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Initial Decision of an SEC Administrative Law Judge
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In the Matter of
Monetta Financial Services, Inc.
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INITIAL DECISION March 27, 2000 |
Appearances:
Jane E. Jarco, David S. Kempers, and Wendy D. Fox for the Division of Enforcement, Securities and Exchange Commission
Steven S. Scholes and Douglas G. Edelschick for Respondents Monetta Financial Services, Inc., and Robert S. Bacarella
Ted S. Helwig, Isabel M. Berio, and Lisa C. Sullivan for Respondents William M. Valiant and Paul W. Henry
Peter B. Shaeffer for Respondent Richard D. Russo
Before:
Brenda P. Murray, Chief Administrative Law Judge
The Securities and Exchange Commission ("Commission") issued an Order Instituting Proceedings ("OIP") on February 26, 1998, pursuant to Section 8A of the Securities Act of 1933 ("Securities Act"), Sections 15(b), 19(h), and 21C of the Securities Exchange Act of 1934 ("Exchange Act"), Sections 203(e), 203(f) and 203(k) of the Investment Advisers Act of 1940 ("Advisers Act"), and Sections 9(b) and 9(f) of the Investment Company Act of 1940 ("Investment Company Act").
Prior to the seven days of hearing in Chicago in July and August 1998, the parties filed an unusually high number of motions, objections, and briefs. (Record Index at 1-4.) In its direct case, the Division of Enforcement ("Division") presented fourteen witnesses including two experts. Respondents presented ten witnesses, including two experts, and offered sixty-four exhibits.1 The Division's rebuttal case was additional testimony from one expert. The Division introduced a total of 140 exhibits.
The posthearing filings included:
The central issue is whether the undisclosed distribution of Initial Public Offering ("IPO") allocations by an investment adviser to certain investment company directors was illegal. Specifically:
My findings are based on the record and my observation of the witnesses' demeanor. I applied preponderance of the evidence as the applicable standard of proof. See Steadman v. SEC, 450 U.S. 91 (1981). I have considered all proposed findings and conclusions and arguments raised by the parties and accept those consistent with this decision. In this decision, the period February 1, 1993, through September 30, 1993 is "the relevant period." (OIP at 2.) The Commission's ability to punish persons for illegal activities is limited to actions that occurred up to five years before the Commission initiated a proceeding. See Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996). Since the Commission initiated this proceeding on February 26, 1998, the actions subject to a penalty must have occurred on or after February 26, 1993. (Tr. 57-58; Div. Br. at 48-49, Resp. Br. at 3 n.2, Div. Reply at 32-34.)
Mr. Bacarella graduated from St. Joseph's College in 1971 with a double major in accounting and finance. He earned an MBA from Roosevelt University. (Tr. 1640.) Mr. Bacarella was employed by the Borg-Warner Corp. ("Borg-Warner") from 1972 to 1989. (Div. Ex. 4 at B-6.) As a director of Borg-Warner's pension investment department, Mr. Bacarella managed one mutual fund, which began with assets of $25 million and peaked with assets of approximately $150 million. (Tr. 12-13.)
In June 1984, Mr. Bacarella formed Monetta Financial Services, Inc. ("MFS"), a Delaware corporation and a registered investment adviser based in Wheaton, Illinois, and in May 1986 he formed the Monetta Fund, Inc. ("Monetta Fund"), a Maryland corporation and an open-end diversified investment company offering a single class of capital stock. (MFS and Bacarella Answer at 1-2.) The Monetta Fund specializes in small-cap stocks and trades mainly over-the-counter securities. (Tr. 144, 1603.) The Monetta Fund's assets increased dramatically in the early 1990s from about $7 million to about $408 million on December 31, 1992, to $524 million at the end of 1993. (Tr. 23-25; Div. Ex. 3 at 39, Div. Ex. 4 at 43.) In the 1992-93 period, the Monetta Fund gained between $3 million to $5 million of new assets each day. (Tr. 1331.)
In January 1993, Mr. Bacarella created the Monetta Trust, a Massachusetts business trust and an open-end diversified investment company. The Monetta Trust offered three series of stock in 1993: the Mid-Cap Equity Fund ("Mid-Cap Fund"), the Intermediate Bond Fund ("Bond Fund"), and the Government Money Market Fund.5 (MFS and Bacarella Answer at 2; Resp. Ex. 37a.)
MFS has always been the investment adviser to the Funds. (Tr. 1438-39; Jt. Stip. 1 at 4.) As was customary in the industry, the Monetta Fund and the Monetta Trust had no employees in 1993. (Tr. 1435-36.) Three funds were eligible to receive IPOs - the Monetta Fund, the Mid-Cap Fund, and the Bond Fund. The Monetta Fund was by far the largest. The Mid-Cap Fund and the Bond Fund began doing business in March 1993, after the relevant period began. (Jt. Stip. 1 at 3.) In 1993, the Mid-Cap Fund was a very small fund with capital of almost $10 million and the Bond Fund was smaller. (Tr. 350.) On December 31, 1993, MFS had almost $620 million under management, which included the Monetta Fund's assets of approximately $524 million. (MFS and Bacarella Response at 3; Div. Ex. 2, Resp. Ex. 38e.)
Reflecting what occurred in the Monetta Fund, MFS experienced a considerable growth in assets under management in the 1992-93 period that taxed MFS's resources. Employees increased from six in June 1992 to twenty in March 1993. (Tr. 1332.) The Monetta Fund paid MFS advisory fees of $2.25 million in 1992 and $5.11 million in 1993. (Div. Ex. 3 at 38, Div. Ex. 4 at 44, 47.)
In 1993, Mr. Bacarella was (1) president, director, and portfolio manager of the Monetta Fund; (2) president and trustee of the Monetta Trust; (3) secretary, treasurer, director and shareholder of Monetta Brokerage, Inc. ("Monetta Brokerage"), a registered broker-dealer affiliated with MFS; and (4) president, director, and majority owner of MFS.6 (Tr. 19-20, 1640, 1642; Jt. Stip. at 1, 4.) Mr. Bacarella was an "interested person" of the Monetta Fund and the Monetta Trust, as defined in the Investment Company Act. (Section 2(a)(19) of the Investment Company Act; Resp. Ex. 13 at 34, Resp. Ex. 17 at B-6.) Mr. Bacarella holds Series 6, 26, 63, and 65 licenses. (Tr. 1643.)
The Monetta Fund and the Monetta Trust each had a Code of Ethics ("Code" or "Codes") in effect in 1993 as required by Rule 17-j, pursuant to Section 17(j) of the Investment Company Act. The two Codes were almost identical. (Div. Exs. 39, 40.) An interested director was by default someone who did not fit the Codes' definition of "non-interested Director," i.e., a Director not affiliated with the adviser, not an officer or 5% shareholder of the Funds, and not otherwise an "interested person" of the Funds as defined in the Investment Company Act. 7 (Div. Ex. 39 at 1(e), Div. Ex. 40 at 1(f).)
Janet Olsen, a partner in the firm of Bell, Boyd & Lloyd and legal counsel to MFS, the Monetta Fund, and the Monetta Trust, drafted or redrafted the Codes.8 Ms. Olsen represented exclusively mutual funds, investment advisers, and companies dealing with them. (Tr. 1959.) Ms. Olsen testified that the Funds' Codes in effect in 1993 did not specifically permit or preclude directors from accepting IPO allocations from the adviser "unless you got there through the general prohibition in [S]ection 17j and [Rule] 17j-1 on conflicting transactions." (Tr. 2017-18.) I assume Ms. Olsen was referring to the following Code provision:
No person subject to the Code shall purchase or sell for his own personal account and benefit . . . any security which the person knows or has reason to believe is being purchased or sold or considered for purchase or sale by the Fund, until the Fund's transactions have been completed or consideration of such transactions is abandoned.
(Tr. 2017-19; Div. Ex. 39 at 3, Div. Ex. 40 at 3.) This provision did not apply to "purchases or sales, which receive the prior approval of Robert S. Bacarella or John P. Rozinsky on the ground[s] that they are not inconsistent with this Code or the provisions of Rule 17j-1(a)." (Div. Ex. 39 at 4(f), Div. Ex. 40 at 4(f).) Mr. Rozinsky was the compliance director for MFS and the Funds. (Tr. 303-04.) The Codes required interested directors/trustees to report to Mr. Rozinsky, on a quarterly basis, all securities transactions in which they had a beneficial interest. (Div. Ex. 39, Div. Ex. 40 at 5(a).)
In 1993, Mr. Bacarella controlled MFS through his ownership of 71.1% of the shares, and he exercised total control over all of MFS's activities. (Tr. 1333, 1350, 1397-99, 1439, 1619, 1636, 1640; Jt. Stip. 1 at 4.)
A firm commitment IPO only occurs where the underwriters judge that the offering is comfortably oversubscribed based on realistic indications of interest that are well in excess of the number of shares that they expect to sell. (Tr. 914-15, 927; Div. Ex. 116 at 8.) IPO allocations are highly sought after. (Div. Ex. 115 at 9, Div. Ex. 116 at 30.) MFS sought to obtain allocations of IPOs that it believed would be good investments, and in 1993 it did not receive all the IPO shares it requested. (Tr. 55.)
In the 1990s, the average first-day performance of IPOs was significantly positive. (Tr. 817.) In 1993, the average IPO increased in price by 11.6%. (Tr. 920.) Between February 1, 1993, and September 30, 1993, ninety-seven underwriters raised $32.9 billion in approximately 379 IPOs. (Div. Ex. 115 at 16.) The average IPO sold 5.2 million shares, raised $86.6 million and was priced nearly in the middle of the preliminary price range shown in the prospectus. (Div. Ex. 115 at 16.) The average appreciation between the underwriter's offering price and opening trade price was 11.6%. (Div. Ex. 115 at 16.) The Division's expert Professor Kent L. Womack offered persuasive testimony that the statistical evidence shows that it was "extremely unlikely" that MFS's choice of IPOs was done randomly and that MFS was well informed regarding which IPOs were hot and which ones were not.9 (Div. Ex. 115 at 22.) The finding by Professor Kathleen Weiss Hanley, Respondents' expert, that all forty IPOs in which MFS chose to participate in the period February 27, 1993, through September 21, 1993, had a very high probability of having a high return and little probability of having a negative return supports my finding of Mr. Bacarella's ability to select successful IPOs.10 (Tr. 1256-57; Resp. Ex. 55 at Exhibit 2.)
In addition to Professor Womack, Professor John C. Coffee, Jr., testified on behalf of the Division; their testimony established that, on average, investors who received IPO shares at the offering price almost certainly profited.11 I accept as accurate the following representation by Professor Womack:
IPO shares are investment opportunities of limited availability, customers desire and aggressively compete for allocations of such shares. This is for a very simple reason: IPO shares are priced, on average, to appreciate immediately on the first day, and those accounts receiving the shares at the offering price garner "instant" first-day profits. For example, in the time period 1993 to 1996, the average first-day return . . . on all U.S. IPOs was +13.5% (from offering price to the opening day trade price). However, it is not the case that all IPOs increase 13.5% on the first day. In recent years, it has not been uncommon for some offerings (about 15%) to increase 30% to 100% or more on the first day. On the other hand, roughly one quarter of offerings have a 0% return or less on the first day (i.e., the IPO stock price closes the first day at or below the offering price). Nevertheless, a representative sample of all IPO shares increased 11.6% in the 1993 time period in question (February-September, 1993).. . . the first important conclusion is that investors who receive these first-day IPO returns through underwriters' allocation "gifts" are substantially advantaged in any investment "competition." It is important to note that investors cannot buy these returns in aftermarket trading. The immediate return is earned only by those investors who receive shares at the offering price from the underwriter. Aftermarket trading (the first opportunity for investors who are not offered shares by the underwriter) begins, on average, after the 13.5% increase. (footnote omitted, underlining and italics in original)
(Div. Ex. 115 at 9-10.) By the term "gift," Professor Womack meant the "on-average positive IPO returns as in the ones [MFS] received" which were "paid for with past and more importantly future commissions." (Tr. 1051.) A 1993 study showed that approximately 90% of the initial day's mean return is earned on the opening transaction. (Div. Ex. 116 at 6 n.5 citing C. Barry and R. Jennings, The Opening Price Performance of Initial Public Offerings of Common Stock, 54-63 Financial Management (Spring 1993).) This indicates that those who receive the IPO allocations capture virtually all of the first-day's gains. (Div. Ex. 116 at 6.)
I reject Respondents' position that an IPO cannot be characterized as "hot" until after it trades at a premium in the secondary market. (MFS and Bacarella Answer at 4-7.) The overwhelming evidence is that: (1) the designation "hot" IPO can be made before the initial trading occurs and (2) Mr. Bacarella, an informed investor, could predict accurately within a range which IPOs on average would likely be the "hottest" and best first-day investments before secondary trading began. (Tr. 434-36, 916-20, 1017-20; Div. Ex. 115 at 1-2, 10-15.) John M. Alogna, a senior vice president in the global value equities department of Putnam Investments who was portfolio manager of the Mid-Cap Fund in 1993, defined a hot IPO as an offering that was expected to start trading at substantially higher prices than the offering price. (Tr. 335-36.)
Knowledgeable persons apply several factors when characterizing an IPO as hot, very hot, or cold. One strong indicator is the ratio of indications of interest or buyer's orders, adjusted for inflation, to the size of the offering, i.e. the over-subscription rate. (Tr. 851-52, 928.) Some argue that an offering that is four or five times oversubscribed is cold while others would consider it hot. (Tr. 694, 715.) Professor Womack opined that a hot deal may be oversubscribed by five times or more, while the "coldest" issues may have just sufficient demand to accommodate the offering size. (Div. Ex. 115 at 6.) An offering would be considered pretty hot or very hot where the indications of interest were four or more times the size of the offering and where the proposed offering price had accelerated upwards through several amendments of the prospectus. (Tr. 691-92, 694-95.) The projected offering price can increase several times prior to the offering where the IPO is extremely hot. (Tr. 969.) Contrary to the law of supply and demand, price increases in the offering price of IPOs do not reduce indications of interest. (Tr. 969.)
Professor Womack found that the over-subscription ratio on a number of deals done by Montgomery Securities ("Montgomery") was a very good predictor of the opening-day returns. (Tr. 928-29.) Professor Hanley agreed it was possible to predict that some IPOs would have better than average initial returns based on research that showed that higher returns occurred in IPOs where the offering price is high relative to the "file range." (Tr. 1286.)
Professor Womack has found an IPO's "announced price relative to the initial price talk range" to be an accurate pre-offering demand indicator. (Div. Ex. 115 at 10.) In his study, The Persistence of IPO Mispricing and the Predictive Power of Flipping, Professor Womack concluded that the more the offering price has been raised from the midpoint of the initial filing range ("Mid-to-Offer"), the more the shares are likely to be above average performers in the aftermarket.12 (Div. Ex. 115 at 10-11.) An early study by Professor Hanley, entitled The Underpricing of Initial Public Offerings and the Partial Adjustment Phenomenon, reached a similar result. (Div. Ex. 22.)
Factors that indicate whether an IPO is hot before secondary market trading begins are: orders far exceeding the amount of shares to be sold, the breadth of interest among potential buyers, the initial price talk range relative to the offering price, and the level and the quality of institutional demand, i.e., whether the potential buyers are considered "flippers" rather than investors. (Tr. 384; Div. Ex. 115 at 10-11, Div. Ex. 116 at 8-9.) A flipper is someone who intends to sell a security shortly after acquiring it for a relatively riskless profit. (Tr. 529-32; Div. Ex. 116 at 29.) MFS flipped the IPOs at issue here. (Tr. 258, 585-86, 777; Div. Ex. 115 at 2.)
The evidence supports Professor Coffee's characterization of the allocation of hot IPOs as the dispensing of "free money" and Professor Womack's view that IPO allocations are a gift because they bestow a clear "benefit" on the recipient. (Div. Ex. 115 at 7, 9, Div. Ex. 116 at 18-19, 37.) Professor Womack and Richard A. Smith13 were persuasive that the majority of offerings labeled hot before the IPO occurs perform as hot offerings in the aftermarket. (Tr. 436-37, 1037; Div. Ex. 115 at 12.)
In 1993, MFS's clients generated total commissions of $471,998.84 to seven broker-dealers: Bear, Stearns & Co., Inc.; Goldman, Sachs & Co.; Montgomery; Morgan Stanley & Co.; Ragan MacKenzie; Robertson Stephens & Co., L.P.; and Volpe Welty & Co. (Div. Ex. 52.) MFS's Funds clients generated approximately 95% of these commissions. (Tr. 568, 863-64; Div. Ex. 52, Div. Ex. 116 at 30.)
In 1993, one of these broker-dealers, Montgomery, allocated to MFS 10,000 shares of several IPOs. (Tr. 381.) The allocation process occurred in the following manner. Early on the day the IPO was scheduled to go public a Montgomery sales trader, usually Martha Georgeson who handled the MFS account, called and told MFS the offering price and allotment for IPOs where MFS had submitted an "indication of interest." (Tr. 449-50, 1609.) Based on that conversation Nancy Boeselager, a MFS trader, found out from Mr. Bacarella before 3 p.m. which MFS clients would receive the allocation and relayed that information to Ms. Georgeson at Montgomery. (Tr. 1608, 1619.) Ms. Georgeson initialed a representation on the trade order (buy ticket) that stated that the sale did not violate the National Association of Securities Dealers ("NASD") Free-Riding and Withholding Interpretation ("Free-Riding Rule"). The following statement that Ms. Georgeson initialed on the buy order for the 10,000 shares of Papa Johns International, Inc. IPO is typical of what appeared on all the buy orders at issue:
I have made inquiry and am informed that no one with a beneficial interest in the above accounts are in the restricted category of para. (1) thru (5) of the [NASD] free-riding & withholding regulations.
(Tr. 462-64; Div. Ex. 58a.) The objective of the NASD's Free-Riding Rule is to ensure a bona fide distribution to the public. (NASD Manual, IM-2110-1 at 4111-20 (July 1996); Div. Ex. 116 at 12.) Among other things the Rule prohibits a broker-dealer from selling to a person who may influence investment decisions of a mutual fund or investment adviser. (Div. Ex. 116 at 11-12.) When she signed the statement, Ms. Georgeson believed that MFS had affirmed that it would not make an allocation that violated the Free-Riding Rule. (Tr. 466.) Ms. Georgeson testified that if she had known that MFS was going to allocate the IPO shares to Fund directors and trustees, she would not have signed the statement and would have referred the issue to Montgomery's compliance department because directors receiving IPOs raised a "red flag" as they could be considered insiders. (Tr. 466-67.) Ms. Boeselager at MFS does not recall Ms. Georgeson making such an inquiry. (Tr. 1610.)
MFS had between 350 and 500 client accounts in 1993 but only the Funds and about twenty other clients were eligible to receive the IPO allocations that MFS received from Montgomery.14 (Tr. 140, 156, 1403-05.) To be eligible for an IPO allocation, MFS required that the client have an account at the Old Kent Bank ("Old Kent") and have sufficient funds in the account. (Tr. 193-94, 257-58, 1474-75.)
Certain people at MFS indicated what IPOs they thought MFS should try to acquire for its clients. For example, Mr. Alogna gave traders "indications of interest" for certain IPOs on behalf of the Mid-Cap Fund. (Tr. 337, 340.) When MFS received an IPO allocation, however, Mr. Bacarella alone decided which MFS clients would receive the IPO shares. (Tr. 53-54, 1604-05, 1619.) Mr. Alogna did not know how Mr. Bacarella allocated IPOs. (Tr. 340.)
In 1993, MFS did not charge an advisory fee to certain accounts, such as non-wrap accounts with less than $100,000 in assets, the Bond Fund, or the Government Money Market Fund. (Tr. 1333-35.) MFS did not charge an advisory fee to Mr. Valiant, Mr. Henry, or Mr. Russo because their accounts were less than $100,000. (Tr. 1336-37, 1339, 1348.)
Following industry practice, Montgomery did not require that MFS identify what customer account(s) would receive the allocation when it notified MFS of the number of shares it would receive. (Tr. 1138; Div. Ex. 115 at 7, 14.) Mr. Bacarella made some allocations after the IPO opened and trading began in the secondary market. (Tr. 1011-12.) When he did so, Mr. Bacarella knew he was giving the directors/trustees a profit since "the majority of price appreciation occurs at the opening trade in the secondary market." (Div. Ex. 115 at 2.)
During the relevant period, MFS participated in fifty-one IPOs underwritten by Montgomery. (Div. Ex. 115 at 17.) MFS/Mr. Bacarella allocated some of these IPOs to both the Funds and the directors/trustees of the Funds, and some IPOs only to the Funds, and some IPOs only to the directors/trustees of the Funds. (Div. Ex. 115 at 17, 19.)
The IPOs Mr. Bacarella chose for MFS did "significantly better" than the average IPO in the relevant period using a "Return-to-Open" measure. Professor Womack defines Return-to-Open as the difference between the share price when the offering opens for trading and the underwriter's issue price. (Div. Ex. 115 at 17.) The Return-to-Open for all IPOs in the relevant period was 11.6%. (Div. Ex. 115 at 17.) The Return-to-Open for the IPOs that MFS received and distributed to the Funds were on average about 24.9% and the IPOs distributed to the directors/trustees averaged 34.2%. (Div. Ex. 115 at 17.) This evidence is persuasive that it was not by chance that Mr. Bacarella selected IPOs that appreciated in value on the first day more than double that of the average IPO. Rather, these results show that Mr. Bacarella is an informed investor who was able to distinguish which IPOs, on average, would be the most successful. (Tr. 1056-57, 1062-63, 1066; Div. Ex. 115 at 12-13.)
The Commission conducted an on-site examination of the Monetta Fund and the Monetta Trust in November 1993. Mr. Bacarella gave the examiners information he knew to be false by representing that (1) he did not know how Mr. Valiant had been able to obtain shares in the IPOs of Papa Johns International, Sunglass Hut International, and Broadband Technology, and (2) perhaps Mr. Valiant received the IPO allocations because of personal contacts he made while he was an executive at Borg-Warner. (Tr. 586-87.) I gave no weight to the Division's claim that Respondents' names were not on a list of MFS clients given to the examiners. (Tr. 587-89, 592.) Respondents denied the charge and the Division did not have a copy of the list. (Tr. 589-92.)
Conduct in Dispute
During the relevant period, when Mr. Valiant was an interested trustee of the Monetta Trust because he was a director of the adviser, MFS/Mr. Bacarella purchased and sold the following IPO shares in Mr. Valiant's Old Kent account for a profit of $12,812. 15 (Tr. 254-55, 258-59, 1520; Valiant Answer at 5-6; Div. Ex. 106.)
| Company |
Shares |
Transaction Dates |
| 3 DO Co. | 1,000 | 5/93 |
| Broadband Technology | 500 | 6 or 7/93 |
| Papa Johns International | 500 | 6/93 |
| Sunglass Hut International | 500 | 6/93 |
(Div. Exs. 13, 16, 17, 18, 23a, 23b.)
Neither Mr. Bacarella nor Mr. Valiant told the other directors of the Monetta Trust that MFS/Mr. Bacarella allocated hot IPO shares to Mr. Valiant. (Tr. 536-37.)
Background
As vice president and treasurer of Borg-Warner from 1976 to 1990, Mr. Valiant was responsible for managerial oversight of the company's pension funds and its retirement savings plan. (Tr. 253, 265.) Some of these funds were managed in-house and others were managed by outside advisers. Mr. Valiant has known Mr. Bacarella for about twenty years because he supervised the office of the treasurer where Mr. Bacarella was employed. (Tr. 1505.) Mr. Valiant has been a director of MFS since 1991. He became an interested trustee of the Monetta Trust when it was created on January 19, 1993. (MFS and Bacarella Answer at 3.)
Mr. Valiant established an account with Monetta Brokerage in 1988. He signed an investment advisory agreement with MFS dated May 25, 1989. Mr. Valiant and Mr. Bacarella discussed every transaction that occurred pursuant to this MFS account. (Tr. 270-71.)
At Mr. Bacarella's suggestion, in 1992 Mr. Valiant signed a second undated investment advisory agreement with MFS and he deposited $50,000 with Old Kent to open an account. (Tr. 1504, 1520.) Mr. Bacarella had complete discretion to effect transactions in this Old Kent account. Mr. Valiant became aware of the transactions after he received confirmation through the mail. (Tr. 268-69, 1508, 1511-12, 1514.) The account handled flip-type transactions exclusively and was not limited to IPOs; however, all the transactions in the account were in IPOs. (Tr. 257-58.) Mr. Valiant noted these transactions on a quarterly report, as required by the Monetta Trust Code, and submitted it to MFS/Mr. Bacarella. (Tr. 272-73.) Before Mr. Valiant became a trustee, from August 21, 1992 to January 19, 1993, Mr. Bacarella flipped three IPOs in this account for a profit to Mr. Valiant of $33,871.45. (Tr. 268; Resp. Ex. 62.)
Conduct in Dispute
Mr. Henry initiated the receipt of IPOs from MFS/Mr. Bacarella. (Tr. 277, 287-88.) After Mr. Bacarella approved his request, Mr. Henry opened an account at MFS and deposited $50,000 to open an account at Old Kent in February 1993 to trade shares of IPOs. (Tr. 277-78, 1347-48, 1474-75.) Mr. Henry gave contradictory testimony as to how he began trading IPOs. When called to testify by the Division, he stated that he believed that Mr. Bacarella had access to IPOs because of trades that MFS arranged for the Monetta Fund through broker-dealers. He further testified that in December 1992, he asked Tim Cekal, president of Monetta Brokerage, where he had an existing account, whether he could open an account to trade IPOs. (Tr. 277, 287-88, 300, 1347.) Later, as part of his direct case, Mr. Henry testified that Mr. Cekal told him at a Christmas party that MFS/Mr. Bacarella had IPOs and they were "a good deal," and he then asked whether he could participate. (Tr. 1471-73.)
Mr. Bacarella had discretionary authority over Mr. Henry's Old Kent account. (Tr. 1475.) Mr. Henry became aware of the transactions after he received confirmations through the mail. (Tr. 289, 1476-78.) All the transactions in the account were IPOs. (Tr. 286.)
Mr. Bacarella flipped the following IPO shares in Mr. Henry's Old Kent account during the second quarter of 1993, for a profit of $10,187.50. (Tr. 277-78; Henry Answer at 5-6; Div. Ex. 22a.)
| Company |
Shares |
Transaction Dates |
| Auspex Systems | 500 | 5/93 |
| BHC Financial, Inc. | 1000 | 4/93 |
| Papa Johns International | 500 | 6/93 |
| Sunglass Hut International | 500 | 6/93 |
(Div. Exs. 12, 14, 16, 17, 22a, 22b, 22c, 22d.)
Mr. Henry claimed that he did not report the IPO transactions on the quarterly report form he filed for the second quarter of 1993 as required by Section 17(j) of the Investment Company Act and Rule 17j-1 thereunder based on the provision in the Monetta Fund Code that does not require duplicate reporting and discussions at the board meeting. (Tr. 283-86, 1484-87, 1495-97; Henry Answer at 7.) This was the only quarter in the relevant period when Mr. Henry failed to report his IPO trades. (Tr. 1483-85.)
Background
Mr. Henry met Mr. Bacarella at Borg-Warner in the 1970s, where Mr. Henry was manager of financial systems from 1971 to 1987. (Tr. 275.) From 1987 until at least 1993, Mr. Henry was manager at Special Projects, Waste Management, Inc. (Div. Ex. 3 at B-5.)
In 1993, Mr. Henry owned 2.22% of the voting shares of MFS and 2.55% of the shares of Monetta Brokerage. (Tr. 1474; Jt. Stip. 1, 23; Div. Ex. 3 at 20, Div. Ex. 22.) Mr. Henry became a director of the Monetta Fund in 1986 and held this position in 1993. (Tr. 276.) Mr. Henry was a director and vice president of the Monetta Fund on July 27, 1989, when it adopted its Code. (Div. Ex. 38.) The Monetta Fund's Form N-1A filed February 12, 1993, described Mr. Henry as an "interested person" of the Monetta Fund because he was an owner of the adviser. (Div. Ex. 3 at 22.) As an interested director, Mr. Henry received $250 for each directors meeting he attended. (Tr. 1491; MFS and Bacarella Response at 6.)
Conduct in Dispute
When he formed the Monetta Trust on January 19, 1993, Mr. Bacarella invited Mr. Russo to be a disinterested or independent trustee and a member of the audit committee. (Tr. 1553, 1566.) Mr. Russo was paid $300 in 1993.16 (Tr. 768.) From February 3, 1993, through September 21, 1993, Mr. Bacarella flipped securities in nine IPOs in Mr. Russo's account ("retirement account") at Old Kent for a profit of $28,823. (Russo Answer at 8.)
| Company |
Shares |
Transaction Dates |
| BHC Financial | 1,000 | 4/93 |
| Catalyst Semiconducter | 1,000 | 5 or 6/93 |
| Cyrix | 2,500 | 7/93 |
| Netmanage Inc. | 500 | 9/93 |
| Papa Johns International | 1,000 | 6/93 |
| Parallan Computer | 1,000 | 3 or 4/93 |
| Powersoft | 200 | 2/3/93 |
| Wall Data | 100 | 3/93 |
| Wonderware Corp. | 1,000 | 7/93 |
(Div. Exs. 10, 16, 20, 21, 24b, 24c, 24d, 24e, 24f, 24g, 24h, 24i.)
Mr. Bacarella directed investments in Mr. Russo's Old Kent account without consulting Mr. Russo. (Tr. 1547-549, 1551.) Mr. Russo did not know prior to September 30, 1993, that Mr. Bacarella had purchased IPOs for his Old Kent account. (Tr. 1549.) Mr. Russo received trade confirmations and bank statements that showed the transactions, however, he did not review these materials but merely filed them for tax purposes. (Tr. 1547-49, 1552.)
Mr. Russo did not tell any of the trustees of the Monetta Trust that he received IPO shares from the adviser. (Tr. 218-19.) Neither Mr. Bacarella nor Mr. Russo told James Boves, an employee of MFS, a director of the Monetta Trust, and portfolio manager of the Bond Fund, that MFS was allocating IPO shares to Mr. Russo. (Tr. 536-37.) Mr. Russo did not inform John Rozinsky, compliance director of MFS, about these trades. (Tr. 219.) He assumed that compliance knew of the trades because a report indicated they were done through Monetta Brokerage. (Tr. 219.)
Background
Mr. Russo, a licensed attorney in Illinois since 1987, is a long-time friend of Mr. Bacarella. (Tr. 181.) In the late 1980s Mr. Russo, who was busy developing his solo law practice, requested that Mr. Bacarella, whom he knew to be a successful money manager, handle his retirement account. (Tr. 1536-38, 1551-52.) Mr. Bacarella agreed. Mr. Russo signed an investment adviser agreement with MFS on September 4, 1991, and he transferred his retirement account to Old Kent at Mr. Bacarella's direction. (Tr. 1539-42; Resp. Exs. 7, 8.) From the end of 1992 through September 1993, Mr. Bacarella was managing all of the financial assets, including retirement savings, of Mr. Russo, his wife, and their four children. (Tr. 1527, 1532-34, 1536-38, 1559, 1575.) MFS/Mr. Bacarella allocated IPOs to Mr. Russo in 1992, before he became a trustee. (Tr. 871.) Between October 25, 1991, and January 19, 1993, Mr. Bacarella flipped securities in six IPOs in Mr. Russo's Old Kent account that resulted in profits to Mr. Russo of $31,073.44. (Tr. 198-200; Resp. Ex. 63.) In 1993, in addition to the Old Kent account, Mr. Russo was invested in the Monetta Fund and he had a joint account at Monetta Brokerage, which he opened in 1988. (Tr. 1532, 1576; Resp. Ex. 3.)
During the relevant period, the Funds offered, purchased, and sold securities in interstate commerce, conducted activities using the mails, and filed with the Commission and circulated to investors and possible investors amendments to registration statements, prospectuses, and quarterly reports to shareholders that did not disclose the allocation of IPOs to the Funds' directors/trustees. (Tr. 118; Div. Ex. 3, Resp. Exs. 14, 37a, 37b, 38b, 38c.) In 1993, the public bought and sold over twenty-six million shares of the Monetta Fund. (Div. Ex. 4 at 47.)
During the relevant period, MFS, Mr. Bacarella, Mr. Valiant, Mr. Henry, and Mr. Russo were fiduciaries of the Monetta Fund and/or the Monetta Trust. A fiduciary duty is a "duty to act for someone else's benefit, while subordinating one's personal interests to that of the other person. It is the highest standard of duty implied by law (e.g. trustee, guardian)." Black's Law Dictionary, 625 (6th ed. 1990). Furthermore:
Fiduciaries should be loyal to their beneficiaries. The duty of loyalty is implicit in the nature of the relationship. The fiduciary acts for the benefit of the beneficiary, and the beneficiary must trust him and rely on him. If the fiduciary's interests conflict with his beneficiary's or if he has interests that might subvert the unbiased and loyal performance of his duties, he breaches his duty, unless he discloses the conflict to the beneficiary and obtains the beneficiary's consent. A fiduciary must therefore refrain from putting himself in a position of conflict of interest since it does not permit him "to retain the freedom of judgment and action" that he ought to have as manager of other people's money.
2 Tamar Frankel, The Regulation of Money Managers 371 (1978).
MFS and Mr. Bacarella claim that they allocated IPOs to Mr. Valiant and Mr. Russo before the two men became trustees of the Monetta Trust and they continued to do so during the relevant period because they relied on legal advice they received from Janet Olsen. They contend that only after receiving this advice did they begin allocating IPOs to Mr. Henry. (MFS and Bacarella Br. at 12.) Mr. Valiant and Mr. Henry acknowledge that the evidence is insufficient to establish a reliance on counsel defense as to them. (Henry and Valiant Br. at 29.)
I find that MFS and Mr. Bacarella have not shown that the affirmative defense of reliance on counsel is applicable here. The essential elements for an effective reliance on counsel defense are that a person: (1) made a complete disclosure to counsel of the intended action; (2) requested counsel's advice as to the legality of the intended action; (3) received counsel's advice that the conduct would be legal; and (4) relied in good faith on that advice. Markowski v. SEC, 34 F.3d 99, 104-05 (2d Cir. 1994); William H. Gerhauser, Sr., 68 SEC Docket 1289, 1300 n.26 (Nov. 4, 1998) (citing John Thomas Gabriel, 51 S.E.C. 1285, 1292 (1994), aff'd, 60 F.3d 812 (2d Cir. 1995) (Table)); Richard J. Lanigan, 52 S.E.C. 375, 377 n.9 (1995).
I do not find credible Mr. Bacarella's testimony that Ms. Olsen told him MFS could continue to allocate IPOs to Mr. Russo and Mr. Valiant after they became trustees of the Monetta Trust. (Tr. 1676-77.) Mr. Bacarella claims to have posed a question to Ms. Olsen after the first meeting of the Monetta Trust directors ended on January 19, 1993, when people were leaving or had left the meeting. (Tr. 1346, 2007.) According to Mr. Bacarella, he asked Ms. Olsen whether Mr. Russo and Mr. Valiant could continue to receive allocations of IPOs now that they were trustees, and she told him it was allowed inasmuch as they were not officers or employees of MFS. (Tr. 1676-77.) Mr. Bacarella offered no explanation as to why he waited to pose such an important question until the meeting was over and Mr. Valiant, Mr. Russo, and the other directors as well as the person in charge of compliance were not present to hear the question and answer. The timing of Mr. Bacarella's alleged question to counsel makes his testimony suspect.
Ms. Olsen's testimony is that she did not know until November 1993 that MFS was allocating IPOs to either Mr. Henry, Mr. Valiant, or Mr. Russo. (Tr. 1966-67, 2032.) Ms. Olsen has no recollection of the conversation that Mr. Bacarella contends took place on January 19, 1993, and she does not believe that it occurred. (Tr. 2007-11.) I find Ms. Olsen's version of these events to be credible for a number of reasons. Ms. Olsen claims that if she had been asked such a question she would have needed more information before responding:
I don't think that question can be answered without knowing more. I don't think I know the answer to that question today because there are things that I don't know. I don't know the basis for – I think one would have to know the basis for allocation. One would have to know what the underlying client relationship was. Those are the things that come immediately to mind as things that would have to be known in order to answer the question that supposedly was posed . . . any time you're talking about allocations you have to know on what basis those allocations are being made.
(Tr. 2052-53.)
Also, the only confirmation of Mr. Bacarella's version of events came from two MFS employees: Maria Cesario DeNicolo and Valerie Lefevre. The validity of this corroborating testimony is suspect because these witnesses are MFS employees whose livelihoods are tied to Mr. Bacarella's continued success and the circumstances they described are peculiar.
Ms. DeNicola, a Certified Public Accountant, left the accounting firm of which she was the sole proprietor to join MFS as controller in June 1992. (Div. Ex. 3 at 22.) In July 1998, when she testified, Ms. DeNicola was certified financial officer, secretary/treasurer, and compliance officer of MFS. (Tr. 1300-01.) In 1993, Ms. DeNicola was treasurer of the Monetta Fund, secretary of the Monetta Trust, and controller of MFS. (Div. Ex. 3 at 22.) Ms. DeNicola is fiercely loyal to Mr. Bacarella. She admits to being biased in favor of "our firm" and she is very upset that it has been charged with violating the antifraud provisions of the securities statutes. (Tr. 1412-13.) According to Ms. DeNicola, she overheard Ms. Olsen tell Mr. Bacarella that Mr. Valiant could continue getting IPOs because he was not an officer or employee while she was cleaning the room following the first meeting of the Monetta Trust on January 19, 1993. (Tr. 1346.) Mr. Valiant, Mr. Rozinsky and the other persons who attended the meeting were not present when the conversation allegedly occurred. (Tr. 1345-47.)
Ms. LeFevre has worked for MFS since 1986. (Tr. 1462.) In 1993 she was employed by MFS and was secretary of the Monetta Fund. (Tr. 1462.) Ms. LeFevre testified that she asked Mr. Rozinsky in 1993 how Mr. Valiant could receive IPOs and she could not. (Tr. 1465.) Mr. Rozinsky allegedly told Ms. LeFevre that she could not receive IPOs because she was an employee of the adviser but that Ms. Olsen said Mr. Valiant could receive IPO allocations. (Tr. 1464-65.) No one else was present to hear the conversation. (Tr. 1465.)
I do not accept Ms. LeFevre's testimony as true because she claims Mr. Rozinsky gave her information which he did not have at the time. Mr. Rozinsky made several contradictory statements under oath as to when he learned MFS was allocating IPOs to the directors/trustees. (Tr. 305-29.) I find Mr. Rozinsky's 1995 investigative testimony to be the persuasive version of events because it was given closer in time to when the events occurred and before people began formulating defenses to the allegations. In his 1995 testimony, Mr. Rozinsky denied knowing that any directors/trustees of the Funds received IPOs until after October 31, 1993, so that Mr. Rozinsky could not have made the statements Ms. LeFevre attributes to him. (Tr. 308.)
A person claiming reliance on counsel as a defense has the burden of persuasion. See William H. Gerhauser, Sr., 68 SEC Docket 1289, 1300 n.26 (Nov. 4, 1998). For all the reasons stated, MFS and Mr. Bacarella have not carried that burden.
1. Did Respondents willfully17 violate Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder by not informing the Funds, the Funds' shareholders, and possible investors that the adviser allocated shares of hot IPOs to the personal accounts of some Funds directors and trustees?
Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 prohibit any person in the offer, purchase, and sale of any security in interstate commerce or by use of the mails: (1) to employ any device, scheme, or artifice to defraud, or (2) to obtain money by means of any untrue statement of material fact or any omission of a material fact necessary so as not to mislead, or (3) to engage in any transaction, practice, or course of business which would operate as a fraud or deceit upon the purchaser. Violations of Sections 17(a) (1), and Section 10(b) and Rule 10b-5 require a showing that a person acted with scienter which has been defined as "a mental state embracing intent to deceive, manipulate or defraud."18 Ernst & Ernst v. Hochfelder, 425 U.S. 185, 193 n.12 (1976). Recklessness, defined as "an extreme departure from the standards of ordinary care, and which presents a danger of misleading [investors] that is either known to the defendant or is so obvious that the actor must have been aware of it[,]" satisfies the scienter requirement. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc).
The Division charges that Respondents willfully violated the antifraud provisions of the securities statutes because each knowingly or recklessly omitted to inform Fund shareholders and prospective shareholders of the conflict of interest caused by the allocation to the directors of hot IPOs by MFS and Mr. Bacarella. (Div. Br. at 49-63.)
Respondents MFS and Mr. Bacarella respond that they did not violate:
MFS and Mr. Bacarella emphasize that there "was no statute, rule or regulation in 1993 which prescribed how an investment adviser should allocate IPOs between and among its clients." (MFS and Bacarella Br. at 13.) The issue, however, is not simply the allocation but the failure to disclose the allocation. Before deciding whether Respondents were required to disclose this information, it is necessary to consider first whether the investment companies, their shareholders, and prospective shareholders would consider the information material. I resolve this issue in the affirmative because there is a substantial likelihood that a reasonable investor would consider it important in making an investment decision that the Funds' adviser was giving investment opportunities which by any reasonable measure belonged to the Funds, to the Funds' directors whose responsibilities included judging the adviser's performance. See Basic Inc. v. Levinson, 485 U.S. 224, 231-32 (1988); TSC Indus. Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976); SEC v. Steadman, 967 F.2d 636, 643 (D.C. Cir. 1992).
No one disagrees with MFS/Mr. Bacarella's position that as an adviser MFS had a fiduciary duty to treat all its all its clients fairly, and that under various legal doctrines the adviser must distribute IPO allocations in an equitable manner. The overwhelming evidence is that MFS did not do so, rather Mr. Bacarella distributed these sought after opportunities to maximize the benefits to the business enterprise he operated, the adviser. (Tr. 709-12, 733; Div. Ex. 115, Div. Ex. 116 at 29-33, 53-55.)
On these facts, Mr. Bacarella's claim that he allocated IPOs to Respondents Valiant, Henry, and Russo because he was required to allocate IPOs among all MFS's clients on an equitable basis is a non-sequitur. MFS received limited amounts of highly attractive IPO investment opportunities from Montgomery based on (1) the past trading activity of the Funds, and (2) the expectation of future trading activity by the Funds. (Tr. 1005-07, 1051, 1140; Div. Ex. 15 at 8.) Even if Mr. Bacarella did not know that that the Funds accounted for precisely $194,317.85 or 96.81% of the $200,726.70 in brokerage commissions that Montgomery earned in 1993 from MFS clients, he certainly knew that the Funds were responsible for almost all the commissions paid to Montgomery.19 (Div. Ex. 116 at 31.) Moreover, Mr. Bacarella knew that Respondents Valiant, Henry, and Russo had accounts at MFS with assets of less than $100,000 and that MFS considered accounts of that size so insignificant that it did not charge an advisory fee. He also knew that Respondents Valiant, Henry, and Russo did little trading in these accounts and that these accounts did not generate any of the commissions paid to Montgomery. (Tr. 555; Div. Ex. 116 at 30.) As Professor Coffee correctly noted, the fiduciary duty an adviser owes its clients does not include the duty to allocate IPOs to trivial accounts. (Tr. 733-34.) The only reasonable conclusion to be drawn from the evidence is that MFS and Mr. Bacarella allocated IPOs to Respondents Valiant, Henry, and Russo because these directors could further the business interests of Mr. Bacarella and MFS.
A major responsibility of fund directors/trustees is to "review the company's operation to evaluate the performance of its portfolio and its adviser." Frankel, supra, at 65. This oversight function could be impaired or unduly influenced where the directors/trustees receive gifts from the adviser. For this reason, MFS/Mr. Bacarella created a conflict of interest situation by allocating shares of IPOs to directors/trustees of the Funds to which MFS was the adviser. The allocation of IPOs to the directors/trustees inured to the benefit of MFS/Mr. Bacarella rather than to the benefit of the Funds. MFS and Mr. Bacarella therefore violated the duty of loyalty they owed as fiduciaries by making the allocation and not disclosing their conflicts of interest.
The Commission has affirmed as "hornbook law" that a fiduciary cannot compete with his beneficiary with respect to the subject matter of the relationship, absent disclosure and a contrary agreement. E.F. Hutton & Co., 49 S.E.C. 829, 832 (1988); see Restatement (Second) of Agency, § 383, cmt. b (1957). By acquiring IPOs, Mr. Valiant, Mr. Russo, and Mr. Henry were competing with the Funds for highly sought after investments.
An affirmative duty of "utmost good faith, and full and fair disclosure of all material facts," as well as an affirmative obligation to "employ reasonable care to avoid misleading" his clients has been required of an adviser as a fiduciary for almost forty years. SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180, 194 (1963) citing William L. Prosser, Law of Torts (1955), 534-535 (citing cases) and 1 Fowler V. Harper & Fleming James, Jr., The Law of Torts (1956) 541. See generally W. Page Keeton, Fraud – Concealment and Non-Disclosure, 15 Tex. L. Rev. 1 (1936). Mr. Henry's acquisition of IPOs from the adviser puts in question the validity of the statement in the Monetta Fund's financial statements that "no remuneration has been paid to any director of the Fund." (Div. Exs. 4, 47.)
A duty to speak arises, and material omissions become fraudulent, when a person or entity has material information that another is entitled to know because of a fiduciary or similar relationship of trust and confidence. See Chiarella v. United States, 445 U.S. 222, 227-28 (1980) (citations omitted); Affiliated Ute Citizens v. United States, 406 U.S. 128, 152-54 (1972); Hughes v. SEC, 174 F.2d 969, 975-76 (D.C. Cir. 1949). Mr. Bacarella violated, and he caused MFS to violate, the fiduciary duty that they owed to the Monetta Fund and the Monetta Trust by making allocations to Mr. Valiant, Mr. Henry, and Mr. Russo and by not disclosing those allocations to the Funds and their shareholders. Mr. Bacarella caused MFS's violations because he controlled the adviser's actions and he made the allocations. (Tr. 1301.) Mr. Bacarella individually owed an independent fiduciary duty to the Funds as an officer and a director/trustee.
Professor Womack's testimony and exhibits demonstrate by a preponderance of the evidence that Mr. Bacarella distributed a portfolio of superior IPOs to the Respondent directors/trustees - higher mean return and lower standard deviation (risk) - than the IPO portfolio he distributed to the Funds. (Tr. 1127-28, 1853-54.) The statistical evidence is persuasive that Mr. Bacarella, on balance, intentionally allocated IPOs to Mr. Valiant, Mr. Henry, and Mr. Russo that he knew, or had every reason to expect, would be more profitable and posed less risk than the IPOs he distributed to the Funds and, on balance, he intentionally distributed to the Funds IPOs that he knew, or had every reason to expect, would be less profitable than those he distributed to the named directors/trustees. (Tr. 1069, 1119, 1811-16, 1924.) The following facts established in the record support this conclusion:
Professor Womack has made a persuasive presentation that by both the Mid-to-Offer and Return-to-Open measures, the IPOs Mr. Bacarella distributed to the directors/trustees were "significantly more attractive" than the IPOs he distributed to the Funds. (Div. Ex. 115 at 22.) Similarly, Professor Womack's expert opinion that these results did not occur by chance is based on unrefuted statistical analysis. (Div. Ex. 115 at 16, 18-20.)
The mathematical calculations detailed above, which are supported by expert witness testimony, make a statistically significant inference that supports a finding that Mr. Bacarella knowingly and willfully distributed IPOs that had, or appeared to have had, the best chance of earning the highest return, the "hottest" performing IPOs, to Mr. Henry, Mr. Russo, and Mr. Valiant, who as board members were positioned to help the adviser, rather than to the Funds. (Tr. 1122, 1133, 1139; Div. Ex. 115 at 1-2, 22.) Statistically significant means with that there is a high probability (95%) that the result did not occur by chance. (Tr. 1038-41.) The individual analyses of Mid-to-Offer, Return-to-Open, and Flipping Activity Ratio produce positively correlated results. (Tr. 1925-26.) These results and the subscription ratios provide "robust" statistical evidence to support Professor Womack's conclusions. (Tr. 1119, 1141.)
Respondents' claim that the distribution was proper because the Monetta Fund, the Mid-Cap Fund, and the Bond Fund received 88% of the IPO shares allocated while the directors/trustees received only 1.49%. (Resp. Ex. 61.) This argument is unpersuasive for several reasons: (1) there was no justification for allocating any IPOs to these directors/trustees, (2) the number of shares is irrelevant, it is the return that is significant and the return on the IPOs allocated to directors/trustees was significantly higher, (3) there is no evidence to support Mr. Bacarella's claim that he followed a guideline which he modified to account for, among other things, Subchapter M of the Internal Revenue Code, and (4) there is no evidence that supports Mr. Bacarella's claim that he distributed IPOs equitably among all eligible MFS clients based on information provided to him by Tim Cekal, a MFS employee, who informed him what accounts had received prior IPO allocations and which accounts had sufficient cash available to make them eligible to purchase an IPO. (Tr. 102-03, 110, 1682, 1686, 1689-90, 1699.) Moreover, the testimony of John Alogna and James Boves, portfolio managers of the Mid-Cap Fund and the Bond Fund, respectively, does not support Mr. Bacarella's claim that these funds were not interested in the IPOs he allocated to Respondents. Mr. Boves accepted IPOs that were going to be flipped which Mr. Bacarella or Mr. Alogna offered and he probably would have taken more if they had been offered. (Tr. 529-32.) Mr. Boves, a Monetta Trust trustee, would have questioned the legality of a trustee receiving IPO allocations if he had known of MFS's allocations to Mr. Russo and Mr. Valiant. (Tr. 537-38.) Mr. Alogna did not indicate he would have refused allocations of more IPOs than he received if they were suitable for the Mid-Cap Fund. (Tr. 346-47, 370-71.)
Finally, even if there was a legitimate basis for allocating IPOs to the directors/trustees, there was no legitimate basis for deliberately allocating the superior IPOs to the directors/trustees, and there was absolutely no justification for not disclosing what was clearly a conflict of interest by the adviser, to the Funds, their investors, and potential investors. Respondents seem to believe that the allegations represent an attempt to impose new standards on a business enterprise; however, the evidence is compelling that Respondents were engaged in self-serving conduct that violated long established principles. Professor Coffee accurately noted "[f]ull and fair disclosure of material information is the oldest and most basic obligation under the federal securities laws." (Div. Ex. 116 at 55.)
Among other things, Respondents cite a 1994 industry survey that revealed that only 26% of fund complexes restricted IPO investing by either personnel of the adviser or fund directors as proof that their actions followed industry practice. (MFS and Bacarella Br. at 19; Resp. Ex. 47.) Respondents' evidence and arguments do not establish that it was common industry practice for fund directors to accept hot IPOs from the Fund's adviser without disclosure. Even if there was evidence that such a practice existed, it would not be controlling. See Doe v. Cutter Biological, Inc., 971 F.2d 375, 382-83 (9th Cir. 1992) (citations omitted).
I reject Respondents' criticisms of Professor Womack's conclusions. I also reject their expert's finding that no significant difference exists between the mean returns of the portfolios of the Funds vis-à-vis the portfolios of the directors/trustees. Professor Womack effectively rebutted Respondents' position that the variables he used were not independent, that application of the bootstrapping test was inappropriate, and that the Powersoft IPO was an "outlier" that skewed the results. (Tr. 1743-44, 1787-90, 1850-54.) I find unpersuasive statistical analysis presented by Professor Hanley to rebut Professor Womack's presentation. Professor Hanley used a common statistical measure known as the "difference in means" test or "t" test as part of her analysis. (Tr. 1243, 1753; Resp. Ex. 55.) The evidence raises significant doubt about the propriety of using the "t" test in this situation because it requires assumptions that are not true: the population was not normally distributed; the two samples being compared were not randomly selected; and they were not chosen independently. (Tr. 1753-59.)
Respondents rely on the holding in Santa Fe Indus. v. Green, 430 U.S. at 473, to support their position that the Division is trying to stretch the federal securities laws to address corporate law issues covered by state law. This is not true. Santa Fe is distinguishable on its facts. In Santa Fe, minority shareholders objected to a merger conducted by the majority shareholders under the provisions of Delaware's "short-form merger" statute. Their main complaint was that $150 per share stock price they were offered was too low. Rather than pursuing the issue of valuation in the Delaware Court of Chancery as the statute provided, the minority shareholders brought an action in District Court action alleging a violation of Section 10(b) of the Exchange Act and Rule 10b-5 thereunder. The Court found that there had been complete disclosure of the material facts.
Unlike Santa Fe, here material facts were not disclosed. The subjects of this proceeding are a registered investment adviser, and officers and/or directors of registered investment companies, and the issue is the legality of their activities under federal statutes. See L.W. Laird v. Integrated Resources, Inc., 897 F.2d 826, 837 (5th Cir. 1990) ("Furthermore, concerning entanglement with state law, because our holding encompasses a developed federal standard it does not require reference to state corporate and securities law or the state law of fiduciary relationships. The Supreme Court has recognized the investment advisers' fiduciary status" (footnotes omitted)).22 It is perhaps most important that in Santa Fe, unlike here, there was no "deception, misrepresentation, or nondisclosure." Santa Fe Indus. v. Green, 430 U.S. at 476. I therefore conclude that the holding in Santa Fe is inapplicable to this situation.
MFS's distribution of IPOs to directors/trustees of the Funds without disclosure to the other directors, trustees, or shareholders of the Funds was a conflict of interest and a breach of fiduciary duty that violated the antifraud provisions of the securities statutes. Specifically, by these actions MFS and Mr. Bacarella employed a scheme to defraud in offering and selling shares of the Funds without disclosing material information in the Funds' official filings; they obtained money by means of untrue and misleading information; and they engaged in a course of business which operated as a fraud on purchasers of the Funds shares. In making this determination it is relevant that Mr. Bacarella possessed all the attributes which indicate that he was aware of the implications of his actions: a high level of formal education in the field of business, over twenty years experience in the securities industry, success in managing investments, and a reputation for high ethical standards. (Tr. 267, 1518.)
Mr. Bacarella's lack of candor and his attempts to hide his actions support my finding that he acted with the intent to deceive. For example, Mr. Bacarella did not tell Mr. Rozinsky that he was allocating IPOs to the directors/trustees; he did not inform the other directors or shareholders of the Monetta Fund of the allocation to Mr. Henry or the trustees or shareholders of the Monetta Trust of the allocations to Mr. Valiant and Mr. Russo; he did not seek a formal written opinion from outside legal counsel; he did not raise the subject for discussion at quarterly board meetings where legal counsel was present; and when the Commission's examiners questioned him as to how Mr. Valiant managed to obtain IPOs, he lied.23 (Tr. 112-17, 304, 308-10, 586-87, 1715-17.) At the very minimum, Mr. Bacarella's conduct was an extreme departure from the standards of ordinary care and thus he acted recklessly. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en banc).
Mr. Valiant and Mr. Henry have never denied that they each received four IPO allocations over periods of approximately sixty days and that they profited by $12,812.50 and $10,187.50, respectively. They contend that the amounts were inconsequential, that this was not material information for Funds shareholders, that they did not act with scienter, and that their conduct did not violate any State or common law practice but rather followed industry practice and custom at the time. (Henry and Valiant Br. at 2.)
I find that Respondents Henry, Russo and Valiant breached the fiduciary duties, including the duty of loyalty owed to the Funds on whose boards they served because they knowingly accepted portions of hot IPO allocations from MFS without disclosing this fact to the Funds, its shareholders, and its prospective shareholders. (Tr. 891-92.) Respondents' conduct amounted to a breach of fiduciary duty because by accepting these IPOs they put their personal interests ahead of the best interests of the Funds and their shareholders and they did so without receiving the consent of the Funds and their shareholders. See SEC v. Capital Gains Research Bureau, Inc., 375 U.S. at 194; Frankel, supra, at 371.
Mr. Henry and Mr. Russo acted with scienter. Each established a bank account for discretionary trades by MFS/Mr. Bacarella. Each received confirmations and account statements from Old Kent showing the IPO trades by MFS/Mr. Bacarella in their accounts. Mr. Russo's claims that in 1993 he did not know what an IPO was, and he did not know that Mr. Bacarella was flipping IPOs in his account because he only looked at his confirmations and Old Kent statements at the end of the year, are not valid defenses. (Tr. 244-45, 247.) Rather, this conduct indicates that Mr. Russo acted recklessly. As a director and audit committee member, Mr. Russo was a Fund fiduciary. He gave the Fund's adviser discretion to handle transactions in his personal account and did not bother to check whether the activity was proper. (Tr. 237-38.) The evidence is persuasive that these Respondents engaged in what on its face is blatantly improper professional behavior because they wanted to make money.
For all the reasons stated, I find that Respondents Henry and Russo violated the antifraud provisions of the securities statutes because in the relevant period they accepted hot IPOs and did not disclose this fact to those to whom they owed a fiduciary duty. By this conduct, these Respondents engaged in a scheme to defraud in offering and selling shares of the Funds; they obtained money by means of untrue and misleading material information; and they engaged in a course of business that operated as a fraud on purchasers of Funds shares.
I do not find that Mr. Valiant violated the antifraud provisions because the evidence is not persuasive that he acted with scienter or that he was negligent. Negligence is a departure from the conduct expected of a reasonably prudent person under like circumstances; the law of negligence is founded on reasonable conduct or reasonable care under all circumstances of a particular case. Black's Law Dictionary 1032 (6th ed. 1990).
Based on my observation of the witness, I judge Mr. Valiant to have given credible testimony. Unlike the other Respondents, Mr. Valiant's testimony was responsive, forthright, and consistent. Unlike the other Respondents, there is nothing in the record that indicates Mr. Valiant ever tried to conceal that he was receiving IPOs from MFS. Mr. Valiant submitted reports to Mr. Rozinsky disclosing his securities transactions, including the IPO transactions in his Old Kent account. (Tr. 310-11.)
Under these circumstances, I conclude that Mr. Valiant acted reasonably in relying on Mr. Bacarella's implicit representations that the activities he proposed for Mr. Valiant were legal and proper. I conclude that Mr. Bacarella took advantage of Mr. Valiant, a person with considerable credibility in the business community.
Q. Did you believe that your acceptance of these IPO allocations into your Old Kent account was somehow a wrongful taking of an opportunity that belonged to the trust?
A. It never occurred to me that there was – nobody ever brought up the fact that there was anything wrong with having an account. I never – I'm relying on Bob's practice of dotting every "I" and crossing every "T" and checking with legal counsel every step of the way. Not only when he first formed the Monetta Fund, but every step of the way in his career, which I think he had a lot of training at Borg-Warner to do his homework and touch all bases and particularly touch the [bases] with legal counsel when there [are] so many regulations involved. (Tr. 1517-18.)
Mr. Valiant has substantial personal assets and an outstanding record of contributions to the community.24 He had observed Mr. Bacarella's success managing investments with Borg-Warner and then as an independent adviser. (Tr. 1513.) He was pleased and proud that Mr. Bacarella, a younger man whom he respected, asked him to serve as a trustee and he had reasonable grounds to believe that the actions Mr. Bacarella advised him to take were legal. (Tr. 1516.)
2. Did MFS willfully violate Section 206(1) and Section 206(2) of the Advisers Act by not disclosing to the Funds, the Funds' shareholders, and possible investors the allocation of hot IPOs to certain directors and trustees, and did Mr. Bacarella cause and willfully aid and abet these violations by MFS?
Section 206(1) and Section 206(2) of the Advisers Act were modeled on the antifraud provisions of the Securities Act and the Exchange Act, and they should receive a similar interpretation.25 Frankel, supra, at 177. A breach by the adviser of the undivided duty of loyalty that it owes the client may constitute a fraud within the meaning of Sections 206(1) and (2) of the Advisers Act, as well as a violation of the antifraud provisions of the Securities Act and the Exchange Act. Frankel, supra, at 374 (citing SEC v. Capital Gains, 375 U.S. at 195 (1963)); 3 Louis Loss, Securities Regulation 1515 (2d ed. 1961).
Section 206(1) of the Advisers Act requires a showing of scienter. See Steadman v. SEC, 603 F.2d 1126, 1134 (5th Cir. 1979); SEC v. Steadman, 967 F.2d at 641-43 & nn. 3, 5. However, Section 206(2) of the Advisers Act does not require a showing that the adviser acted with scienter:
To impose . . . the burden of showing deliberate dishonesty as a condition precedent to protecting investors through the prophylaxis of disclosure would effectively nullify the protective purposes of the statute . . . . The statute, in recognition of the adviser's fiduciary relationship to his clients, requires that his advice be disinterested. To ensure this it empowers the courts to require disclosure of material facts . . . . The high standards of business morality exacted by our laws regulating the securities industry do not permit an investment adviser to trade on the market effect of his own recommendations without fully and fairly revealing his personal interests in these recommendations to his clients.
SEC v. Capital Gains, 375 U.S. at 200-01 (1963).
I find that MFS willfully violated Section 206(1) and Section 206(2) of the Advisers Act, for all the reasons that supported my findings in connection with Section 17(a) of the Securities Act, Section 10(b) of the Exchange Act and Rule 10b-5 thereunder.
Aiding and abetting violations of the securities laws involve three elements: (i) a primary violation by another party; (ii) awareness or knowledge by the aider and abettor that his or her role was part of an overall activity that was improper; and (iii) that the aider and abettor knowingly and substantially assisted in the conduct that constituted the primary violation. Woods v. Barnett Bank of Fort Lauderdale, 765 F.2d 1004, 1009 (11th Cir. 1985); Investors Research Corp. v. SEC, 628 F.2d 168, 178 (D.C. Cir. 1980); Woodward v. Metro Bank of Dallas, 522 F.2d 84, 94 (5th Cir. 1975). Mr. Bacarella caused and willfully aided and abetted MFS's primary violations because he knew or was reckless in being part of an activity that was improper, and he initiated and carried out the illegal activities.
3. Did Mr. Henry willfully violate Section 17(j) of the Investment Company Act and Rule 17j-1 thereunder by not including IPO transactions in a report required by Rule 17j-1 for the second quarter of 1993?
Rule 17j-1, Personal Investment Activities of Investment Company Personnel, issued pursuant to Section 17(j) of the Investment Company Act, imposes quarterly reporting requirements on the "access persons" of registered investment companies, and the investment advisers, and principal underwriters of these investments companies. As a director of a registered investment company, Mr. Henry was an "access person" and was required to file quarterly reports on his transactions in securities to the Monetta Fund. This reporting requirement is also set out in paragraph 5 of the Monetta Fund Code. Mr. Henry's report for the second quarter of 1993, did not include the four IPOs that MFS allocated to his Old Kent account.
Mr. Henry's claim that he was relieved of the obligation to report the IPO transactions is based on the following language from the Monetta Fund Code:
To the extent that the Adviser maintains the reports and records required hereunder pursuant to its obligations under the Investment Advisers Act . . ., the Securities Exchange Act . . . , nothing herein shall be construed to require duplicate or additional records.
(Div. Ex. 39 at 5(c); Henry Proposed Findings at 11-12.) Mr. Henry argues that because MFS and Mr. Bacarella knew about his IPO transactions, the above language nullifies his reporting requirement. This argument is unpersuasive because language in the Monetta Fund Code does not relieve Mr. Henry of his obligation under Rule 17j-1. The fact that an investment adviser might have information or maintain a record does not relieve an interested director from his obligation to file a report required of him by Rule 17j-1.
I find that Mr. Henry's violation of Rule 17j-1 was willful for several reasons. Willfulness means no more than intentionally committing the act that constitutes the violation.26 It is well settled that failure to make a required report, even if inadvertent, is a willful violation. Hammon Capital Management Corp., 48 S.E.C. 264, 265 & n.3 (1985) (citing Jesse Rosenblum, 47 S.E.C. 1065, 1067 (1984) and the cases cited therein, aff'd without opinion, 760 F.2d 260 (3rd Cir. 1985)); Oppenheimer & Co., 47 S.E.C. 286, 288 (1980); Haight & Co., 44 S.E.C. 481, 507 (1971), aff'd without opinion, (D.C. Cir. June 30, 1971).
Finally, Mr. Henry's testimony that he made a good faith effort by asking the advice of knowledgeable people whether he should include the IPOs on the report conflicts with all the other evidence that indicates that he operated surreptitiously. The unanimous evidence is that the subject of ethics came up at every meeting; yet, Mr. Henry did not use those opportunities to inquire whether he need to include the IPOs in his report and did not raise the issue with either Ms. Olsen or Mr. Rozinsky, counsel and compliance director, respectively, for the Funds and MFS who were present at every directors meeting. (Tr. 281, 290-91, 300.) Mr. Rozinsky and Mr. Henry had both been associated with the Monetta Fund and Monetta Brokerage since about 1986; yet, Mr. Rozinsky did not know in the second quarter of 1993 that MFS had allocated IPOs to Mr. Henry. (Tr. 276, 301-03, 328-29.)
Respondents MFS and Mr. Bacarella contend that even if the allegations occurred, the measures recommended by the Division are not necessary or appropriate in the public interest. Respondents point to the following factors to support their position: the Respondents and their affiliates have spotless regulatory records and the conduct at issue did not harm the clients of the Funds; the conduct was no more than inadvertent, and MFS and Mr. Bacarella complied with industry custom and laws on disclosure; and the Commission failed to provide regulatory guidance as to how advisers should allocate IPOs and did not direct advisers to disclose their private advisory relationships with directors of mutual funds they advised. (MFS and Bacarella Br. at 57-58.)
Respondent Henry believes that the sanctions sought by the Division are unwarranted and not in the public interest. Mr. Henry contends that he did not act with intent to deceive or harm shareholders interests; that the profits he received were at worst de minimus; that he terminated his trading activity in IPOs from the adviser shortly after discovering there was a potential for impropriety; and that he is unlikely to engage in improper behavior in the future. Respondent Henry maintains that suspension is not in the public interest because he did not act willfully, and disgorgement is improper because his profits did not result from a purchase or sale of Fund securities. (Henry and Valiant Br. at 29-30.)
Respondent Russo contends that the "fiduciary duty" theory of liability is not regulated by the federal securities laws; that he did not wrongfully receive IPO allocations from MFS; that the disclosures allegedly required were not material; and that he did not act or fail to act with scienter, and was not negligent. (Russo Br. at 7-17, 45.) Respondent Russo argues that the penalty provisions of the Section 21B(c) of the Exchange Act are inapplicable because he did not act deliberately or recklessly; no one was harmed because there was no evidence of any monetary loss to any investor in the Monetta Trust; he was not unjustly enriched; he has no prior regulatory violations; and there is no need for deterrence because he is no longer in a position to violate the law. (Russo Br. at 44.)
The following considerations comprise the relevant norms for assessing the public interest determination:
the egregiousness of the defendant's actions, the isolated or recurrent nature of the infraction, the degree of scienter involved, the sincerity of the defendant's assurances against future violations, the defendant's recognition of the wrongful nature of his conduct, and the likelihood that the defendant's occupation will present opportunities for future violations.
Steadman v. SEC, 603 F.2d 1126, 1140 (5th Cir. 1979), aff'd on other grounds, 450 U.S. 91 (1981). The severity of a sanction depends on the facts of the particular case and the value of the sanction in preventing a recurrence. See Butz v. Glover Livestock Comm'n Co., 411 U.S. 182, 187 (1973); Hiller v. SEC, 429 F.2d 856, 858-59 (2d Cir. 1970); Berko v. SEC, 316 F.2d 137, 141 (2d Cir. 1963); Richard C. Spangler, Inc., 46 S.E.C. 238, 254 n.67 (1976); Leo Glassman, 46 S.E.C. 209, 211-12 (1975).
I will next apply the Steadman norms to this situation. Respondents MFS, Mr. Bacarella, Mr. Henry and Mr. Russo committed egregious acts in terms of blatant violations of the norms of acceptable conduct by a fiduciary. The violations by Respondents MFS and Mr. Bacarella reoccurred over a seven month period and involved the purchase and sale of twelve IPOs. The violations by Mr. Russo, who as an attorney should have been aware of a fiduciary's responsibilities, occurred from March until September 1993 and involved eight IPOs.27 The violations by Respondent Henry occurred from April until June 1993, and involved the purchase and sale of four IPOs. Respondents' surreptitious use of a position of trust for their personal benefit, the conflicting or evasive testimony they gave under oath, and their inability to acknowledge the wrongful nature of their conduct despite persuasive expert testimony to the contrary all indicate that they will likely commit future violations.
The Division's position is that MFS should be censured pursuant to Section 203(e) of the Advisers Act and Section 9(b) of the Investment Company Act.28 (Div. Br. at 72.) A censure is the mildest form of reprimand available to the Commission.
In view of the legal conclusions in this decision a censure of MFS is in the public interest.
The Division's position is that Mr. Bacarella should be suspended from associating with any entity in the securities industry pursuant to Sections 15(b) and 19(h) of the Exchange Act, Section 203(f) of the Advisers Act, and Section 9(b) of the Investment Company Act. (Div. Br. at 73.) The Division advocates a comprehensive response inasmuch as Mr. Bacarella's conduct involved a broker-dealer, an investment adviser, and an investment company. (Div. Br. at 75 n.21.)
The Division would suspend Mr. Henry and Mr. Russo from association with a registered investment company pursuant to Section 9(b) of the Investment Company Act. (Div. Br. at 72, 76.)
I find it to be in the public interest to suspend Mr. Bacarella from association with any investment adviser and any investment company for ninety days and to suspend Mr. Mr. Henry and Mr. Russo from association with any investment company for thirty days.
The fact that this sanction is more limited than what the Division recommended as to Mr. Bacarella does not minimize the seriousness of Mr. Bacarella's violations; however, those violations occurred solely in relation to his activities as the controlling person of an investment adviser and as a person associated with an investment company. There has been no showing that Mr. Bacarella represents a threat to the investing public in other facets of the securities industry. The Division's recommendation goes beyond what is called for by the Commission's case law. See James Harvey Thornton, 69 SEC Docket 0049 (Feb. 1, 1999), appeal filed, No. 99-60201 (5th Cir.) (bar from participating in a penny stock offering found inappropriate because, among other things, Respondent's illegal activities did not involve penny stocks).
The Division's position is that each Respondent should be ordered to cease and desist pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, Section 203(k) of the Advisers Act, and Section 9(f) of the Investment Company Act. (Div. Br. at 76-77.)
Respondent Russo contends that a cease and desist can only be issued where there is a finding of a reasonable likelihood of a future violation and this is not possible because Mr. Russo has resigned as a trustee of the Monetta Trust; he does not intend to become involved with another investment company and there is no reasonable likelihood that he will enter any other aspect of the securities business. (Russo Br. at 43-44.)
Respondents committed serious violations of the securities statutes. Their conduct that is the basis of the allegations and their testimony at the hearing indicate that Respondents are ignorant of and insensitive to a fiduciary's duty to put the principal's interests above his personal self-interest. Respondents' defense that there were no statutes or Commission regulation that prohibited a fiduciary from taking for himself an investment opportunity that belonged to the entity to which he owed a fiduciary duty is bizarre. These factors indicate a substantial likelihood of future violations.
Based on these factors, and the record as a whole, I order that Respondents MFS, Mr. Bacarella, Mr. Henry, and Mr. Russo cease and desist from committing or causing any violations or future violations of Section 17(a) of the Securities Act and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; that MFS cease and desist from committing or causing any violations or future violations of Sections 206(1) and 206(2) of the Advisers Act, and that Mr. Bacarella cease and desist from causing and aiding and abetting those violations or future violations; and that Mr. Henry cease and desist from committing or causing any violations or future violations of Sections 17(j) of the Investment Company Act and Rule 17j-1 thereunder.
It is the Division's position that Mr. Henry and Mr. Russo should be ordered to disgorge $10,187.50 and $28,823.00, respectively, as well as prejudgment interest pursuant to Section 8A(e) of the Securities Act, Section 21C(e) of the Exchange Act, Section 203(j) of the Advisers Act, and Section 9(f)(5) of the Investment Company Act. (Div. Br. at 77-78.) The Division would include the $3,650.00 Mr. Russo received from the Powersoft IPO, which occurred outside the five-year statute of limitations because it is part of a continuing course of conduct. (Div. Reply Br. at 77 n. 52.)
Disgorgement is a remedial measure equitable in nature. Its purpose is "to deprive a wrongdoer of his unjust enrichment and to deter others from violating the securities laws." SEC v. First City Financial Corp., 890 F.2d 1215, 1230 (D.C. Cir. 1989.) It was illegal for Mr. Henry and Mr. Russo to have received IPOs from MFS so it follows that that they should not be allowed to keep the profits they realized on the sale of those IPOs. I will order Mr. Russo to disgorge $28,823.00, including $3,650.00 garnered from the Powersoft IPO, because the statute of limitations does not apply to disgorgement. See Johnson v. SEC, 87 F.3d 484, 491 (D.C. Cir. 1996); Joseph J. Barbato, 69 SEC Docket 178, 197 & n.27 (Feb. 10, 1999).
It is the Division's position that pursuant to Section 21B of the Exchange Act, Section 203(i) of the Advisers Act, and Section 9(d) of the Investment Company Act, Respondents should receive civil penalties in the following amounts: MFS $100,000.00, Mr. Bacarella $50,000.00, Mr. Henry $10,187.50, and Mr. Russo $28,823.00. (Div. Br. at 78-79.) The Division contends that fines at the second tier level are appropriate because Respondents exhibited a high degree of scienter and their conduct involved "fraud, deceit, manipulation, or deliberate or reckless disregard." (Div. Br. at 78-79.)
Where, as here, a person willfully violated a provision of the securities statutes and where the acts or omissions involved "fraud, deceit, manipulation, or deliberate or reckless disregard of a regulatory requirement" the maximum penalty for each act or omission is $50,000 for a natural person or $250,000 for any other person (second-tier penalty). Section 21B(b)(2) of the Exchange Act, Section 203(i)(2)(B) of the Advisers Act, and Section 9 (d)(2)(B) of the Investment Company Act.
The Monetta Fund paid MFS advisory fees of $5.11 million in 1993. (Div. Ex. 4 at 44.) As the one who initiated and implemented the violations, Mr. Bacarella and the investment adviser firm he controls merit a substantial penalty. I find that MFS and Mr. Bacarella should be assessed civil penalties of $200,000 and $100,000, respectively.
Considering that Mr. Russo is an attorney, his testimony that he did not know what an IPO was when he became a Monetta Trustee and that he did not know he should have disclosed the profits the adviser to the Monetta Trust put in his accounts from IPOs is unbelievable. I find that Mr. Russo should be assessed a civil penalty of $25,000. The persuasive evidence is that Mr. Henry sought out the IPOs and that he hid the fact that he was receiving them. I find that Mr. Henry should be assessed a civil penalty of $10,000.
Pursuant to Rule 351(b) of the Commission's Rules of Practice, 17 C.F.R. § 201.351(b) (1998), I certify that the record includes the items described in the record index issued by the Secretary of the Commission on January 3, 2000.
Based on the findings and conclusions set forth above:
I Order, pursuant to Section 8A of the Securities Act, Section 21C of the Exchange Act, Section 203(k) of the Advisers Act, and Section 9(f) of the Investment Company Act that Monetta Financial Services, Inc., Robert S. Bacarella, Paul W. Henry, and Richard D. Russo shall cease and desist from committing or causing any violations or any future violations of Section 17(a) of the Securities Act, and Section 10(b) of the Exchange Act and Rule 10b-5 thereunder; that Monetta Financial Services, Inc. shall cease and desist from committing or causing any violations or any future violations of Sections 206(1) and 206(2) of the Advisers Act and that Robert S. Bacarella shall cease and desist from causing and/or aiding and abetting those violations or any future violations; and that Paul W. Henry shall cease and desist from committing or causing any violations or any future violations of Section 17(j) of the Investment Company Act and Rule 17j-1.
I Further Order, pursuant to Sections 15(b) and 19(h) of the Exchange Act, Section 203(f) of the Advisers Act, and Section 9(b) of the Investment Company Act, that Robert S. Bacarella is suspended from associating with any investment adviser and from associating with any registered investment company for ninety days, and that pursuant to Section 9(b) of the Investment Company Act, Paul W. Henry and Richard D. Russo are each suspended from associating with any registered investment company for thirty days.
I Further Order, pursuant to Section 8A(e) of the Securities Act, Sections 21C(e) of the Exchange Act, Section 203(j) of the Advisers Act, and Section 9(f)(5) of the Investment Company Act that Paul W. Henry, and Richard D. Russo should disgorge $10,187.50, and $28,823.00, respectively, and that they pay prejudgment interest on these amounts.29
I Further Order, pursuant to Section 203(e) of the Advisers Act, that Monetta Financial Services, Inc. be censured.
I Further Order, pursuant to Section 21B of the Exchange Act, Section 203(i) of the Advisers Act, and Section 9(d) of the Investment Company Act that Monetta Financial Services, Inc., and Robert S. Bacarella be assessed civil penalties of $200,000 and $100,000, respectively, (2) Richard D. Russo be assessed a civil penalty of $25,000, and (3) Paul W. Henry be assessed a civil penalty of $10,000.
Payment of disgorgement and penalties, plus interest, shall be made on the first day following the day this decision becomes final by certified check, United States postal money order, bank cashier's check, or bank money order payable to the U.S. Securities and Exchange Commission. The check and a cover letter identifying Monetta Financial Services, Inc., Robert S. Bacarella, Paul W. Henry, and Richard D. Russo as Respondents in Administrative Proceeding No. 3-9546, should be delivered by hand or courier to the Comptroller, Securities and Exchange Commission, Operations Center 6432 General Green Way, Stop 0-3, Alexandria, Virginia 22312. A copy of the cover letter should be sent to the Commission's Division of Enforcement.
This order shall become effective in accordance with and subject to the provisions of Rule 360 of the Commission's Rules of Practice, 17 C.F.R. § 201.360 (1998). Pursuant to that rule, a petition for review of this initial decision may be filed within twenty-one days after service of the decision. It shall become the final decision of the Commission as to each party who has not filed a petition for review pursuant to Rule 360(d)(1) within twenty-one days after service of the initial decision upon such party, unless the Commission, pursuant to Rule 360(b)(1), determines on its own initiative to review this initial decision as to any party. If a party timely files a petition for review, or the Commission acts to review as to a party, the initial decision shall not become final as to that party.
| ______________________________ Brenda P. Murray Chief Administrative Law Judge |
| 1 | "(Tr.__.)" refers to the transcript of the hearing. I will refer to the Division's exhibits and Respondents' exhibits as "(Div. Ex.__.)," and "(Resp. Ex.__.)," respectively. The transcript contains many transcription errors some of which seriously distort the witness's testimony. See for example Tr. 1616 where the witness testified about illiquidity. |
| 2 | Corrected Table of Contents for Post-Hearing Brief and Counter Statement of Proposed Findings of Fact and Conclusions of Law filed October 20, 1998. |
| 3 | Mr. Valiant and Mr. Henry adopted and incorporated the response of Monetta Financial Services, Inc. and Mr. Bacarella. |
| 4 | The Division's posthearing brief is referred to as "(Div. Br.__.)," the Division's proposed findings of fact and conclusions of law is referred to as "(Div. Proposed Findings __.)" and the Division's reply brief is referred to as "(Div. Reply __.)"; Respondents' answers to the OIP are referred to as "([Respondent] Answer __.)," respectively; Respondents' posthearing briefs are referred to as "([Respondent] Br.__.)," respectively; Respondents' counterstatements of proposed findings of fact and conclusions of law are referred to as "([Respondent] Proposed Findings __.)," respectively; Respondents' responses to the Div. Proposed Findings are referred to as "([Respondent] Response __.)," respectively; joint stipulations are referred to as "(Jt. Stip.__.)." |
| 5 | The Government Money Market Fund is not relevant to the issues in this proceeding. (Tr. 33-34; Div. Ex. 5 at 9-10, Resp. Ex. 14 at 2, 6-8.) |
| 6 | Monetta Brokerage was subsequently renamed Monetta Investment Services, LLC. (Tr. 1641.) |
| 7 | Section 2(a)(19)(A) of the Investment Company Act defines an independent or disinterested director as a person who directly, or through an immediate family member, has no affiliation with the mutual fund, who is not an interested person of the fund's investment adviser or underwriter, who is not a broker or dealer or a person affiliated with a broker-dealer, who is not a person or partner or employee of someone who has acted as legal counsel within the last complete two fiscal years, and who has had no material business or professional relationship with the fund for two fiscal years. |
| 8 | The law firm began representing MFS and the Monetta Fund in early 1988, and the Monetta Trust in 1993. It ceased representing MFS in late 1996 or early 1997 and withdrew from representing the Monetta Fund and Monetta Trust on August 7, 1997. (Tr. 1961-66.) |
| 9 | Kent L. Womack, an Associate Professor of Finance at the Amos Tuck School of Business Administration, Dartmouth College, holds a B.A. from Yale (1978), an M.B.A. from Stanford (1982), and a Ph. D. from Cornell (1995). Professor Womack has been a Certified Public Accountant and was a vice president in the equities division of Goldman, Sachs & Co. (1981-89). Professor Womack is the author or co-author of many published studies and papers and, in addition to his teaching schedule, has given many academic presentations. In 1998, he was engaged in five ongoing research projects and was writing a book on IPOs. (Div. Ex. 115 at Exhibit A.) |
| 10 | Respondents offered the expert testimony of Kathleen Weiss Hanley and Geoffrey H. Bobroff. (Resp. Exs. 55 and 56.) Professor Hanley is an Associate Professor of Finance at the R. H. Smith College of Business, University of Maryland. Professor Hanley received a B.S. from Indiana University (1983) and a Ph. D. from the University of Florida (1988). Professor Hanley has taught at the University of Michigan and has been employed as a research economist at the Commission. Professor Hanley is an associate editor of the Journal of Financial Research. Her research on the subject of IPOs has been published in such academic journals as the Journal of Finance, Journal of Financial Economics, and the Journal of Financial Intermediation and Financial Management. (Resp. Ex. 55 at Appendix C.)
Geoffrey H. Bobroff, president of Bobroff Consulting, Inc., has almost thirty years experience working in the area of investment companies. Mr. Bobroff began his career as a trial attorney with the Commission. He has worked as an attorney and officer with two investment advisers and managed an office of Lipper Analytical Services, Inc. |
| 11 | John C. Coffee, Jr., is the Adolpf A. Berle Professor of Law at Columbia University Law School. Professor Coffee is the co-author of six books including Business Organization and Finance, (6th ed. 1996), Cases and Materials on Corporations, (4th ed. 1985), and Cases and Materials on Securities Regulation (7th ed. 1992). (Div. Ex. 116 at Exhibit A.) Professor Coffee was a reporter for the American Law Institute's Principles of Corporate Governance and Structure (1980-1993, final draft 1993), and is a member of the National Association of Securities Dealers ("NASD") Market Regulation Committee, and the Legal Advisory Board of both the NASD and the New York Stock Exchange (emeritus member). (Tr. 649; Div. Ex. 116 at Exhibit A.) Professor Coffee was qualified as an expert on the IPO underwriting process, the fiduciary duties a fund director owes other directors and shareholders, and some of Respondents' affirmative defenses. (Tr. 649-50, 661.) |
| 12 | In July 1998, this article, which Professor Womack co-authored with Laurie Krigman and Wayne Shaw, had been accepted for publication in the Journal of Finance. (Tr. 1044.) |
| 13 | Richard A. Smith is the senior managing partner of Nations Bank Montgomery Securities and has thirty-three years of experience in taking companies public. |
| 14 | The bulk of MFS's accounts were brokerage accounts at A.G. Edwards where MFS provided investment adviser services ("wrap around accounts"). MFS and A.G. Edwards divided the fees set at 1/2% to 2% of total assets in the accounts equally. Montgomery would not allocate IPO shares to accounts at other broker-dealers and these accounts were considered A.G. Edwards accounts. (Tr. 140-41, 1403-05.) |
| 15 | Respondent did not challenge Professor Coffee's recollection that Mr. Valiant was a shareholder of MFS. (Tr. 870.) Mr. Bacarella testified that Mr. Valiant was an owner of Monetta Brokerage. (Tr. 1694.) |
| 16 | In 1993, disinterested trustees received $100 for each meeting they attended, and interested trustees were not compensated. (MFS and Bacarella Response at 8.) |
| 17 | This proceeding was instituted pursuant to Section 15(b) of the Exchange Act, Section 203 of the Advisers Act, and Section 9 of the Investment Company Act. Those sections are operative where the violations are willful. It is well settled that willfulness means no more than intentionally committing the act that constitutes the violation. See Wonsover v. SEC, No. 99-1167, 2000 U.S. App. LEXIS 3750, at *15-24 (D.C. Cir. March 14, 2000); Tager v. SEC, 344 F.2d 5, 8 (2d Cir. 1965); C. James Padgett, 52 S.E.C. 1257, 1266 n.34 (1997), aff'd sub nom. Sullivan v. SEC, 159 F.3d 637 (D.C. Cir. 1998) (Table). |
| 18 | Violations of Section 17(a)(2) and 17(a)(3) of the Securities Act do not require a finding of scienter. Aaron v. SEC, 446 U.S. 680, 695-97 (1980). |
| 19 | In the same time period, MFS non-Funds clients generated $5,408.85 or 3.19% of commissions paid to Montgomery, a ratio of Funds clients commissions to non-Funds client commissions of 30 to 1. (Tr. 1067; Div. 116 at 31.) |
| 20 | Zero or even negative returns indicate a "cold" IPO. (Div. 115 at 12.) |
| 21 | Return-to-Open is sometimes called the Offer-to-Open Return. (Tr. 1030-31.) |
| 22 | See Transamerica Mortgage Advisors Inc. v. Lewis, 444 U.S. 11, 17 (1979) ("As we have previously recognized, section 206 [of the Advisers Act] establishes `federal fiduciary standards' to govern the conduct of investment advisers" (citations omitted)); see also Lowe v. SEC, 472 U.S. 181 (1985); SEC v. Capital Gains Research Bureau, Inc., 375 U.S. 180 (1963). |
| 23 | Mr. Rozinsky, compliance director, was at various times an employee of Monetta Brokerage and MFS and an officer and director of the Monetta Fund and the Monetta Trust. Mr. Rozinsky gave conflicting testimony. In investigative testimony given on Oct. 18, 1995, he testified he was not aware of any Funds directors receiving IPOs from MFS between November 1, 1992 and October 31, 1993. (Tr. 307-08.) At the hearing, he testified that sometime between February and September 1993, Mr. Bacarella told him that Fund directors were receiving IPOs. (Tr. 305-06.) Later he reaffirmed his prior testimony that Mr. Bacarella did not tell him he was allocating IPOs to directors and trustees until November 1993, and that Mr. Bacarella had not told him in the period February through September 1993 that MFS had allocated IPOs to Mr. Henry, Mr. Valiant and Mr. Russo. (Tr. 309-10.) |
| 24 | As Borg-Warner's vice president and treasurer, before he retired Mr. Valiant had sole signatory authority to borrow up to $200 million. (Tr. 1500-01.) In 1998, Mr. Valiant chaired the administrative board, the highest lay organization, of the Community United Methodist Church, and he served on the board and was treasurer of the Lisle, Illinois, Chamber of Commerce. (Tr. 1502.) In 1993, Mr. Valiant's net worth was in excess of either $5 million or $35 million. (Compare Tr. 1504 with Valiant Proposed Findings at 4.) He has served as president and board member of the Spina Bifida Association of America (two years) and the Illinois Spina Bifida Association (six years). (Tr. 1501.) He was president of the Illinois Manufacturers Association and was on the board for several years. He was a founding member of the corporate advisory board of the National Bankers Association ("NBA"). The NBA represents minority banks in the United States and the corporate advisory board is composed of a small number of financial officers of major corporations. (Tr. 1502.) He has been a member of the budget committee of the Chicago Crusade of Mercy that decided how to distribute funds among four major charities, and president of the Prospect Heights, Illinois, homeowners association that represented the largest unincorporated area in Cook County, Illinois. (Tr. 1503.) |
| 25 | Section 206 makes it unlawful for any investment adviser, by use of the mails or any means or instrumentality of interstate commerce, directly or indirectly:
|
| 26 | See supra note 17. |
| 27 | The Powersoft IPO occurred in early February 1993. |
| 28 | Section 9(b) of the Investment Company Act does not appear to be applicable. |
| 29 | The Commission's Rules of Practice mandate the assessment of prejudgment interest "on any sum required to be paid pursuant to an order of disgorgement." 17 C.F.R. § 201.600(a). |
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