act which constitutes the violation. There is no requirement that the actor also be aware that he is violating the federal securities laws. See Tager v. SEC, 344 F.2d 5 (2d Cir. 1965).
-[7]- The August 16, 1993 procedures and the June 6, 1994 supplement thereto are hereinafter referred to as "the Procedures."
In re Michael S. Goodman, Exchange Act Release No. 36279, A.P. File No. 3-8829 (September 26, 1995).
I. The Commission deems it appropriate and in the public interest to institute administrative proceedings against Michael S. Goodman (Goodman), pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 (Exchange Act). In anticipation of these proceedings, Goodman has submitted an Offer of Settlement (Offer) which the Commission has determined to accept. Solely for the purpose of these proceedings and any other proceedings brought by, or on behalf of, the Commission or in which the Commission is a party, and without admitting or denying the findings contained herein, except those matters contained in subparagraph III. (z) below, which are admitted, Goodman, by his Offer, consents to the entry of this Order, its findings and the imposition of sanctions set forth below.
II. ACCORDINGLY, IT IS ORDERED that proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act be, and hereby are, instituted.
III. On the basis of this Order and Goodman's Offer, the Commission finds1 that:
ENTITIES INVOLVED
a. First Humanics Corp. ("First Humanics"), a not-for-profit corporation, was in the business of acquiring, renovating and operating nursing homes. From 1984 through 1989, First Humanics renovated and operated 21 nursing homes acquired through 21 separate offerings totalling approximately $82 million in publicly sold municipal and corporate bonds. On October 15, 1987, the Economic Development Corporation of the City of Detroit, Michigan, for the benefit of First Humanics, acquired the Medicos Recovery Care Center (Medicos) through the issuance of $6,955,000 in tax-exempt bonds. This was First Humanics' last offering.
b. International Elderly Care, Inc. ("IEC"), also a not-for-profit corporation, performed the same function as First Humanics after First Humanics defaulted on numerous bonds in 1988. During 1988 and 1989, IEC renovated and operated five nursing homes acquired through 5 separately financed offerings totalling approximately $25 million in publicly sold municipal and corporate bonds. On May 26, 1988, the Industrial Development Authority of the City of Boonville, Missouri, for the benefit of IEC, acquired the Colonial Gardens Convalescent Center (Colonial Gardens) through the issuance of $3,795,000 in tax-exempt bonds. This was IEC's first offering.
c. Grey, Randolph & Abbott ("GRA"), a broker-dealer registered with the Commission, was the principal underwriter for thirteen offerings in which First Humanics was involved from 1985 through 1987, including the Medicos offering, and all five offerings in which IEC was involved from 1988 through 1989, including the Colonial Gardens offering. GRA filed a Form BDW with the Commission, and is no longer doing business.
RESPONDENT
d. Goodman was a principal and controlling person of GRA from August 1984 through March 1991. Goodman was GRA's representative for the First Humanics and IEC offerings, and participated in drafting the Medicos and Colonial Gardens offering circulars. Goodman, through GRA, distributed those offering circulars to the investing public.
BACKGROUND
e. In connection with each offering, First Humanics and, thereafter IEC, typically contracted to purchase a particular nursing home (in paragraphs III.e. through j. only, unless otherwise stated, First Humanics and IEC are jointly referred to as "the Company" since the offering process for each entity was nearly identical). To finance the purchase, the Company arranged for a municipality to issue tax-free municipal bonds. However, the Company remained liable for all payments to bondholders. To finance the issuance costs on certain of the above offerings, the Company, in some instances, also issued a modest amount of corporate bonds in conjunction with the tax-exempt bonds. Again, the Company was liable for all payments to bondholders.
f. Each prospective nursing home was initially located by Lee F. Sutliffe ("Sutliffe"), the undisclosed control person of both First Humanics and IEC and the undisclosed promoter of First Humanics' and IEC's offerings. If Sutliffe decided a nursing home was acceptable for acquisition, the Board of Directors then typically voted to acquire the facility. Sutliffe generally received an acquisition fee of between $100,000 and $300,000 in connection with each nursing home purchased by the Company. Subsequent to the Board's approval, Sutliffe initiated the offering process, through which the Company obtained the funds necessary to purchase the nursing home. In connection therewith, Sutliffe assembled a "working group" which coordinated the offering process and was responsible for preparing the offering circulars. The working group included Sutliffe; the Company's officers; Company counsel; underwriters' representatives, including Goodman; and underwriters' counsel. The activities of the working group were largely directed by Sutliffe. In this manner, Sutliffe acted as the promoter of the offerings.
g. In connection with each offering, an offering circular was also prepared. The offering circular typically contained sections describing the Company, the nursing home to be acquired, the bonds, sources and uses of bond proceeds, risk factors and, as appendices, a financial feasibility study and the Company's audited financial statements. The primary purpose of the offering circular was to provide the investing public with all material facts pertaining to the relevant offering. Goodman reviewed and commented on offering circular drafts and analyzed investment risks. Thus, he was involved in the process of preparing offering circulars. Furthermore, as a principal and controlling person of the lead underwriter for the Company's offerings, Goodman, through GRA, distributed the offering circulars to the investing public.
h. Upon completion of the offering process, Sutliffe coordinated the bond closings. At each bond closing, the municipal issuer sold the bonds to underwriters who, in turn, re-sold them to the investing public through various retail broker-dealers. Upon receiving the bond proceeds from the underwriters, the municipal issuer either lent such proceeds to the Company so that the Company could purchase the nursing home, or purchased the nursing home and leased it back to the Company. At all times, however, effective control of the nursing homes remained with the Company. A certain amount of bond proceeds were also set aside as working capital for the benefit of the Company. The Company then assumed the municipal issuer's repayment obligation to the bondholders. Thereafter, the Company was required to make monthly bond payments to the indenture trustee sufficient for the trustee to meet semi-annual interest payments to the bondholders. In addition, pursuant to various bond and trust indentures, the Company was required to allocate a certain amount of each offering's proceeds to a debt service reserve fund. The debt service reserve fund was used to offset any insufficiencies in funds available for the semi-annual interest payments to bondholders. However, the Company was required to pay back any monies withdrawn from this account.
i. Prior to promoting the First Humanics and IEC offerings, Sutliffe was involved in the promotion of numerous other bond issues. Most of these earlier offerings, however, had experienced financial problems and some eventually defaulted prior to the Medicos offering. Furthermore, in March 1985, the State of Missouri found that Sutliffe had participated in the making of false filings, and issued a cease and desist order against him.
j. In addition to Sutliffe's promoting activities, he also controlled the Company. The Company's officers and Board of Directors allowed Sutliffe to dictate virtually all significant decisions. Sutliffe even served on various First Humanics' Board sub-committees, including a management sub-committee. Sutliffe determined which nursing homes First Humanics and IEC would acquire and was involved in the day-to-day operations of the nursing homes. Sutliffe's control was openly displayed at Company Board of Directors meetings and reflected in the pertinent minutes, internal memoranda and correspondence.
FIRST HUMANICS/OPERATIVE FACTS
k. Revenues from First Humanics' nursing homes were generally paid directly to the company and, from 1984 on, First Humanics freely and openly commingled all such revenues in a central bank account located in Dixon, Illinois (Dixon account). First Humanics then used the revenues from any one nursing home to pay the expenses of other homes, as the need arose. When a nursing home's revenues were insufficient to meet a bond payment, money was simply taken from available funds in the Dixon account, whatever the source. Thus, each nursing home's expenses were paid according to the urgency of the bill and not limited by the amount of revenue generated by the particular nursing home. From 1986 on, however, most of the nursing homes failed to generate an amount of revenues sufficient to meet their own expenses. As a result, commingling became essential to the operation and survival of First Humanics. The success or failure of any one nursing home was thereby dependent upon the success or failure of all the other nursing homes. Therefore, each municipal offering was, in fact, a de facto investment into First Humanics and its existing nursing homes.
l. In addition, the vast majority of First Humanics' nursing homes were located in Illinois and heavily dependent on Illinois' Medicaid reimbursements, which were often insufficient and continually late. Given the nursing homes' interdependence, as the result of the commingling discussed above, such late and insufficient payments affected all nursing homes, even those located outside of Illinois. Thus, largely because of the Medicaid problems, in late 1985 First Humanics became late in its required monthly bond payments to the indenture trustees for certain bond issues. Therefore, First Humanics began using the funds from some of these delinquent nursing homes' debt service reserve accounts to offset the insufficiencies. Although First Humanics was required to pay back monies withdrawn from such accounts, these payments were often late and insufficient.
m. As a result of First Humanics' cash flow shortages, First Humanics also became reliant on the working capital generated from new bond offerings as a source of funds for current operations. Additionally, a procedure was developed, of which Goodman was aware, whereby Sutliffe "kicked-back" a portion of his acquisition fee to First Humanics at, or shortly after, each bond closing. Thus, the success of existing nursing homes and the payments to existing bondholders became largely dependent on First Humanics' ability to obtain funds from future offerings. In this manner, First Humanics operated a Ponzi scheme.
n. Nonetheless, First Humanics continued to be late in its monthly bond payments to the trustees. As a result, First Humanics also continued to deplete certain bond issues' debt service reserve funds. In August 1986, one of the trustees, in fact, informed First Humanics that based on its continued failure to repay these funds it was in violation of four of its bond indentures and, therefore, in technical default. First Humanics experienced a $1.5 million loss for its fiscal year ended November 30, 1986. Furthermore, none of the nursing homes had met their cash flow projections as originally stated in their offering circulars. In December 1986, one of the trustees again informed First Humanics that it was in technical default on two of its municipal bonds. However, Sutliffe caused six new bond issues to close on December 18, 1986. As a result, and in connection with First Humanics' Ponzi scheme, additional working capital was generated and, undisclosed to investors, $500,000 of Sutliffe's acquisition fee was kicked-back to First Humanics. These funds were immediately applied to cure First Humanics' monthly bond payment deficits and to pay its past due bills. Nonetheless, First Humanics' cash flow problems continued.
MEDICOS OFFERING
o. Despite First Humanics' financial problems, in early 1987 Sutliffe directed First Humanics to acquire Medicos. In connection therewith, Sutliffe arranged to have the City of Detroit issue $6,955,000 in tax-exempt bonds. Sutliffe also directed First Humanics board members to issue $530,000 in taxable bonds to cover the issuance expenses. Both series of bonds were issued pursuant to one offering circular. Sutliffe, acting as the promoter, then began the offering process by assembling the working group which prepared the Medicos offering circular. Again, Sutliffe largely directed the working group's activities as the undisclosed promoter for Medicos.
p. Upon completion of the offering process, Sutliffe then coordinated the Medicos bond closing. The Medicos offering closed on October 15, 1987 and the municipal and corporate bonds were sold to the public through underwriters and various broker-dealers. Upon receiving the proceeds from the underwriters, the municipal issuer purchased Medicos and thereafter leased the facility back to First Humanics. Finally, Sutliffe kicked-back approximately $200,000 of his Medicos acquisition fee to First Humanics as part of First Humanics' ongoing Ponzi scheme.
q. However, not all of the taxable bonds had sold by the time the Medicos offering closed. Since this could have postponed the closing, Sutliffe, undisclosed to investors, agreed to buy the remaining taxable bonds until they could be resold. To finance that purchase, Sutliffe arranged for a loan of $250,000 from the sellers of Medicos to himself. Goodman was aware of this transaction.
r. The primary purpose of the Medicos offering circular was to provide the investing public with all material facts related to the Medicos offering. As the representative and principal of the underwriter, Goodman was one of those responsible for the preparation and contents of the final offering circular distributed to the investing public. Despite Goodman's knowledge of the above facts, however, the Medicos offering circular omitted to disclose numerous material facts. For instance, the Medicos offering circular failed to adequately disclose Sutliffe's promotion of the Medicos offering, his control over First Humanics, his prior bond failures and his past securities law sanction. Additionally, the Medicos offering circular portrayed Medicos as a "stand alone" nursing home. Thus, the Medicos offering was simply presented as an investment into Medicos. Nothing adequately describing the commingling of nursing home revenues or the resulting financial interdependence among First Humanics' nursing homes was disclosed. Thus, Medicos bondholders were not informed that Medicos revenues would be used to pay First Humanics' existing nursing homes' expenses. Consequently, bondholders were not informed that, in fact, their investments constituted de facto investments into First Humanics and its existing nursing homes and not merely Medicos. Similarly, the serious Illinois Medicaid problem which at the time was adversely affecting all First Humanics nursing homes was not disclosed. Thus, Medicos bondholders were not informed that, given the nursing homes' financial interdependence, their future bond payments were largely dependent on First Humanics' ability to secure the late Medicaid payments from the State of Illinois. The offering circular also failed to disclose both the August and December 1986 defaults which related directly to First Humanics' ability to pay bondholders. Furthermore, neither Sutliffe's $200,000 kick-back nor First Humanics' dependence on the capital generated from future offerings to finance its existing nursing homes, as part of its ongoing Ponzi scheme, were disclosed. Thus, Medicos bondholders were not informed that their ability to receive payments was also dependent on First Humanics' ability to secure funds from future offerings. Finally, there was no disclosure that First Humanics was unable to sell all of the taxable bonds by closing and that, as a result, Sutliffe had arranged for a loan from the sellers to purchase the bonds.
s. Goodman, as the underwriter's representative, participated in working group meetings, reviewed the Medicos offering circular and the related offering documents and analyzed investment risks. As a member of the working group, through his due diligence review, and through conversations and correspondence with other working group members, Goodman knew, or was reckless in not knowing, of the above material misrepresentations and omissions. Despite his knowledge and his role in the offering as underwriter's representative, however, Goodman, through GRA, distributed the offering circular to the investing public and caused the bonds to be sold.
IEC/COLONIAL GARDENS OFFERING
t. In late 1987, First Humanics contracted to acquire Colonial Gardens. In connection with the proposed offering, an offering circular was prepared by the First Humanics working group, which included Goodman. However, prior to closing, First Humanics defaulted on numerous municipal bonds. In light of this and First Humanics' deteriorating financial condition, there were no additional First Humanics offerings. As a result, Sutliffe utilized IEC to acquire Colonial Gardens through an offering of tax-exempt municipal bonds. However, IEC was simply a successor corporation to First Humanics and performed the same function. In fact, former First Humanics directors served as directors for IEC. Furthermore, the company responsible for managing First Humanics' nursing homes performed a similar role for IEC and managed both entities' nursing homes at the same time. In some instances, assets were even intermingled between the two companies. In addition, the IEC-Colonial Gardens working group was virtually identical to the one for Medicos as each member had nearly the same role. Likewise, the terms of First Humanics' and IEC's offerings were almost identical.
u. Although Sutliffe was not a named officer or director of IEC, he controlled the company. IEC's officers and directors were generally Sutliffe's friends or business associates and acted under his direction. As with First Humanics, Sutliffe determined which nursing homes IEC would acquire. Sutliffe also dominated and controlled the Colonial Gardens offering process. In connection therewith, Sutliffe arranged to have the City of Boonville issue $3,795,000 in tax-exempt bonds to be used to purchase Colonial Gardens. Sutliffe also directed IEC to issue $380,000 in taxable bonds to finance the issuance costs. Although there were two separate offering circulars, one for the tax-exempt bonds and another for the taxable bonds, the substantive disclosures contained in the two offering circulars were virtually identical. Sutliffe also assembled the working group and acted as the offering coordinator. As such, Sutliffe determined working group members, time schedules, and the sources and uses of bond proceeds. Although each working group member had specific duties, their activities were primarily directed by Sutliffe. In this manner, Sutliffe acted as the promoter for the Colonial Gardens offering.
v. The primary purpose of the Colonial Gardens offering circulars was to provide the investing public with all material facts related to the Colonial Gardens offering. As the representative and principal of the lead underwriter, Goodman was one of those responsible for the preparation and contents of the final offering circulars distributed to the investing public. Despite Goodman's knowledge of the above facts, however, the Colonial Gardens offering circulars omitted to disclose numerous material facts. Despite Sutliffe's active role in both IEC's operations and in the Colonial Gardens offering, there was no mention of him in the offering circulars. As a result, neither his role in the offering nor his control over IEC was disclosed. Similarly, there was also no disclosure concerning Sutliffe's prior bond failures or his securities law sanction. In addition, the Colonial Gardens offering circulars contained virtually no disclosures concerning the nexus between First Humanics and IEC. Thus, no pertinent information concerning First Humanics' poor financial performance or its defaults on municipal bonds similar to those of Colonial Gardens was disclosed. Instead, the Colonial Gardens offering circulars highlighted First Humanics' high nursing homes occupancies. These high occupancies made it appear that First Humanics' nursing homes were financially viable when, in fact, such nursing homes were unable to pay their debt service. As a result, investors were unaware that the same persons, namely management, Sutliffe and company counsel, among others, responsible for the financial problems of a predecessor not-for-profit corporation, were now involved in IEC and the Colonial Gardens offering.
w. Goodman, as underwriter's representative, participated in working group meetings, reviewed the Colonial Gardens offering circulars and related offering documents, and analyzed investment risks. Through Goodman's role as principal and controlling person of GRA and through his participation in the First Humanics and Colonial Gardens offering process, Goodman was aware of the above material facts. In light of his participation in the preparation of the Colonial Gardens offering circulars, Goodman knew or was reckless in not knowing that the offering circulars omitted and misrepresented these facts. However, despite this knowledge, Goodman, through GRA, distributed the Colonial Gardens offering circulars to the investing public and caused the bonds to be sold.
x. Respondent Goodman willfully violated Section 17(a) of the Securities Act in that he, in the offer or sale of certain securities, namely Medicos and Colonial Gardens municipal bonds and First Humanics and IEC corporate bonds described in paragraphs III. (a), (b), (o) and (u) above, by use of the means or instruments of transportation or communication in interstate commerce or by use of the mails, directly or indirectly, employed devices, schemes or artifices to defraud; obtained money or property by means of untrue statements of material facts or 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; or engaged in transactions, practices or courses of business which operated as a fraud or deceit upon purchasers or prospective purchasers. As part of the aforesaid conduct, Respondent made misrepresentations and omissions of material facts to purchasers and prospective purchasers concerning, among other things, Sutliffe's role in promoting the offerings, Sutliffe's control over First Humanics and IEC as well as his regulatory history and numerous prior bond and business failures; First Humanics' prevalent commingling of revenues from past nursing home projects and the resulting financial interdependence of all First Humanics nursing homes; the Illinois Medicaid problem; First Humanics' on-going Ponzi scheme; and the nexus between First Humanics and IEC.
y. Respondent Goodman willfully violated Section 10(b) of the Exchange Act and Rule 10b-5 promulgated thereunder in that he, in connection with the purchase or sale of certain securities, namely Medicos and Colonial Gardens municipal bonds and First Humanics and IEC corporate bonds described in paragraphs III. (a), (b), (o) and (u) above, by use of the means or instrumentalities of interstate commerce or by the use of the mails, directly or indirectly, employed devices, schemes or artifices to defraud; made untrue statements of material facts or omitted 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; or engaged in acts, practices or courses of business which operated as a fraud or deceit. As part of the aforesaid conduct, Respondent made misrepresentations and omissions of material facts to purchasers and sellers concerning, among other things, Sutliffe's role in promoting the offerings, his control over First Humanics and IEC as well as his regulatory history and numerous prior bond and business failures; First Humanics' prevalent commingling of revenues from past nursing home projects and the resulting financial interdependence of all First Humanics nursing homes; the Illinois Medicaid problem; First Humanics' on-going Ponzi scheme; and the nexus between First Humanics and IEC.
z. On April 28, 1995, the United States District Court for the Eastern District of Michigan, in Securities and Exchange Commission v. Michael S. Goodman and Harold A. Tzinberg, (Civil Action No. 95-CV-71563), entered a Final Judgment of Permanent Injunction and Other Equitable Relief by consent against Goodman. The order enjoins Goodman from future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
IV. In view of the foregoing, it is in the public interest to impose the sanctions agreed to in the Offer.
ACCORDINGLY, IT IS HEREBY ORDERED THAT Michael S. Goodman be barred from association with any broker, dealer, municipal securities dealer, investment adviser or investment company.
Footnotes
-[1]- The findings herein are made pursuant to Michael S. Goodman's Offer of Settlement and are not binding on any other person or entity named as a respondent in this or any other proceeding.
In re Preston C. Bynum, Exchange Act Release No. 35870, A.P. File No. 3-8729 (June 20, 1995).
I. The Commission deems it appropriate and in the public interest that public administrative proceedings pursuant to Sections 15(b) (6) and 15B(c) (4) of the Securities Exchange Act of 1934 ("Exchange Act") be, and they hereby are, instituted against Preston C. Bynum ("Respondent" or "Bynum") to determine what action, if any, is necessary in light of the permanent injunction entered against Preston C. Bynum by the United States District Court for the Northern District of Florida on June 6, 1995.
II. In anticipation of the institution of these proceedings, Bynum has submitted an Offer of Settlement ("Offer") which the Commission has determined to accept. Solely for the purpose of these proceedings, and any other proceeding brought by or on behalf of the Commission or to which the Commission is a party, and without admitting or denying the findings contained herein, except for those contained in Section III.A, III.B, and III.C below, which are admitted, Bynum consents to the issuance of this Order, the entry of the findings contained herein and the imposition of the sanctions set forth below.
III. The Commission makes the following findings:1
A. From February 1983 through February 1995, Bynum was associated with Stephens Inc. ("Stephens"), a broker-dealer and municipal securities dealer registered with the Commission pursuant to Sections 15 and 15B(a) of the Exchange Act;
B. Bynum is permanently enjoined by judgment of the United States District Court for the Northern District of Florida, in the action styled Securities and Exchange Commission v. Terry D. Busbee and Preston C. Bynum ("SEC v. Busbee"), Civil Action No. 95-30024 RV (N.D. Fla., judgment entered June 6, 1995), from violating Section 17(a) of the Securities Act of 1933, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, and Section 15B(c)(1) of the Exchange Act and Rules G-17 and G-20 of the Municipal Securities Rulemaking Board.
C. On March 3, 1993, Bynum pleaded guilty to one count of theft or bribery concerning programs receiving federal funds in violation of 18 U.S.C. § 666, in United States District Court for the Northern District of Florida in the action styled United States v. Preston C. Bynum, 95-03001/RV.
D. The Commission's complaint in SEC v. Busbee alleges that, from at least 1990 through at least 1993, Bynum defrauded the Escambia County Utilities Authority ("ECUA") and investors in three offerings of municipal securities issued by the ECUA. According to the complaint, Bynum, then an employee of Stephens, a municipal securities underwriter, provided certain benefits to an elected public official of the ECUA during a time when the official had an important role in selecting the underwriter for municipal securities issued by the ECUA and, in fact, voted on three separate occasions to select Bynum's employer as the underwriter or senior managing underwriter for ECUA municipal securities issues. The Complaint further alleges that, although under a duty to do so, Bynum failed to disclose to the ECUA and investors in the three offerings the benefits Bynum provided to the official and the conflicts of interest created by those financial arrangements.
IV. Based on the foregoing, the Commission deems it appropriate and in the public interest to impose the following sanctions specified in Bynum's Offer.
Accordingly, it is ORDERED that, effective immediately, Bynum be, and he hereby is, barred from association with any broker, dealer, investment adviser, investment company, or municipal securities dealer.
Footnotes
-[1]- The findings herein are solely for the purpose of these proceedings. These findings are not binding on any other person named or not named as a defendant or respondent in any other proceeding.
In re George L. Tuttle, Jr. and Alexander S. Williams, Exchange Act Release No. 35605, A.P. File No. 3-8668 (April 14, 1995).
I. The Commission deems it appropriate and in the public interest that public administrative proceedings be instituted pursuant to Section 15B(c) of the Securities Exchange Act of 1934 ("Exchange Act") against George L. Tuttle, Jr. ("Tuttle") and Alexander S. Williams ("Williams").
II. In anticipation of the institution of this administrative proceeding, Tuttle and Williams have each submitted an Offer of Settlement ("Offer"), which the Commission, after due consideration, has determined is in the public interest to accept. Solely for the purpose of this proceeding, and any other proceeding brought by or on behalf of the Commission or in which the Commission is a party, and without admitting or denying the findings contained in this Order Instituting Public Administrative Proceedings Pursuant to Section 15B(c) of the Securities Exchange Act of 1934, Making Findings and Imposing Remedial Sanctions ("Order"), except as to the entry of the injunction set forth in Section IV.E. below, which Tuttle and Williams each admits, Tuttle and Williams each consents to the issuance of this Order and to the entry of the findings and the imposition of the remedial sanctions set forth below.
Accordingly, IT IS ORDERED that a public administrative proceeding pursuant to Section 15B(c) of the Exchange Act be, and hereby is, instituted.
III. On the basis of this Order and the Offers, the Commission finds that1 :
A. Since in or about December l975, First Fidelity Securities Group ("FFSG") has been a municipal securities dealer registered with the Commission pursuant to Section l5B(a) (2) of the Exchange Act. It is also a separately identifiable department of the treasury division of First Fidelity Bank, N.A. ("FFB"), which in turn is a wholly-owned subsidiary of First Fidelity Bancorporation, a bank holding company.
B. From in or about January 1983 to in or about November 1994, Tuttle was associated with FFSG and was a senior vice president of FFB.
C. From in or about September 1970 to in or about December 1994, Williams was associated with FFSG. Williams was the head of FFSG and an executive vice president of FFB.
D. Tuttle and Williams each willfully violated Section 17(a) of the Securities Act of 1933 ("Securities Act"), sections 10(b) and 15B(c)(1) of the Exchange Act and Rule 10b-5, and Rules G-17 and G-20 of the Municipal Securities Rulemaking Board ("MSRB"). Tuttle agreed to make undisclosed payments to Consolidated Financial Management, Inc. ("CFM"), the financial advisor of the Camden County Municipal Utilities Authority ("CCMUA"), to assure FFSG's continued participation as book-running senior manager for the CCMUA's February 1990 offering of approximately $ 237,000,000 of debt securities. Pursuant to this agreement, and with Williams' knowledge and approval,Tuttle caused FFSG to pay over $ 200,000 to CFM between February and April 1990. Tuttle and Williams also willfully violated Section 15B(c)(1) of the Exchange Act and MSRB Rule G-8 by failing to record these payments on FFSG's municipal securities dealer books and records.
E. On February 23, 1995, the Commission filed a complaint in SEC v. Nicholas A Rudi, et al., 95 Civ. 1282 (LAK) (S.D.N.Y.), alleging that Tuttle and Williams, among others, engaged in the conduct described in Section IV.D., above. In that civil action, on March 21, 1995, Tuttle and Williams were permanently enjoined on consent by the United States District Court for the Southern District of New York from future violations of Section 17 (a) of the Securities Act, Sections 10(b) and 15B(c)(1) of the Exchange Act, Rule 10b-5, and MSRB Rules G-8, G-17 and G-20. Tuttle and Williams neither admit nor deny the allegations in the complaint.
IV. In view of the foregoing, the Commission finds it is in the public interest to impose the sanctions specified in the Offer.
Accordingly, it is ORDERED that, effective immediately, Tuttle and Williams be, and hereby are, barred from association with any broker, dealer, investment adviser, investment company or municipal securities dealer.
Footnotes
-[1]- The findings herein are not binding on anyone other than the Respondents.
In re Matthews & Wright Group, Inc., Exchange Act Release No. 34-26841, A.P. File No. 3-7191 (May 19, 1989).
I. INTRODUCTION
The Commission deems it appropriate and in the public interest that proceedings pursuant to Section 15(b) (4) of the Securities Exchange Act of 1934 ('Exchange Act') be, and they hereby are, instituted with respect to Matthews & Wright, Inc. ('M&W Inc.' or the 'Company') to determine what action, if any, is necessary in light of the permanent injunction entered against M&W Inc. by the United States District Court for the Southern District of New York on May 4, 1989.
Simultaneously with the institution of this proceeding, M&W Inc. has submitted an Offer of Settlement ('Offer') for the purpose of settling the issues raised by this proceeding. Under the terms of this Offer, M&W Inc. consents to the issuance of the Order Instituting Proceedings Pursuant to 15(b) (4) of the Securities Exchange Act of 1934 and Findings and Order of the Commission ('Order') set forth herein.
The Commission has determined that is appropriate and in the public interest to accept M&W Inc.'s Offer of Settlement and accordingly is issuing this Order.
II. FINDINGS
The Commission finds as follows:
(i) That the Commission filed a Complaint for Permanent Injunction against M&W Inc. on April 27, 1989 in the United States District Court for the Southern District of New York in the action styled Securities and Exchange Commission v. Matthews & Wright Group, Inc., et al., 89 CIV.2877;
(ii) That Respondent, without admitting or denying any allegations of the Complaint, except as to jurisdiction admitted, consented to the entry of a Final Judgment of Permanent Injunction as to M&W Inc.; and
(iii) That on May 4, 1989 pursuant to the filing of the Complaint and Consent, the United States District Court for the Southern District of New York entered a Final Judgment of Permanent Injunction enjoining Respondent from violations of Section 17(a) of the Securities Act of 1933 ('Securities Act'), Sections 10(b), 15(c)(1), 15B(c)(1) and 17(a) of the Exchange Act, Rules 10b-5, 15cl-2 and 17a-5 promulgated thereunder, and Rules G-8, G-9, G-14 and G-17 of the Municipal Securities Rulemaking Board.
III. Offer of Settlement
M&W Inc. has submitted an Offer of Settlement in which it consents, without admitting or denying any of the allegations of the Complaint for Permanent Injunction served upon it, except as to jurisdiction, to the issuance of this Order revoking its registration with the Commission as a broker-dealer on the bases, as provided in Section 15(b) (4) (C) of the Exchange Act, that the Company is permanently enjoined by order of a court of competent jurisdiction from engaging in any conduct or practice in violation of Section 17(a) of the Securities Act, Sections 10(b), 15(c)(1), 15B(c)(1) and 17(a) of the Exchange Act, Rules 10b-5, 15cl-2 and 17a-5 promulgated thereunder, and Rules G-8, G-9, G-14, and G-17 of the Municipal Securities Rulemaking Board. The Commission deems it appropriate and in the public interest to accept this Offer of Settlement.
IV. Order
IT IS HEREBY ORDERED that the registration of M&W Inc. with the Commission as a broker-dealer be, and it hereby is, revoked.
In re Bullington-Schas & Co., Inc., Exchange Act Release No. 17832, A.P. File No. 3-6028 (June 1, 1981).
I. The Commission deems it appropriate that public administrative proceedings be instituted with regard to Bullington-Schas & Co., Inc. ("Bullington-Schas"), a registered broker-dealer, a member of the National Association of Securities Dealers, Inc., and a member of the Philadelphia Stock Exchange and the Cincinnati Stock Exchange; A. Dulaney Tipton ("Tipton"), the president, a director and owner of more than 50% of Bullington-Schas' common stock; and Terry Allen Frost ("Frost"), a securities salesman associated with Bullington-Schas (collectively, the "Respondents"), alleging that Respondents willfully violated Section 17(a)(2) and (3) of the Securities Act of 1933 ("Securities Act") in connection with the offer and sale of revenue bonds of the Calhoun County Medical Facility, Inc. (hereinafter "Calhoun County") of Bruce, Mississippi,n1 and that Tipton failed reasonably to supervise Frost and others in connection with the offering.
II. In connection with the administrative proceedings, each of the Respondents has submitted an Offer of Settlement, which the Commission has determined to accept. Solely for the purpose of these proceedings, without admitting or denying the allegations or findings herein, Respondents Bullington-Schas, Tipton and Frost consent to the entry of the findings and sanctions set forth below.
III. Accordingly, it is ORDERED that administrative proceedings pursuant to Sections 15(b) and 19(h) of the Securities Exchange Act of 1934 be, and they hereby are, instituted.
On the basis of the Order for Proceedings and the Offers of Settlement, it is found that:
1. In or about October 1977, Respondent Bullington-Schas acted as underwriter in connection with a $1.8 million public bond offering by Calhoun County for the purchase of an existing hospital;
2. In connection with the underwriting, Respondents Bullington-Schas, Tipton and Frost, among others, were responsible for the preparation and dissemination of an Offering Circular containing certain information with respect to Calhoun County and the bond offering;
3. The foregoing Offering Circular contained certain pro forma financial statements and projections relating to future revenues and income of Calhoun County, which statements and projections were prepared by an independent firm with experience in such matters;
4. In connection with its operations during the period 1971-76, the hospital prepared or caused to be prepared certain unaudited financial statements which reflected lower revenues and higher bad debt losses than the pro forma statements and projections referred to hereinabove, and which financial statements reflected operating losses or nominal profits during said period;
5. Respondents Bullington-Schas, Tipton and Frost, among others, determined not to include in the offering circular the prior unaudited financial statements described herein;
6. In failing to include the prior unaudited financial statements in the Offering Circular, Respondents Bullington-Schas, Tipton and Frost willfully violated and aided and abetted violations of Sections 17(a)(2) and 17(a)(3) of the Securities Act in that, among other things, they failed to disclose material facts to purchasers of the Calhoun County bonds concerning, but not limited to, those matters set forth in item 4 hereinabove.
7. Respondent Tipton failed reasonably to supervise securities salesmen associated with Bullington-Schas; and
8. It is in the public interest to impose the sanctions contained in the Officers of Settlement.
In imposing the sanctions herein, the Commission recognizes the existence of certain mitigating factors, including the Respondents' cooperation in the staff's investigation and their prior inexperience as a principal underwriter of municipal securities.
IV. Accordingly, it is ORDERED that:
1. Respondent Bullington-Schas be, and hereby is, censured;
2. Respondent Tipton be, and hereby is, suspended from association with any broker or dealer for a period of five (5) business days, said period of suspension to commence on the second Monday following the date on which the Order instituting these proceedings is entered by the Secretary of the Commission.
3. Respondent Frost be, and hereby is, suspended from association with any broker or dealer for a period of fifteen (15) business days, said period of suspension to commence on the second Monday following the date on which the Order instituting these proceedings is entered by the Secretary of the Commission.
4. Respondent Bullington-Schas comply with its undertaking that within thirty (30) days following the date of entry of this Order by the Secretary of the Commission, it shall retain the services of a person or persons knowledgeable in the matter of broker-dealer compliance with the federal securities laws.
a) to conduct a review of Respondent Bullington-Schas' due diligence and compliance procedures with respect to its activities as a principal underwriter of municipal securities, and
b) to prepare a manual of due diligence and compliance procedures which shall be adopted, implemented and adhered to by Respondent and its employees in all of its future principal underwritings of municipal securities.
5. Respondents Tipton and Frost comply with their undertaking to enroll in and complete a course of study for municipal bond principals which course is not objectionable to the staff of the Commission and which will be conducted by a recognized firm that administers such courses.
Footnotes
-[n1]- See Securities Exchange Act of 1934 Release No. 17831 containing a report issued by the Commission pursuant to Section 21(a) of the Securities Exchange Act of 1934 concerning William M. Gotten, underwriter's counsel; and Litigation Release No. 9366, discussing the institution of a Commission injunctive action and the issuance of permanent injunctions against the Respondents herein and others, which action arises directly from the factual basis for the instant matter.
In re First Citizens Municipal Corp., Exchange Act Release No. 16725, A.P. File No. 3-5900 (April 8, 1980).
I. The Commission deems it appropriate that public administrative proceedings be instituted with regard to First Citizens Municipal Corporation ("First Citizens"), a registered broker-dealer and a member of the National Association of Securities Dealers, Inc.; Michael A. C. Siemer ("Siemer"), the president and a director of First Citizens; Paul A. Goldberg ("Goldberg"), the secretary-treasurer and a director of First Citizens; Thomas F. Ventresca ("Ventresca"), a vice-president of First Citizens; Ronald C. Fontane, an employee of First Citizens and Robert J. Seifert ("Seifert"), Jon W. Montesinos ("Montesinos"), Gary J. Pollack ("Pollack"), Alan Richard Holman ("Holman"), Richard T. Tanaka ("Tanaka"), Charles P. Bernstein ("Bernstein"), John A. Adamek ("Adamek"), Paul S. Whitaker ("P. Whitaker"), Frederick Whitaker, III ("F. Whitaker"), Richard C. Ellis ("Ellis"), Robert J. Lubin ("Lubin"), Nicholas H. Keegstra ("Keegstra") and Richard A. Williamson ("Williamson"), who are all securities salesmen associated with First Citizens [First Citizens and all of the above-listed individuals are hereinafter collectively referred to as the "Respondents"], alleging that Respondents willfully violated Section 17(a) of the Securities Act of 1933 ("Securities Act") and Section 10(b) of the Securities Exchange Act of 1934 ("Exchange Act") and Rule 10b-5 thereunder in connection with the offer and sale of revenue bonds of the Park Nursing Center, Inc. (hereinafter "PNC"), Taylor, Michigan.
II. In connection with the administrative proceedings, each of the Respondents has submitted Offers of Settlement which the Commission has determined to accept. Solely for the purpose of these proceedings, without admitting or denying the allegations or finding herein, Respondents First Citizens, Siemer, Ventresca, Goldberg, Montesinos, Seifert, Pollack, Holman, Tanaka, Bernstein, Adamek, P. Whitaker, F. Whitaker, Ellis, Lubin, Keegstra and Williamson consent to the entry of findings and sanctions set forth below.
Accordingly, it is ORDERED that administrative proceedings pursuant to Sections 15(b) and 19(h) of the Exchange Act be and they hereby are instituted.
On the basis of the Order for Proceedings and the Offers of Settlement, it is found that:
1. Respondents First Citizens, Montesinos, Seifert, Pollack, Holman, Tanaka, Bernstein, Adamek, P. Whitaker, F. Whitaker, Ellis, Lubin, Keegstra and Williamson willfully violated Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in that, among other things, they each made certain of the following misrepresentations and they each failed to disclose certain of the following material facts to purchasers of PNC bonds:
(a) The insolvency of the issuer;
(b) Regulatory enforcement proceedings by the States of Arizona and Michigan;
(c) Liabilities involving real estate taxes and income tax liabilities;
(d) The significance of the ratio of Medicare/Medicaid patients to private paying patients and its potential adverse impact on PNC's financial condition;
(e) That this was a "safe investment;"
(f) That "there was no risk in the bonds;"
(g) That "there was no risk in the bonds because the nursing home was 80% occupied and making money;"
(h) That "the purpose for the issuance of the bonds was to refund some 10% bonds that had been issued two years earlier in order to save money on the difference in interest rates;"
(i) That "one of the trustees purchased $125,000 so it must be a good issue;"
2. Respondents Siemer, Ventresca and Goldberg have failed reasonably to supervise the other individual respondents herein who were subject to their supervision with a view toward preventing certain of the violations in paragraph 1 above which were committed by such persons.
3. Respondents Siemer, Ventresca and Goldberg willfully violated and willfully aided and abetted violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in that, among other things, they participated in certain of the violations set forth in paragraph one (1) above.
4. Respondents Fontaine willfully aided and abetted violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder in that, among other things, he participated in certain of the violations set forth in paragraph one (1) above.
5. It is in the public interest to impose the sanctions contained in the Offers of Settlement.
Accordingly, IT IS ORDERED that:
1. Respondent First Citizens be, and hereby is, censured;
2. Respondent First Citizens shall comply with its undertakings, including the provision by independent sources, of further training for each of its registered representatives in the duties and responsibilities imposed upon them by the federal securities laws.
3. Respondent First Citizens shall comply with its undertaking to have each of its registered representatives take the Series 7 Examination of the National Association of Securities Dealers, Inc.
4. Respondent Siemer be, and hereby is, suspended from association with any broker or dealer or investment adviser for a period of twenty-two (22) business days; said period of suspension to commence on the second Monday following the date of the Order instituting these proceedings.
5. Respondent Ventresca be, and hereby is, suspended from association with any broker or dealer or investment adviser for a period of fifteen (15) business days; said period of suspension to commence on the first business day following termination of the suspension of Respondent Siemer.
6. Respondent Goldberg be, and hereby is, suspended from association with any broker or dealer or investment adviser for a period of fifteen (15) business days; said period of suspension to commence on the first business day following termination of the suspension of Respondent Ventresca.
7. Respondents Montesinos, Williamson and Keegstra be, and hereby are, suspended from association with any broker or dealer or investment adviser for a period of twelve (12) business days; said periods of suspension to commence on the second Monday following the date of the Order instituting these proceedings.
8. Respondents Adamek, Holman, F. Whitaker, Seifert, and P. Whitaker be, and hereby are, suspended from association with any broker or dealer or investment adviser for a period of ten (10) business days; and periods of suspension to commence on the second Monday following the date of the Order instituting these proceedings.
9. Respondents Tanaka and Bernstein be, and hereby are, suspended from association with any broker or dealer or investment adviser for a period of eight (8) business days; said periods of suspension to commence on the second Monday following the date of the Order instituting these proceedings.
10. Respondents Pollack, Lubin, Fontaine, and Ellis be, and hereby are, suspended from association with any broker or dealer or investment adviser for a period of five (5) business days; said periods of suspension to commence on the second Monday following the date of the Order instituting these proceedings.
11. Respondents Montesinos, Seifert, Pollack, Holman, Tanaka, Bernstein, Adamek, P. Whitaker, F. Whitaker, Ellis, Lubin, Keegstra, and Williamson shall comply with their undertaking to acquire further education and training in their duties and responsibilities imposed upon them by the federal securities laws with a view toward taking the Series 7 Examination of the National Association of Securities Dealers, Inc.
In re Rovinsky & Co., Inc., Exchange Act Release No. 15451, A.P. File No. 3-5609 (January 2, 1979).
The Securities and Exchange Commission has ordered the institution of public administrative proceedings pursuant to Sections 15(b), 15B(c), and 19(h) of the Securities Exchange Act of 1934 ("Exchange Act") against Rovinsky & Co., Inc., a registered broker-dealer and municipal securities dealer, and Elliot Ben Rovinsky of Scottsdale, Arizona.
The Commission's Order for Proceedings alleges that the respondents willfully violated Sections 5 and 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Order for Proceedings charges that the respondents made false and misleading statements to purchasers of bonds issued by Park Nursing Center, Inc. of Taylor, Michigan. More specifically, the respondents are charged with making false and misleading statements with regard to the risks of an investment in said bonds, the financial condition of the issuer, various potential conflicts of interest and the amount of compensation paid to the respondents for their role in underwriting the sale of these bonds to the public. In addition, the Order alleges that the respondents sold unregistered securities, namely Park Professional Center 12% First Mortgage Series 1 bonds.
A hearing will be scheduled by further Order to determine whether the allegations are true, to afford the respondents an opportunity to offer any defense and to determine whether any remedial action is necessary or appropriate in the public interest.
In re Rovinsky & Co. , Inc., Exchange Act Release No. 15756, A.P. File No. 3-5609 (April 23, 1979).
In these broker-dealer and municipal securities dealer proceedings under the Securities Exchange Act of 1934 ("Exchange Act"),n1 Respondents Rovinsky & Co., Inc. ("Registrant") and Elliot Ben Rovinsky ("Rovinsky"), Registrant's president and controlling shareholder, without admitting or denying the substantive allegations of the Order for Proceedings, have submitted an offer of settlement which the Commission has determined to accept.
On the basis of the Order for Proceedings and the offer of settlement, the Commission finds that Registrant and Rovinsky willfully violated, and willfully aided and abetted violations of, Sections 5(a), 5(c) and 17(a) of the Securities Act of 1933 and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder, as alleged in the Order for Proceedings.
It is, therefore, in the public interest to impose the sanctions specified in the offer of settlement.
Accordingly, IT IS ORDERED that, effective at the opening of business on the second Monday after the date of this Order:
(1) Rovinsky be, and hereby is, suspended for a period of twelve months from being associated with any broker, dealer, municipal securities dealer, investment company, or investment adviser;
(2) For a period of three years after the suspension described in paragraph (1) hereof, the activities and functions of Rovinsky be, and they hereby are, limited in that Rovinsky is prohibited from being associated with any broker, dealer, municipal securities dealer, investment company, or investment adviser in any supervisory or proprietary capacity, and further, if Rovinsky thereafter becomes associated in any such capacity, he shall file with the Commission, prior to assuming any such position, an affidavit describing his experience and the affirmative steps he has taken to qualify himself for such a position;
(3) For a period of three years after the suspension described in paragraph (1) hereof, the activities and functions of Rovinsky be, and they hereby are, also limited in that he is prohibited from being associated with any broker, dealer, municipal securities dealer, investment company, or investment adviser unless he has filed an affidavit with the Commission: (a) affirming that he has complied with the aforesaid suspension; (b) affirming that he is not assuming any supervisory or proprietary position with such firm; and (c) demonstrating that the broker, dealer, municipal securities dealer, or other firm or entity which employs him, or with which he becomes associated, has instituted adequate supervisory procedures, and shall adequately implement such procedures with respect to Rovinsky; and
(4) The broker-dealer registration and municipal securities dealer registration of Registrant are hereby ordered withdrawn.
-[n1]- In the Matter of Rovinsky & Co., Inc., et al., instituted on December 12, 1978. See Securities Exchange Act of 1934 Release No. 15451, 16 SEC Docket 589 (January 2, 1979).
In re Midwest Securities Co. , Exchange Act Release No. 14544 (March 8, 1978).
The Securities and Exchange Commission has ordered public administrative proceedings under the Securities Act of 1934, as amended ("Exchange Act"), against Midwest Securities Co., ("Midwest") and Arthur Bruce Weichelt of Chicago, Illinois and Howard Herndon Percy of St. Louis, Missouri.
The proceedings are based upon allegations of the Commission's staff that the respondents violated the antifraud provisions of the Securities Act of 1933 and the Exchange Act in the offer and sale of municipal bonds while acting as underwriter to various municipalities in certain revenue refunding bond issues. The order for proceedings alleges that Weichelt and Percy aided and abetted Midwest in violating the antifraud provisions of the Securities Act and Exchange Act by utilizing an interim financing and immediate refunding scheme to circumvent the effect of an Illinois Statute that limited the net cost that could be paid by a municipality in the sale of its bond issues. The Order alleges that pursuant to the scheme Midwest purchased an interim revenue bond at a discount such that the net interest cost to the issuing municipality did not exceed the statutory interest rate and then immediately either exchanged the aforesaid revenue bonds at par for refunding bonds issued at the statutory interest rate, or caused the municipality to issue refunding bonds at par at the statutory interest rate with the proceeds from such sale deposited in an escrow account subsequent to which Midwest sold the refunding issue and presented the aforesaid revenue bond to the escrow agent for redemption at par.
The Order also alleges that Midwest, Weichelt and Percy distributed offering circulars that failed to disclose the aforementioned scheme.
A hearing will be scheduled by further order to take evidence on the staff allegations and to afford the respondents an opportunity to offer any defense thereto, for the purpose of determining whether the allegations are true and if so, whether any action of a remedial nature should be ordered by the Commission.
In re Midwest Securities Co., Exchange Act Release No. 14919, A.P. File No. 3-5391 (July 3, 1978).
In these broker-dealer proceedings under the Securities Exchange Act, Midwest Securities Co. (Registrant), a registered municipal securities dealer; Howard Herndon Percy ("Percy"), and Arthur Bruce Weichelt ("Weichelt"), partners, have submitted an offer of settlement, without admitting or denying the allegations in the order for proceedings, which the Commission has determined to accept.
On the basis of the order for proceedings and the offer of settlement, it is found that Modwest, Percy and Weichelt willfullyn1 violated and willfully aided and abetted violations of Section 17(a) of the Securities Act of 1933 (Securities Act), Section 10(b) of the Exchange Act and Rule 10b-5 thereunder as allege in Paragraphs II B1(a) and (b), II B2(a)-(d), that portion of II B2(e) which states that "the bonds were issued in deliberate circumvention of an Illinois statute which establishes a maximum rate of interest on municipal bonds" and II C of the Order.
ACCORDINGLY, IT IS ORDERED THAT:
(1) (a) Respondent Midwest's registration with the Commission as a broker-dealer be suspended for twenty-one (21) calendar days, and
(b) Respondents Percy and Weichelt be suspended from being associated with Midwest, or any other registered broker-dealer, for twenty-one (21) calendar days, said suspensions to commence the second Monday following the week in which this Order is entered.
(2) Midwest retain experienced securities counsel to review their future securities underwritings.
(3) In connection with any future underwriting of a municipal bond refunding issue used to refund or redeem an earlier municipal bond issue Midwest shall obtain an opinion from experienced municipal bond counsel that such bonds were issued in conformity with the requirements of Illinois law, including the statutory interest rate limitations.
For the Commission, by its Secretary, pursuant to delegated authority.
Footnotes
-[n1]- "For the purposes of this Offer, the term "willfully", as defined by the Second Circuit in Tager v. Securities and Exchange Commission, 344 F.2d 5 (2d Cir. 1965), shall mean that the actions alleged in the order were knowingly done by the respondents but without knowledge of any violation of, or intent to violate the federal securities laws."
In re Carl Hanauer & Co., Exchange Act Release No. 9099, A.P. File No. 3-723 (March 12, 1971).
These were private proceedings pursuant to Section 15(b) of the Securities Exchange Act 0f 1934 ("Exchange Act") in which Carl Hanauer & Company ("Hanauer Co.") , a California corporation which held itself out to the public as a specialist in municipal bonds, issued by the State of California and its political subdivisions, and Carl Hanauer, who was president and the principal stockholder of Hanauer Co., have submitted an offer of settlement.
Under the terms of the offer, respondents waived a hearing and post-hearing procedures and, solely for the purpose of settlement of these proceedings, and without admitting the violations alleged in the order for proceedings, consented to findings of willful violations of certain provisions of the Exchange Act alleged in such order, and to the entry of an order imposing certain sanctions.
After due consideration of the offer of settlement and upon the recommendation of its staff, the Commission determined to accept such offer.
On the basis of the order for proceedings and the offer of settlement, is found that from about July 1, 1962 to about September 1963 respondents, singly and in concert, willfully violated and willfully aided and abetted violations of Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 10b-5 and 15cl-2 thereunder in the offer and sale of "5-1/2% Act Improvement Bonds of Rio Ramaza Community Services District, Sutter County, California", which were speculative and unseasoned securities.
Respondents represented that such securities were "good tax-exempt bonds", "high-grade municipal bonds" and "good secure bonds", although they were aware or upon reasonable inquiry would have become aware of information casting doubt upon the ability of the issuer to meet the payments thereon as they become due, including the fact that the land included within the Rio Ramaza Community Service District ("District") was owned by one individual who would be unable to meet the assessments necessary to service such bonds. In addition, respondents made untrue and misleading statements concerning the District's financial condition, ability to meet its financial obligations, and prospective income, the purpose of the bond issue and the use of proceeds to be derived therefrom, the amount of the underwriting discount to be derived by Hanauer Co. and others, the ownership of the land within the District and the background and financial condition of its sole owner, the nature and method of financing a marina or boat harbor to be operated by such owner as part of the development of the land comprising the District, the identity and interrelationship of the persons instrumental in forming the District, the assessed value of the land included within the District as compared to the valuation placed thereon for purposes of selling the bonds, and unfavorable factors relating to the land which might inhibit its sale and the consequent effect on the District's ability to meet its obligations.
The settlement offer submitted by respondents provided that an order may be entered suspending them from association with any broker or dealer for a period of six months. It further provided that thereafter Hanauer shall not be barred by virtue of such order from any future association in the securities industry but that he would not enter into such association without first submitting to the Commission a full statement of all the facts, circumstances and conditions thereof, with specific regard to control and review of transactions in which he may or will engage. In support of the settlement offer respondents state that Hanauer Co. is defunct and that for about seven years Hanauer has not engaged in or been connected with the securities industry.
It is concluded that it is appropriate in the public interest to impose the sanctions specified in the offer of settlement.
Accordingly, IT IS ORDERED that Carl Hanauer & Company and Carl Hanauer be, and they hereby are, suspended from being associated with any broker or dealer for a period of six months from the date of this order, subject to the terms, conditions, and undertaking specified above.
For the Commission, by the Office of Opinions and Review, pursuant to delegated authority.
In re Walston & Co. Inc. , and Harrington, Exchange Act Release No. 8165 (September 22, 1967).
These proceedings were instituted pursuant to Sections 15(b), 15A and 19(a) (3) of the Securities Exchange Act of 1934 ("Exchange Act") to determine what remedial action, if any, should be taken in the public interest with respect to Walston & Co., Inc. ("registrant"), a registered broker-dealer and Gregory I. Harrington, who had been a vice president of registrant and manager of the Municipal Bond Department of the Western Division of registrant at its office in San Francisco, California. The order for proceedings among other things alleged violations of the anti-fraud provisions of the Exchange Act and of the Securities Act of 1933 ("Securities Act"), in connection with the offer and sale of securities of the Rio Ramaza Community Services District, Sutter County, California ("Rio Ramaza District"), during the period from about May to September 1963.
Registrant and Harrington submitted offers of settlement, accompanied by a stipulation of facts, in which they waived hearings and post-hearing procedures and without admitting any of the allegations of the order for proceedings or any violation of law, consented to findings that they had willfully violated the anti-fraud provisions as alleged in the order for proceedings. They further consented to the entry of an order censuring respondents; directing registrant, subject to certain conditions, to suspend for a period of 30 days all operations of its National Municipal Bond Department; and suspending Harrington from being associated with any broker or dealer for a period not to exceed six months, provided that such order shall not constitute a bar to his employment or association in the securities business after the expiration of the suspension period. Our Division of Trading and Markets recommended that the offers be accepted, and for the reasons hereinafter set forth, we have determined to accept such offers.
On the basis of the allegations in the order for proceedings, and the stipulations, consents and offers of the respondents, we make the following findings.
Registrant is a Delaware corporation formed in 1955 as a successor to a partnership which had been in existence since 1932. It is a member of the New York Stock Exchange and other principal securities and commodities exchanges, as well as of the National Association of Securities Dealers, Inc., and had principal offices in New York, Chicago and San Francisco. In January 1963, registrant acquired the assets and business of a firm which had been engaged in the municipal bond filed. Harrington had been manager of the municipal bond department of the other firm, and he then became a vice president and manager of the municipal bond department of registrant's Western division headquartered in San Francisco, California.
In May 1963, Harrington, who had authority to commit registrant to participation in municipal bond offerings up to $1,500,000 at any one time, entered into an agreement on behalf of registrant with another dealer which represented itself as a specialist in California municipal bonds. Pursuant to this agreement registrant purchased $250,000 principal amount of a $555,000 issue of 5 1/2% bonds issued by the Rio Ramaza District for which the other dealer acted as principal underwriter. In June and July 1963, registrant as dealer sold the $250,000 of bonds to 34 of its customers then residing in California, Washington, Oregon, Nebraska and Hawaii.
Although Harrington's commitments on behalf of registrant were to be subsequently reviewed by registrant's vice president in charge of its National Bond Department, registrant's records contain no evidence that the Rio Ramaza commitment was ever submitted to that Department for review beyond the routine review of the position of the municipal bond portfolio. The only information given to registrant's salesmen about the bonds was that contained in an offering circular which Harrington adapted from an offering circular of the principal underwriter and which Harrington distributed to various of registrant's offices for use by salesmen in the sale of the bonds. The offering circular bore a prominent legend "TAX FREE MUNICIPAL BONDS", recited the amount, maturity, yield and approximate price of the bonds, and identified them as bonds issued pursuant to the provisions of the California Improvement Bond Act of 1915,n1 under which they were secured by special assessments against the property in the District. It also stated that the District comprised approximately 171 acres adjacent to the Sacramento River 14 miles north of the City of Sacramento; that the bonds were being issued to pay the cost of certain improvements within the District such as streets, sidewalks, sewers and water lines; that approximately $150,000 would be spent immediately on construction of a marina; and that development of a new subdivision within the District of 123 residential lots would also begin immediately.
Registrant's salesmen recommended the purchase of the bonds, in some instances as "good" or "high grade" or "secure" tax-free municipal bonds. Various customers purchased the bonds in reliance on these specific recommendations, as well as on the general impression that the bonds were safe and conservative investments, and that registrant, as a reputable firm, would not recommend them unless they were of that quality. Various customers also obtained the impression that the bonds were issued by a district in a rapidly growing part of the country, or for the expansion of an established community, or by an established district already developed.
The recommendations and representations made to the purchasers of the bonds were highly misleading in view of the failure to disclose material facts concerning the nature of the District and its ability to meet its obligations and service the bonds. Contrary to the express and implied representations made to customers, the bonds were highly speculative and of the most dubious investment quality.
Respondents did not make known to customers that the entire tract included in the District was owned by one individual, who was a farmer and a candy vendor at county fairs who had no previous experience in selling real estate subdivisions or the financial ability to service the bonds himself; that the District had been formed by the vote of the six eligible voters on the tract, including the owner and two members of his family, who elected the owner of the land, his son and one other, as the three directors of the District. Nor were purchasers told that the District consisted entirely of undeveloped farm lands, situated 12 miles from a shopping center and with no public transportation available; that existing schools were 13 miles away; that the tract was in the general vicinity of and under the pattern of approach to a metropolitan airport and within a zone of intense noise; and that the entire tract of land in the District had a current assessed value of only $15,560.n2
The fact that bond issues under the California Improvement Bond Act of 1915 and other similar acts had been widely used by cities, counties and special districts in California made it all the more necessary to inform purchasers of the Rio Ramaza bonds that in this case the assessment district was merely the newly-formed instrument of an inexperienced developer and consisted of one tract of undeveloped land not a part of any established community, and that service of the bonds depended entirely on the sale of lots in the district. At the time registrant bought the Rio Ramaza bonds and sold them to its customers, Harrington had not inspected the land and he did not know or inquire as to the financial condition of the owner and developer, although he did know that all the land in the District was owned by one individual and the facts as to the election of the directors of the District.
It is incumbent on firms participating in an offering and on dealers recommending municipal bonds to their customers as "good municipal bonds" to make diligent inquiry, investigation and disclosure as to material facts relating to the issuer of the securities and bearing upon the ability of the issuer to service such bonds. It is, moreover, essential that dealers offering such bonds to the public make certain that the offering circulars and other selling literature are based upon an adequate investigation so that they accurately reflect all material facts which a prudent investor should know in order to evaluate the offering before reaching an investment decision. The offering circular used by registrant in this situation fell far short of that standard of disclosure.
We conclude and find that registrant and Harrington willfully violated and willfully aided and abetted in violations of the anti-fraud provisions of Section 17(a) of the Securities Act and Sections 10(b) and 15(c)(1) of the Exchange Act and Rules 17 CFR 240.10b-5 and 15c1-2 thereunder in connection with their offer and sale of the Rio Ramaza bonds.
In connection with the offers of settlement, respondents cite the facts that a firm specializing in California municipal bond issues was the principal underwriter of the Rio Ramaza bonds, that the District was organized and the bonds were issued in accordance and compliance with the applicable State statutes and procedures, and that the District was advised by experienced engineers and bond counsel. It is also noted that registrant's municipal bond department in San Francisco had only recently been established following Harrington's employment. Since that time registrant has taken various actions and instituted procedures intended to correct the shortcomings in registrant's review and control of underwritings of tax-exempt issues and to prevent reoccurrence of any situation resembling the transactions in Rio Ramaza bonds.n3
Registrant has also been active in efforts to protect the interests of bondholders. The bonds came into default when the developer was unsuccessful in selling lots and could not meet the assessments necessary to service the bonds. Through the organization of a bondholders' committee and otherwise, and in large part as a result of registrant's efforts the District was reorganized, possession of the property has been obtained, and some progress has been made in selling lots for the District.
Registrant has offered to repurchase all the bonds it sold at the prices paid by the customers plus interest and also to return to each customer any contribution he made to the bondholders' committee. As of July 1967, registrant had repurchased 234 of the 250 bonds it had sold.n4
Under the circumstances, it is concluded that it is appropriate in the public interest to accept the offers of settlement, and to censure respondents, direct that registrant suspend its municipal bond activities for a period of 30 days in accordance with its agreement, and suspend Harrington from association with a broker or dealer for a period of six months.
Accordingly, IT IS ORDERED that:
(1) Walston & Co., Inc. and Gregory I. Harrington be, and they hereby are, censured.
(2) Walston & Co., Inc. shall, for a period of 30 days beginning on October 9, 1967, suspend trading and dealing in municipal securities and the operations of its National Municipal Bond Department, provided, however, that such suspension shall not apply to (1) execution of unsolicited orders of customers, which executions shall be accomplished without commission or other remuneration to Walston, and (2) performance of Walston's obligations under Fiscal Agency Contracts or Municipal Underwriting Contracts entered into prior to October 9, 1967. Walston may apply to the Division of Trading and Markets for modification of the suspension in the event some extraordinary development in the municipal bond market makes it necessary for it to liquidate or adjust its inventory of municipal securities.
(3) Gregory I. Harrington be, and he hereby is, suspended from association with a broker or dealer for a period of six months, effective October 2, 1967, provided, however, that at the expiration of the period of such suspension these findings and order shall not constitute a bar to any future employment or association of Harrington in the securities industry.
By the Commission (Chairman COHEN and Commissioners OWENS, BUDGE, WHEAT, and SMITH).
Footnotes
-[n1]- California Streets and Highways Code, Sections 8500 et seq.
-[n2]- This valuation was prior to the construction of improvements financed by the bonds. The assessed value was supposed to represent 25% of the fair market value.
-[n3]- Among other things, registrant will not underwrite any special assessment bonds of the California 1915 Act type which constitute new or promotional developments. While it may underwrite or sell special assessment type municipal securities relating to developments which are already existing, customers will be furnished an offering circular fully descriptive of the securities, and agreements by local managers to underwrite or purchase substantial amounts of municipal securities will be reviewed and approved by the vice president in charge of registrant's National Municipal Bond Department. Registrant's Executive Committee will review the activities of the Municipal Bond Department periodically and no less than six times a year, and maintain a constant supervision over the activities of that Department. Harrington's employment with registrant has been terminated and he ceased to be associated with registrant effective May 31, 1967.
-[n4]- The remaining 16 bonds had been purchased by three customers. One, who purchased five bonds, did not accept registrant's repurchase offer. The other two had sold their bonds and registrant has paid them the amounts of their realized losses plus interest.
Last Reviewed or Updated: March 23, 2000