==========================================START OF PAGE 1====== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. SECURITIES EXCHANGE ACT OF 1934 Rel. No. 37600 \ August 26, 1996 Admin. Proc. File No. 3-8519 ------------------------------------------------- : In the Matter of the Applications of : : EVEREST SECURITIES, INC. : 90 South Seventh Street : Minneapolis, Minnesota 55402 : : and : : JEANNE ALYCE KUNKEL : 2860 West River Parkway : Minneapolis, Minnesota 55406 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : : -------------------------------------------------- OPINION OF THE COMMISSION REGISTERED SECURITIES ASSOCIATION -- REVIEW OF DISCIPLINARY PROCEEDINGS Violations of Rules of Fair Practice Conduct Inconsistent with Just and Equitable Principles of Trade False or Misleading Representations in the Sale of Securities Alleged Failure of Firm to Register Employee Failure to Maintain Accurate Books and Records Where member firm of registered securities association and its president violated antifraud provision in connection with the sale of securities, and failed to maintain complete customer records, held, association's findings of violation and sanctions it imposed sustained. ==========================================START OF PAGE 2====== APPEARANCES: Michael C. Mahoney, Mark W. Peery, and Bentley J. Anderson, of Mahoney, Hagberg & Rice, for Everest Securities, Inc. Vernon J. Vander Weide, of Head, Seifert, and Vander Weide, for Jeanne Alyce Kunkel. T. Grant Callery, Norman Sue, Jr., and Shirley H. Weiss, for the National Association of Securities Dealers, Inc. Appeals filed: October 3, 1994 Briefing completed: February 21, 1995 I. Everest Securities, Inc. ("Everest" or "the Firm"), a member of the National Association of Securities Dealers, Inc. ("NASD"), and Jeanne Alyce Kunkel, president and FINOP of Everest in 1992, appeal from NASD disciplinary action. The NASD found that, during the period from February to April 1992, Everest offered and sold securities using offering materials that were misleading. -[1]- It also found that Everest and Kunkel permitted Dennis Breen to function as a securities representative in mid-February 1992 without being registered. In addition, it found that Everest, during the period from January 1992 to February 1993, and Kunkel in 1992, failed to maintain accurate books and records, including new account information for customers of an offering. 2/ ---------FOOTNOTES---------- -[1]- The NASD found that Everest and Kunkel thereby violated Article III, Sections 1 and 18 of the NASD Rules of Fair Practice (the "Rules"). Article III, Section 1 of the Rules requires members to observe "high standards of commercial honor and just and equitable principles of trade." Section 18 of the Rules provides that "[n]o member shall effect any transaction in, or induce the purchase or sale of, any security by means of any manipulative, deceptive or other fraudulent device or contrivance." 2/ The NASD found that Everest thereby violated Article III, Sections 1 and 21 of the Rules and that Kunkel was responsible for the Firm's violations occurring in 1992. Section 21 requires that a member maintain for each account specified types of information and that it "make reasonable efforts" to obtain that information prior to settlement of the initial transaction in the account. ==========================================START OF PAGE 3====== The NASD censured Everest and Kunkel, fined them $15,000, jointly and severally, and ordered them to make restitution of $22,500 within 90 days. 3/ In addition, it barred Kunkel in a principal capacity and required her to requalify as a registered representative before she may re-enter the industry. 4/ Our findings are based on an independent review of the record. II. In early 1992, G.E.D. International, Inc. ("GED") began a private placement of 600,000 shares of its common stock at 75 cents a share on a best efforts basis to only "accredited investors." 5/ The offering memorandum ("Memorandum"), dated February 11, 1992, and distributed to purchasers explained that, although most of GED's shares would be sold by its officers, to whom no selling commission would be paid, GED had engaged Everest as the exclusive agent to sell the shares and would pay Everest a selling commission of 5% of the aggregate purchase price of all shares sold. 6/ Checks were made payable directly to GED. By April 9, all 600,000 shares were sold. All but one of the purchasers were solicited by officers of GED. Each customer filled out a subscription agreement on which he or she indicated that he or she was qualified as an accredited investor. It was Everest's obligation to open an account for each customer and obtain specific customer information to verify eligibility to purchase the shares. 7/ Everest was paid a commission of 3/ Everest was also fined $2,500 in connection with findings of net capital violations, which it does not appeal. 4/ The NASD also assessed costs. 5/ The securities were offered in reliance on the exemption from registration for limited offerings under Regulation D of the Securities Act of 1933. 17 C.F.R. 230.501-508. The term "accredited investor" is defined in Rule 501(a) of Regulation D. 17 C.F.R. 230.501(a). 6/ It also agreed to pay Everest a nonrefundable expense allowance of $13,500 and a nonrefundable investment banking fee of $11,500 for future assistance in obtaining additional financing. 7/ The Memorandum specified that the investor must be a natural person either with an individual net worth, or a joint net worth with his or her spouse, exceeding $1,000,000 at the time of purchase, or with an individual income of at least $200,000 (or jointly with his or her spouse, of $300,000) for each of the two most recent years and a reasonable expectation of at least that level in 1992. ==========================================START OF PAGE 4====== $18,000 (5% of the $450,000 raised in the offering, less $4,500 paid to Everest's counsel). The Memorandum disclosed that in May 1990 GED had entered into a partnership, known as the Pyromed Minnesota Partnership ("Pyromed"), with two other firms 8/ to build a medical waste burning facility in Watkins, Minnesota. As stated in the Memorandum, GED had not yet generated any income, nor had it obtained the necessary permits to proceed with the project "on an economic basis." As described in the Memorandum, the proceeds of sales of the securities in the private placement were to be used by GED to purchase all the outstanding shares of Midwest Tire Services, Inc. ("MTS") from two MTS officers, for $250,000 and one million shares of GED. MTS collected, processed, and disposed of waste tires. 9/ According to the Memorandum, the combined operation would focus on the waste tire business, although GED would "continue to pursue permits for its medical waste incineration business." After completing its merger with MTS, GED changed its name to National Tire Service, Inc. ("National") and began a public offering in December 1992. In describing the issuer's history, the prospectus for that offering stated: Due to changes in the political climate in Minnesota relating to the disposal of medical wastes, in the Fall of 1991, the respective parties [GED, Endeco, and Volund USA] decided to: discontinue seeking the necessary permits to operate that business and agreed to terminate the Joint Venture; dissolve and liquidate the Partnership; and release and indemnify each other from any and all obligations relating to the Partnership or the Project. More specifically, Note 2 to the GED financial statements, entitled "Investment in Pyromed, Minnesota," explained: Due to difficulties in obtaining the necessary permits, the project was abandoned and the investment written off as of December 31, 1991. Under the agreement with Endeco and Volund USA dated June 30, 1992, but effective as of October 16, 1991, the Company has agreed to pay into the partnership the sum of $273,150 as final settlement of all obligations in connection 8/ The other firms were Endeco, Inc. and Volund USA, Ltd. 9/ For the year ending December 31, 1991, MTS had revenues of $482,943 and a net operating loss of $154,760. ==========================================START OF PAGE 5====== with the partnership agreement and with Endeco and Volund USA. (emphasis added) ==========================================START OF PAGE 6====== In light of these disclosures, the NASD found that the Memorandum, dated February 11, 1992, materially misrepresented GED's condition and prospects. 10/ According to the disclosures in the National prospectus, GED had concluded well before February 11, 1992, that it would not proceed with Pyromed. The NASD found, therefore, that the Memorandum not only failed to disclose that GED had abandoned the project but portrayed the project as viable and ongoing. For example, the Memorandum stated that GED owned an unimproved site in Watkins "upon which it plans to build an incinerator facility"; that GED "has also been pursuing the issuance of permits from the Minnesota Pollution Control Agency and others"; and that, after the merger, GED would "continue to pursue permits for its medical waste incineration business." These statements created a false picture of GED's business. The NASD also found that GED's total investment in Pyromed should have been written off before the private offering. The Memorandum included unaudited statements dated June 30, 1991. The GED balance sheet reflected total assets of $547,501, of which $546,500 represented its investment in Pyromed. Its total liabilities of $511,970, all current, were incurred in connection with Pyromed. The Memorandum also did not disclose that one of GED's partners, Endeco, Inc. ("Endeco"), had advised GED by letter dated October 16, 1991, that GED had breached its partnership agreement with Endeco, that no further work would be done on the project, and that GED owed Endeco $183,128 plus unreimbursed costs of some $60,000. This default created a deficit equity in lieu of the reported stockholders' equity of $35,531. The default, known to GED by October 16, 1991, was first disclosed in the National prospectus. We find that the Memorandum materially misrepresented GED's business and financial status and the condition of Pyromed. III. Everest first argues that the Memorandum did not materially misrepresent GED's condition and prospects and that "even a casual reading" of the Memorandum would not have misled any accredited investor. It contends that the reader would have been able to determine that GED was "broke," that its business was at a standstill, that its only real prospect for survival was its proposed merger with MTS, and that, even after the merger, a 10/ In addition, the NASD noted that the National prospectus disclosed that Douglas Grobe, GED's only employee in February 1992, who was listed as GED's president, treasurer, and a director, had previously been permanently enjoined on two occasions. There had been no mention of Grobe's disciplinary history in the Memorandum. ==========================================START OF PAGE 7====== significant infusion of capital would be essential to allow the company to continue. Everest maintains that, more significantly, the Memorandum is replete with warnings and notices of the risks involved in investing in GED. Even if some doubt may have been created in a reader's mind about GED's ability to proceed with Pyromed, that doubt could not dispel the false picture that GED was still seeking ways of obtaining licenses for Pyromed and hoped eventually to operate that business. There was no mention of its having defaulted on its partnership agreement well before February 11, or, as stated in the National prospectus, having already determined to abandon the project. Everest contends that the Memorandum states clearly that the merged company intended primarily to develop MTS' waste-tire operation. Everest argues that, even if the Memorandum were misleading as to the prospects and value of Pyromed, it is clear that purchasers were being asked to invest in MTS, not Pyromed, and that the valuation of Pyromed was not material to a decision to invest in MTS. We agree with the NASD that it would be material to an investor to know that the offering company's existing project had been abandoned, that none of its asset value was to be recouped, and that the project was actually worth less than nothing, because the surviving merged company would be left with partnership liabilities of approximately $273,000. There can be little doubt that reasonable investors would consider such information "actually significant in their deliberations," and therefore material. 11/ IV. We now turn to the issue of applicants' liability for the misleading disclosure. Everest did not participate in the preparation of the Memorandum, but did distribute it to the purchasers. The Memorandum, which contained affirmative misrepresentations, designated Everest as the selling agent for the offering, for which Everest received 5% of the total proceeds. As selling agent and provider of the Memorandum, Everest represented that it was recommending the purchase of those securities. 12/ 11/ See TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Although the NASD found that applicants should also have discovered through greater inquiry Grobe's disciplinary history, no sanction was imposed for that failure. 12/ See, e.g., the series of cases arising from the sales of Penn Central Transportation Company commercial paper shortly (continued...) ==========================================START OF PAGE 8====== Broker-dealers are under a duty to investigate the securities that they recommend, 13/ and their failure to do so subjects them to liability for violations of the antifraud provisions of the securities laws. 14/ Everest was thus obligated to investigate the GED securities sold in the private placement in accordance with professional standards. 15/ The NASD observed that, although Everest cannot be expected to possess the same knowledge of GED's corporate affairs as GED's insiders, it was required to exercise a "high degree of care" in investigating and verifying independently GED's representations. We agree. When an issuer seeks funds to finance a new and speculative venture, brokers and underwriters "must be particularly careful in verifying the issuer's obviously self- serving statements as to its operations and prospects." 16/ Indeed, Everest apparently recognized that it had a duty to inquire about the representations in the Memorandum. When the offering began, Everest arranged with Andolshek Management Group, Inc. ("AMGI") to hire Robert Wold, a professional investigator, to make what it called a due diligence investigation. The owner of Everest was the Andolshek Family Trust, which was controlled 12/(...continued) before its bankruptcy filing: Alton Box Board Co. v. Goldman Sachs & Co., 560 F.2d 916, 922 (8th Cir. 1977); Franklin Savings Bank v. Goldman, Sachs & Co., 551 F.2d 521, 527 (2d Cir. 1977); and University Hill Foundation v. Goldman, Sachs & Co., 422 F. Supp. 879, 893 (S.D.N.Y. 1976). As the exclusive source for the purchase of the Penn Central notes, Goldman, Sachs was necessarily recommending them as creditworthy. Franklin Savings Bank, 551 F.2d at 527. 13/ Hanly v. SEC, 415 F.2d 589, 595-97 (2d Cir. 1969). 14/ Distribution by Broker-Dealers of Unregistered Securities, Securities Act Release No. 4445 (February 2, 1962), 3 Fed. Sec. L. Rpt. (CCH) 22,758. 15/ We have also warned that the mere fact that a security may allegedly be exempt from the registration requirements of the Securities Act "does not relieve a dealer of these obligations. On the contrary, it may increase his responsibilities, since neither he nor his customers receive the protection which registration under the Securities Act is designed to provide." Securities Act Release No. 4445, 3 Fed. Sec. L. Rpt. (CCH) 22,759. 16/ Hamilton Grant & Company, Inc., 48 S.E.C. 788, 794 (1987); Kidder Peabody & Co., Incorporated, 46 S.E.C. 928, 930 (1977). ==========================================START OF PAGE 9====== by Richard Andolshek, also head of AMGI. Wold described himself, in a cover letter accompanying the report on AMGI stationery, as AMGI's general manager. Wold's report, dated March 31, 1992, devoted one short paragraph of the eight-page report to GED, three sentences to the offering, and the remainder to MTS, presumably because that company was the primary focus of the proposed operation. He did not mention any problem with the valuation of Pyromed; in fact, Pyromed was not mentioned by name at all. Both the content and the timing of Wold's investigation were grossly inadequate. His report essentially ignored GED. He uncritically relied on the information provided by GED, its accountants and lawyers, and accepted patently aged financial statements. He repeated misrepresentations in the Memorandum concerning GED's future plans. 17/ Moreover, applicants did not even receive this report until most of the shares were sold and the Memorandum distributed, a practice that is unacceptable. We agree with the NASD that applicants' claimed reliance on such a superficial inquiry was sufficiently reckless to constitute a violation of the NASD's antifraud rule. 18/ Applicants vigorously contest the NASD's finding that they acted recklessly. Everest argues that the NASD ignored the exemptive provisions under Regulation D for small business offerings to accredited investors by holding Everest liable for information about GED that became clearly false only after the securities had been sold. Though Regulation D offerings are subject to fewer requirements, affirmative misleading state- 17/ Wold's only reference to GED's business was in the first paragraph: "GED is in the business of developing Medical Waste Disposal facilities, the first of which is to be located in Watkins, Minnesota. GED has not generated any income to date. As of October 31, 1991, GED had negative share holder equity of $120,919." Not only was the description sparse, it was highly misleading. His description of GED's plans to develop waste disposal facilities in Minnesota hardly comports with GED's having abandoned the project the previous October. 18/ See n. 1, supra. ==========================================START OF PAGE 10====== ments are not permitted. 19/ The fact that GED sought to limit the offerees to accredited investors does not insulate applicants from antifraud charges. 20/ Everest failed to investigate the truth of the representations in the Memorandum. Had it done so, it could have learned of Endeco's letter to GED and the state pollution board's abandonment of GED's application for Pyromed. Applicants also seek to shield themselves by claiming that their role was essentially ministerial. They ignore their responsibility for allowing the name of a registered broker- dealer to be used to promote and legitimize the offering. If they could not endorse the purchase of GED's shares, they should not have been associated with the offering. Moreover, their role was more than ministerial. Everest received a substantial payment from GED for services in connection with the offering. It opened accounts for GED investors as its own customers. Applicants were charged with assuring that each investor was "accredited," as required by the Memorandum. 21/ Kunkel called the customers on behalf of Everest to validate the information on the subscription agreements. Everest handled the checks, executed the sales, entered into an escrow agreement to handle a wire transfer of funds for one customer, and conducted a "closing." V. Kunkel contends that she did not have control over the events in question. She explains that she was introduced to Andolshek in his capacity as a local entrepreneur who was interested in starting his own broker-dealer. He proposed that, as the initial employee of the Firm, she would be called the president, and he would have the position of chairman. She asserts that, although she was nominally president of the Firm, the actual operations were controlled by Andolshek and his attorney. Andolshek, as well as his attorney, maintained offices in the same suite as the Firm. Kunkel claims that she was not 19/ Preliminary Note Number 1 to Regulation D states, "The following rules relate to transactions exempted from the registration requirements of Section 5 of the Securities Act of 1933. . . . Such transactions are not exempt from the antifraud, civil liability, or other provisions of the federal securities laws." 20/ See James F. Novak, 47 S.E.C. 892, 895 (1983), and the cases there cited. 21/ They failed to discharge this responsibility, for at least one of the purchasers (according to her testimony) did not qualify. ==========================================START OF PAGE 11====== consulted about whether Everest should do the GED offering or when sales were to be made, and was given almost no advance notice of the closing date. It was Andolshek who selected Wold, already employed by another family member, to do the "due diligence" for Everest. We have repeatedly emphasized that the president of a brokerage firm is responsible for the firm's compliance with applicable requirements unless and until he or she reasonably delegates a particular function to another person in the firm, and neither knows nor has reason to know that such person is not properly performing his duties. 22/ Kunkel took no action to transfer her responsibility for compliance. She argues that she had only limited control over the Firm's affairs. In a somewhat different context where a president stressed the difficulty in interacting with an unregistered owner who was on the premises, we pointed out that, when a person chooses to accept the office of firm president, he or she assumes the obligation of ensuring compliance. 23/ Thus, as the Firm's president and only employee, Kunkel acted recklessly in not assuring the Firm's compliance with applicable requirements. It is clear from the record that applicants failed to undertake an adequate investigation designed to determine the accuracy of the statements in the Memorandum. We find that they acted recklessly and hence with scienter. VI. The NASD also found that applicants allowed Dennis Breen unlawfully to function in the securities industry from February 11 to 26, 1992, before his registration as a general securities representative became effective on February 29. The NASD based its finding on Breen's having brought the GED offering to Everest's attention in December 1991 and his receipt on April 9 of a $9,000 payment, characterized as a finder's fee, in connection with his activities relating to the offering. The NASD specifically noted that there is no evidence in the record that Breen contacted customers during the relevant time. The NASD nonetheless determined that Breen participated in investment banking activities during that time. We disagree. Appropriate qualification and registration of securities firm personnel are important. Determining the level of activity permitted without registration involves analysis of 22/ Charles L. Campbell, 49 S.E.C. 1047, 1051 (1989); Mark James Hankoff, 48 S.E.C. 705, 707 (1987); Collins Securities Corporation, 46 S.E.C. 20, 36 (1976). 23/ Kirk A. Knapp, 50 S.E.C. 858, 862-63 (1991). ==========================================START OF PAGE 12====== all relevant facts and circumstances. Here, among other factors, we note that there is no evidence that Breen contacted customers during the relevant time or was responsible for structuring the terms of the offering. VII. The NASD, as relevant here, found that Everest, acting through Kunkel, failed to prepare and maintain adequate new account information for 22 of the 23 customers in the GED offering. The records lacked required suitability information and failed to note whether the customer was of legal age or whether the customer was associated with another NASD member. In addition, all but one of the 22 records failed to indicate the customer's occupation and the name and address of the customer's employer. 24/ Applicants assert that they had all of the required information by April 9, but that the completed new account forms were not in the Firm's files during an NASD inspection in May because Kunkel had sent them to the customers for verification and signature. The record includes two cover letters dated May 26, 1992, that were sent to customers stating that the enclosed form was for their review and "completion." The NASD noted that, because the GED sales were a pure "best efforts" offering, GED was free to cash investors' checks upon receipt. Therefore, even though most of the customers' checks were not cashed before April 9, complete new account information should have been maintained as the checks were received by the Firm. 25/ 24/ The NASD found that these practices constituted violations of Article III, Sections 1 and 21 of the Rules of Fair Practice. Section 21 requires that for each account a member firm "shall maintain" information regarding whether the customer is of legal age and "shall also make reasonable efforts to obtain, prior to settlement of the initial transaction in the account . . ." information regarding the occupation for the customer and the name and address of the customer's employer and whether the customer is associated with another member firm. 25/ About half of the sales were made in February, and by the end of March, only 103,000 of the 600,00 shares were unsold. The record shows that checks were dated all throughout the period, presumably reflecting the date the subscription agreement was completed and returned to GED. Formal acceptance by GED of those agreements, as evidenced by Grobe's signatures, occurred on April 8. ==========================================START OF PAGE 13====== It appears that many of the new account forms were completed, if at all, after the sales. Moreover, most of them were never completed. In addition to the items mentioned above, 14 of the 23 did not have the appropriate net-worth box marked and only two contained information about previous investments. At least one of the customers who bought in the GED offering did not, in fact, qualify as an accredited investor. The NASD concluded that Everest and Kunkel appeared to have disregarded whether customers were suitable for this offering or were actually accredited investors. We sustain the findings of violation. VIII. Applicants claim that the sanctions are excessive. Everest asserts that it was a fledgling broker-dealer in 1992. The alleged violations, which occurred in the first several months of its existence, were the result of inexperience and mistake, not intentional misconduct. Everest undertook to act as a selling agent without taking appropriate steps to fulfil the concomitant responsibility of investigating the offering it was sponsoring. It distributed offering materials that were false and misleading. We do not find the fine and restitution order to be excessive or oppressive. Kunkel asserts that the NASD wrongly characterized her attempt to explain her lack of effective control over a family- owned concern as a refusal to assume responsibility for her violations. She urges that there was no basis for the National Business Conduct Committee to increase her sanction from the five-day suspension imposed by the District Business Conduct Committee to a bar as principal. 26/ The factors Kunkel cites, her acceptance of managerial responsibility despite her inexperience and her inability to control the affairs of Everest, support the NASD's conclusion that she should not be permitted to occupy a position as principal. The NASD did not indicate how much weight it was giving to each of the three violations discussed in this opinion. We have set aside one of the charges against applicants. Nonetheless, we do not find that a bar as principal is excessive or oppressive. 27/ 26/ This is in addition to the fine and restitution order. 27/ The NASD noted in its opinion that Kunkel is entitled to indemnification from Everest for any fine or restitution she may pay. ==========================================START OF PAGE 14====== An appropriate order will issue. 28/ By the Commission (Chairman LEVITT and Commissioners JOHNSON and HUNT); Commissioner WALLMAN not participating. Jonathan G. Katz Secretary 28/ All of the contentions advanced by the parties have been considered. They are rejected or sustained to the extent that they are inconsistent or in accord with the views expressed herein. UNITED STATES OF AMERICA before the SECURITIES AND EXCHANGE COMMISSION SECURITIES EXCHANGE ACT OF 1934 Rel. No. 37600 \ August 26, 1996 Admin. Proc. File No. 3-8519 __________________________________________________ : In the Matter of the Applications of : : EVEREST SECURITIES, INC : 90 South Seventh Street : Minneapolis, Minnesota 55402 : : and : : JEANNE ALYCE KUNKEL : 2860 West River Parkway : Minneapolis, Minnesota 55406 : : For Review of Disciplinary Action Taken by the : : NATIONAL ASSOCIATION OF SECURITIES DEALERS, INC. : __________________________________________________: ORDER SUSTAINING DISCIPLINARY ACTION TAKEN BY REGISTERED SECURITIES ASSOCIATION On the basis of the Commission's opinion issued this day, it is ORDERED that the disciplinary action taken by the National Association of Securities Dealers, Inc. against Everest Securities, Inc. and Jeanne Alyce Kunkel, and the Association's assessment of costs, be, and they hereby are, sustained. By the Commission. Jonathan G. Katz Secretary